Investing In Bulgaria

Introduction

Overview of the Transition in Bulgaria

Bulgaria started the economic reform in February 1991 by liberalizing almost all prices and breaking the state monopoly on foreign trade. The structural and the institutional changes were supported by a heterodox stabilization program, based on a restrictive monetary and fiscal policy, and also on a strongly restrictive incomes policy.

The implementation of a strongly restrictive macroeconomic policy provoked social tension in the country and made the government initiate in September 1991 a loosening of incomes policy and fiscal restrictions. The 1992 and 1993 softening of restrictions was not underpinned by a serious structural reform especially in terms of the property and management of state-owned enterprises. The initial achievements of the reform, related to the change in the relative prices and adjusting the supply to the demand, were wiped out. The process of legalization of the soft budget constraints by bailing out debts of state-owned enterprises and transforming them into a government debt, was sustained ever after 1990, when it was initiated.

In March 1994 the first foreign exchange crisis burst out (resulting in a doubling of the exchange rate of the BGL against the dollar in 1994 compared to 1993). Inflation soared and reached the average annual level of 90%, an intensive process of currency substitution started, which affected the portfolio investments, credits and deposits in the banking system. The change in the economic policy showed in the attempt to reapply the principles of the initial stabilization program of 1991 supplemented by the introduction of administrative measures at an ever enlarging scope. The high public borrowing requirements, the deteriorating portfolios of the commercial banks and their low liquidity sustained a high interest rate and repressed the financial market while the dominance of administered prices and foreign trade controls (though selective) depressed the commodity markets.

The economic stabilization over the first half of 1995 justified the central bank lowering the base interest rate from 72% in the beginning of 1995 to 34% in August 1995. This gradually undermined the interest rate parity, the process of currency substitution was reactivated and the nominal exchange rate began to upturn in September. In order to curb the lev depreciation the Central Bank (BNB) intervened in the currency market. The drop in the foreign reserves at the end of 1995 and the forthcoming payments on the external debt at the beginning of 1996 destroyed the confidence in the financial system. The low liquidity of some of the commercial banks which caused disturbance of the inter-enterprise payments brought about a severe banking system confidence crisis, the climax being the run on banks at the beginning of 1996.

The confidence crisis became even more acute at the beginning of 1997. The political instability after the resignation of the government in December 1996 strengthened the negative outlook of the economic entities. Because of the panic and the escape from the Bulgarian Lev the demand for the national currency shrank considerably, despite all attempts to solve the crisis. Inflation soared to hyperinflationary levels (February 1997 – 240%), the BGL depreciated (by more than 500% against the US dollar between 31 December 1996 and 12 February 1997), markets collapsed coupled by almost complete dollarization of payments.

The economic crises subsided as the political agreement has been reached (on 5 February 1997) and the decision for preliminary elections has been taken. The appointment of a caretaker government endorsed with high public confidence, the measures undertaken in the sphere of the economic policy, and the resumption of the dialogue with the international financial institutions created prerequisites for restoring the confidence in the national currency and institutions. After the parliamentary elections in April 1997 the new majority in Parliament appointed a government which set itself the objective to conclude the transition from a centrally-planned towards a market economy on the basis of accelerated privatisation and a stability and economic growth oriented macroeconomic policy.

Bulgaria’s economy since 1997

The macroeconomic policy, implemented since mid-1997, embodied a currency board arrangement, a fiscal policy aimed at a broadly balanced government budget, a restrictive incomes policy (from which the private sector is exempted), further liberalization of domestic prices and foreign trade, acceleration of structural reforms in the real sector and the budget sphere.

The economy started to recover in 1998 as the year was marked by events with favourable impact on market reforms, such as the three-year IMF agreement and the accession to CEFTA. In 1998 all prices except for household power consumption and industrial central heating utilities were liberalised. Bulgaria achieved financial stabilisation, 4% real GDP growth and 1% end-year inflation. Important steps were taken in the areas of privatisation, banking sector reforms, and agricultural liberalisation. Fiscal policy was prudent as the general government budget deficit was limited to 0.9% of GDP, and income policy for state-owned enterprises was implemented strictly. Privatisation was accelerated, recording the highest level of sale of state assets in Bulgaria’s history. Liberalisation of the agricultural sector continued consistently with the Government program for structural reform. Significant trade and price liberalisation was achieved and state control on prices of agricultural and food products was eliminated. A system of licensed warehouse receipts was introduced to provide options for further development of the grain market.

The greatest challenge for Bulgaria in 1999 - the Kosovo crisis - heavily affected the country’s economy. The total direct losses for Bulgaria amounted to USD 95 million. The GDP growth in 1Q ’99 slowed down to 0.8% but accelerated to 4.8% during the second half of 1999. In 1998 and 1999 Bulgarian exports were adversely affected by lower foreign demand and falling prices of major export commodities in the chemical and metallurgical sectors. On the other hand the Kosovo crisis hit badly the Bulgarian exports imposing barriers on the main export route (Yugoslavia). A trade deficit of USD 380 million appeared in 1998, which widened to USD 1,068 million in 1999. Despite the overall drop in the total value of exports, an increase was recorded in many commodity groups, compared to 1997. Confidence in the Bulgarian national currency remained strong, with gross official reserves at USD 3.2 billion and the fiscal reserve account at USD 1.4 billion at end-1999. A broad international acknowledgement of the political and economic changes in Bulgaria was the invitation to start accession negotiations with the EU in December 1999 and their initiation in March 2000.

While exports recovered substantially in 2000, the current account deficit remained high due to a sharp increase in imports induced by higher international oil prices. On the positive side, the turmoil on international financial markets did not cause any apparent threat to the stability of the financial system or to the continuation of the currency board arrangement.

The macroeconomic results in 2000 and 2001 of 5.4% and 4.1% real GDP growth respectively and inflation of 11.4% and 4.8% respectively allowed for medium- and long-term business planning. Despite the world economic slowdown in 2002 Bulgaria also performed well with real GDP growth of 4.8% and end-of-year inflation estimated at 3.8%. Reflecting ongoing economic restructuring, the private sector now represents almost 65% of GDP and its share in total employment is increasing. As of end-2002 foreign direct investment (FDI) stock in Bulgaria reached USD 5.2 billion with about 85% generated since the new start of the economic reforms in 1997. Banking sector privatisation was completed with the privatisation of the last state bank – DSK Bank – in 2003. Deficit growth seems to be overcome in 2002 as exports grew faster than imports. With a revenue growth of about 10% in the last couple of years, tourism contributes significantly to better results.

Over the last two years, the investment climate has been improved by positive changes in the tax legislation. In terms of income and corporate tax rates Bulgaria has become the most competitive location in CEE. Since 1 January 2002 the highest bracket for the personal income tax has been dropped to 29% and since January 2003 all the other brackets have been reduced to 15%, 22% and 26%. Since 1 January 2003 the corporate tax rate is set at 23.5% and the municipality tax has been repealed. The government proposed to cut the corporate tax to 19.5% in 2004 in a bid to encourage investment and speed up economic growth.

BULGARIA: Key macroeconomic indicators (1997-2003)

Direct investments in Bulgaria

By the end of 2002, about 53.5% of the long-term assets of the state owned enterprises were transferred into private hands with a financial effect of USD 7,546 million. If assets not subject to privatisation in the long run are excluded, this ratio reaches 81%. About 99% of the agricultural lands and 92% of forest areas have been returned to their former owners. The bank privatisation was finalised.

As of January 2003 foreign direct investment (FDI) stock in Bulgaria reached USD 5.2 billion with about 85% generated since the new start of the economic reforms in 1997. For a fifth consecutive year FDIs through greenfield, joint ventures, reinvestments and additional investments in already acquired enterprises exceeded FDIs through privatisation.

The top investor in Bulgaria is Greece, followed by Germany, Italy, Belgium and Austria. Other major investors include the USA, the Netherlands, the UK and Russia. The European Union is the major source of FDI for Bulgaria with about 70% of the FDI stock. FDI distribution by sectors shows the major role of industry (43.6% of the total), followed by finance (18.7%) and trade (16%).

2003 FDI data

According to preliminary data, the foreign direct investment in Bulgaria for the period January – July 2003 amounted to USD 533.8 million (2.8% of GDP). It grew 63.3% (USD 206.8 million) against that attracted in the same period of 2002 (USD 327.0 million, 2.1 % of GDP).

(in USD million)

The attracted Equity capital (acquisition/disposal of shares and equities in cash and in kind by non-residents in/from the capital and reserves of Bulgarian enterprises) totalled USD 189.4 million, amounting to 35.5% of the foreign direct investment for the reporting period. It grew by USD 54.8 million (40.8%) year-on-year (USD 134.6 million). 

For the period January – July 2003 no equity capital on privatisation deals was reported, whereas in the same month of the previous year it amounted to USD 54.6 million. The attracted equity capital on non-privatisation deals totalled USD 189.4 million in the reporting period, increasing 137.0% (USD 109.5 million) against that for the same period of 2002 (USD 79.9 million).

The Other capital (the change in the net liabilities of the direct investment enterprise to the direct investor on financial loans, trade credits and debt securities) amounted to USD 322.7 million (net) for the period January – July 2003, increasing considerably by USD 156.9 million (94.6%) against that for the same period of 2002 (USD 165.8 million). In result the relative share of Other capital in the total amount of foreign investment increased to 60.5% from 50.7% in 2002.

According to preliminary data, the Reinvested earnings (the share of non-residents in the undistributed earnings/ loss of the enterprise) amounted to USD 21.7 million, decreasing by USD 4.9 million against those in the same period of 2002 (USD 26.6 million).

By countries, the largest investments in the reporting period of 2003 were those of Switzerland (34.6% of the total foreign direct investment), Italy (8.9%) and Netherlands (8.5%).

Macroeconomic Policy

Under a currency board arrangement, Bulgaria’s monetary and foreign exchange polices have a less important role to play in comparison to countries with a full-fledged independent central bank. Fiscal policy will continue to be the principal macroeconomic policy instrument to maintain stability and create incentives for the restructuring of the economy and economic growth since the currency board arrangement will carry on operating without alterations at the BGN/EUR exchange rate peg.

The key objectives of the government fiscal agenda till 2006 are aimed at maintaining macroeconomic stability and generating sustainable and balanced long-term growth in the economy. They are fully in line with the country’s foreign policy priorities, viz. integration into NATO and the European Union. The government medium-term fiscal framework will sustain the conservative fiscal stance. The framework allows for a gradual reduction in the general budget deficit while striving to achieve a balanced government budget in 2005. The above policy goal is guided by the commitments of the government to curtail the current account deficit and government debt levels to safeguard the country’s macroeconomic stability and foster sustainable growth in the economy. The mid-term fiscal framework foresees further reduction (commenced in 2001) of the GDP share of expenditures re-allocated by the public sector, given a concurrent improvement in the expenditure structure.

The tax policy package underlying the Tax Strategy of the government till 2005 is aimed at ensuring sustainable growth and equitable taxation while maintaining fiscal sustainability. It complies with EU tax requirements, marking an important step forward in the gradual alignment of the country’s tax legislation to the EU acquis. As a result of the fiscal policy implemented, general government budget revenues are expected to smoothly and evenly decrease as percentage of GDP over 2003-2006. The share of direct taxes will decline at the expense of the growing weight of indirect taxes within total tax revenues. The forecasts draw upon the improvements in tax collection expected.

Currency board

Bulgaria's currency board arrangement (CBA) was introduced as a key element of the macroeconomic stabilisation programme adopted in April 1997. The Law on the Bulgarian National Bank, which entered into force in June 1997, put in place the entire legislative framework for the CBA. Under the CBA, which was effective from 1 July 1997, the objective of the Central Bank is to foster the stability of the national currency. The key element of Bulgaria's medium-term economic strategy is the continuation of the CBA.

The Law on the Bulgarian National Bank determined the rate at which the lev was fixed to the peg currency, the deutsche mark (BLG 1000 per DM). On 1 January 1999, the fixed exchange rate to the DM was converted to the Euro on the basis of the official exchange rate of conversion of the DM to the euro. On July 5, 1999 the Bulgarian currency – lev is denominated. Three zeros (000) were slashed (eliminated). BGN 1 = DEM 1, or BGN 1.95583 = Euro 1; Old code: BGL (lev), New code: BGN (lev) The choice of the Euro as peg currency is designed to reinforce the political objective of EU accession and, eventually, to facilitate Bulgaria's integration into the Economic and Monetary Union.

According to the rules of the currency board arrangement the Central Bank is obliged to buy and sell any amount of foreign or domestic currency at the fixed exchange rate, and the size of the domestic money supply is dependent on the central bank’s stock of foreign exchange reserves and the demand for domestic currency. The central bank cannot lend to the State or to any state agencies, except against purchases of special drawing rights (SDR) from the IMF. Also, under the rules of the CBA, the central bank cannot lend to commercial banks, except if the stability of the financial system is endangered. In that case excess foreign reserves are to be used which are the difference between total foreign reserves and the liabilities of the currency board (reserve money and government deposits). The currency board contributes to fostering financial discipline as banks and companies have to repay loans with no prospect of being bailed out by the state. The BNB is not allowed to do open market operations including repurchase agreements as the CBA cannot hold domestic assets.

The introduction of the currency board arrangement was a key element in the successful lowering of inflation and interest rates. The yield on short-term treasury bills, which fell rapidly to 6% in the second half of 1997, is currently about 2.5%. The market of long-term government securities is in a process of development thanks to the positive effects of financial stabilization, and the increased predictability of the economic policy environment.

Structural Reforms

The major objective of structural reforms is to make the Bulgarian economy, i.e. its enterprises, institutions etc., a viable and competitive actor on the internal market of the EU and in the global economy. The macroeconomic stabilisation achieved since the introduction of the currency board regime has created a favourable environment for the implementation of the authorities’ reform agenda. It is now crucial to take advantage of this opportunity since macroeconomic stabilisation alone does not automatically lead to the supply responses needed to achieve sustained growth and to the creation of a market economy.

Financial Sector

Bulgaria faces the challenge to build up a competitive and well-regulated financial market. The future membership in the EU requires the market regulatory framework to be in compliance with the EU standards. The laws and regulations adopted in the last several years have transposed in banking legislation the main EU Bank Directives and the Basle principles for prudential banking supervision.

The privatisation of commercial banks as well as the improvement of banking regulations in conformity with the recommended international practice and efficient banking supervision are the main reasons for the good financial performance of the banking system and, together with macroeconomic stabilization, for the gradual remonetisation of the economy and the expansion of credit to the non-government sector. Regardless of the substantial growth of credit to the non-government sector, the Bulgarian economy is still less monetised than the other economies in transition.

The legislative amendments in the area of creditor rights guaranteeing, the faster and more efficient settlement of credit disputes and the development of financial instruments in 2001-2002 underlie the increased credit activity of commercial banks. The changes at the international financial market also contributed to this effect. The growth of lending was accompanied by a quality improvement of commercial banks credit portfolio. Increased competition in the banking sector following the successful divestiture is also an important factor boosting credit activity. The diversification of financial instruments as a result of the introduction of mortgage bonds in 2001 was a result of competition among commercial banks too.

In 2001-2003, the banking system remained well capitalized and profitable while competition followed a steady upward trend after the privatisation carried out in the preceding years. According to the overall assessment, the banking system is well supervised, highly capitalized, with moderate profitability and with good risk management. Non-bank financial intermediation however is relatively underdeveloped. Still, following the amendments to the regulatory framework of pension and insurance intermediaries, a sustained upward trend is discerned in their share of the financial markets. The concentration of assets in the insurance sector as well as in the universal, occupational and voluntary pension funds remains relatively high.

Since the introduction of the CBA and the stabilization of the economy interest rates have followed a steady downward trend, converging with international interest rates. In early-1997 the base interest rate (BIR) reached about 200% and slumped to 6.65% in end-year. In October 2003, the base interest rate ran at 2.59%. However, the BIR is determined by a small segment of the market of government securities and is therefore less illustrative of the money price dynamics in the economy.

Interest on short-term credits has been going on to decrease since 1997 to reach 7.78% in October 2003 as compared to a 13.73% interest rate on long-term loans. Deposit interest levels steadied around 2.03% while the interest rate spread between credits and deposits remained high, judged by international standards.

On the privatisation front, the last three years should be definitely viewed as successful - the strategy of the Bulgarian government was to sell first the best state-owned banks, with the purpose to attract additional capital and expertise necessary for building up a competitive banking system. In 1997, the Bank Consolidation Company was given a mandate to privatise the state-owned banks that emerged from the consolidation process. After UBB and Postbank privatisation in 1998, the privatisation procedures for Expressbank (sold to Societe Generale-France) and Hebrosbank (sold to Regent Pacific Fund) were completed by end-1999. Since the beginning of 2000, more banks have been privatised as a result of increased Government efforts – largest Bulgarian bank Bulbank (sold to a consortium between Italy's UniCredito and Germany's Allianz), and Corporate Bank, previously owned by Bulbank also sold to private owners. In 2002 Bank Austria Creditanstalt purchased 99.59% of the shares of Biochim Bank for USD 82m and on 20 May, 2003 OTP Bank, Hungary signed a contract for privatisation of 100% of the shares of the third largest Bulgarian bank – DSK for EUR 311m. The deal has finalized the privatisation process in the banking sector.

Enterprise Sector

Enterprise sector reform is at the heart of the transition and accession process. The main objective is to restructure the Bulgarian enterprise sector in an outward-looking and export-oriented way, to make it a viable, active and competitive participant on the international markets, especially on the internal market of the EU.

The main priority of the development of the Bulgarian economy over the 2000-2006 period is the improvement of the real sector’s competitiveness on the basis of viable enterprises guided by market principles and in compliance with the assumed obligations under international agreements. The attainment of this priority involves the betterment of the economic climate and more extensive use of the existing national advantages and technical and production capacities and potential. The prudent usage of natural resources and the achievement of compliance with environmental legislation are also necessary requirements to further revive the Bulgarian manufacturing.

Privatisation

Privatisation has been a top priority for all governments since the beginning of the economic and political changes in Bulgaria in the early 90s. It started in 1993 using various techniques and witnessing big legislative changes, all aimed at improving transparency and attracting bigger foreign investors. However, as of spring 1996, less than 4% of state assets had been transferred to private ownership. The slow advance of privatisation between 1992 and 1996 was the result of limited political will, poor implementing procedures, and little interest from potential buyers in an environment characterised by an inadequate legal framework and substantial macroeconomic instability. The slow advance of privatisation severely affected the extent of economic restructuring, favoured widespread asset stripping and failed to limit the rising need for SOE subsidization.

In the period after the 1996-1997 crisis, privatisation and state-owned enterprise restructuring in Bulgaria have principally aimed at imposing tight budget constraints in the real sector and simultaneously providing additional financial resources to the budget from the sale of state property. Two phases in the restructuring of state assets were delineated to accomplish the formulated task.

The first phase witnessed the swift privatisation of state-owned enterprises through sales predominantly to strategic investors and, in the absence of such investors, through management and employee buy-outs (MEBOs); the second wave of mass privatisation also took place. After the successful completion of the first phase, the preparation process for liberalization, restructuring and deregulation of state monopolies was launched in the end of 2000.

Privatisation contributed to the expansion and strengthening of private sector in the country. The high percentage of GDP (around 70%) produced in the private sector in 1999-2000 as well as the sustained output growth in the sector were also consequences of the privatisation of state-owned enterprises. At the same time, a number of shortcomings in the privatisation procedures applied before the end of 2000 have been reported, viz. insufficient transparency, unequal treatment of potential buyers following the preferential treatment of MEBOs, and non-observance of commitments assumed by buyers at the conclusion of the privatisation deal. These shortcomings, magnified by the concurrent unfavourable impact of the external environment, brought about lower than expected demand for the Bulgarian enterprises offered for sale, hence the deficient participation of strategic foreign investors.

The pace of divestiture considerably slackened in 2001 forcing the government to develop new privatisation policy. Its primary objective is to finalise the privatisation of all state-owned assets earmarked for divestiture by 2005.

The Privatisation and Post-Privatisation Control Act (PPPCA) has provided for equal treatment of legal entities and physical persons alike, without giving any preference to MEBOs and abolishing the right of employees to buy shares on preferential terms. All state-owned companies (with a few exceptions - regional utility companies, airports, sea ports, free trade zones, Bulgarian Posts, NPP Kozlodui, Bulgargas, the Bulgarian Stock Exchange, etc.) are offered for sale by virtue of the PPPCA. State-owned shares in companies are only offered by public auctions and public tenders. The Act has put an end to mass privatisation and separated privatisation procedures and post-privatisation control, assigning them to different agencies. The Privatisation Agency (PA) has assumed full responsibility for the privatisation of state-owned interest in the share capital of companies or detached parts thereof with more than 50% of state interest. A new independent Agency is the only competent authority to exercise post-privatisation surveillance in privatised companies. The law also ruled out explicitly any re-negotiation of the commitments undertaken under privatisation contracts. As practice in the second half of 2002 evidenced, the further pace and effect from privatisation will be highly dependent on the speed of both the adoption and enforcement of EU Company Law and the implementation of structural reforms in the judiciary system.

A new Transactions in Compensatory Instruments Act was passed in 2002 to regulate the market of compensatory instruments, the building-up of a modern register of compensatory instruments and their trading at the stock exchange. The Act aimed to achieve a just completion of the process of compensating citizens who have been indemnified with compensatory notes, housing-compensatory notes and compensation bills. In the beginning of March 2003 a list of state-owned enterprises subject to privatisation with non-cash payment instruments was promulgated. The list comprises of 1,084 companies, 95 of which will be privatised through the Bulgarian Stock Exchange, 761 through centralised public auctions and 228 enterprises through public tenders arranged by the Privatisation Agency.

As a result of restructuring and further liberalisation of the economy through divestiture, a considerable part of state assets was transferred in private hands. By the end of 2002, more than 80% of the assets subject to privatisation have been privatised. The majority of privatisation deals in the period 1993 -2002 took place in the industry and commerce sectors. In the period 1 January 1993 - 28 February 2003 there were 158 privatisation deals with foreign investors. The deals that marked highest value were in the financial sector, followed by the chemical industry. The goal of the present Bulgarian government is to complete the sale of the major state-owned assets by the end of 2004.

The Bulgarian Equity Market

General Overview

Source: Bulgarian Stock Exchange