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Business Insight: The Importance of Being 'Stingy'

30 04 2007  

Bulgaria’s finance ministry announced last week that it had jumped ahead of schedule to pay off the last remaining portion of its debt to the International Monetary Fund, worth about $302 million. The move generated nary a ripple, neither in Bulgaria's financial markets nor on the political circuit.

The repayment was too small to seriously dent the country's fiscal reserves, which now stand at a comfortable 2.8 billion euros. Most Bulgarians, for their part, feel they have seen it all before. Those once impressed by sensational announcements about foreign debt swaps and payments no longer are.

But this repayment is different, for it marks the end of an era.

Ten years ago, the IMF helped pull Bulgaria out of the deepest economic crisis in its modern history, a period of hyperinflation that saw consumer prices rise by 678 per cent during 1997. The currency board arrangement introduced under IMF pressure on July 1 of that year had an immediate sobering effect, setting a key milestone on Bulgaria’s path to membership of the European Union.

Today, with Bulgaria aiming not merely for stability but for accession to the euro zone, its client relationship with the IMF is effectively over. But the fruits of the relationship are just now ripening for harvest.

Bulgaria has benefited from an essentially seamless transition from IMF supervision to EU compliance. The recommendations made by the European Commission in its Convergence Programme for Bulgaria read like a carbon copy of what the IMF wrote in its final report in December 2006 and confirmed in its March 2007 review.

Both the IMF and the EC described Bulgaria's budget policy as a textbook example of solid fiscal practices. Both recommended that Bulgaria should maintain a high budget surplus as a buffer against possible external destabilizing factors. Both warned against the reduction of taxes and the increase of budget spending for salaries, pensions and like expenditures. In brief, the transition changes very little in the substance of fiscal policy recommendations.

Yet with the switch from IMF supervision to EU compliance, dynamics of oversight and enforcement slacken. Bulgaria's accession to the EU came as a logical outcome of a strict compliance with conditions set with the IMF. These conditions fortunately lay beyond the reach of domestic political manoeuvring. The currency board arrangement, as an IMF legacy, remains in effect and should help to cushion the European currency's introduction after 2009. But with its debt paid off Bulgaria will discover it has more room for manoeuvre in terms of fiscal policy than it had before.

This makes sense because the financial system is no longer as vulnerable as it once was.

The 1996-1997 economic crisis in Bulgaria was brought on in large part by the collapse of the banking system. Today Bulgaria's banks today are considered strong enough to weather disturbances, domestic or international. There are virtually no Bulgarian-owned commercial banks left.

As if by coincidence, the retirement of Bulgaria’s debt to the IMF fell on the very day that three large Bulgarian-registered banks, owned by Italy's UniCredito, completed their merger into one mega-bank, UniCredito-Bulbank, controlling 27 percent of the banking assets in the country. The robust presence of major foreign banks operating locally changes the rules of the game.

Liberalising policy changes were already being seen before final repayment of IMF debt, from the first day of this year when Bulgaria joined the EU. Notably, the central bank scrapped one of its most powerful instruments of leverage, its rule on compulsory provisional reserves. The rule on reserves forced commercial banks to deposit reserve funds with the central bank, restraining the growth of credit and thereby, in theory, keeping the quality of credit high.

Restraining credit expansion, a favourite refrain of the IMF, had never been music to the ears of Bulgarian lenders. They assiduously sought to exploit loopholes, and as elsewhere in southeast Europe they frequently succeeded. One common method was the transference of components of domestic loan portfolios to the portfolios of foreign managers.
Nonetheless, the quality of credit accumulated has stayed broadly good.

The existence of stable banking institutions in Bulgaria, the emergence of a fiscal and financial discipline in general, and sustained economic growth has helped Bulgaria to land a better credit rating, helping both banks and businesses to look for loans abroad.

This market should be substantial and dynamic. At the end of February 2007, Bulgaria's public foreign debt stood at 4.261 billion euros (15.9 per cent of GDP), while private debt stood at 14.69 billion euros (60.4 per cent of GDP). By contrast, Greece's foreign debt exceeds its GDP. A mark of the Bulgarian credit market's current dynamism is that just 1.4 per cent of the foreign debt accrued by commercial banks is long-term.

If these factors are indicative, Bulgaria's banking system appears primed for a major economic breakthrough as it absorbs demand artificially restrained during recent years. This should be welcome news. When adopting its currency board arrangement in 1997, Bulgaria relinquished its former levers of monetary policy. The central bank's regulation on bank provisions became, in one sense, monetary policy by other means. Bankers resented the strategy, despite its benefits.

Yet in fiscal policy, restraint looks likely to remain the rule. One factor is the continued role of Plame Oreharski, the finance minister. A key figure behind the currency board's success to date, his nimble straddling of Bulgarian partisan political divides has kept him at the centre of the action since 1997, despite changes in government.

Oresharski has a reputation as one of the most conservative, 'stingy' financiers in Bulgaria. He is unlikely to deviate from the course established over the past three government mandates, characterised by reasonably low consumer price inflation, exchange rate stability with the Bulgarian lev pegged to the euro and budget surpluses.

This is where Bulgaria faces some potential political risk. The IMF once absorbed some of the blame for the government's fiscal restraint, keeping salaries and pensions low and social security taxes high. In fact, IMF interference in these areas was never as aggressive in Bulgaria as the Fund's critics claimed, but successive governments have shared blame with the IMF and the currency board. With IMF debts repaid, this is a harder to do, but the need for fiscal restraint remains.

Full recuperation from the economic nadir Bulgaria experienced in 1997 requires more than a decade's work. For at least a generation, tremendously strong political will and wisdom will be needed to fix the mechanisms governing personal and corporate incomes – salaries, social benefits, pensions, healthcare, and taxes. And this takes patience, the one thing that Bulgarians are slowly starting to lose.

Though citizens of the EU, month by month the average Bulgarian lives on one-third of the money spent by the average European. Even after ten years of economic growth, GDP per capita stands at about $4,800.

High taxes are a drag on wealth creation, with individuals shouldering twin burdens of high income taxes and a 38 per cent social security tax taken from salaries. The consequence is a flourishing grey economy. The public sector pays an average 220 euros per month, and the private sector pays even less, officially.

Official statistics appear skewed. From a workforce of 3 million, last year just 35,000 people fell within the highest bracket of social security tax obligation of 1400 leva (700 euros) per month. This figure held steady through the first three quarters of 2006. Yet during the same period, the number of new cars sold rose by 21 per cent. James Roaf, senior IMF representative in Bulgaria, has pointed to widespread wage concealment by private companies.

In other words, Bulgaria's economy is healthy and may soon capitalise on restrained potential, yet it is also fragile. Both the IMF and EU warn that rash moves could rouse the spectre of devaluation and speculative pressures on the lev, potentially yielding serious setbacks en route to the euro zone.

But Bulgarians have come to take financial stability for granted. Witness the chatter on Bulgarian economic blogs following the IMF debt repayment. "Why opt for the euro zone with a meagre salary, when a decent salary will feel much more comfortable with the currency board?" one blogger asks. His rhetorical question does not demand an answer, but it deserves one.

Nikolay Petrov is a senior editor of international news at BTA, the Bulgarian News Agency. Balkan Insight is BIRN`s online publication.