EUROPEAN COMMISSION Brussels, 1.6.2022 SWD(2022) 280 final COMMISSION STAFF WORKING DOCUMENT CONVERGENCE REPORT 2022 Accompanying the document REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL CONVERGENCE REPORT 2022 (prepared in accordance with Article 140(1) of the Treaty on the Functioning of the European Union) {COM(2022) 280 final}



Member States BG Bulgaria

CZ Czechia HR Croatia HU Hungary PL Poland RO Romania SE Sweden EA Euro area EA-19 Euro area, 19 Member States EA-18 Euro area, 18 Member States before 2015 EA-17 Euro area, 17 Member States before 2014 EU-28 European Union, 28 Member States EU-27 European Union, 27 Member States before July 2013 (i.e. EU-28 excl. HR) and from February 2020 (i.e. EU-28 excl. UK) EU-25 European Union, 25 Member States before 2007 (i.e. EU-28 excl. BG, RO and HR) EU-15 European Union, 15 Member States before 2004 Currencies EUR Euro BGN Bulgarian lev

CZK Czech koruna HRK Croatian kuna HUF Hungarian forint PLN Polish zloty RON Romanian leu (ROL until 30 June 2005) SEK Swedish krona USD United States dollar Central Banks BNB Bulgarska narodna banka (Bulgarian National Bank – central bank of Bulgaria) ČNB Česká národní banka (Czech National Bank – central bank of Czechia) HNB Hrvatska narodna banka (Croatian National Bank – central bank of Croatia) MNB Magyar Nemzeti Bank (Hungarian National Bank – central bank of Hungary) NBP Narodowy Bank Polski (National Bank of Poland – central bank of Poland) BNR Banca Naţională a României (National Bank of Romania – central bank of Romania) Other abbreviations AMR Alert Mechanism Report BoP Balance of Payments CAR Capital adequacy ratio

CBA Currency board arrangement CEE Central and Eastern Europe CIT Corporate Income Tax CPI Consumer price index CR5 Concentration ratio (aggregated market share of five banks with the largest market share) EC European Community ECB European Central Bank EDP Excessive Deficit Procedure EMU Economic and monetary union ERM II Exchange rate mechanism II ESA European System of Accounts ESCB European System of Central Banks EU European Union Eurostat Statistical Office of the European Union FDI Foreign direct investment FGS Funding for Growth Scheme FSA Financial Supervisory Authority GDP Gross domestic product HICP Harmonised index of consumer prices HFSA Hungarian Financial Supervisory Authority

IDR In-Depth Review MFI Monetary Financial Institution MIP Macroeconomic Imbalance Procedure NCBs National central banks NEER Nominal effective exchange rate NIK Najwyższa Izba Kontroli (Poland's Supreme Chamber of Control) NPL Non-performing loans OJ Official Journal OJL Official Journal Lex PIT Personal Income Tax PPS Purchasing Power Standard REER Real effective exchange rate RRF Recovery and Resilience Facility RRP Recovery and Resilience Plan SGP Stability and Growth Pact TFEU Treaty on the Functioning of the European Union ULC Unit labour costs VAT Value added tax

The Convergence Report and its Technical Annex were prepared in the Directorate-General for Economic and Financial Affairs. The main contributors were Lucian Briciu, Staffan Linden, Adriana Reut, Virgilijus Rutkauskas, Matteo Salto and Vaclav Zdarek. Other contributors were Ronald Albers, Pedro Arevalo, Lucian Albulescu, Martin Åström, Cristiana Belu Manescu, Adrian Bodea, Alessandra Cepparulo, Stefan Ciobanu, Angela D’Elia, Lukas Demoen, Patrick D’Souza, Ben Deboeck, Milan Deskar-Skrbic, Dorel-Adrian Dumitrescu-Pasecinic, Hugo Ferradans Ramonde, Carmine Gabriele, Nicola Gagliardi, Gabriele Giudice, Oskar Grevesmuhl, Valeska Gronert, James Hinton, Martjin Hoogeland, Szabolcs Klubuk, Willem Kooi, Daniel Kosicki, Ingo Kuhnert, Ivan Lozev, Robert Markiewicz, Philipp Mohl, Allen Monks, Markus Münch, Eloise Orseau, Stéphanie Pamies, Anda Patarau, Gábor Pellényi, Arian Perić, Lucia Piana, Simona Pojar, Diana Radu, Ernesto Reitano, Vincent Rietvink, Maja Šamanović, Martina von Terzi, Daniel Vâlcu, Bartlomiej Wiczewski, Rafał Wielądek and Christos Zavos. Statistical assistance was provided by Luisa Boa and Puck Boom, administrative assistance by Erdemia Malagrida and Sien Vangompel. The report benefitted from comments and suggestions by Isabel Grilo, Charlotte van Hooydonk, Michael Stierle, Massimo Suardi, Septimiu Szabo and Luc Tholoniat. The report was coordinated by Adriana Reut under the supervision of Eric Ruscher, Head of Unit and approved by Lucio Pench, Director, Declan Costello, Deputy Director General, and Maarten Verwey, Director General. Questions and comments may be referred to Adriana Reut (adriana.reut@ec.europa.eu). Convergence Report 20221 Convergence Report 2022 - Technical annex3 1.Introduction5 1.1.Role of the report5 1.2.Application of the criteria8 1.2.1.Compatibility of legislation8 1.2.2.Price stability8 1.2.3.Public finances12 1.2.4.Exchange rate stability16 1.2.5.Long-term interest rates18 1.2.6.Additional factors19

2.Bulgaria23 2.1.LEGAL COMPATIBILITY23 2.1.1.Introduction23 2.1.2.Central Bank independence23 2.1.3.Prohibition of monetary financing and privileged access24 2.1.4.Integration in the ESCB24 2.1.5.Assessment of compatibility25 2.2.Price stability25 2.2.1.Respect of the reference value25 2.2.2.Recent inflation developments25 2.2.3.Underlying factors and sustainability of inflation26 2.3.Public finances29 2.3.1.Recent fiscal developments29 2.3.2.Medium-term prospects30 2.4.Exchange rate stability32 2.5.Long-term interest rates33 2.6.Additional factors33 2.6.1.Developments of the balance of payments34 2.6.2.Market integration36 3.Czechia41

3.1.LEGAL COMPATIBILITY41 3.1.1.Introduction41 3.1.2.Central Bank independence41 3.1.3.Prohibition of monetary financing and privileged access42 3.1.4.Integration in the ESCB42 3.1.5.Assessment of compatibility43 3.2.Price stability43 3.2.1.Respect of the reference value43 3.2.2.Recent inflation developments43 3.2.3.Underlying factors and sustainability of inflation44 3.3.Public finances47 3.3.1.Recent fiscal developments47 3.3.2.Medium-term prospects48 3.4.Exchange rate stability49 3.5.Long-term interest rates50 3.6.Additional factors51 3.6.1.Developments of the balance of payments52 3.6.2.Market integration53 4.Croatia57 4.1.LEGAL COMPATIBILITY57

4.1.1.Introduction57 4.1.2.Central Bank independence57 4.1.3.Prohibition of monetary financing and privileged access57 4.1.4.Integration in the ESCB57 4.1.5.Assessment of compatibility57 4.2.Price stability57 4.2.1.Respect of the reference value57 4.2.2.Recent inflation developments58 4.2.3.Underlying factors and sustainability of inflation58 4.3.Public finances61 4.3.1.Recent fiscal developments61 4.3.2.Medium-term prospects62 4.4.Exchange rate stability64 4.5.Long-term interest rates65 4.6.Additional factors66 4.6.1.Developments of the balance of payments67 4.6.2.Market integration68 4.7.sustainability of convergence71 5.Hungary79 5.1.LEGAL COMPATIBILITY79

5.1.1.Introduction79 5.1.2.Central Bank independence79 5.1.3.Prohibition of monetary financing and privileged access80 5.1.4.Integration in the ESCB81 5.1.5.Assessment of compatibility82 5.2.Price stability82 5.2.1.Respect of the reference value82 5.2.2.Recent inflation developments82 5.2.3.Underlying factors and sustainability of inflation83 5.3.Public finances86 5.3.1.Recent fiscal developments86 5.3.2.Medium-term prospects87 5.4.Exchange rate stability89 5.5.Long-term interest rates90 5.6.Additional factors91 5.6.1.Developments of the balance of payments92 5.6.2.Market integration93 6.Poland97 6.1.LEGAL COMPATIBILITY97 6.1.1.Introduction97

6.1.2.Central Bank independence97 6.1.3.Prohibition of monetary financing and privileged access98 6.1.4.Integration in the ESCB99 6.1.5.Assessment of compatibility100 6.2.Price stability100 6.2.1.Respect of the reference value100 6.2.2.Recent inflation developments100 6.2.3.Underlying factors and sustainability of inflation101 6.3.Public finances103 6.3.1.Recent fiscal developments103 6.3.2.Medium-term prospects104 6.4.Exchange rate stability106 6.5.Long-term interest rates106 6.6.Additional factors107 6.6.1.Developments of the balance of payments108 6.6.2.Market integration109 7.Romania113 7.1.LEGAL COMPATIBILITY113 7.1.1.Introduction113 7.1.2.Central Bank independence113

7.1.3.Prohibition of monetary financing and privileged access114 7.1.4.Integration in the ESCB115 7.1.5.Assessment of compatibility115 7.2.Price stability115 7.2.1.Respect of the reference value115 7.2.2.Recent inflation developments116 7.2.3.Underlying factors and sustainability of inflation117 7.3.Public finances120 7.3.1.Recent fiscal developments120 7.3.2.Medium-term prospects121 7.4.Exchange rate stability122 7.5.Long-term interest rates123 7.6.Additional factors124 7.6.1.Developments of the balance of payments126 7.6.2.Market integration127 8.Sweden131 8.1.LEGAL COMPATIBILITY131 8.1.1.Introduction131 8.1.2.Central Bank independence131 8.1.3.Prohibition of monetary financing and privileged access132

8.1.4.Integration in the ESCB132 8.1.5.Assessment of compatibility133 8.2.Price stability133 8.2.1.Respect of the reference value133 8.2.2.Recent inflation developments133 8.2.3.Underlying factors and sustainability of inflation134 8.3.Public finances138 8.3.1.Recent fiscal developments138 8.3.2.Medium-term prospects138 8.4.Exchange rate stability140 8.5.Long-term interest rates141 8.6.Additional factors142 8.6.1.Developments of the balance of payments143 8.6.2.Market integration144 LIST OF Tables 2.1.Bulgaria - Components of inflation 2.2.Bulgaria - Other inflation and cost indicators 2.3.Bulgaria - Budgetary developments and projections (as % of GDP unless indicated otherwise) 2.4.Bulgaria - Balance of payments

2.5.Bulgaria - Market integration 2.6.Bulgaria - Allocation of assets by financial sub-sector 2.7.Bulgaria - Financing of the economy1) 3.1.Czechia - Components of inflation 3.2.Czechia - Other inflation and cost indicators 3.3.Czechia - Budgetary developments and projections (as % of GDP unless indicated otherwise) 3.4.Czechia - Balance of payments 3.5.Czechia - Market integration 3.6.Czechia - Allocation of assets by financial sub-sector 3.7.Czechia - Financing of the economy1) 4.1.Croatia - Components of inflation 4.2.Croatia - Other inflation and cost indicators 4.3.Croatia - Budgetary developments and projections (as % of GDP unless indicated otherwise) 4.4.Croatia - Balance of payments 4.5.Croatia - Market integration 4.6.Croatia - Allocation of assets by financial sub-sector 4.7.Croatia - Financing of the economy1) 5.1.Hungary - Components of inflation 5.2.Hungary - Other inflation and cost indicators 5.3.Hungary - Budgetary developments and projections (as % of GDP unless indicated otherwise)

5.4.Hungary - Balance of payments 5.5.Hungary - Market integration 5.6.Hungary - Allocation of assets by financial sub-sector 5.7.Hungary - Financing of the economy1) 6.1.Poland - Components of inflation 6.2.Poland - Other inflation and cost indicators 6.3.Poland - Budgetary developments and projections (as % of GDP unless indicated otherwise) 6.4.Poland - Balance of payments 6.5.Poland - Market integration 6.6.Poland - Allocation of assets by financial sub-sector 6.7.Poland - Financing of the economy1) 7.1.Romania - Components of inflation 7.2.Romania - Other inflation and cost indicators 7.3.Romania - Budgetary developments and projections (as % of GDP unless indicated otherwise) 7.4.Romania - Balance of payments 7.5.Romania - Market integration 7.6.Romania - Allocation of assets by financial sub-sector 7.7.Romania - Financing of the economy1) 8.1.Sweden - Components of inflation 8.2.Sweden - Other inflation and cost indicators

8.3.Sweden - Budgetary developments and projections (as % of GDP unless indicated otherwise) 8.4.Sweden - Balance of payments 8.5.Sweden - Market integration 8.6.Sweden - Allocation of assets by financial sub-sector 8.7.Sweden - Financing of the economy1) LIST OF Graphs 2.1.Bulgaria - Inflation criterion 2.2.Bulgaria - HICP inflation 2.3.Bulgaria - Inflation, productivity and wage trends 2.4.Bulgaria - Fiscal stance and its components 2.5.Bulgaria - BGN/EUR exchange rate 2.6.Bulgaria - Annual effective interest rate spread to 1-M Euribor 2.7.Bulgaria - Long-term interest rate criterion 2.8.Bulgaria - Long-term interest rates 2.9.Bulgaria - Effective exchange rates 2.10.Bulgaria - 2020 World Bank's Worldwide Governance Indicators 2.11.Bulgaria - Foreign ownership and concentration in the banking sector 2.12.Bulgaria - Intra-EU integration in equity and debt portfolio investment 3.1.Czechia - Inflation criterion

3.2.Czechia - HICP inflation 3.3.Czechia - Inflation, productivity and wage trends 3.4.Czechia - Fiscal stance and its components 3.5.Czechia - CZK/EUR exchange rate 3.6.Czechia - 3-M Pribor spread to 3-M Euribor 3.7.Czechia - Long-term interest rate criterion 3.8.Czechia- Long-term interest rates 3.9.Czechia - Effective exchange rates 3.10.Czechia - 2020 World Bank's Worldwide Governance Indicators 3.11.Czechia - Foreign ownership and concentration in the banking sector 3.12.Czechia - Intra-EU integration in equity and debt portfolio investment 4.1.Croatia - Inflation criterion 4.2.Croatia - HICP inflation 4.3.Croatia - Inflation, productivity and wage trends 4.4.Croatia - Fiscal stance and its components 4.5.Croatia - HRK/EUR exchange rate 4.6.Croatia - 3-M Zibor(1) and 3-M NRR(2) spread to 3-M Euribor 4.7.Croatia - Long-term interest rate criterion 4.8.Croatia - Long-term interest rates 4.9.Croatia - Effective exchange rates

4.10.Croatia - 2020 World Bank's Worldwide Governance Indicators 4.11.Croatia - Foreign ownership and concentration in the banking sector 4.12.Croatia - Intra-EU integration in equity and debt portfolio investment 5.1.Hungary - Inflation criterion 5.2.Hungary - HICP inflation 5.3.Hungary - Inflation, productivity and wage trends 5.4.Hungary - Fiscal stance and its components 5.5.Hungary - HUF/EUR exchange rate 5.6.Hungary - 3-M Bubor spread to 3-M Euribor 5.7.Hungary - Long-term interest rate criterion 5.8.Hungary - Long-term interest rates 5.9.Hungary - Effective exchange rates 5.10.Hungary - 2020 World Bank's Worldwide Governance Indicators 5.11.Hungary - Foreign ownership and concentration in the banking sector 5.12.Hungary - Intra-EU integration in equity and debt portfolio investment 6.1.Poland - Inflation criterion 6.2.Poland - HICP inflation 6.3.Poland - Inflation, productivity and wage trends 6.4.Poland - Fiscal stance and its components 6.5.Poland - PLN/EUR exchange rate

6.6.Poland - 3-M Wibor spread to 3-M Euribor 6.7.Poland - Long-term interest rate criterion 6.8.Poland - Long-term interest rates 6.9.Poland - Effective exchange rates 6.10.Poland - 2020 World Bank's Worldwide Governance Indicators 6.11.Poland - Foreign ownership and concentration in the banking sector 6.12.Poland - Intra-EU integration in equity and debt portfolio investment 7.1.Romania - Inflation criterion 7.2.Romania - HICP inflation 7.3.Romania - Inflation, productivity and wage trends 7.4.Romania - Fiscal stance and its components 7.5.Romania - RON/EUR exchange rate 7.6.Romania - 3-M Robor spread to 3-M Euribor 7.7.Romania - Long-term interest rate criterion 7.8.Romania - Long-term interest rates 7.9.Romania - Effective exchange rates 7.10.Romania - 2020 World Bank's Worldwide Governance Indicators 7.11.Romania - Foreign ownership and concentration in the banking sector 7.12.Romania - Intra-EU integration in equity and debt portfolio investment 8.1.Sweden - Inflation criterion

8.2.Sweden - HICP inflation 8.3.Sweden - Inflation, productivity and wage trends 8.4.Sweden - Fiscal stance and its components 8.5.Sweden - SEK/EUR exchange rate 8.6.Sweden - 3-M Stibor spread to 3-M Euribor 8.7.Sweden - Long-term interest rate criterion 8.8.Sweden - Long-term interest rates 8.9.Sweden - Effective exchange rates 8.10.Sweden - 2020 World Bank's Worldwide Governance Indicators 8.11.Sweden - Foreign ownership and concentration in the banking sector 8.12.Sweden - Intra-EU integration in equity and debt portfolio investment LIST OF Boxes 1.1.Article 140 of the Treaty 1.2.Assessment of price stability and the reference value 1.3.Excessive deficit procedure 1.4.Fiscal policy in the EU since COVID-19 crisis 1.5.A reinforced approach to ERM II participation by means of upfront policy commitments by the applicant Member States 1.6.Data for the interest rate convergence 1.7.The Macroeconomic Imbalance Procedure (MIP)

LIST OF Maps No table of contents entries found. Report 1.1.Role of the report The euro was introduced on 1 January 1999 by eleven Member States. Since then, Greece (2001), Slovenia (2007), Cyprus and Malta (2008), Slovakia (2009), Estonia (2011), Latvia (2014) and Lithuania (2015) have also adopted the euro. Member States for which the Council has not yet decided that they fulfil the necessary conditions for the adoption of the euro are referred to as "Member States with a derogation". Article 140 of the Treaty lays down provisions and procedures for examining the convergence situation of Member States with a derogation (Box 1.1). At least once every two years, or at the request of a Member State with a derogation, the Commission and the European Central Bank (ECB) prepare Convergence Reports for such Member States. Denmark negotiated an opt-out arrangement before the adoption of the Maastricht Treaty () and does not participate in the third stage of EMU. Until Denmark indicates that it wishes to participate in the third stage and adopt the euro, it is not the subject of an assessment as to whether it fulfils the necessary conditions for such a participation. In 2020, the Commission and the ECB adopted their latest regular Convergence Reports (). None of the Member States assessed in those reports was deemed to meet the necessary conditions for adopting the euro. In 2022, two years have elapsed since the last regular reports were prepared. Denmark has not expressed a wish to enter the third stage of EMU (). Therefore, this convergence assessment covers Bulgaria, Czechia, Croatia, Hungary, Poland, Romania and Sweden. This Commission Staff Working Document is a Technical Annex to the Convergence Report 2022 and includes a detailed assessment of the progress with convergence, as required by Article 140(1) of the Treaty. The outbreak of the COVID-19 pandemic in March 2020 led to a severe economic downturn for the EU as a whole and in all the Member States. Unprecedented action taken at the level of the EU and the individual Member States cushioned the impact of the crisis and led to a robust recovery in 2021. In particular, the swift activation of the general escape clause of the Stability and Growth Pact, coupled with the temporary framework on State aid, enabled large-scale fiscal support in all Member States. In parallel, the EU mobilised its budget, in particular with the EU temporary instrument to Support to mitigate Unemployment Risks in an Emergency (SURE), to mitigate the impact of the crisis on workers and companies. The ECB also took a broad set of monetary policy measures to preserve favourable financing conditions for all sectors of the economy in order to support economic activity and safeguard medium-term price stability. The roll-out of the Recovery and Resilience Facility (RRF), which is the centrepiece of NextGenerationEU, is further bolstering the EU’s resilience through large-scale financial support to Member States of up to EUR 723.8 billion (in current prices) in grants (EUR 338 billion) and loans (EUR 385.8 billion) to finance reforms and investments, especially those for the green and digital transitions. At the same time, the stronger-than-expected recovery in 2021, supply chain bottlenecks and a surge in energy prices contributed to a sharp rise in inflation throughout the year and in 2022. Russia’s invasion of Ukraine on 24 February 2022 forced a re-assessment of the outlook for the EU economy, which was hitherto expected to expand vigorously in 2022 and 2023. The crisis mainly has dealt a new supply-side shock to an economy that was already facing inflationary pressures. It has weakened recovery prospects and reinforced upward price pressures, while further underlining the need for higher private and public investment to diversify Europe’s energy supplies and improve energy security. Several of the Member States with a derogation assessed in this report are among the most heavily exposed to the crisis triggered by Russia’s invasion of Ukraine. To varying degrees, this exposure reflects the relatively high-energy intensity of their economies, strong dependency by some on Russian gas and oil supplies, trade linkages with Russia and the provision of frontline assistance to people fleeing Ukraine. On 18 May 2022, the Commission proposed a REPowerEU plan, for which the RRF will be a key tool. The plan aims to phase out dependence on fossil fuels from Russia well before 2030 by diversifying the EU’s gas supplies and speeding up the green transition.

On 23 May 2022, the Commission also presented its European Semester spring 2022 package. Member States should primarily focus on the timely implementation of the RRPs. Therefore, the Commission proposes to the Council to address to all Member States with an approved RRP: i) a recommendation on fiscal policy, including fiscal-structural reforms where relevant; ii) a recommendation on the implementation of the RRP and the cohesion policy programmes; iii) a recommendation on energy policy in line with the objectives of REPowerEU; iv) where relevant, an additional recommendation on outstanding and/or newly emerging structural challenges. The scope of the recommendations is larger for Member States that do not have approved RRPs. The successive economic shocks triggered by the COVID-19 pandemic and Russia’s invasion of Ukraine have important implications for the convergence assessment presented in this report. In particular, the outbreak of the COVID-19 pandemic, the measures taken in response to that crisis, the surge in commodity prices, the supply bottlenecks and the robust recovery in 2021 have had a significant impact on some of the economic convergence indicators used in this report. This is especially the case for the assessment of the price stability criterion. Differences in inflation performance across the EU have increased mainly due to the heterogeneous impact of the recovery on Member States’ inflation rates and the differences in energy price inflation. In addition, national authorities have taken a range of fiscal and regulatory measures to cushion the impact of higher energy prices. While some of these measures, such as social transfers to most vulnerable households, do not have a direct impact on consumer prices, others have a more direct impact on the inflation convergence assessment. These include price caps in wholesale or retail energy markets, changes in indirect taxes on energy products, and subsidies on energy production and consumption. In addition, long-term interest rates were influenced, initially, by the policy measures taken to stabilise financial markets and preserve favourable financing conditions and, later, by higher inflation expectations and the differentiated paths of monetary tightening across Member States. The 2020 economic recession and the fiscal response to the COVID-19 pandemic led to a sharp increase in government deficits and debt. Government deficits in most Member States rose to above the 3% of GDP reference value of the Treaty. In 2021, government deficits and debt improved and fifteen Member States had deficits higher than 3% of GDP. In March 2020, the European Commission, with the agreement of the EU Ministers of Finance of the Member States, activated the general escape clause of the Stability and Growth Pact. On 23 May 2022, in its Communication on the 2022 European Semester spring package, the Commission considered that the Union was not yet out of a period of severe economic downturn and that the conditions to maintain the general escape clause in 2023 and to deactivate it as of 2024 were met. The Commission invited the Council to endorse this conclusion to provide clarity to Member States. In spring 2020, 2021 and 2022, the Commission considered that a decision on whether to place Member States under the Excessive Deficit Procedure should not be taken, taking into account the extraordinary macroeconomic and fiscal impact of the COVID-19 pandemic that, together with the geopolitical situation in spring 2022, create exceptional uncertainty, including for designing a detailed path for fiscal policy (). These conclusions have straightforward implications for the assessment of the criterion on the government budgetary position presented in this report. The impact of Russia’s invasion of Ukraine on the historical data used in the 2022 Convergence Report is limited. This is a consequence of the cut-off date of the report (18 May 2022), which together with the Treaty-defined calculation methods of the price stability and long-term interest rate criteria (i.e. one year averages), mean that the corresponding data largely reflect the situation prior to Russia’s invasion. Instead, the extent to which the economic convergence indicators are affected by the crisis triggered by Russia’s invasion as well as other ongoing economic developments is fully captured in the economic projections for 2022 and 2023, namely the Commission services’ Spring 2022 Forecast, which are used to assess the sustainability of convergence. The forward-looking elements of this report are based on inputs from the Commission Spring 2022 Forecast, which was published on 16 May 2022. This forecast is the first comprehensive assessment from the Commission of the likely economic effects in 2022 and 2023 of the crisis triggered by Russia’s invasion of Ukraine, and as such, it is surrounded by higher than usual uncertainty (). The remainder of the first chapter presents the methodology used for the application of the assessment criteria. Chapters 2 to 8 examine, on a country-by-country basis, the fulfilment of the convergence criteria and other requirements in the order in which they appear in Article 140(1) (see Box 1.1). The cut-off date for the statistical data included in this Convergence Report was 18 May 2022. 1.2.Application of the criteria In accordance with Article 140(1) of the Treaty, the Convergence Reports shall examine the compatibility of national legislation with Articles 130 and 131 of the Treaty and the Statute of the European System of Central Banks (ESCB) and of the European Central Bank. The reports shall also examine the achievement of a high degree of sustainable convergence by reference to the fulfilment of the four convergence criteria dealing with price stability, public finances, exchange rate stability and long term interest rates as well as some additional factors. The four convergence criteria are developed further in a Protocol annexed to the Treaty (Protocol No 13 on the convergence criteria). 1.2.1.Compatibility of legislation In accordance with Article 140(1) of the Treaty, the legal examination includes an assessment of compatibility between a Member State’s legislation, including the statute of its national central bank, and Article 130 and 131 of the Treaty. This assessment mainly covers three areas. ·First, the independence of the national central bank and of the members of its decision-making bodies, as laid down in Article 130, must be assessed. This assessment covers all issues linked to a national central bank's institutional, financial independence and to the personal independence of the members of its decision-making bodies. ·Second, in accordance with Articles 123 and 124 of the Treaty, the compliance of the national legislation is verified against the prohibition of monetary financing and privileged access. The prohibition of monetary financing is laid down in Article 123(1) of the Treaty, which prohibits overdraft facilities or any other type of credit facility with the ECB or the central banks of Member States in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States; and the purchase directly from these public sector entities by the ECB or central banks of debt instruments. As regards the prohibition on privileged access as set out in Article 124, the central banks, as public authorities, may not take measures granting privileged access by the public sector to financial institutions if such measures are not based on prudential considerations. ·Third, in accordance with Article 131, the integration of the national central bank into the ESCB has to be examined, in order to ensure that at the latest by the moment of euro adoption, the objectives of the national central bank are compatible with the objectives of the ESCB as formulated in Article 127 of the Treaty. The national provisions on the tasks of the national central bank are assessed against the relevant rules of the Treaty and the ESCB/ECB Statute. 1.2.2.Price stability The price stability criterion is defined in the first indent of Article 140(1) of the Treaty: “the achievement of a high degree of price stability; this will be apparent from a rate of inflation which is close to that of, at most, the three best performing Member States in terms of price stability”. Article 1 of the Protocol on the convergence criteria further stipulates that “the criterion on price stability […] shall mean that a Member State has a price performance that is sustainable and an average rate of inflation, observed over a period of one year before the examination, that does not exceed by more than 1.5 percentage points that of, at most, the three best performing Member States in terms of price stability. Inflation shall be measured by means of the consumer price index on a comparable basis, taking into account differences in national definitions”. Since national consumer price indices (CPIs) diverge substantially in terms of concepts, methods and practices, they do not constitute the appropriate means to meet the Treaty requirement that inflation must be measured on a comparable basis. To this end, the Council adopted on (Continued on the next page)

Box (continued) (Continued on the next page) Box (continued) 23 October 1995 a framework regulation () setting the legal basis for the establishment of a harmonised methodology for compiling consumer price indices in the Member States. This process resulted in the production of the Harmonised Indices of Consumer Prices (HICPs), which are used for assessing the fulfilment of the price stability criterion. As has been the case in past convergence reports, a Member State’s average rate of inflation is measured by the percentage change in the arithmetic average of the last 12 monthly indices relative to the arithmetic average of the 12 monthly indices of the previous period. The reference value is calculated as the arithmetic average of the average rate of inflation of the three 'best-performing EU Member States in terms of price stability' plus 1.5 percentage points (see Box 1.2). Accordingly, the reference value is currently 4.9%, based on the data of France (3.2%), Finland (3.3%) and Greece (3.6%) over the 12-month period covering May 2021-April 2022. Malta and Portugal were identified as outliers, as their inflation rates deviated by a wide margin from the euro area average reflecting country-specific economic circumstances (see Box 1.2). The Protocol on the convergence criteria not only requires Member States to have achieved a high degree of price stability but also calls for a price performance that is sustainable. The requirement of sustainability aims at ensuring that the degree of price stability and inflation convergence achieved in previous years will be maintained after adoption of the euro. This deserves particular attention as sustained divergences in price developments in one or more euro area Member States can lead to the emergence of competitiveness losses that must be corrected via painful adjustment processes and can trigger negative spillover effects on other Member States. Inflation sustainability implies that the satisfactory inflation performance must essentially be due to the adequate behaviour of input costs and other factors influencing price developments in a structural manner, rather than reflecting the influence of cyclical or temporary factors. Therefore, this Technical Annex also takes account of the role of the macroeconomic situation and cyclical position in the inflation performance, of developments in unit labour costs as a result of trends in labour productivity and nominal compensation per head, and of developments in import prices to assess how external price developments have impacted on domestic inflation. Similarly, the impact of administered prices and indirect taxes on headline inflation is also considered. From a forward-looking perspective, the report includes an assessment of medium-term prospects for price developments. The analysis of factors that have an impact on the inflation outlook – cyclical conditions, labour market developments and credit growth – is complemented by a reference to the most recent Commission services’ forecast of inflation. That forecast can subsequently be used to assess whether the Member State is likely to meet the reference value also in the months ahead (). Medium-term inflation prospects are also assessed by reference to the economies' key structural characteristics, including the functioning of the labour and product markets. 1.2.3.Public finances The convergence criterion dealing with the government budgetary position is defined in the second indent of Article 140(1) of the Treaty as “the sustainability of the government financial position; this will be apparent from having achieved a government budgetary position without a deficit that is excessive as determined in accordance with Article 126(6)”. Furthermore, Article 2 of the Protocol on the convergence criteria states that this criterion means that “at the time of the examination the Member State is not the subject of a Council decision under Article 126(6) of the said Treaty that an excessive deficit exists”. The convergence assessment in the budgetary area is thus directly linked to the excessive deficit procedure which is specified in Article 126 of the Treaty and further clarified in the Stability and Growth Pact (see Box 1.3 for further information on the excessive deficit procedure as strengthened by the 2011 reform of the Stability and Growth Pact). The details of the excessive deficit procedure are defined in Regulation 1467/97 as amended in 2005 and 2011 which sets out the way in which government deficit and debt levels are assessed to determine whether an excessive deficit exists, under Article 126 of TFEU. The convergence assessment in the budgetary area is therefore judged by whether the Member State is subject to a Council decision under 126(6) on the existence of an excessive deficit (). On 23 May 2022, the Commission adopted a report under Article 126(3) of the TFEU for 18 Member States, including for Bulgaria, Czechia, Hungary and Poland (). Overall, taking into account all relevant factors as appropriate, the analysis in the report suggests that the deficit criterion as defined in the Treaty and in Regulation (EC) No 1467/1997 is not fulfilled by Bulgaria, Czechia, Hungary and Poland. Taking into account all relevant factors, the analysis also suggests that the debt criterion as defined in the Treaty and in Regulation (EC) No 1467/1997 is not fulfilled by Hungary. The Commission considered, within its assessment of all relevant factors, that compliance with the debt reduction benchmark could imply a too demanding frontloaded fiscal effort that risks to jeopardise growth. Therefore, in the view of the Commission, compliance with the debt reduction benchmark is not warranted under the current exceptional economic conditions. In its conclusions, the Commission noted that the COVID-19 pandemic continues to have an extraordinary macroeconomic and fiscal impact that, together with the invasion of Ukraine by Russia, creates exceptional uncertainty, including for designing a detailed path for fiscal policy. On these grounds, the Commission considered that a decision on whether to place Member States under the EDP should not be taken in spring 2022. While Romania had become subject to an Excessive Deficit Procedure (EDP) due to the planned non-compliance with the deficit criterion in 2019, the Commission has not proposed to open other Excessive Deficit Procedures since the outbreak of the COVID-19 pandemic. In the context of the European Semester, the fiscal recommendations for 2022 and 2023 were consistent with the principles of cross-country differentiation, while also taking into account the quality of public finances (see Box 1.4). (Continued on the next page) Box (continued)

(Continued on the next page) Box (continued) 1.2.4.Exchange rate stability The Treaty refers to the exchange rate criterion in the third indent of Article 140(1) as “the observance of the normal fluctuation margins provided for by the exchange-rate mechanism of the European Monetary System, for at least two years, without devaluing against the euro”. Article 3 of the Protocol on the convergence criteria stipulates: “The criterion on participation in the exchange rate mechanism of the European Monetary System […] shall mean that a Member State has respected the normal fluctuation margins provided for by the exchange-rate mechanism of the European Monetary System without severe tensions for at least the last two years before the examination. In particular, the Member State shall not have devalued its currency’s bilateral central rate against the euro on its own initiative for the same period” (). Based on the Council Resolution (Continued on the next page) Box (continued) on the establishment of the ERM II (), the European Monetary System has been replaced by the Exchange Rate Mechanism II upon the introduction of the euro, and the euro has become the centre of the mechanism. In its assessment of the exchange rate stability criterion, the Commission takes into account developments in auxiliary indicators such as foreign reserve developments and short-term interest rates, as well as the role of policy measures, including foreign exchange interventions, and international financial assistance wherever relevant, in maintaining exchange rate stability. The assessment of this criterion verifies the participation in ERM II and examines exchange rate behaviour within the mechanism. Currently two of the Member States assessed in this Convergence Report, namely Bulgaria and Croatia, participate in ERM II (see Box 1.5 for further information on ERM II participation). The relevant period for assessing exchange rate stability in this Technical Annex is 19 May 2020 to 18 May 2022. 1.2.5.Long-term interest rates The fourth indent of Article 140(1) of the Treaty requires that “the durability of convergence achieved by the Member State with a derogation and of its participation in the exchange rate mechanism” is “reflected in the long-term interest rate levels”. Article 4 of the Protocol on the convergence criteria further stipulates that “the criterion on the convergence of interest rates […] shall mean that, observed over a period of one year before the examination, a Member State has had an average nominal long-term interest rate that does not exceed by more than two percentage points that of, at most, the three best performing Member

States in terms of price stability. Interest rates shall be measured on the basis of long-term government bonds or comparable securities, taking into account differences in national definitions” (see Box 1.6). For the assessment of the criterion on the convergence of interest rates, yields on benchmark long-term bonds have been taken, using an average rate over the latest 12 months. The reference value for April 2022 is calculated as the simple average of the average long-term interest rates in France (0.3%), Finland (0.2%) and Greece (1.4%) plus 2 percentage points, yielding a reference value of 2.6%. 1.2.6.Additional factors Article 140(1) TFEU also requires that the reports take into account other factors relevant to economic integration and convergence. These additional factors include financial, product and labour market integration and the development of the balance of payments. The analysis of the development of unit labour costs and other price indices, which is also prescribed by Article 140 of the Treaty, is covered in the price stability section. The assessment of additional factors gives an important indication of a Member State's ability to integrate into the euro area without difficulties. As regards the balance of payments, the focus is on the situation and development of the external balance (). Market integration is assessed through (Continued on the next page) Box (continued) trade, foreign direct investment and a smooth functioning of the internal market. Moreover, progress in financial integration is examined, together with the main characteristics, structures and trends of the financial sector. Given that Member States which adopt the euro also participate in the banking union, developments in national banking sectors are specifically looked at as well. Starting with the 2012 Convergence Report, the convergence assessment is aligned with the broader European Semester approach which takes an integrated look at the economic policy challenges facing EMU in ensuring fiscal sustainability, competitiveness, financial market stability and economic growth. The section on additional factors makes reference to the surveillance of macroeconomic imbalances under the Macroeconomic Imbalance Procedure, which was adopted in December 2011 as one of the key elements of the legislative package (the "Six-Pack") to enhance the governance structures in EMU, and integrates its results into the assessment (see Box 1.7). 2.1.LEGAL COMPATIBILITY 2.1.1.Introduction The legal basis for the Bulgarska Narodna Banka (BNB – central bank of Bulgaria), the Law on the Bulgarian National Bank (the BNB Law) of 1997, has been amended since the 2020 Convergence Report. Bulgarian authorities have amended the BNB Law to remedy certain incompatibilities and imperfections highlighted in the Commission's 2020 Convergence Report (). In particular, it concerns issues flagged in previous convergence reports in the section on central bank independence and prohibition of monetary financing and privileged access. Other issues remain unresolved. Therefore, certain comments provided in the 2020 report are repeated also in this year's assessment. 2.1.2.Central Bank independence The Conflict of Interest Prevention and Ascertainment Act of 2008, which regarding the possibility to dismiss the Governor of the BNB had to be brought in line with Article 14.2 of the ESCB/ECB Statute, was fully repealed and replaced by the Act on Corruption Counteraction and Eviction of Illegally Acquired Property of 2018 (). Article 80(1) of the Act on Corruption Counteraction and Eviction of Illegally Acquired Property was supplemented and now explicitly provides that the ascertainment of a conflict of interest by an enforceable instrument shall be a ground for release from office, unless otherwise provided for in the Constitution or the Statute of the European System of Central Banks and of the European Central Bank. This provision is compatible with Article 14.2 of the ESCB/ECB Statute. Pursuant to Article 12(1) of the BNB Law, the Governor shall be elected by the National Assembly. The National Assembly has taken the view that it has the power to annul or amend its decisions, including decisions under Article 12(1) of the BNB Law. The National Assembly has substantiated this assertion by stating that pursuant to a Constitutional Court decision of 26 February 1993, the Bulgarian Constitution does not explicitly prohibit the National Assembly from amending or annulling its decisions. Such understanding would allow the dismissal of the Governor under conditions other than those mentioned in Article 14.2 of the ESCB/ECB Statute. It should be ensured that the Governor, when properly elected or appointed, may not be dismissed under conditions other than those mentioned in Article 14.2 of the ESCB/ECB Statute. Article 13(2) of the BNB Law foresees that the Governor of the BNB shall swear an oath before the Parliament. The content of the oath laid down in paragraph one of the same provision refers inter alia to abiding by law and to contribute to the performance of the functions of the BNB. Article 13(1) was amended to provide explicitly that upon taking office, the Governor, the Deputy Governors and the other three members of the Governing Council shall be sworn in to contribute to the independent performance of the functions entrusted to the Bank. However, the imperfection in this provision has only been partially solved. Since the Governor, the Deputy Governors and the other three members of the Governing Council are involved in the performance of ESCB-related tasks, any oath should make a clear reference to the central bank independence under Article 130 of the TFEU. The Governor of the BNB acts in dual capacity as a member of BNB’s decision-making bodies and of the relevant decision-making bodies of the ECB. Article 13 of the BNB Law needs to be adapted to reflect the status and the obligations and duties of the Governor of the BNB as member of the relevant decision-making bodies of the ECB. The oath as it stands is an imperfection and should be remedied.

Article 44(1) second sentence of the BNB Law refers to the public institutions and bodies not having the right to influence the BNB, the Governor and the members of the Governing Council. The wording should be further improved by referring to the wording of Article 130 of the TFEU, which states that public authorities may not seek to influence the members of national central banks’ decision-making bodies. Article 3 of the BNB Law providing that “in the formulation of the general outlines of the monetary policy, the BNB and the Council of Ministers shall inform each other” has been repealed. Thus, the incompatibility in the area of independence, with Article 130 of the TFEU and Article 7 of the ESCB/ECB has been solved. 2.1.3.Prohibition of monetary financing and privileged access Article 45(1) of the BNB Law provides that the BNB shall not extend credits and guarantees, including through purchase of debt instruments, to the Council of Ministers, municipalities, other government and municipal institutions, organisations and undertakings in the public sector, European Union institutions, bodies, offices or agencies, the central government, regional, local or other public authorities, other bodies governed by public law or public sector entities of EU Member States. The list of national entities referred to in Article 45(1) is an imperfection and should be amended with a view to including the national public entities mentioned in Article 123(1) of the TFEU and Article 21.1 of the ESCB/ECB Statute. Article 45(3) of the BNB Law provides that the BNB shall not purchase in the primary and secondary markets public debt instruments. This paragraph is inconsistent with Article 45(1) of the BNB Law and with Article 123 of the TFEU given the word ‘direct’ refers to the prohibition to purchase debt instruments on the primary market only. Purchases on the secondary market are not prohibited unless they qualify as a circumvention of the objective of Article 123 of the TFEU. For this reason, the wording ‘and secondary” in Article 45(3) should be removed. In addition, since the first paragraph of Article 45 of the BNB Law already covers the prohibition to buy directly debt instruments, i.e. on the primary market, the third paragraph’s content becomes redundant after adjustment. Pursuant to Article 45(2) in conjunction with Article 33(2) of the BNB Law, Article 45(1) of the BNB Law does not apply to the extension of credits to state-owned and municipal banks in emergency cases of liquidity risk that may affect the stability of the banking system. The scope of this exemption should be amended to be fully consistent with the wording of Article 123(2) of the TFEU and Article 21.3 of the ESCB/ECB Statute. 2.1.4.Integration in the ESCB Objectives The secondary objective of the BNB (Article 2(2) of the BNB Law) is compatible with the Treaty on the Functioning of the European Union. Article 2(1) of the BNB Law correctly reflects that the primary objective of the BNB is to maintain price stability. However, as from the day that Bulgaria adopts the euro, the latter will replace the national currency (lev) in accordance with Article 140 (3) of the TFEU. The reference to the wording ‘through ensuring the stability of the national currency’ will become obsolete as from that day. The incompatibilities in the BNB Law are linked to the following ESCB/ECB tasks: ·absence of a general reference to the BNB as an integral part of the ESCB (Article 1(1) of the BNB Law) and to its subordination to the ECB’s legal acts (Articles 16 (1) and (2) and 60 of the BNB Law); ·definition of monetary policy and monetary functions, operations and instruments of the ESCB (Articles 2(1) and (3), 16(4) and (5), 28, 29, 30, 31, 32, 33, 35, 38, 41 and 61 of the BNB Law); ·conduct of foreign exchange operations and the definition of foreign exchange rate policy (Articles 20(1), 28, 29, 30, 31, 32 of the BNB Law); ·right to authorise the issue of banknotes and the volume of coins (Articles 2(5), 16(9), 24 to 27 of the BNB Law); ·non-recognition of the role of the ECB in the field of international cooperation (Articles 5, 16(12) and 37(4) of the BNB Law); ·ECB's right to impose sanctions (Article 61, 62 of the BNB Law). There are also numerous imperfections regarding: ·non-recognition of the role of the ECB in the functioning of the payment systems (Articles 2(4) and 40(1) of the BNB Law); ·non-recognition of the role of the ECB and the EU in the collection of statistics (Article 4(1) and 42 of the BNB Law);

·non-recognition of the role of the ECB and of the Council in the appointment of the external auditor (Article 49(4) of the BNB Law); ·absence of an obligation to comply with the Eurosystem's regime for the financial reporting of NCB operations (Article 16(11), 46 and 49 of the BNB Law). Tasks 2.1.5.Assessment of compatibility The Commission welcomes the efforts of Bulgarian authorities to remedy the incompatibilities and imperfections in comparison to its previous 2020 Convergence Report. However, the BNB Law is not yet fully compatible with Article 131 of the TFEU as regards central bank independence, the prohibition of monetary financing and the integration in the ESCB at the time of euro adoption. 2.2.Price stability 2.2.1.Respect of the reference value The 12-month average inflation rate, which is used for the convergence assessment, was above the reference value at the time of the last convergence assessment of Bulgaria in 2020. It then decreased to a low of 0.5% in March 2021, after which it increased rapidly throughout the rest of 2021. In April 2022, the reference value was 4.9%, calculated as the average of the 12-month average inflation rates in France, Finland and Greece plus 1.5 percentage points. The corresponding inflation rate in Bulgaria was 5.9%, i.e. 1 percentage point above the reference value. The 12-month average inflation rate is projected to remain above the reference value in the months ahead. 2.2.2.Recent inflation developments The annual HICP inflation rate decreased from 1.3% in April 2020 to -0.3% in January 2021, then increased throughout 2021 and accelerated further to 12.1% in April 2022. The decline in the period April 2020 to January 2021 was mostly driven by deflation in unprocessed food prices and low inflation rates in processed food prices. Prices of meat and meat products fell after the price hike in 2019 that was caused by the African swine fever, contributing to lower food inflation. The acceleration of inflation in 2021 was due to contributions from all broad categories. Fuel prices had a contribution of 3.5 percentage points to the annual inflation in December 2021. Inflation rates in Bulgaria have exceeded those of the euro area over the past two years. Core inflation (measured as HICP inflation excluding energy and unprocessed food) was on a declining path since April 2020, arriving at 0.6% in August 2021. It then accelerated sharply as of September 2021 and reached 3.9% in December 2021. Core inflation remained above headline inflation for one year from April 2020 onwards and was then surpassed by overall HICP inflation due to energy price increases. Annual inflation in processed food was the most important determinant of core inflation dynamics. It decelerated from 4.9% in April 2020 to 1.3% in March 2021, and then gathered pace as of September 2021. The increase in processed food prices in Q4-2021 was driven by cost-push factors, such as higher prices of energy and agricultural production in this period. Annual average inflation in services decelerated in 2020 and 2021. Weaker seasonal demand for travel, food and accommodation services in the summer exercised a sizable downward pressure on services prices in 2020 and 2021. Price weakness in the sector of hotels and restaurants was also magnified by a downward adjustment in wages during the months of lockdown. Price dynamics in non-energy industrial goods had a negligible influence on overall inflation in 2020 and most of 2021. Towards the end of 2021, prices in this category also started to rise with contributions from higher energy and from intermediate input costs and import prices. 2.2.3.Underlying factors and sustainability of inflation Macroeconomic policy mix and growth developments Due to the adverse impact of the pandemic, real GDP contracted by 4.4% in 2020, and then recovered by 4.2% in 2021. Across demand components, economic activity in 2020 contracted mostly due to lower external demand and reduced private investment and consumption. Exports of goods rebounded quickly already in Q3-2020, while exports of services remained subdued also in 2021. Aggregate investment remained largely unchanged in 2020, despite the impulse from public investment, and then registered a sizable decline of 11% in 2021. The contraction in capital formation in 2021 was driven by high uncertainty, combined with reduced business activity in the sectors most affected by the pandemic. In Q2-2020, private consumption contracted sharply by 3.2% quarter-on-quarter with the introduction of social distancing measures in March 2020, and then swiftly regained ground in Q3-2020. The social distancing measures subsequently introduced in late 2020 and in 2021 were less strict and more selective. Combined with the businesses adjusting to operate in the new environment (e.g. introducing home delivery), this largely avoided repeated demand slumps. In 2021, private consumption expanded strongly by 8%, underpinned by positive wage dynamics, limited job losses, due to the swift introduction of job retention schemes, supported by the SURE instrument and REACT-EU, and relatively optimistic expectations about economic activity.

According to the Commission’s Spring 2022 Economic Forecast, economic growth is forecast to slow down to 2.1% in 2022, due to both slower expansion in domestic and external demand. GDP is then forecast to grow by 3.1% in 2023. In response to increased energy and other input costs and general high uncertainty, firms are set to postpone investments and new hires. The slump in private investment is forecast to be fully compensated by public investments, supported by the Recovery and Resilience Plan. The decreased hiring intensity is expected to lead to a stabilisation of the unemployment rate slightly below 5%. Private consumption growth is expected to decelerate markedly to 2.8% in 2022 and then increase marginally to 3% in 2023. The relative slow-down in consumer spending is linked to the expected strong price increases in 2022, which are set to erode real disposable income. The output gap is projected to narrow, but remain negative in 2022 and then turn slightly positive in 2023. In 2021, the fiscal stance () remained supportive at the same level as in 2020 (‑0.6% of GDP), based on the Commission’s Spring 2022 Economic Forecast. The fiscal stance is expected to become even more supportive in 2022 (-3.4% of GDP) due to the expenditures financed through the Recovery and Resilience Fund and other EU grants and temporary support to mitigate the impact of high energy prices on vulnerable households and firms (around 0.3% of GDP ()). The budgetary costs related to people fleeing the war in Ukraine is assumed at 0.11% of GDP. The no policy-change forecast for 2023 shows a further supportive stance (‑1.3% of GDP) thanks to the increasing expenditure financed by Recovery and Resilience Fund and other EU grants, despite the assumed phasing out of energy crisis measures. The BNB pursues its primary objective of price stability through an exchange rate anchor in the context of a currency board arrangement (CBA) with the lev pegged to the euro. The CBA serves as a key macroeconomic policy anchor. During the COVID-19 crisis, the sound public finances and a stable banking sector combined with the exchange rate stability, ensured by the currency board, allowed Bulgaria to finance itself at favourable interest rates. In March 2020, the Bulgarian National Bank introduced a package of measures in response to the COVID-19 crisis, amounting to BGN 9.3 billion to preserve the stability and improve the flexibility of the banking system. These measures included reducing the commercial banks’ foreign exposure by BGN 7 billion and full capitalisation of profits for BGN 1.6 billion, and both were discontinued at the beginning of 2022. In April 2020, the BNB approved a non-legislative moratorium on loan repayments, in line with the Guidelines of the European Banking Authority (EBA/GL/2020/02) until end-2020. This measure expired at the end of 2021, with a total of BGN 8.1 billion of loans deferred under the arrangement. The central bank also agreed with the ECB in April 2020 to set up a precautionary currency agreement (swap line) to provide euro liquidity up to EUR 2 billion until end-2020. Given the uncertain economic outlook, the risks to the debt-service capacity of borrowers, and the quality of banks’ assets, the BNB decided in March 2022 to respond to the continued strong lending activity in the house-loan segment by increasing the countercyclical capital buffer rate applicable to domestic credit risk exposures from 0.5% to 1.0% from October 2022 and to 1.5% in effect from the beginning of 2023. Wages and labour costs At the onset of the COVID-19 pandemic employment quickly adjusted downwards in the sectors most affected by the domestic and external demand slump — manufacturing, trade, transport, hotels and restaurants and other services. Nevertheless, the number of persons employed fell by less compared to the economic activity in these sectors. On aggregate, gross value added declined by 6.6% quarter-on-quarter in Q2-2020, while the number of persons employed fell by 2.2% in the same period. Further job losses in the subsequent periods were prevented by the quick rebound in manufacturing production, the relaxation of containment measures and swift introduction of subsidised short-time work schemes. The recovery in employment levels continued in 2021 across all sectors. On average for 2020, the number of employed dropped by 2.3% and then grew by 0.2% in 2021. Nominal compensation per employee in the most affected sectors contracted sizably in Q2-2020, reflecting to a large extent the reduction in hours worked (). In the following periods aggregate wage growth resumed its upward trend, in line with the stabilisation and partial recovery of the labour market situation. On aggregate, compensation per employee grew by 7.2% in 2020 and 9.5% in 2021, broadly in line with the pre-crisis trend. Labour productivity dropped by 4.5% in Q2-2020 as a result of labour hoarding in the sectors most affected by the COVID-19 crisis. It then recovered to pre-pandemic levels at the beginning of 2021. Overall, aggregate labour productivity declined by 2.1% in 2020 and then rebounded by 4% in 2021. The aggregate numbers, however, obscure diverging trends. Productivity in manufacturing exhibited a strong rebound already in 2020, while in the retail and wholesale trade, catering and accommodation services productivity is still on a declining path. The dynamics in nominal unit labour cost (ULC) have been strongly influenced by fluctuations in labour productivity. Wages resumed their steady growth after the contraction at the onset of the COVID-19 crisis in Q2-2020, which was driven by wage cuts in the private sector. In particular, nominal ULC went up by 5.8% quarter-on-quarter in Q2-2020 and then returned to trend growth rates, typical for the pre-crisis period. On average, ULC increased by 9.5% in 2020 and then by 5.4% in 2021. According to the Commission’s Spring 2022 Economic Forecast, ULC is expected to increase by 7.7% in 2022 and 4.8% in 2023. External factors Given the high import component of aggregate demand, imported inflation plays an important role in domestic price formation. Import prices of mineral fuels, food and other manufactured goods and materials are particularly relevant for inflation in Bulgaria. Since mid-2021, the prices for electricity on the unregulated domestic market have increased four-fold, following the regional and global price increase. In 2021, the domestic ‘Day ahead’ market became more tightly linked to the EU electricity market, as its trading platform was integrated with the ones in Greece and Romania. The lev’s nominal effective exchange rate, which is determined by the price of the lev vis-à-vis the currencies of 36 major trade partners, appreciated by 2.8% in 2020 and 2.7% in 2021. The appreciation at the end of 2021 was strongly influenced by the depreciation of the Turkish lira against the euro. Turkey is the most important trading partner for Bulgaria outside the EU, accounting for 6.1% of total exports and 7.8% of total imports in 2021. Administered prices and taxes The share of administered prices in the HICP basket is relatively high at around 17%, compared to 13% in the euro area. Regulated prices of electricity, heat and water follow a seasonal pattern, as they are usually updated at the beginning of the year or in the summer months. Administered price inflation accelerated from 1.7% in 2020 to 2.4% in 2021 on the back of increasing energy prices. The National Assembly imposed a moratorium on future increases in the price for electricity, central heating and water supply in December 2021. The moratorium expired at the end of March 2022. Meanwhile, the government introduced support programmes for firms, public utilities and household gas consumers. Without the moratorium, the energy regulator had envisaged a 12% increase in the electricity price. Administered price inflation surpassed overall HICP in 2020 and then went below headline consumer price inflation in 2021. Changes in indirect taxes had a negative effect on inflation in 2020 and 2021. As a response to the pandemic and the containment measures, VAT on hotels, restaurants and other tourist services, as well as the sale of books and other items was temporarily reduced as of mid-2020. Annual constant-tax HICP was thus 0.3 of a percentage point and 0.4 of a percentage point above headline inflation in 2020 and 2021, respectively. The measures were still in place in 2021, which explains the persistence in the inflation differential in 2021 through the carry-over effect from 2020. In the euro area, annual constant-tax HICP also exceeded the headline inflation by 0.3 of a percentage point in 2020, but then fell below overall inflation by -0.2 of a percentage point in 2021. Medium-term prospects Looking forward, annual HICP inflation is expected to accelerate significantly in 2022 on the back of persistently high costs of energy and other intermediate products, expected increases in regulated gas and heating prices, as well as higher international food prices and growing import deflators. In 2023, inflation is forecast to abate relative to the previous year, but to remain somewhat elevated at 5.0%, due to the lagged indirect effect of high energy cost on final goods and services prices. In the context of the weaker expected labour market pressures, the second-round effects via a wage-price spiral are projected to be limited. In parallel to the introduction of the moratorium on prices of utilities between 15 December 2021 and 31 March 2022, the government introduced support programmes for firms, public utilities suppliers and household gas consumers that have so far mitigated the impact of sharp increases in energy prices. The discontinuation of natural gas supplies by Gazprom in late April is expected to be compensated through alternative sources, leading to a one-off increase in gas prices. The level of consumer prices in Bulgaria stood at about 55% of the euro area average in 2020. This suggests that there is a significant potential for price level convergence in the long term, as GDP per capita in PPS (about 55% of the euro-area average in 2021) increases towards the euro-area average. Medium-term inflation prospects will depend on wage and productivity developments as well as on the functioning of product and services markets. These developments may be substantially affected by the cyclical position of the economy. The sizable inflows of EU funds, including the RRF funding, could bring the economic output above potential. In that context, an important aspect to minimise the overheating pressures and maximise long-term productivity gains is ensuring that public investments effectively expand the production capacity of the economy in the medium term. This could be done via investments in physical and human capital and reforms to improve the functioning of product and labour markets, so that demand increase is matched by positive supply side reactions. 2.3.Public finances 2.3.1.Recent fiscal developments

After a period of budget surpluses, the general government balances recorded deficits of 4.0% and 4.1% of GDP in 2020 and 2021, respectively, as the Bulgarian government took measures to respond to the pandemic-induced shock. Measures like those raising or preserving remuneration in the public and private sector sustained income taxes and revenues from social contributions. However, the reduced economic activity led to a decline in receipts from taxes on production and imports, while sales starkly declined too. As a result, total revenue decreased by around 1.3% and by 0.3 percentage points as a percentage of GDP. By contrast, the expenditure-to-GDP ratio increased by 5.7 percentage points during the same period as the government introduced emergency measures like higher wage bonuses for medical staff, subsidies to corporations, pension top-ups and the purchase of medical equipment. In 2021, revenues largely recovered, thanks to higher receipts from higher taxes on production and imports, income and wealth taxes, and the upswing in sales. Overall, total public revenue as a percentage of GDP increased by 0.9 of a percentage point from 2020 to 2021, slightly lowered by the recovery of GDP. Emergency measures remained largely in place, leading to a further 1.1 percentage point in the expenditure-to-GDP ratio. Bulgaria entered the crisis with a strong fiscal position, as reflected by budget surpluses in previous years and a low debt-to-GDP ratio of 20% in 2019. The primary deficits in 2020 and 2021 translated into a rising debt-to-GDP ratio, reaching 25.1% in 2021, which had already increased to 24.7% in 2020. A positive snowball effect of 0.6% of GDP on gross public debt contributed to the rise in 2020. However, given Bulgaria’s strong commitment towards sound fiscal policy, a negatively turning interest rate-growth differential and the expected gradual phase-out of emergency measures, the government debt-to-GDP ratio is set to stay below 26% in the medium-term. 2.3.2.Medium-term prospects The elections held at the end of 2021, and the subsequent protracted government formation, delayed the usual adoption of the 2022 budget, which the National Assembly adopted on 25 February 2022. The budget includes, among others, the gradual increase in the excise duty on tobacco and toll taxes, increases in the minimum wage, and changes in pension policy parameters. While initially Bulgaria’s budget balance was expected to largely improve due to the gradual phasing-out of pandemic-related measures from 4.3% in 2021 to 1.8% of GDP in 2022, the worsened economic outlook due to Russia’s invasion of Ukraine and rising energy costs impede the deficit recovery. Key emergency support measures that remain in place to fight the pandemic include the provision of vaccines and medical products, pension top-ups, and business support schemes. As a consequence of Russia’s invasion of Ukraine, the Bulgarian government has introduced new measures like the evacuations of Bulgarian nationals residing in Ukraine and the provision of humanitarian aid (e.g. providing accommodation and daily allowances for up to three months upon arrival) to Ukrainian refugees arriving in Bulgaria. According to Commission estimations, the related total costs of the flow of refugees, due to the Russian military aggression in Ukraine, amount to 0.11% and 0.16% of GDP in 2022 and 2023. On 29 April 2022, Bulgaria submitted its 2022 Convergence Programme. According to the Programme, the headline deficit is projected to increase to 5.3% of GDP in 2022 and 2.9% in 2023. The Commission’s Spring 2022 Economic Forecast, which is based on a no-policy change assumption, forecasts a general government deficit of around 3.7% of GDP in 2022. The projected government deficit is lower than the planned deficit in the Convergence Programme due to different underlying macroeconomic assumptions, including the inflow of people fleeing the war in Ukraine and the associated costs, higher growth in revenues from taxes on production and imports as well as a smaller increase in intermediate consumption. The Commission projects the general government deficit to further decrease to around 2.4% of GDP in 2023, as the costs of both COVID-19 and energy price measures are set to phase out. In 2022, the fiscal stance is projected in the Commission’s Spring 2022 Economic Forecast to continue to be supportive, at -3.4% of GDP (). The positive contribution to economic activity of expenditure financed by the Recovery and Resilience Facility grants and other EU funds is projected to increase by1.1 percentage points of GDP in 2022, compared to 2021. Nationally financed investment is projected to provide as well an expansionary contribution to the fiscal stance in 2022 by 1.1 percentage points of GDP. At the same time, the growth in nationally financed primary current expenditure (net of discretionary revenue measures) in 2022 is projected to provide an expansionary contribution of -1.4 percentage points to the overall fiscal stance, as current expenditure is set to grow at a faster pace than medium-term potential growth. However, some of this expansion is due to measures related to the energy crisis (-0.2 of a percentage point) and the assistance to those fleeing Ukraine (-0.1 of a percentage point). In 2023, the fiscal stance is projected at -1.3% of GDP. The additional positive contribution to economic activity of expenditure financed by Recovery and Resilience Facility grants and other EU funds is projected to increase by 0.7 of a percentage point of GDP, compared to 2022. Nationally financed investment is projected to be expansionary too by 0.2 percentage points of GDP (). The growth in nationally financed primary current expenditure is projected to provide an expansionary contribution of -0.5 of a percentage point to the overall fiscal stance in 2023. This includes the impact from the phasing out of the measures addressing the increased energy prices (0.82% of GDP). The deficit is set to fall below the Treaty threshold of 3% in 2023. While the global economic outlook remains uncertain, the positive impact of investments financed through the Recovery and Resilience Fund, as well as the continued phasing out of COVID-19 and energy price measures, improve the deficit to 2.4% of GDP. The government debt-to-GDP ratio is forecast to increase slightly to 25.6% due to the persistent primary deficits, but cushioned by economic growth. Debt sustainability risks appear medium over the medium term. Government debt is projected to increase, reaching around 37% of GDP in 2032. This projection assumes that the structural primary balance remains constant (except for the impact of ageing) at the forecast level for 2023 of -2.2% of GDP, hence below the 2019 level. The sensitivity to possible macro-fiscal shocks contributes to this assessment. While Bulgaria’s debt is projected to stay at a low level by 2032 under all deterministic scenarios, the stochastic projections point to a particularly large degree of uncertainty. Several factors mitigate risks, including the lengthening of debt maturity in recent years historically low borrowing costs and the expected positive impact on long-term growth of reforms under the Recovery and Resilience Plan. Risk-increasing factors include Bulgaria’s negative net international investment position, the substantial share of public debt in foreign currency and contingent liability risks stemming from the poor financial performance of some state-owned enterprises (). Bulgaria has developed a strong institutional setting. According to the Commission’s Fiscal Governance Database, with nine national fiscal rules in place at the general and subnational level, Bulgaria has the highest number of fiscal constraints in the EU, while also showing an improving track-record of compliance. The rules system, however, appears complex, not least because of using different accounting standards (both Maastricht-based and cash-based), which raises the need to streamline the process. In 2020, Bulgaria added additional flexibility in the form of escape clauses to four rules targeting the general government to enable the necessary fiscal adjustments in the face of the COVID shock (according to the Commission’s Fiscal Governance Database). Based on its broad remit, the Fiscal Council has gradually established a system for releasing its mandatory monitoring reports on the annual and medium-term fiscal plans and compliance with all the numerical rules laid down in the Public Finance Act. However, issues remain with respect to the management and planning of the government finances. The Ministry of Finance does not always seem to have enough information for the purposes of budgetary planning on the detailed content of major public expenditures. This together with the failure to produce fiscal projections in terms of the European System of National and Regional Accounts (ESA), and a systematic underestimation of budget projections raise the need to strengthen the capacity of the administration to plan, forecast and report on the general government budget in both accrual (ESA) and cash terms. 2.4.Exchange rate stability The Bulgarian lev joined the ERM II on 10 July 2020 and in parallel, the Bulgarian National Bank entered into a close cooperation with the ECB. After joining, Bulgaria committed to pursue a set of policy measures, the so-called post-entry commitments, to ensure that their participation in the mechanism is sustainable and achieves a high degree of economic convergence ahead of the euro adoption. The measures cover four policy areas: the non-banking financial sector, the insolvency framework, the anti-money laundering framework, and governance of state-owned enterprises. Bulgaria is currently working towards the completion of these post-commitments, in close liaison with the Commission, who monitors their progress. Bulgaria introduced its CBA on 1 July 1997, pegging the Bulgarian lev to the German mark and subsequently to the euro (at an exchange rate of 1.95583 BGN/EUR). Under the CBA, the BNB has to cover its monetary liabilities with foreign reserves fully. The BNB is obliged to exchange monetary liabilities and euro at the official exchange rate without any limit. Bulgaria's international reserves increased to around EUR 35 billion by the end of 2021, after having increased from EUR 25 billion at the beginning of 2020 to around EUR 31 billion at the end of the same year. International reserves increased in the course of 2021 mainly because of positive net currency inflows. The transfers of EU funds and the BNB’s net purchases of reserve currency from commercial banks account for most of the inflows. With the further increase in international reserves in 2021, their share as a percentage of GDP also increased to 51% from around 50% at the end of 2020. The BNB does not set monetary policy interest rates. The monetary policy of the euro area affects the domestic interest rate environment directly through the operation of Bulgaria's CBA. The BNB discontinued the production of short-term reference rates (e.g. SOFIBOR) as of 1 July 2018. Instead, the central bank publishes a base interest rate (BIR) based on the index LEONIA Plus (LEv OverNight Interest Average Plus), which is a reference rate of concluded and effected overnight deposit transactions in Bulgarian levs on the interbank market in Bulgaria. In June 2020, the BIR stood at -0.7%. Since then it has been very stable until the end of 2021, when the BIR exhibited more volatility. After an increase to -0.45% in December, it fell back to -0.6% in February 2022. As a result, bedside the short increase at the beginning of the year, the interest rate differential of the BIR to the 1-month Euribor rate has remained relatively stable at around -10 basis points -7 basis points in March 2022.

2.5.Long-term interest rates Long-term interest rates used for the convergence examination reflect the secondary market yield on a single benchmark Bulgarian government bond with a residual maturity of around 10 years. The Bulgarian 12-month moving average long-term interest rate relevant for the assessment of the Treaty criterion was below the reference value in the 2020 convergence assessment of Bulgaria. Since then the interest rates has been very low and very stable. It stood at 0.3% at the end of 2020 and edged down to 0.2% by the end of 2021. In April 2022, the reference value, given by the average of long-term interest rates in France, Finland and Greece plus 2 percentage points, stood at 2.6%. At the same time, the 12-month moving average of the yield on the Bulgarian benchmark bond stood at 0.5%, i.e. 2.1 percentage points below the reference value. The Bulgarian long-term interest rate has been very low and rather stable since the beginning of 2020, remaining within a band of 0.1-0.4%. There was only a brief peak in June-July, 2020, when the interest rate increased to 0.7%. The low long-term interest rates reflect the loose monetary policy in the euro area. The spread to German long-term benchmark rates has also remained broadly stable within a band of 0.4-0.8 of a basis point, with a brief episode above 100 basis points in mid-2020. At the beginning of 2022, Bulgarian long-term interest rate started to increase and reached 1.6% in April. The German long-term interest rate also increased, but by a slightly smaller amount, resulting in the spread breaking through the above-mentioned bounds to 0.9 of a basis point. 2.6.Additional factors The Treaty (Article 140 TFEU) calls for an examination of other factors relevant to economic integration and convergence that the Commission should take into account in its assessment. The assessment of the additional factors — including balance of payments developments, as well as product, labour and financial market integration — gives an indication of a Member State's ability to integrate into the euro area without difficulties. In November 2021, the Commission published its last Alert Mechanism Report (AMR 2022) under the Macroeconomic Imbalance Procedure (MIP – see also Box 1.7), which concluded that it was not necessary to carry out further in-depth analysis in the context of the MIP. In the past, vulnerabilities in the financial sector were coupled with high indebtedness and non-performing loans in the corporate sector. Consistent policy action and a favourable macroeconomic environment have reduced risks and vulnerabilities before the onset of the COVID-19 crisis. Taking into account the assessment in its 2020 In-Depth Review, the Commission concluded that Bulgaria was experiencing no imbalances. Notwithstanding the progress made, non-performing loans are still relatively high albeit declining in the segment of corporate loans granted by domestically owned banks. Increased vulnerabilities in the housing market stem from the higher, although still contained, risk for overvaluation. House prices accelerated to a growth rate of 8.7% in 2021. In parallel, mortgage growth increased rapidly to 16.5% in 2021, while as a percentage of GDP, mortgages remain low compared to the euro area. The European Systemic Risk Board has issued a warning to Bulgaria in February 2022 to address these risks, as it considers macroprudential polices only partially appropriate and sufficient. Based on similar concerns, the Bulgarian National Bank increased the countercyclical capital buffer in March 2022, from 0.5% to 1% as of 1 October 2022, and 1.5% in effect from the beginning of 2023. Bulgaria submitted its recovery and resilience plan on 15 October 2021. The Commission’s positive assessment on 7 April 2022 and the Council’s approval on 4 May, paved the way for the implementation of the Recovery and Resilience Plan and the disbursement of EUR 6.3 billion in grants () over the period 2022-2026, which is equivalent to 10.2% in 2019 GDP. Bulgaria’s plan includes an extensive set of mutually reinforcing reforms and investments (56 investments and 47 reforms) that contribute to effectively addressing all or a significant subset of the economic and social challenges outlined in the country-specific recommendations addressed to Bulgaria by the Council in the European Semester in 2019 and 2020. The plan will address key macro-economic challenges such as social inclusion, education and skills, healthcare, decarbonisation and digital transition and business environment. Key investments are included in renewable energy production, electricity storage and interconnection capacities, energy efficiency of buildings and in the digitalisation of public administration and digital skills. Key reforms include the introduction of a framework for coal phase-out, the liberalisation of the electricity market, a comprehensive educational reform, and a strengthening of the minimum income scheme. A significant number of reforms and investments are expected to reinforce the institutional framework. These include reforms to improve the functioning of the judiciary system and the anti-corruption bodies, to strengthen anti-money laundering and insolvency frameworks, public procurement, whistle-blower protection, regulation of lobbying, e-government and integrity of public servants. The plan devotes 58.9% of its total allocation to measures supporting climate objectives and 25.8% to the digital transition, all while respecting the do no significant harm principle. The implementation of the investments in the Bulgarian plan, along with other investments under NextGenerationEU, is estimated to raise Bulgaria’s GDP by 1.9% to 2.9% by 2026, of which 0.6% due to the positive spillover effects of the coordinated implementation of NextGenerationEU across Member States (Pfeiffer et al. 2021) (). This does not take into account the positive impact of structural reforms on growth. 2.6.1.Developments of the balance of payments Bulgaria’s external balance (i.e. the combined current and capital accounts) shrank, but remained positive at 1.5% and 0.3% of GDP in 2020 and 2021, respectively. The reduction was driven by the current account, which turned slightly negative in 2020 and 2021, from a surplus of 1.9% in 2019. Secondary income, which largely consists of remittances from abroad, fell roughly by 50% in 2020 and 2021 possibly due to the worsened economic situation of nationals residing abroad. In addition to the deterioration of the secondary income balance, the deterioration of the external position in 2020 was also caused by an abrupt contraction in exports of services, reflecting the imposed travel restrictions and the weaker external demand for tourist services. The trade balance became less negative than in the preceding years, as nominal imports contracted more than nominal exports on account of positive terms of trade effects. The higher share of mineral fuels in imports than in exports, combined with the 31% oil price drop in 2020, partially explains these terms of trade gains. In 2021, the external balance of services improved, but remained below 2019 levels as a share of GDP, as the recovery in tourism revenues was incomplete. The balance of goods deteriorated in 2021 as imports of goods increased faster than exports of goods. The recovery in economic activity and private consumption spurred growth in imports of intermediate, investment and consumer goods. Exports of goods also grew strongly in 2021 and benefitted from further gains in terms of trade. The capital account remained in surplus. The financial account, net of official reserves, deteriorated in 2020 and then improved in 2021. In March 2020, as part of a package of measures to preserve the stability of the banking system at the onset of the COVID-19 pandemic, the Bulgarian National Bank imposed a limit on commercial banks’ foreign exposures. These measures to increase the liquidity in the banking system resulted in a simultaneous net outflow of other investments and an increase in official reserves at the central bank. In 2021, the banking sector maintained high liquidity and capital adequacy ratios and improved profitability. This positive development led to renewed investment in other assets abroad by the foreign-owned banks, while official reserves kept growing, albeit less strongly. The net inflow of Foreign Direct Investment (FDI) remained positive with positive contributions from debt instruments in 2020 and from reinvested earnings in 2020 and 2021.

The negative net international investment position continued to shrink rapidly in 2020-2021. Net external liabilities consist mostly of FDI equity, which have been relatively stable as a share of GDP after the crisis of 2009. In 2020-2021, measures of competitiveness exhibited different dynamics depending on the deflator used. The rate of appreciation of the real effective exchange rate (REER) deflated by ULC, accelerated, as labour hoarding pushed up labour costs. () The appreciation in REER deflated by HICP has been more moderate, reflecting moderate price inflation until mid-2021. The swift acceleration of inflation at the end of 2021 has not caused real appreciation vis-à-vis the rest of the world, since inflation picked up globally, including in major trade partners. The swift rebound of exports following their decline in Q2-2020, caused by the global demand slump, indicates that exporting firms managed to maintain their export market share. The global hikes in prices of energy and other materials pose challenges to domestic producers to remain competitive, in addition to the problems caused by supply bottlenecks. So far, terms of trade developments have been favourable for exporters. The high energy intensity of the economy, however, bear some risks for the economic outlook. Firms are expected to respond to the cost-push shock by restricting nominal wage growth and postponing new hiring and investment decisions. This cost-saving strategy to maintain competitive position is set to be more prominent in manufacturing, while the services sector is expected to pass through higher costs to final consumers. Apart from the direct and indirect impact of the war on goods exports, Bulgarian firms are forecast to maintain market shares abroad. According to the Commission’s Spring 2022 Economic Forecast, the current account balance is expected to deteriorate further to -1.8% in 2022 and remain at that level in 2023. 2.6.2.Market integration The economy is well integrated with the euro area through trade and investment linkages. After a period of decline between 2017 and 2020, the ratio of trade openness rebounded to close to 64% in 2021, which is close to the peak of above 68% in 2017. Bulgaria thus remains a relatively open economy. Trade with the euro area was close to 29% of total trade in 2021. Outside the EU, Bulgaria's main trading partners are Turkey and Russia (especially for energy imports). Net FDI inflows increased, but remained relatively low at 4.5% of GDP in 2020 and 1.7% of GDP in 2021. The stock of FDI amounted to 75% of GDP in 2020 and 71% in 2021. The decline in 2021 is explained by the high nominal GDP growth. 26% of all FDI stock is directed to industry (excluding construction), 22% are invested in real estate, while the trade sector attracted 15% of total FDI stock. The business environment is generally not supportive of investment, and institutional quality remains a challenge. According to the World Bank's Worldwide Governance Indicators (2020), Bulgaria ranks low in voice and accountability, government effectiveness, rule of law and control of corruption compared with the average of the five euro area Member States with the lowest scores. () Bulgaria also ranks relatively low in the World Bank’s Ease of Doing Business indicator, where it maintained its rank of 61 between 2019 and 2020, but in a longer perspective the trend has been negative (). In addition, institutions remain among the least performing areas in the Global Competitiveness Index. In the Council Implementing Decision, approving the Recovery and Resilience Plan, the authorities have committed to a number of measures that address challenges identified in the Cooperation and Verification Mechanism (CVM), the Rule of Law Report, and also the recitals to the country-specific recommendations. This includes problems with the functioning of the judiciary, corruption and issues with the accountability and criminal liability of the Prosecutor General. For the latter, important elements are the introduction of necessary safeguards and guarantees for an independent investigation of the Prosecutor General and his deputies; possibility for a judicial review of a prosecutor’s decision not to open an investigation, and annual reporting by the Prosecutor General on investigations and convictions in corruption cases. Anti-corruption measures include the set-up of a new anti-corruption body with criminal investigation powers, introduction of legislative measures to protect whistle-blowers and to regulate lobbying activities, and the establishment of an integrity verification mechanism for civil servants occupying positions that have a high corruption risk. Labour and skills shortages as well as skills mismatches relative to labour market needs represent a significant barrier to business investment and limit productivity gains. The uptake of digital technologies is slow in both public and private sectors and Bulgaria ranks last among EU Member States in digital skills. There are measures in the Recovery and Resilience Plan focusing on improving the labour market relevance of the education and lifelong-learning systems, including targeting the development of digital skills, and more broadly on advancing digitalisation. This should also help to alleviate some of the labour market bottlenecks and to modernise the economy. The 4th Anti-money Laundering Directive imposed transposition by 26 June 2017. Bulgaria communicated to the Commission several adopted measures to transpose the Directive between April 2018 and November 2019. The Commission’s analysis of the communicated measures concluded that the Directive had been fully transposed. An assessment of the concrete implementation and effective application of the 4th Anti-money Laundering Directive in Bulgaria is at present ongoing. As regards the 5th Anti-money Laundering Directive, whose transposition deadline elapsed on 10 January 2020, Bulgaria has notified national transposition measures and declared the transposition to be complete. The Commission is at present completing its analysis of whether there are any potential completeness or conformity issues in the transposition or implementation of the Directive. The COVID-19 crisis has entailed employment losses and increased inactivity rates. More severe adverse outcomes have largely been avoided through the swift transition to short-time work schemes that were supported by the state. Unemployment increased in Q2-2020 and then broadly stabilised until the end of 2021. The COVID-19 crisis highlighted the existing social vulnerabilities, such as a high share of population at risk of poverty and social exclusion, high levels of inactivity in some population groups (e.g. NEETs, Roma), combined with regional disparities and skills mismatches. The high social inequalities weigh on the prospects for fair and inclusive growth. Demographic developments strongly affect the labour market, and may constrain future economic growth. The population has shrunk by around 10% for the past decade on account of both mortality due to ageing and emigration. Furthermore, the share of population in working age (15-64 year) is also on a declining path, coming down from 68.5% in 2010 to 63.9% in 2020. The financial sector in Bulgaria is smaller and less developed than in the euro area. Relative to GDP, assets managed by the financial sector are a quarter of that of the euro area. The financial sector has grown since 2016, but not at the same pace as in the euro area. Banking dominates the Bulgarian financial sector and makes up more than 53% of the financial sector’s assets. The central bank is the second largest holder of financial assets with a share of 26%, more than all non-banking financial intermediaries together. Although these shares are larger than in the euro area, they compare well with the five euro-area Member States with the smallest financial sectors. The insurance and the pension-fund sector in Bulgaria is much smaller than in the euro area, relative to GDP. However, the sector’s share of the total financial sector is comparable to that of the euro area. Since end-2016, the Bulgarian sector has increased its holdings of financial assets by 3.5 % of GDP, in the euro area it increased by 12.3 percentage points. Nevertheless, the financial position of the National Bureau of Bulgarian Motor Insurers has come into question due to delays in the claims handling process in one undertaking. This has led to monitoring by the international Council of Bureaux, which is still ongoing. Moreover, the introduction of the bonus-malus system has not progressed in the last two years. The investment-funds sector plays a very small role in the Bulgarian financial system, but its size is comparable to those of the five euro-area Member States with the smallest financial sectors.

As to the financing of the economy, Bulgaria has less developed credit and equity markets relative to GDP than countries in the euro area, and market financing (debt securities and listed shares) is relatively under developed. However, Bulgaria is still fully comparable to the five euro-area Member States with the smallest national capital markets. Loans are the dominant source of funding and make up 116% of GDP in 2020, compared to 240% of GDP in the euro area. Still, corporate debt surpasses the fundamental threshold, although the gap has been narrowing and the prudential benchmark is satisfied. () Equity and private-sector-debt markets are very small compared to those of the euro area and represent only 14% of GDP altogether. This compares to 83% for private-sector debt and 73% for listed stocks in the euro area. Government debt is significantly lower than in the euro area. In terms of share in the sum of liabilities, loans in Bulgaria are comparable to that of the euro area. For securities, the differences reflect the smaller share of market funding available in Bulgaria. Bulgaria's banking sector is well integrated into the euro-area financial sector, in particular through a high level of foreign ownership in the banking system. The share of foreign-owned institutions in total bank assets stood at 77% in 2020. Bank concentration, as measured by the market share of the five largest credit institutions in total assets, has increased significantly since 2016, and reached almost 67% in 2020. This is 14 percentage points above the euro area average in 2020. In parallel with the inclusion of the Bulgarian lev in the ERM II, the Bulgarian National Bank entered into a close cooperation with the ECB, effectively joining the Banking Union. As of 1 October 2020, Bulgaria joined the Single Resolution Mechanism, and the ECB became responsible for the direct supervision of the significant institutions in Bulgaria, as well as the oversight of less significant institutions. Although intra-EU integration in equity and debt markets, as measured by the home bias in portfolio investments, are in general relatively low across EU Member States, Bulgaria is commensurate to levels of integration of the average euro-area Member State in debt markets. () Moreover, integration in this market segment has improved markedly between 2016 and 2020. Concerning portfolio investments in equity, however, the home bias is very strong in Bulgaria relative to euro-area Member States. Almost all investments in equity markets take place domestically. 3.1.LEGAL COMPATIBILITY 3.1.1.Introduction The Česká národní banka (ČNB – Czech national bank, hereafter ČNB) was established on January 1, 1993. Its main legal basis is the Czech National Council Act No. 6/1993 Coll. on the Czech National Bank, adopted on 17 December 1992 (the ČNB Law). Following the Commission’s 2020 Convergence Report, the ČNB Law was amended (). However, since there have been no amendments as regards the incompatibilities highlighted in the Commission's 2020 Convergence Report, the comments made in the latter report are repeated also in this year's assessment. 3.1.2.Central Bank independence Article 9(1) of the ČNB Law prohibits the ČNB and its Board from taking instructions from the President of Czechia, Parliament, the Government, administrative authorities, European Union institutions, any government of a Member State of the European Union or any other body. Article 9(1) of the ČNB Law needs to be adapted to fully reflect the provisions of Article 130 of the TFEU and Article 7 of the Statute and consequently expressly prohibit third parties from giving instructions to the ČNB and its Board members who are involved in the performance of ESCB-related tasks. The power for the Chamber of Deputies of the Parliament to impose modifications to the annual financial report, which was previously submitted and rejected (Article 47(5) of the ČNB Law) could hamper the ČNB’s institutional independence. More