The "laggard" of the East European transition countries is today experiencing a prolonged period of economic and political stability for the first time since the central-planning regime was abandoned. In early 1997, Bulgaria was in the throes of a full-blown economic and political crisis. Inflation, the public debt and the budget deficit were spiralling out of control, financial markets had virtually collapsed and the Bulgarian authorities were unable to defend the national currency because of insufficient foreign exchange reserves. In this desperate economic context, the new government that emerged from the elections of April 1997 adopted policies on the basis of an IMF agreement and embarked on an ambitious programme for fiscal consolidation and structural reform. In addition, it set up a currency board and pegged the exchange rate to the Deutsch Mark.
The results of the new economic policy, which marks a radical break with the past, have been remarkable: the annual rise in the CPI, which was close to 600% in 1997, fell to a negligible level the following year, interest rates eased rapidly, GDP has shown some signs of recovery, and the privatisation process has received new impetus. As for the fiscal consolidation objectives, virtually all of them have been achieved or even exceeded: from 17% of GDP in 1996, the consolidated budget deficit was reduced to 5% in 1997 and entirely eliminated in 1998, while domestic debt fell from nearly 70% of GDP at the end of 1996 to under 15% at the end of 1998.
Bulgaria's macroeconomic situation and financial stability do not appear threatened in the near future. Due in part to the presence of relatively low interest rates, potentially volatile short-term capital flows have been limited. Furthermore, the balance-of-payments support provided by the IMF should be sufficient to ensure that the overall external balance is roughly in equilibrium. Nevertheless, in the medium term, the crises in a number of other emerging market economies could have a significant impact on the current-account balance. The CIS countries have still absorbed a large share of Bulgarian exports -- 17% in 1997 -- and the currency depreciation in Russia and other countries affected by the crisis could have an impact on Bulgaria's competitiveness. To this should be added the indirect effects of the Kosovo crisis, which could still compromise the stabilisation programmes and economic reforms in neighbouring countries, even though the conflict is over. The Federal Republic of Yugoslavia is a very important transit route for Bulgaria -- about 60% of Bulgaria's exports pass through it. Even though they can still go through Romania, destroyed bridges on the Danube and the difficulties of overland transport have pushed up Bulgaria's transport costs.
The Kosovo conflict may have also had an unfortunate effect on the attraction of foreign investment to Bulgaria. But important difficulties in attracting foreign direct investment were present even before the Balkans crisis. Balance-of-payments statistics show a slowdown in direct and portfolio foreign investment inflows in 1998 compared with 1997, estimated to have fallen from approximately US$500 million to US$300 million. While the environment for international investment in transition economies has been difficult in general during this period, foreign investors still also complain about the instability of tax rules and other regulations.
In the banking sector, the situation has improved substantially, with a "revival of commercial banks" (see box on page 20). Broadly speaking, the Bulgarian government seems to have succeeded in laying the foundations for the rebuilding of commercial banking and the financial sector following the collapse in 1996 and 1997. But the commercial banks are still not effective financial intermediaries between domestic saving and investment.
Since the start of the crisis, they have invested principally in relatively safe liquid assets such as foreign and national government securities. A consequence of the commercial banks' low participation in the financing of the economy is that firms, especially SMEs, are faced with a serious shortage of liquidity and are unable to tap the still embryonic stock market. It is to be expected, however, that the creation of institutions to support credit markets will take time. The low level of institutional development of credit markets raises some concerns about possible future difficulties. While the progress on stabilisation facilitated a recovery in GDP after it had plummeted at the height of the crisis, it is still below its previous levels. On a quarter-by-quarter basis, aggregate output has not shown much growth since the latter half of 1997. While the Kosovo conflict increased somewhat Bulgaria's needs in balance-of-payments support, beyond that provided in the 1998 three-year agreement concluded with the IMF, sufficient additional assistance should be forthcoming. Nevertheless, Bulgaria's foreign debt remains considerable -- nearly 80% of GDP -- and the annual servicing of the official external debt will amount to about US$700 million in the next few years.
While such a burden is bearable today, it could prove difficult to obtain foreign loans outside the IMF programme unless international institutions grant new loans as part of a reconstruction strategy for the countries in the region.
In the immediate term, the revival of output, financial markets, and especially the standard of living, could prove to be a long and difficult process. The budget has been balanced partly by squeezing social expenditure to levels which are fairly low compared with most other transition countries. Such a policy may not be sustainable, given the magnitude of social assistance required. Very high inflation, the tightening of financial policy and the blocking of households' access to bank deposits during the second half of 1996 and in early 1997, had a drastic impact on the standard of living of Bulgarian households, many of which were already close to the poverty line. At the beginning of 1997, food shortages had even triggered riots in some regions. Subsequently, incomes and wages picked up slightly, but they are still below their end-1995 levels, before the crisis, and are low compared with those of most other East European countries. In addition, the rate of unemployment worsened, rising from 13.7% in 1995 to 16% in 1998. In view of the scale of the restructuring that is still required, this could pose serious problems in coming years. The population will be hit by further shake-outs in unprofitable large industrial undertakings if the private sector proves incapable of absorbing surplus labour.
To meet these social challenges, the government has provided for a substantial rise in public spending and social expenditure in the 1999 budget. But at the same time it has announced its determination to maintain a balanced budget and to restrict spending further if expected levels of tax revenues do not materialise. The degree of success achieved in economic policy since mid-1997 gives hope that the Bulgarian government will continue to meet the considerable challenges that lie ahead, assuming, however, that the fallout of the Balkans crisis remains limited.
©OECD Observer No 217/218, Summer 1999