EUROPEAN COMMISSION Brussels, 27.2.2019 SWD(2019) 1001 final COMMISSION STAFF WORKING DOCUMENT Country Report Bulgaria 2019









Including an In-Depth Review on the prevention and correction of macroeconomic imbalances Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2019 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2019) 150 final}



Contents Executive summary 1.Economic situation and outlook 2.Progress with country-specific recommendations 3.Overall findings regarding imbalances, risks and adjustment issues 4.Reform priorities 4.1.Public finances and taxation 4.2.Financial sector 4.3.Labour market, education and social policies 4.4. Competitiveness reforms and investment Annex A: Overview Table Annex B: Commission Debt Sustainability Analysis and fiscal risks Annex C: Standard Tables Annex D: Investment Guidance on Cohesion Policy Funding 2021-2027 for Bulgaria References LIST OF Tables Table 1.1:Financial soundness indicators, all banks in Bulgaria Table 1.2:Key economic and financial indicators - Bulgaria

Table 2.1:Assessment of 2018 CSR implementation Table 3.1:MIP assessment matrix Table C.1:Financial market indicators Table C.2:Headline Social Scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth LIST OF Graphs Graph 1.1: Real GDP growth by demand components Graph 1.2: Potential growth breakdown Graph 1.3: Regional disparities Graph 1.4: Current account developments Graph 1.5: Net international investment position Graph 1.6: Labour market indicators Graph 1.7: Level of income inequality Graph 1.8: Non-performing Loans, share of total loans and advances— total, households and NFCs (1) Graph 1.9: Domestic credit growth - Households and NFCs Graph 1.10: Overvaluation gap with respect to price/income, price/rent and fundamental model valuation gaps (1)

Graph 2.1: Overall multiannual implementation of 2011- 2018 country-specific recommendations to date (1), (2), (3) Graph 4.1.1: Degree of progressivity of labour income taxation in EU Member States, 2017 Graph 4.1.2: Size of liabilities of State-owned enterprises by policy area (ministry) Graph 4.2.1: Fundamental-based and prudential benchmarks and NFC debt Graph 4.2.2: Breakdown of y-o-y changes in debt-to-GDP ratios of NFCs (1) Graph 4.3.1: Population pyramid Graph 4.3.2: Labour shortage index (1) Graph 4.3.3: Inactivity rates and shares of the inactive people Graph 4.3.4: Expenditure and participation in activation measures, 2017 and January-August 2018 Graph 4.3.5: At-risk-of-poverty or social exclusion rate and its components (AROP, SMD, LWI) Graph 4.3.6: At-risk-of-poverty or social exclusion by NUTS2, 2017 Graph 4.3.7: Early leavers from education and training by regions, 2017 Graph 4.4.1: Nominal unit labour costs Graph 4.4.2: Breakdown of rate of change of Unit Labour Costs Graph 4.4.3: Real effective exchange rate, Unit Labour Costs deflator (IC-37) Graph 4.4.4: BGN-denominated export price evolution Graph 4.4.5: Investment by sector Graph 4.4.6: Gross fixed capital formation Graph 4.4.7: World Bank Doing Business 2019 score Graph 4.4.8: Regional disparities

LIST OF Boxes Box 2.1: EU funds and programmes contribute to addressing structural challenges and to fostering growth and competitiveness in Bulgaria Box 4.3.1: Monitoring performance in light of the European Pillar of Social Rights Box 4.4.1: Investment challenges and reforms in Bulgaria Executive summary Bulgaria’s strong growth momentum and the soundness of government finances offer an opportunity to tackle its remaining structural challenges and raise growth potential. Levels of poverty, social exclusion and income inequality are still among the highest in the EU. As the population ages and skilled workers become progressively scarcer, adequately addressing these challenges and accelerating economic growth will increasingly depend on Bulgaria’s capacity to implement structural reforms. Investment in improving people's skills, in infrastructure and in research and innovation would support productivity and help Bulgaria catch up with the rest of the EU. This would also help to bolster the resilience and competitiveness of Bulgaria's open economy, especially given the increasing international risks. Building on past progress, the authorities have made further efforts to tackle the identified macroeconomic imbalances by strengthening financial supervision and taking steps to address financial sector vulnerabilities ( ). Economic growth remains robust and the labour market continues to perform well. Real Gross Domestic Product (GDP) (adjusted for inflation) grew by an estimated 3.2 % in 2018 and is expected to increase by 3.6 % in 2019 and 2020, driven by domestic demand. Real wage growth will continue to support consumer spending, while investment is increasingly spurred by EU funding. The unemployment rate (5.2 % in Q4-2018) stands below its pre-crisis level. Long-term unemployment has decreased and youth unemployment has fallen below the EU average. Despite its relatively good overall economic performance, Bulgaria has been slow to catch up with the rest of the EU. GDP per head, at 50 % of the EU average in 2017, has grown only slightly faster than the EU average since 2011. Potential GDP growth has strengthened over recent years. This has been driven mainly by improvements in total factor productivity( ) while the contributions of capital and labour have been modest. The growth potential may be hampered by negative demographic trends and the increasing scarcity of skilled workers, as well as by increasing regional disparities. Labour shortages and planned government wage increases are expected to drive wage growth above productivity growth until 2020, potentially leading to losses in Bulgaria's cost-competitiveness. Budgetary developments remain positive. The government achieved a budget surplus equivalent to 1.1 % of GDP in 2017 due to improved tax collection and higher-than-projected nominal (non-inflation-adjusted) growth. On the spending side, public investment started to recover and public sector wages increased. The supportive overall economic situation and a generally prudent approach to government finances are expected to lead to sustained budget surpluses until 2020. Investment in skills, social cohesion, infrastructure, and research and innovation is needed to support competitiveness, productivity and the process of catching up with the rest of the EU. Insufficient investment is holding back the modernisation of the economy. Bulgaria's considerable labour and skills shortages warrant investments in training and reskilling; addressing the lack of digital skills; improving the quality and inclusiveness of education and aligning it to the needs of the labour market; and improving the capacity of public employment services. Investments in transport, energy and water infrastructure will improve the conditions for attracting foreign direct investment and will strengthen companies’ competitiveness. More investment in research and development (R&D) is needed to boost productivity gains, as well as strengthened links between businesses and research institutions and a better integrated research and innovation system. Key priorities for support by the European Regional Development Fund, the European Social Fund Plus and the Cohesion Fund over 2021-2027 are identified in Annex D, building on the analysis of investment needs and challenges outlined in this report. Overall, Bulgaria has made some progress in addressing the 2018 country-specific recommendations. There has been substantial progress in: ·taking measures to follow up on the financial sector reviews; There has been some progress in: ·improving tax collection and public spending, including by stepping up enforcement of measures to reduce the extent of the informal economy; ·implementing supervisory action plans in the financial sector and ensuring adequate valuation of assets, including collateral held by banks; ·making disadvantaged groups more employable by strengthening measures to get them into work or training and improving their skills; ·providing quality and inclusive mainstream education (however, measures to address the particular situation of Roma and other disadvantaged groups are lagging behind).

There has been limited progress in: ·upgrading the governance framework for state-owned enterprises in line with international good practices; ·completing the reform of the insolvency framework and promoting a functioning secondary market for non-performing loans; ·improving access to health services, reducing 'out-of-pocket' payments and addressing shortages of health professionals; ·introducing a transparent scheme to revise the minimum income and improving its coverage and adequacy. Regarding progress towards its national targets under the Europe 2020 strategy, Bulgaria is expected to achieve its target for reducing greenhouse gas emissions and increasing the share of renewable energy. It has taken measures to improve energy efficiency but energy consumption remained above the indicative national targets. Bulgaria has made progress on employment, early school leaving and tertiary education rates, but has yet to meet its targets. The situation has worsened regarding poverty reduction. There was no progress towards the R&D intensity target. Bulgaria faces challenges on a number of indicators of the Social Scoreboard supporting the European Pillar of Social Rights. Bulgaria still has one of the highest shares of people living at risk of poverty or social exclusion, as well as high levels of income inequality. Social transfers have a low impact on poverty reduction. Major challenges for the education and training system remain, including providing quality inclusive education and tackling early school leaving. The population's level of digital skills remains very low. Despite improvements in the labour market, the low-skilled, the Roma and people with disabilities still face significant difficulties in finding work. The main findings of the in-depth review contained in this report and the related policy challenges are as follows: The banking sector has been strengthened overall, but some vulnerabilities remain. Banks have addressed the recommendations arising from the 2016 asset quality review, with one exception. New initiatives in 2018 included new rules for large exposures and the identification of connected clients; improved policies in several banks for making provisions for potential loan losses: an increase in the counter-cyclical capital buffer rate(); and macro-prudential() tools for borrower-based measures. Measures to be completed include addressing valuation issues, implementing regulatory initiatives and strengthening the framework for resolving banks in an orderly way. The reform of non-bank supervision has continued. Follow-up measures to the insurance and pension funds reviews are being implemented. Remaining steps include fully implementing an action plan to establish a proper risk-based, forward-looking supervisory process, and adequately following up on outstanding issues highlighted by the non-bank financial sector reviews, including valuation practices and group-level supervision. Concerns that have recently emerged in the car insurance sector also remain to be addressed. These include the rudimentary pricing model and the effectiveness of the National Bureau of Bulgarian Motor Insurers, as well as the lack of a harmonised methodology for compensations set by judges. The private sector is reducing its debt, but the level remains high. The high debt of non-financial corporations continues to present a challenge, although it has been decreasing over the last few years, partially due to robust nominal GDP growth. While slowing the reduction in private sector debt, the recent increase in lending activity could support higher investment and growth. Levels of non-performing loans have been falling, in part due to a recovery in credit flows and a more dynamic secondary market, but still remain well above the EU average. Deficiencies in the insolvency framework are slowing the reduction in private sector debt and the work-out of non-performing loans. The labour market has improved, supported by economic growth. The employment rate reached 71.3 % in 2017, the highest since Bulgaria joined the EU in 2007. Despite low take-up, better-targeted policies to help people into work or training are starting to yield results, supported by economic growth. Nonetheless, some groups (the low- skilled, young people, the Roma, people with disabilities) continue to face challenges. A shrinking working-age population as well as skills shortages and skills gaps continue to be of concern. Other key structural issues analysed in this report, which point to particular challenges for Bulgaria’s economy, are the following: The social protection system is insufficient to tackle the significant social issues. Wide income inequalities and the high number of people at risk of poverty point to the need for ‘active inclusion’ policies designed to enable every citizen to work and participate fully in society. These challenges also point to the need for targeted support to vulnerable groups, as well as better availability and quality of integrated social and healthcare services and housing. The adequacy and coverage of the minimum income remain limited and there is no objective mechanism for regularly updating it. The impact of taxes and benefits on reducing poverty and inequality is significantly lower than the EU average. This reflects the low level of social spending, the uneven availability of social services across the territory and the limited redistributive effects of the taxation system. The education system is being modernised at all levels but significant challenges remain. Persistently high rates of early school leaving and low educational outcomes highlight the need for significant investment in education. This is particularly relevant for addressing the challenges of quality and equality of opportunity in early childhood education and care, school education and vocational education and training. Despite ongoing efforts, higher education is insufficiently aligned with the needs of the jobs market. The rate of participation in adult learning is one of the lowest in the EU. Inclusion of Roma in education and the high impact of socio-economic status on educational outcomes remain problematic. Many Bulgarians still face significant obstacles in accessing healthcare. Public expenditure on healthcare remains very low, with formal and informal out-of-pocket payments() covering almost half of healthcare costs — one of the highest shares in the EU. The strategy for long-term care is under way, but implementation of the National Health Strategy action plan is considerably delayed. Public administration reform continues to be slow and is yielding insufficient improvements while the business environment remains weak. Institutional shortcomings, regulatory uncertainty and corruption remain among the main obstacles to investment. There has been little progress in the provision of public services and the perception of their quality remains low. Notwithstanding the generally good progress in programming and implementing EU funding, administrative capacity remains a challenge. The design and implementation of public policy, as well as capacity-building at all levels of public administration, would benefit from strengthening. The practical benefits of the ongoing reforms to public procurement are limited; aggregated purchases have advanced only at the central level and the uptake of electronic procurement has been delayed. On a positive note, the provision of digital public services for businesses has improved significantly and the introduction of e-government is advancing. The fight against corruption remains a challenge. In 2018, Bulgaria adopted a comprehensive reform of its anti-corruption legislation and established a new unified anti-corruption agency, but results have yet to be seen. Significant progress has been made towards reinforcing the independence of the judiciary. Still, a number of challenges remain, in particular to strengthen the accountability of the prosecution service and public trust in it, and to rebalance the workload among courts. In recent years, Bulgaria has been addressing deficiencies in its anti-money laundering framework, but a number of concerns remain. These include the effective transposition of the European Union’s legal framework and the use of financial information in the investigation and prosecution of financial crime and high-level corruption. State-owned enterprises suffer from weak corporate governance. The situation of state-owned enterprises reflects to some extent their management and supervision, as well as restructuring challenges. A reform of the corporate governance framework is being prepared, which would help to address current weaknesses.

1. Economic situation and outlook GDP growth The economy continued to grow robustly. Real GDP grew an estimated 3.2 % in 2018, driven by domestic demand. Rising real wages increased households' income and confidence, spurring private consumption. Both public and, to a lesser extent, private investment contributed to the GDP growth. Public consumption growth also increased, mainly reflecting higher spending on wages and intermediate consumption. The growth of exports slowed down due to one-off events and a decline in exports to Turkey, while the strong domestic supported high imports growth. Overall, foreign trade had a significant negative contribution to growth. Robust growth led to a positive output gap in 2018, which is projected to further expand in 2019 and 2020, to 0.6 % and 1.0 %, respectively. Graph 1.1:Real GDP growth by demand components Source: European Commission Wage growth and EU-funded investment are expected to continue to drive economic growth. Bulgaria’s growth momentum is expected to remain strong, mainly driven by solid domestic demand. Real wage growth will continue to stimulate private consumption. High demand, increased capacity utilisation and EU funding are set to boost investment, while imports should outpace exports, leading to a further reduction in the current account surplus. Overall, real GDP growth is expected to strengthen to 3.6 % % in 2019 as well as in 2020 (see Graph 1.1). Potential growth has benefited mostly from gains in total factor productivity. Potential GDP growth has strengthened in recent years, reaching above 3 % in 2017 (see Graph 1.2). It was driven by total factor productivity, which has constantly increased since 2014. The contribution of capital accumulation has shrunk over the last 10 years and reached its lowest level in 2016-2017, which coincided with the beginning of a new EU funding period (see Graph 1.2). Labour supply has made a relatively small contribution to potential growth and is expected to contribute even less in the medium to long term due to adverse demographics and the increasing scarcity of skilled workforce. Graph 1.2:Potential growth breakdown Source: European Commission Regional disparities Convergence with the EU has been slow. GDP per head has grown faster than the EU average since 2011, but it has reached only 50 % of the EU average in 2017. Regional disparities are growing and hampering the competitiveness of the country. Output and incomes across Bulgaria are very uneven, as shown by a coefficient of variation of 49 % in the 2016 GDP per capita. Moreover, five of Bulgaria's six planning regions are among the 20 poorest in the EU. Although it accounts for just 18.8 % of the population, the Sofia region generates nearly half of the country’s GDP (Graph 1.3). As a percentage of GDP, investment is below the EU average, with significant regional discrepancies. Sofia attracts more than half of non-financial foreign direct investment. Other major recipients of foreign direct investment are the larger urban centres, particularly in the south of the country, boosting the economic performance of these regions (NSI, 2018a). Labour productivity has been increasing steadily since 2008 (ECB, 2018b) but is still well below the EU average. It is particularly low (below 40 % of the EU average) in the three northern planning regions and in one region in the south. Graph 1.3:Regional disparities Source: European Commission The southern regions provide better conditions for doing business. There are considerable regional differences in economic output, socio-economic indicators as well as in unemployment and employment rates ( ). This likely reflects a concentration of investment and better infrastructure. The growing capital attracts skilled people to high value added sectors, while in the rest of the country gains in employment are concentrated in lower value added sectors, also in the context of outward migration (see section 4.3. and 4.4). Investment Investment is set to grow, mainly as a result of a public investment recovery. As of 2018, total investment seemed to be slowly recovering from its downward trend of the previous years. Public investment is increasing as more projects co-financed by the EU get underway and some national investment initiatives, e.g. in the transport sector, are being put into effect. Public investment is estimated to have increased by 57.8 % in 2018 and is expected to grow by around 20 % and 10 % in 2019 and 2020, respectively. Private investment, whose contribution to growth has been negative for several years, has also improved and is expected to continue increasing by around 4 % annually. External position The current account balance is positive though decreasing. It is estimated at around 3.6 % of GDP in 2018, significantly lower than its 2017 peak of 6.5 % of GDP (see Graph 1.4). This is mainly the result of a slowdown in export growth due to the strong base effect, some one-off events and a decline in exports to Turkey. At the same time, strong domestic demand spurred imports resulting in a negative contribution of net exports to GDP growth. This negative contribution is also set to decrease in 2019. Current account balance remains well above the deficit of 1.1% that the structure of the economy could warrant (current account norm) ( ). Graph 1.4:Current account developments Source: European Commission, 2018 data are estimates based on quarterly data The net international investment position (NIIP) continued to improve. In 2018, the NIIP improved a further 6.3 pp compared to end-2017 to reach -35.5 % of GDP. The structural improvement is mainly related to an increase in reserve assets, the reduction of bank liabilities to parent companies and higher holdings of foreign assets by domestic companies (mainly pension funds, but also banks). The less negative NIIP has also benefited from strengthening nominal growth and continuous current account surpluses, combined with a capital account surplus (see Graph 1.5). The NIIP, however, remains above the prudential level of 35.2 % of GDP indicating that further improvement could lead to safer levels of international debt ( ) .

Graph 1.5:Net international investment position Source: European Commission Inflation Inflation, mainly driven by oil prices, is expected to moderate in 2019 and 2020. Annual HICP inflation was 2.6 % in 2018. Price pressures increased due to a steep rise in oil prices, second round effects on food prices and increases in unprocessed food prices following a weak summer harvest. Administered prices also rose significantly over the same period. In the coming years, inflation is expected to decrease somewhat, to 2.0 % in 2019 and 1.8 % in 2020. The strong base effects from energy prices are expected to push down inflation growth, while an increase in core inflation due to a rise in real disposable income and household consumption will act in the opposite direction. Labour market, poverty and social exclusion Labour market conditions continue to improve alongside strong economic growth. The unemployment rate decreased for the fifth consecutive year (see Graph 1.6) and is now well below the EU average (5.3 % v 6.5 % in Q3-2018), while the employment rate reached a higher level than before the crisis (71.3 % in 2017 vs. 70.7 % in 2008). Despite these positive developments, adverse demographic trends and intensifying skills shortages pose an increasingly serious challenge to future growth. Graph 1.6:Labour market indicators Source: European Commission A tightening labour market is exerting upward pressure on wages. Nominal compensation per employee grew by 10.5 % in 2017 and are estimated to have further increased by 8 % in 2018. This is faster than developments in labour productivity, prices and the unemployment rate would predict. Wage discrepancies across regions and sectors are relatively high, depending on where labour shortages are more acute. Moreover, the shortage of professionals in key public policy domains, such as education and healthcare, is limiting the delivery of services. Some population groups are not fully integrated into the labour market. Despite the overall positive developments, structural challenges persist. In 2017, the long-term jobless still represented 55 % of the unemployed, while the rate of young people not in employment, education or training remains above the EU average (15.3 % v 10.9 %). There are also significant discrepancies between inactivity and employment rates depending on education levels and across regions. Those living in rural areas and small cities, the low-skilled and the Roma have lower levels of activity and employment. While the targeting of active labour market policies has improved, the level of resources allocated to training is still insufficient and the share of participants in activation measures remains very low. The rate of people living in poverty is still very high and income inequality is growing. Despite a slight decrease, the rate of poverty or social exclusion in 2017 was 38.9 %, well above the EU average of 22.5 % ( ) (see Graph 1.7). Income inequality has increased continuously in recent years, driven by a steady rise in earnings at the top end ( ) as well as a gradual erosion of the income share of the poorest households. In 2017, the income of the richest 20 % of population was over eight times higher than that of the poorest 20 %. Market outcomes were only slightly more unequal than in other EU countries, but the impact of taxes and benefits on reducing poverty and inequality is significantly lower in Bulgaria. This reflects the low level of social spending, the uneven availability of social services and the limited redistributive effects of the taxation system. Inequality of opportunities remains a key challenge. Children’s educational outcomes and poverty are highly correlated with the socio-economic background of their parents. The poverty rate for children of parents with low qualifications is 77.5 % compared to 3.1 % for parents with high qualifications. This divide is also reflected in the self-reported unmet need for medical care, which was 6.3 % for the poorest households compared to 0.9 % for the richest ones. Access to social services is characterised by large discrepancies between rural and urban areas and among regions. Moreover, the low quality of the services hampers the social inclusion of the most vulnerable groups. The family income in densely populated areas is 141 % of the average equalised disposable income for the country, while Roma families with children living in thinly populated areas are at only 36 % of the average income. Graph 1.7:Level of income inequality Source: European Commission Financial sector Economic growth helped the banking sector to further strengthen its capital and liquidity ratios. In September 2018 commercial banks’ total assets were 8.5 % up on the previous year. Funding appears relatively comfortable, driven mostly by a significant increase in deposits ( ), while the loan-to-deposit ratio declined to 72.7 % in June 2018. Both households and non-financial corporations continued to place deposits mainly in domestic currency, signalling a sustained confidence effect. Profitability remained relatively high in the first half of 2018, while capital positions were broadly stable. The total capital ratio marginally decreased from 22.2 % in June 2017 to 20.8 % in June 2018 (ECB, 2018c). Table 1.1:Financial soundness indicators, all banks in Bulgaria Source: European Central Bank, Consolidated Banking Data; European Commission calculations; annualised data Despite improvements, non-performing loans by non-financial corporations remain high. The overall ratio of non-performing loans declined to 9.2 % in June 2018 from 12.1 % a year earlier (see Graph 1.8). Non-performing loans by non-financial corporations also decreased but still topped 15.4 % of total loans and advances (v 19.9 % a year earlier). These levels are well above the EU averages in June 2018 of 3.4 % overall and 6.7 % for non-financial corporations. Progress with restructuring has been slow. In Q1-2018 the share of forborne loans, most of which are non-performing, decreased only slightly, to 5.6 % of total loans. Graph 1.8:Non-performing Loans, share of total loans and advances— total, households and NFCs (1) Source: European Central Bank Credit continued to expand at an elevated pace. In September 2018, credit to non-financial corporations grew by 7.6 % year-on-year, and that for households by 8.8 % (ECB, 2018d) (see Graph 1.9). Housing loans also accelerated. They grew by 11.6 % year-on-year, driven by the improved economic environment and increases in household income. Graph 1.9:Domestic credit growth - Households and NFCs Based on index of notional stocks Source: European Central Bank House prices continued to grow strongly. House prices, which have been increasing since summer 2016, grew by 7.5 % year-on-year in Q2-2018. Regional differences remain substantial. The largest increases were recorded for existing housing in Plovdiv, up 14.5 %, while prices in Sofia rose 8.3 %. The recovery in real estate prices appears to be supported by rising real wages, higher consumer confidence and low bank interest rates. Furthermore, supply is not yet catching up with demand, although the continued improvement in the construction confidence indicator is a positive signal. The growth of residential building investment is increasing but its share of GDP is still below the EU average. Despite the strong increase in house prices, there is no indication of overvaluation. Although recovering, the price-to-income ratio is still below the long-term average (Graph 1.10), while the price-to-rent ratio is back to the long-term average. The resulting aggregate valuation gap estimates shows that Bulgaria is recovering from undervalued house prices. Strong price increases are occurring from below-equilibrium levels and the undervaluation is a legacy of the previous house price boom and bust cycle. Nonetheless, the recent strong increase suggests that the pace of recovery should be closely monitored, especially for those regions that have seen the highest growth rates recently.

Graph 1.10:Overvaluation gap with respect to price/income, price/rent and fundamental model valuation gaps (1) Source: European Commission Public finances Budgetary developments remained positive. The general government budget recorded a surplus of 0.8 % of GDP in 2018. On the expenditure side, public investment started to recover, despite the slower than expected progress with implementing EU-funded projects. Public sector wage increases were another major contributor to the expenditure rises. On the revenue side, taxes and social security contribution revenues increased as a result of both the favourable macroeconomic environment and improvements in tax collection. This is especially the case for indirect taxes such as value-added tax and excise duties (see also section 4). Medium-term budget projections point to sustained surpluses and low debt. Public expenditure on wages and investment is forecast to increase further in 2019 and 2020. These increases, however, are expected to be partly offset by higher revenue from taxes and transfers. Further improvements in tax collection, if realised, could add to the available fiscal space. The overall positive fiscal and macroeconomic outlook is contributing to a fast reduction in public debt, which is forecast at below 20 % of GDP by 2020. In addition, according to the Commission Debt Sustainability Analysis and the fiscal sustainability gap indicators, Bulgaria faces low risk in the short, medium and long term( ). Table 1.2:Key economic and financial indicators - Bulgaria Source: Eurostat and ECB as of 31-1-2019, where available; European Commission for forecast figures (Winter forecast 2019 for real GDP and HICP, Autumn forecast 2018 otherwise) 2. Progress with country-specific recommendations Since the start of the European Semester in 2011, 75 % of all country-specific recommendations addressed to Bulgaria have recorded at least ‘some progress”. () 25 % of these country-specific recommendations recorded 'limited' or 'no progress' (see Graph 2.1). Measures have been taken in several policy areas subject to country-specific recommendations, but further efforts are needed for implementation of the reforms to have more tangible results. Graph 2.1:Overall multiannual implementation of 2011- 2018 country-specific recommendations to date (1), (2), (3) Source: European Commission Labour market conditions continue to improve. Policy efforts and measures implemented since 2012 to help disadvantaged groups access the labour market are bearing fruit. Despite this, labour shortages appear to have reached an historical peak in 2018, intensified by emigration and adverse demographic trends. Challenges remain in healthcare and education, in combating poverty and in promoting social inclusion. There has been limited progress in improving access to health services and in reducing out-of-pocket payments, as well as in addressing the shortages of health professionals. There are also outstanding issues with introducing a transparent revision scheme for the minimum income and improving its coverage and adequacy. There has been some progress in the area of education but major challenges related to quality and equity remain at all levels. The inclusion of the Roma and the impact of socio-economic status on educational outcomes remain problematic. Some progress has been made in dealing with a number of fiscal structural challenges. Bulgaria addressed, albeit with some delay, the recommendation to adopt a comprehensive strategy to improve tax collection and reduce the extent of the informal economy. It officially expired in December 2018 but the challenge remains, so a number of measures and initiatives to improve tax collection and combat undeclared work are continuing. To improve the efficiency of public spending, the authorities launched a spending review project with the World Bank. The government also put in place a project to improve the corporate governance framework for state-owned enterprises. Some progress was achieved over 2015-2018 in strengthening banks and other financial sector undertakings and improving financial sector supervision. Policy action and positive macroeconomic developments helped strengthen balance sheets and reduce macro-financial risks stemming from the financial sector. The supervisory action plans have mostly been implemented, with some measures still underway. The consolidation of recent progress will depend on fully implementing the reforms to the supervision and governance of banks and other financial corporations. There has been some progress in tackling the deficiencies of the insolvency framework since 2014. A procedure for business restructuring entered into force on 1 July 2017 but measures are needed to ensure it fulfils its purpose. The reforms came to a standstill in 2018, with no further steps taken even though some elements of a functioning insolvency framework are still lacking. More positively, in 2018 Bulgaria requested assistance to help advance the insolvency reform. This project will produce a roadmap addressing the identified gaps. Bulgaria has made some progress in addressing the 2018 country-specific recommendations( ). There has been substantial progress in taking follow-up measures resulting from the financial sector reviews. There has been some progress in tax collection and public spending, in implementing supervisory action plans in the financial sector and ensuring adequate valuation of assets, in increasing employability of disadvantaged groups and providing quality inclusive mainstream education. There has been limited progress with the governance of State-owned enterprises, insolvency framework, secondary market for non-performing loans, reforms in the healthcare sector and with minimum income coverage, adequacy and setting mechanism.

Table 2.1:Assessment of 2018 CSR implementation Source: European Commission Box 2.1: EU funds and programmes contribute to addressing structural challenges and to fostering growth and competitiveness in Bulgaria EU funding provides a significant contribution to Bulgaria’s public investment. The financial allocation from European Structural and Investment Funds to help Bulgaria tackle reform challenges amounts to EUR 11.7 billion in the 2014-2020 multiannual financial framework, potentially representing around 2.8% of GDP annually. EUR 9.87 billion of this total is from the EU and EUR 1.85 billion from national co-financing. By the end of 2018, around EUR 7.27 billion (74% of the total allocation) had already been allocated to specific projects. In addition, over EUR 400 million had been allocated to specific projects on strategic transport networks through a dedicated EU funding instrument, the Connecting Europe Facility. Furthermore, numerous Bulgarian research institutions, innovative firms and individual researchers benefited from other EU funding instruments, notably Horizon 2020 which provided around EUR 65 million. EU funding has helped to address various challenges identified in the 2018 country-specific recommendations. By the end of 2018, European Structural and Investment Funds had a significant social impact. Investments in emergency care are giving access to faster and more modern medical aid to citizens across Bulgaria, including those in remote regions. Vulnerable children and those with special needs, once in state-owned institutions, have been reintegrated into society through the establishment of new family-type centres. Integrated support to vulnerable groups has been strengthened to cover the whole country’s territory with the support of the European Social Fund. In addition, European Structural and Investment Funds contributed to actions to improve competitiveness and the business environment; to promote job creation; to improve the employability of vulnerable groups, including through skills acquisition; and to strengthen the labour market relevance of education and training. Thousands of small and medium-sized enterprises and start-ups in priority sectors such as information and communication technology, e-health and engineering benefited from grants, loans and equity investments. In environmental services, millions of people were linked to more efficient waste-management systems and hundreds of thousands gained access to modern water treatment and supply services, all amounting to a cleaner and healthier environment for citizens. In transport, new road and rail sections of the Trans-European Transport Network are being developed alongside the expansion of the Sofia Metro and projects for improving navigability and safety along the Danube River and in the Black Sea. EU funding is helping to mobilise private investment. European Regional Development Fund grants for enterprises alone have mobilised additional private capital of about EUR 113 million. In addition, 5.2 % of the European Regional Development Fund and the Cohesion Fund are earmarked for delivery via financial instruments in areas like research, development and innovation, small and medium-sized enterprises and entrepreneurship, energy efficiency, urban development and environmental management. These resources will raise a further EUR 247 million of public and private investment. In addition, the Commission can provide tailor-made technical support upon a Member State's request via the Structural Reform Support Programme to help Member States implement growth-sustaining reforms to address challenges identified in the European Semester process or other national reforms. Bulgaria, for example, is receiving support to develop a digital tool designed to help small and medium-sized enterprises comply with legislation and to enhance its capacity to prepare sound Private Partnership Projects. The Commission is also assisting Bulgaria's tax authorities in their efforts to improve the control of e-commerce. In addition, in 2018, work has started to help prepare a review of the insolvency framework, improve the governance of state-owned enterprises and improve the administrative capacity of the Inspectorate of the Supreme Judicial Council. The volume of operations approved by the European Investment Bank, backed by the European Fund for Strategic Investments, totals EUR 438 million. This is set to trigger a total of EUR 2.2 billion in additional private and public investments (February 2019). Bulgaria ranks second on the overall volume of approved operations as a share of GDP. Six projects involving Bulgaria have so far been approved under the infrastructure and innovation window of the Fund. They amount to EUR 302 million in total financing, which should, in turn, generate EUR 769 million in investments. Under the small and medium-sized enterprises component, 13 agreements with intermediary banks have been approved for a total of EUR 136 million, which should mobilise around EUR 1.5 billion of total investment. An estimated 9 606 small and medium-sized enterprises and mid-cap companies are expected to benefit from this support. ‘Biovet’ is a notable example of such projects in Bulgaria. Biovet is a global animal health company with several production facilities. The European Investment Bank is providing a EUR 100 million loan to finance a boost in production levels and research and development. The European Fund for Strategic Investments project includes setting up two new facilities, in Peshtera and in Razgrad. EU actions strengthen national, regional and local authorities and civil society. Over EUR 690 million from the European Structural and Investment Funds have been allocated to strengthen the capacity of public administration at different levels by prompting close cooperation with stakeholders. More information at: https://cohesiondata.ec.europa.eu/countries/BG 3. Overall findings regarding imbalances, risks and adjustment issues The 2019 Alert Mechanism Report concluded that a new in-depth review should be undertaken for Bulgaria to assess the persistence or unwinding of the imbalances (European Commission, 2018k). In spring 2018, Bulgaria was identified as having macroeconomic imbalances (European Commission, 2018l). They related in particular to vulnerabilities in the financial sector coupled with high indebtedness and non-performing loans in the corporate sector, in a context of incomplete labour market adjustment. This chapter summarises the findings of the analyses carried out as part of the macroeconomic imbalances procedure in-depth review that is contained in this report( ). 3.1.Imbalances and their gravity The banking sector has been addressing the shortcomings identified in 2016. Following the asset quality review and stress tests conducted in 2016, banking supervision resources, governance tools and supervisory legislation have been strengthened. Banks' capital and liquidity buffers have increased, provisioning policies have been enhanced and credit-granting practices have improved. Pending concerns include addressing valuation issues, completing the strengthening of banking supervision and enhancing the resolution framework. The non-banking financial sector is being reformed but new challenges have emerged. Following reviews of the sector concluded in 2017, the solvency and liquidity of insurance companies have improved. The reviews have been followed by legal and administrative changes strengthening the supervisor and developing a risk-based forward-looking supervision system. Some actions are still pending and new elements are of concern. The latter include the sustainability and liquidity of the motor vehicle insurance segment and trust in and the stability of the Green Card system, which supports compensation-payments in case of cross-border road traffic accidents. Other concerns are the systematic appealing of the decisions by the Financial Supervision Commission and the unpredictability of court decisions. Group-level supervision remains a challenge. The levels of non-performing loans and private sector debt have been decreasing but remain high. Despite the reduction of non-performing portfolios and de-risking of balance sheets, non-performing loans remain well above the EU average. In June 2018, non-performing loans by non-financial corporations were 15.4 %, well below the level registered a year earlier (19.9 %) but more than twice the EU average (6.7 %). Private sector debt has also decreased, from 132 % of GDP in 2013 to 100 % of GDP in 2017. This is mainly due to non-financial corporations, as the households’ debt ratio remains among the lowest in the EU. The corporate debt burden could hurt investment and growth over the medium term. Strong economic growth has led to a solid labour market recovery. The activity rate continued to increase, helping to compensate for a shrinking working age population. As a result, employment rates are above pre-crisis levels. Despite improvements, some groups are still not fully integrated into the labour market, including those with low education, the Roma, the young and people with disabilities.

3.2.Evolution, prospects and policy responses The overall robustness of the banking sector has further improved, with some important actions ongoing. Strong economic growth, alongside the banks’ response to the regulator’s recommendations, has helped to strengthen capital and liquidity ratios. Some actions are still ongoing, including those to strengthen corporate governance and risk management. New initiatives in 2018 included new rules for large exposures and the identification of connected clients, improved provisioning policies in several banks, an increase in the counter-cyclical capital buffer rate and macroprudential tools for borrower-based measures. Revision of supervisory review and assessment manual of Banking Supervision Department has already been finalised and adopted by decision № 279 on 14 November 2018 by the Governing Council of Bulgarian National Bank. Measures to be completed include addressing valuation issues, implementing regulatory initiatives and strengthening the resolution framework for banks. The impact of on-going reforms to non-bank supervision rests on their full implementation. Follow-up measures to the reviews of the insurance and pension funds sectors are being implemented. Remaining steps include the full implementation of an action plan to establish a proper risk-based forward-looking supervisory process and the adequate follow-up to remaining issues highlighted by the non-bank financial sector reviews. While the authorities have introduced relevant legal and regulatory provisions, their concrete implementation will be crucial. New challenges for the non-banking financial sector emerged in 2018. Supervision of the car-insurance sector is being strengthened and premiums substantially increased, but the sector's sustainability requires continued monitoring. Furthermore, risks stemming from some of the undertakings' business models and strategies may have implications beyond the motor third-party liability. Additionally, challenges have recently emerged, including uncertainty over the extent of motor third-party liability claims, following a ruling by the Supreme Court. Another emerging challenge concerns increased doubts over the liquidity of the ‘Green Card Bureau’, which have been triggered in December 2018 by the announcement that the International Council of Bureaux had initiated formal monitoring. The financial stability of the Green Card system would benefit if its liquidity and governance issues were addressed promptly. There is scope to further reduce non-performing loans and debt levels in the non-financial corporate sector. High levels of debt and non-performing loans mostly reflect the situation of non-financial corporations. Both have been decreasing thanks to robust economic growth and a more dynamic secondary market. The authorities have announced their intention to comply with the European Banking Authority guidelines for non-performing loans, which are to be applied as of 30 June 2019. Improvements to the legal framework for the valuation of collateral would help accelerate the reduction of non-performing loans. Completing the insolvency reform would further help to reduce corporate indebtedness. In October 2018, Bulgaria asked for assistance to continue the reform of the insolvency framework. Some missing elements reduce the efficiency and effectiveness of the framework. At the same time, the absence of adequate monitoring tools prevents a proper analysis of current and new procedures. Improvements in the labour market have been supported by active labour market policies and economic growth. Unemployment decreased for the fifth consecutive year, to 5.3 % in Q3-2018, while long-term and youth unemployment have also dropped. The latter more than halved between 2013 and 2017, from 28.4 % to 12.9 %. The employment rate reached 71.3 % in 2017, the highest since EU accession. However, Bulgaria continues to face adverse demographics. Despite the slow take up, better targeted active labour market policies are starting to make a positive impact, alongside economic growth. 3.3.Overall assessment Positive macroeconomic developments and policy action resulted in a further unwinding of imbalances. Important steps were taken towards reducing potential macro-financial risks stemming from the banking and non-banking sectors. Together with strong economic growth, they helped making the Bulgarian financial sector more robust. Deleveraging continued in the private sector, also benefitting from the strong growth momentum, even if non-performing loans and debt levels for non-financial corporations remain relatively high. Remaining fragilities in the financial sector combined with still relatively high corporate debt suggest that vulnerabilities still exist. Measures to address vulnerabilities in the financial sector are ongoing. Full implementation and monitoring of the recent reforms to the supervision and governance of banks and other financial corporations will be crucial to complement and consolidate recent efforts. The insolvency framework reform is still missing important elements which would improve the efficiency of procedures and proceedings. New risks in the motor vehicle insurance market need to be addressed. Overall, imbalances have abated but some fragilities in the financial sector and the still high corporate debt require further monitoring. Table 3.1:MIP assessment matrix (Continued on the next page) Table (continued) Source: European Commission 4. Reform priorities 4.1.Public finances and taxation 4.1.1.Tax policy The tax system is relatively growth-friendly, but has a limited redistributive effect. The overall tax burden in Bulgaria (29.5 % of GDP in 2017) is one of the lowest in the EU. The tax structure mainly relies on consumption taxes, like Value Added Tax and excise duties, and generates relatively high revenue from environmental taxes (2.7 % of GDP). This characteristic tends to result in a relatively growth-friendly tax structure. However, the Bulgarian tax and benefit system has little power to reduce inequalities and to promote policies to reduce poverty, which is the highest in the EU (see Section 4.3.). This is partly a result of inefficiencies in the social benefit system and in the design of labour taxation, which is the least progressive in the EU; the difference between the relative tax burdens for low- and high-income earners is the lowest in the EU (Graph 4.1.1). Graph 4.1.1:Degree of progressivity of labour income taxation in EU Member States, 2017 Source: European Commission based on OECD data

Despite the relatively simple tax structure, tax compliance costs remain high. Bulgaria applies a standard Value Added Tax rate (20 %), which is close to the EU average, and one reduced rate (9 %) on a relatively limited range of products and services. The personal and corporate income tax rates are both flat at 10 % and are among the lowest in the EU. Nevertheless, Bulgaria has consistently ranked low on paying taxes in the World Bank’s ‘Doing Business’ index, especially on compliance requirements for labour taxes and social security contributions. In 2018, Bulgaria dropped from the 90th to 92nd place (World Bank, 2018). The shadow economy remains a challenge. Estimates indicate it is bigger than in many other EU countries (European Commission, 2018a). Undeclared work is one of the most prominent signs of the problem in many industries, such as trade, restaurants, tourism, construction and agriculture. It is estimated to account for about one fifth of labour and of gross value added in the private sector (European Commission, 2018n), while the number of people declaring that they worked without a contract increased from 55 900 in 2016 to 62 700 in 2017 (NSI, 2018c). Other widespread practices are bogus part-time work and under-reporting of wages. Illicit trade is another significant form of the shadow economy. According to a recent study (CSD, 2018), illicit trade in tobacco products and VAT fraud have shrunk, but the black market in fuel has expanded to BGN 600-700 million (EUR 300-350 million). A number of measures have been taken to tackle the shadow economy and improve tax collection. To combat undeclared work, measures such as one-day flexible contracts in agriculture and the exclusion from public procurement of companies convicted for undeclared work (in the last 3 years) were taken. The General Labour Inspectorate has agreed with the trade unions a joint initiative against undeclared work, while the National Revenue Agency applies a number of measures to improve compliance in high-risk sectors, including undeclared work. To increase voluntary compliance the Agency has launched information campaigns and implemented projects to increase electronic services to taxpayers. Other particularly successful measures were checks of the cash declared by companies and the introduction of tax controls on the movement of high-risk goods. Many of the above measures were included in the ‘Single National Strategy for improving tax collection, tackling shadow economy and reducing compliance costs’. The strategy and its latest action plan were in effect until the end of 2018. The authorities intend to maintain the most effective measures and mechanisms of inter-institutional cooperation introduced with the strategy. The measures to improve tax compliance have yielded some positive results. This is particularly the case for consumption taxes such as VAT and excise duties, and for corporate income tax. VAT revenue collection increased as of 2015, and especially in 2016 and 2017 they rose to above their tax base. The Value Added Tax gap ( ) decreased from 20.6% in 2015 to 13.6% in 2016 remaining, however, slightly above the EU average of 12.3% (CASE, 2018). Revenues from other consumption taxes, especially excise duties, developed in a similar way. On income taxes, the progress is mixed. Collection of corporate income tax has been improving almost every year since 2012. However, for labour taxes the results are less positive as they increased slower than the compensation of employees, indicating some deterioration in compliance. This is yet another sign of the challenges related to undeclared work. 4.1.2.Public expenditure The government has taken steps to improve the effectiveness of public expenditure. Even though their needs are still high, expenditure in areas such as social protection, health and education is relatively low. At the same time, effectiveness could improve in areas with relatively high spending such as infrastructure (see European Commission, 2018a). In 2018, some policy initiatives to improve efficiency were completed. A spending review by the World Bank covering a number of public institutions (ministries and municipalities) was one of them. The Bank finished two pilot studies, on policing and firefighting and waste water and delivered a manual for future reviews by the government. The government has not yet announced follow-up measures or additional spending reviews. Another government initiative in this area was the introduction of a new set of performance indicators per policy area in the medium-term fiscal strategy. The main innovation is that the ad hoc indicators used until now were updated and finalised. They will serve as a basis to assess the impact of spending in the different policy areas over time and to inform the budget evaluation and planning. 4.1.3.Fiscal framework The Bulgarian Fiscal Council has made some progress in rolling out its activities. Based on its broad mandate, the Council has established a system for releasing its mandatory monitoring reports on the annual and medium-term fiscal plans as well as on budgetary execution and compliance with all the numerical rules laid down in the Public Finance Act. With the recent strengthening of its staff, the analytical underpinning of its reports is expected to improve. Moreover, to bring the domestic fiscal framework into full compliance with the budgetary frameworks directive ( ), the Fiscal Council's mandate was extended to encompass the regular and comprehensive ex post evaluations of the government’s macroeconomic and fiscal forecast. 4.1.4.State-owned enterprises State-owned enterprises form an important part of the economy. In Bulgaria there are more than 900 State-owned enterprises of all sizes at national and local level. Of these, about 220 companies, under the control of the central government, represent more than 90 % of the asset value and more than 70 % of total employment. According to Ministry of Finance data for 2017, these 220 State-owned enterprises contribute 5 % of total employment and their turnover corresponds to about 13.5 % of GDP. The presence of State-owned enterprises is more prominent in the energy, transport, water and mining sectors. State-owned enterprises' profitability is relatively weak in all sectors of the economy. Their return on equity is systematically lower than in private companies and the difference in Bulgaria is higher than in most regional peers. This applies to all sectors except mining (see Bower, 2017). In energy, transport, water and other sectors (including agriculture), the private sector outperforms the State-owned enterprises by a wide margin. Part of this difference could be explained by the objectives of those enterprises and the role they often play in the economy, including providing non-commercial goods and services. Graph 4.1.2:Size of liabilities of State-owned enterprises by policy area (ministry) Source: European Commission based on Bulgarian Ministry of Finance data The economic situation of some State-owned enterprises can entail fiscal risks in the absence of restructuring plans. Fiscal risks are elevated in systematically loss-making companies and in those which are prohibited by law from becoming insolvent — meaning that the state must always bail them out if they fail. About half of the BGN 18 billion (EUR 9 billion) in State-owned enterprises' liabilities come from companies that made losses in more than 3 of the last 5 years. For example, the loss-making railway sector, with liabilities of more than BGN 3 billion (3 % of GDP) in 2017 and 2018, received BGN 197 million of reimbursable financial contribution to BDZ Holding for repayment of debts. In 2017, a state aid of BGN 223.4 million in the form of a cancellation of debts in favour of BDZ Holding was authorised(). So far there is no clear restructuring plan to improve the operational performance in any of the sector's four companies (BDZ freight transport, BDZ passenger transport, BDZ holding and National Railways Infrastructure Company). BDZ Holding seems to count on a subsidy from the proceeds of Sofia’s airport concession, which has not been contracted yet( ). The financial situation of the energy State-owned enterprises has somewhat improved but investment in the sector remains a challenge. The Bulgarian Energy Holding, NPP Kozloduy and the Mines in the Maritsa Basin (Mini Maritsa Iztok) have significantly improved their financial results (from Q3-2017 to Q3-2018), but the financial situation of National Electrical Company and especially Thermal Power Plant Maritsa East 2 has deteriorated. Both companies registered net losses over the last year, mainly linked to increased operational costs fuelled by rising prices of emission allowances. Low profitability and resource efficiency combined with weak corporate governance are hurting investment, which in turn might hamper the stability and reliability of the system. Investment in energy decreased from 4.1 % of GDP in 2012 to 0.7 % in 2017. A reform of the corporate governance framework is being prepared. The economic results of Bulgarian State-owned enterprises partly reflect challenges related to their management, supervision and restructuring (European Commission, 2018a). The government has recognised these challenges and has taken the initiative to (i) review and assess the legal, regulatory and operational framework for State-owned enterprises and (ii) revise and align Bulgaria's legislation with the Organisation for Economic Co-operation and Development (OECD) guidelines on corporate governance of State-owned enterprises. The initiative is part of the government's action plan to prepare for applying to participate in the Exchange Rate Mechanism. A technical assistance project with the European Commission and the OECD was launched in August 2018. The adoption of the new framework is expected by July 2019. 4.2. Financial sector Bulgaria has started preparing for membership of the Exchange Rate Mechanism (ERM II). In July 2018, Bulgaria announced its intention to apply for ERM II membership and the Banking Union in July 2019. At the same time, Bulgaria announced a set of commitments to improve the economy’s resilience in areas of high relevance for a smooth transition to participation in ERM II. The commitments cover both the banking sector (close cooperation with the Single Supervisory Mechanism and development of the macro-prudential framework) and the non-banking financial sector. They also include measures to strengthen institutional quality and governance, namely the insolvency framework, combating money laundering, and governance of the State Owned Enterprises (Ministry of Finance, 2018a). 4.2.1.Banking sector

Most recommendations from the 2016 asset quality review have been addressed, but a few important points remain to be tackled. The asset quality review conducted by the Bulgarian National Bank in 2016 (European Commission 2017a, 2018a) has led to several follow-up actions. These include a strengthening of capital buffers, provisioning policies, credit-granting practices and corporate governance; the reduction of non-performing portfolios; and de-risking of balance sheets, e.g. by selling-off repossessed collateral. As regards actions outstanding, one of the two banks found in need of replenishing its capital buffers has finally achieved the required levels organically, but has not yet raised fresh capital as initially recommended with an agreed deadline by April 2017. Attracting new bona fide investors could further strengthen credibility and improve governance (see also IMF, 2017). Following up on legislative initiatives on related-party exposures and sustained supervisory efforts to limit loans to related parties and penalise infringements of collateral provisions are also crucial to support sound business practices. Bank supervision has been strengthening despite some delays in making the changes operational. Institutional decision-making has been strengthened by an amendment of the Bulgarian National Bank Law transferring competences over banking and payment supervision from the Deputy Governors in charge to the Bulgarian National Bank Governing Council. Furthermore, delayed actions for improving banking supervision from the 2015 plan are being completed. In addition, new information and communications technology tools are available to the banking supervision department. They include an upgraded data warehouse for banking supervision, automated update of key risk indicators and regularly updated data point model to verify the quality of data reported by banks. In November 2018 the Bulgarian National Bank adopted a revised supervisory review and assessment manual. Several other important regulatory initiatives are being implemented. Amendments to the Law on Credit Institutions adopted in December 2017 strengthened the definition of bank related-party exposures (Article 45). A decision of the Bulgarian National Bank adopted in April 2018 implements the European Banking Authority guidelines on large exposures and identification of connected clients as of the beginning of 2019 and it introduced a reporting template for related-party lending. The adoption of Ordinance 37 of the Bulgarian National Bank in July 2018 defined the scope of banks’ internal rules and procedures, rules for calculating exposures and reporting requirements to the supervisor. Banks were requested to implement their internal rules and procedures within a six-month period; therefore it is too early for an assessment of the effectiveness of these measures. The new International Financial Reporting Standard (IFRS 9) is improving provisioning policies. IFRS 9 was phased in by around half of Bulgaria's banks as of the beginning of 2018. The supervisor expects this to result in increased loan-loss provisions in some banks, something which could be verified once the remaining banks have phased in IFRS 9 (European Commission, 2018b). At the same time, the implementation of IFRS 9 is coinciding with a cyclical upturn. This poses a challenge for banks to correctly estimate risk during future unfavourable economic developments, namely from the reduced capacity of borrowers to service their debt. Issues with the valuation of collateral limit the incentive to dispose of non-performing loans. A range of hard-to-value assets still exist, notably related to immovable property. Examples include real estate collateral in the banking sector, receivables and real estate holdings in the insurance sector, as well as stocks, bonds, real estate and other financial instruments in the pension funds sector. In addition, the uneven quality of auditing affects the valuation of illiquid instruments traded on stock exchanges, as well as non-traded assets, including receivables, minority equity stakes and subsidiaries. New macro-prudential tools would further support financial stability. The Bulgarian National Bank set the level of the counter-cyclical capital buffer rate at 0.5 % as of October 2019. It will also be applied in Q1-2020. This level is more prudent than implied by economic developments under strict adherence to the applicable methodology( ) and constitutes an important signal to the market. In addition, the authorities have adopted amendments to the Law on Credit Institutions implementing a legislative framework for borrower-based macro-prudential measures. The Bulgarian National Bank may activate part or all of these macro-prudential tools, thereby responding in a flexible and proportionate way to potential risks to financial stability. An impact assessment will permit to verify the effect and appropriateness of the new tools before their activation. These tools would complement the existing capital-based measures in limiting the accumulation of risks in the banking sector. 4.2.2.Combating money laundering Bulgaria has been addressing deficiencies of its anti-money laundering framework. In 2013, Bulgaria was placed in regular follow-up in the context of the 4th round evaluation process of the Committee of Experts on the Evaluation of Anti-Money Laundering Measures and the Financing of Terrorism, or Moneyval( ) (Moneyval, 2013). Bulgaria has since made substantial progress to address the identified deficiencies. , In December 2017, Moneyval concluded that deficiencies remained, despite the positive steps taken, in particular regarding some aspects of criminalising terrorist financing, as well as confiscation and provisional measures (Moneyval, 2017). In July 2018, however, Bulgaria was removed from the follow-up process of Moneyval, having passed legislation to further address the deficiencies previously identified (Moneyval, 2018). The transposition of the 4th Anti-money Laundering Directive still needs to be completed. Bulgaria notified transposition measures for Directive EU/2015/849 in April 2018 and December 2018 (the 4th Anti-money Laundering Directive), and is working towards a fully conform transposition. Additionally, an inter-institutional working group is assessing residual gaps and preparing the early adoption of transposition measures for the 5th Anti-money Laundering Directive. However, Bulgaria has still not finalised and notified its National Risk Assessment, which is a cornerstone to devising adequate national policies to combat money laundering and terrorist financing. The risk of corruption needs to be better addressed as it is a predicate offence to money laundering( ). In particular, authorities need to show a stable record of effectively investigating and prosecuting high-level corruption cases, including involving politicians. Potential financial crimes are not appropriately investigated( ). Two thirds of the suspicious transaction reports sent by financial institutions to the Financial Intelligence Unit( ) involve domestic politically exposed persons but those cases have not been given the appropriate follow-up by law enforcement. No significant progress has been made so far in examining obstacles that prevent the investigation of such cases and turning them into evidence for prosecution. The use of financial investigation and financial profiling is limited, which prevents effective asset recovery in organised crime and corruption cases. There are risks linked to the Citizenship by investment scheme. The scheme does not require that an individual needs to spend a significant amount of time in Bulgaria to obtain Bulgarian citizenship. As such, the new citizen may not become a tax resident and his income would not be taxable in Bulgaria. This creates potential for misuse, as personal identification documents issued by Bulgaria can be used to hide assets held abroad from reporting. On 30 January 2019 the Council for Development debated draft amendments to the Bulgarian Citizenship Act that aims at repealing the Citizenship by investment scheme as well as shortening the deadlines and clarifying the criteria for granting Bulgarian citizenship. The applicants for citizenship due to origin shall be required to have knowledge of Bulgarian as well as occupation and income in the country. 4.2.3.Non-banking Supervision Non-bank supervision is being reformed. The Financial Supervision Commission adopted an action plan for reforming non-bank financial supervision in September 2017, in cooperation with the European Insurance and Occupational Pensions Authority. The action plan draws upon the shortcomings identified during independent pension funds’ assets review and insurance balance sheet review as well as the findings of the Financial Sector Assessment performed by the World Bank, all published in 2017( ). The full and timely implementation of the action plan, still on-going, will contribute to an adequate supervision of the non-banking financial sector. Legislative changes aimed at improving non-bank financial supervision have been adopted. Firstly, in the area of pension funds, amendments to the Social Insurance Code, which were adopted by Parliament in November 2017 and entered into force in November 2018, include a broader definition of related parties in line with international standards. Secondly, legislative amendments introduced in 2017 strengthened the Financial Supervision Commission by providing it with sufficient funding and staff and expanding its supervisory capacity (European Commission, 2018a). The adopted risk-based supervisory framework, once tested and assessed to be fit, will support the improved supervisory capacity. The non-bank supervisor faces new challenges in 2018. The head of insurance supervision in the Financial Supervision Commission resigned in August 2018, in the aftermath of the failure of Olympic Insurance (see below). Despite announced plans to designate a successor, no formal steps have been taken so far. The announced change in the Financial Supervision Commission chair in March 2019 could generate further uncertainty. It is important in both cases to ensure the timely appointment of professionals who duly fulfil fit-and-proper requirements. Concerns over legal proceedings are still present. The frequent appeals by non-banking financial companies against the decisions of the Financial Supervision Commission remain a challenge. The undertakings regularly succeed in having the regulator’s decisions overturned. The unpredictability of the courts’ decisions may suggest the need to expand technical expertise among judges and other judicial practitioners. Insurance and pension funds Insurance companies’ solvency has improved since the completion of the sector’s reviews. According to the Financial Supervision Commission, all recommendations of the independent balance sheet reviews of insurance companies and pension funds were fully implemented by April 2017. At the end of 2017, all but one insurer satisfied solvency capital requirements without the application of long-term guarantee and transitional measures. However, some insurers’ solvency ratios are close to 100 %, which could indicate potential weaknesses that should be closely monitored. In 2017, the Financial Supervision Commission withdrew the licences of two insurers for a number of reasons, including their failure to comply with capital requirements. Both companies have appealed this sanction. The decision is still pending before the administrative higher court. Some issues related to valuation require further monitoring. According to the Financial Supervision Commission, auditors have not identified any particular problem with the clean-cut reinsurance contracts. However, concerns over their supervisory treatment remain to be addressed ( ). The issue of hard-to-value assets, including non-traded assets and traded securities with low liquidity and low free float, has been identified in the reviews of both the banking and non-bank financial sectors but has not yet been fully addressed. Amendments to secondary legislation are in place, aiming to improve the valuation rules and their application. For this application to be fully effective, however, they would also benefit from changes to the rules governing the work of valuation practitioners.

Group-level supervision remains a challenge for adequate risk-based insurance supervision. The group-level assessment of two insurance groups was never completed. In one case group supervision is no longer applicable due to restructuring. In the other case, the Supreme Administrative Court revoked the decision of the authority to identify it as a group. The authorities’ approach following the court’s decision will have to consider the requirements under the transposed Solvency II Directive stipulating that group-level supervision is to be applied at the ultimate parent level. The failure of Olympic Insurance illustrates the difficulties with cross-border supervisory and resolution arrangements. Bulgaria’s branch of Olympic, a non-life insurer based in Cyprus, represented a relatively large share of the Bulgarian motor third-party liability market. However, the exchange of supervisory information between the two national supervisors did not appear optimal. Further, it is unclear which guarantee fund, if any, will cover Olympic’s liabilities in Bulgaria. Motor vehicles insurance Supervision of the car insurance sector is being strengthened. In November 2017, the authorities started to automatically match information from car registration databases with motor third-party liability contracts in order to combat fraud. The Financial Supervision Commission has also taken further measures to ensure that victims of car accidents receive proper compensation, particularly in cases of cancelled insurance contracts, and that all Bulgarian insurers have a network of claims representatives in all EU Member States, as required by the Motor Insurance Directive. As expected under the 2017 action plan, the Financial Supervision Commission has published a report on the level of motor third-party liability premiums. Nevertheless, significant challenges regarding the business model and business strategy of market participants remain a concern, with potential spillovers beyond the sector itself. Motor third-party liability premiums have increased significantly, but the sustainability of this line of business is not yet ensured. Following a period of low premiums and in some cases negative margins, insurers have been increasing their premiums since the beginning of 2018( ). However, a recent ruling by the Supreme Court has extended the scope of beneficiaries of motor third-party liability claims to include family members and relatives. They will be entitled to claim moral (non-material) damages in court. The ruling concerns both future claims and those incurred over the last 5 years. The possible impact on the insurance sector is still unknown but could be significant, although the Financial Supervision Commission believes that the recently increased premium levels may be enough to absorb the losses. To mitigate the risks, on 22 November 2018 the National Assembly adopted an amendment to the Insurance Code imposing ceilings on the amount of compensation to be awarded to those entitled to it under the recent Supreme Court ruling. A methodology for claims and improved pricing methods would contribute to the stability of the sector. Well-specified rules on compensation would facilitate a more harmonised approach by judges when deciding on individual cases. In the longer term, such a methodology would help to reduce costs, volatility and underwriting risk in the motor third-party liability line of business. The sustainability of the sector would also benefit from improved pricing, which is still largely rudimentary. In contrast to most developed markets in other Member States, motor third-party liability pricing in Bulgaria does not take into account the clients' driving history, the best predictor of future claims. The Financial Supervision Commission has proposed a bonus-malus system, which is undergoing broad public debate. If well designed, the system could significantly improve the pricing of motor third-party liability policies and positively influence the driving behaviour of policyholders. Its prompt implementation would contribute to the stabilisation of this line of business. The liquidity of the ‘Green Card Bureau’ has raised substantial concerns. In early 2018, the International Council of Bureaux initiated informal monitoring of its Bulgarian member, the National Bureau of Bulgarian Motor Insurers (or ‘Green Card Bureau’), due to the non-payment of claims by two Bulgarian insurers. This resulted in a higher guarantee required by the International Council, which translates into increased contributions by the whole Bulgarian sector. The situation worsened in December 2018 when the International Council initiated formal monitoring and required a sector-wide reinsurance contract, together with monthly reporting in order to safeguard the Bulgarian bureau’s membership. The market impact of those additional requirements is yet to be fully assessed but could prove substantial. The liquidity of the Green Card Bureau is benefiting from ongoing on-site inspections and specific provisions of the new Insurance Code. These measures should be promptly and fully implemented, while the potential remaining governance issues should also be tackled to ensure the trust and participation of member insurers. 4.2.4.Private indebtedness The debt of non-financial corporations has been rapidly decreasing. In 2017, private sector debt fell to 100 % of GDP, from a peak of 134 % of GDP in 2009. At end-2017 four fifths of the debt was linked to non-financial corporations as households have much lower debt levels than the EU average. At 80 % of GDP in 2017, non-financial corporations debt levels are still well above fundamentals, but increasingly below the prudential benchmark (Graph 4.2.1)( ). Graph 4.2.1:Fundamental-based and prudential benchmarks and NFC debt Source: European Commission Robust economic growth has been the main driver of debt reduction, together with a modest pick-up in inflation, valuation changes and write-offs (see Graph 4.2.2). However, the pace of deleveraging has slowed down recently. Graph 4.2.2:Breakdown of y-o-y changes in debt-to-GDP ratios of NFCs (1) Source: European Commission Tools to address the still high levels of non-performing loans have not yet been developed. Increased lending activity and a more dynamic secondary market contributed to the decline in the share of non-performing loans, but levels remain well above the EU average (see Section 1). However, tools to deal with the current stock, mainly the legacy of the pre-2009 credit boom, are still to be developed. Earlier plans to introduce the European Central Bank's guidelines have not been pursued (European Commission 2018a, 2018b). Instead, the authorities have announced their intention to comply with the European Banking Authority's guidelines for non-performing loans, to be applied as of 30 June 2019. Other factors could further accelerate the reduction in non-performing loans. Improvements in the valuation of collateral should substantially improve the clearing of non-performing loans, while comfortable capital buffers in the banking system provide space for a balance sheet clean-up (see Section 4.2.1). The improved recent dynamism of the secondary market is helping reduce non-performing loans. Stronger legal framework for foreclosure would further accelerate this process (see Section 4.2.4 and European Commission, 2018b). Credit flows have rebounded driven by the improved macroeconomic environment, lower interest rates and the accommodative European Central Bank monetary policy. In September 2018, loans to non-financial corporations grew by 7.5 % year-on-year. Given the strong capital and liquidity positions of the banking sector, declining non-performing loans and strong deposit growth, this is set to continue. Accordingly, the decrease in private sector debt is set to decelerate, but increased lending activity could in turn support higher investment expenditure, which is yet to recover from its post-crisis slump, as well as stronger potential growth. 4.2.5.Insolvency framework Insolvency proceedings are slow and costly and produce unsatisfactory results. The length (3.3 years compared to the EU average of 2) and cost of insolvency proceedings mean they usually result in very low recovery rates for creditors (35 % v the 65 % EU average (World Bank, 2017c). They also create a very heavy workload for the 28 district courts that hear insolvency cases. Between 2010 and 2017, on average 1 200 insolvency cases were lodged with the district courts annually (Institute for Market Economics, 2018). At the same time, about 900 cases per year remained unresolved. In the same period, 49 % of insolvency cases were settled within 3 months while 51 % of cases took longer. There were also large regional differences in terms of courts’ workloads. For 2010-2017, the District Court in Vratsa had an annual average of 88 bankruptcy decisions per 10 000 companies, which is almost three times the national average and well above the District Court in Montana that came in second. Measures designed to improve the efficiency and effectiveness of the insolvency framework, in combination with appropriate flanking policies, could help to reduce the high outstanding private sector debt and the still high share of non-performing loans (see section 4.2.3). Reform of the insolvency framework is still incomplete, with important legislative elements lacking. The pre-insolvency restructuring procedure entered into force on 1 July 2017, but its take-up has been weak. The new framework could benefit from further streamlining and less complexity, also by encouraging out-of-court settlements, less court involvement and administration and lower voting thresholds for the adoption of restructuring plans. Functioning rules for granting a second chance to consumers and entrepreneurs in a reasonable timeframe following a bankruptcy are still missing. In 2018, Bulgaria asked for assistance to help it advance the reform of the insolvency framework. This project will produce a roadmap addressing the identified gaps. The weak regulatory and institutional set-up does not support timely and cost-effective conduct of insolvency proceedings. The share of successful reorganisation plans is very low and there is a problem with constant reopening of insolvency proceedings. Cumbersome requirements for commencing insolvency, inefficient rules and processes for recognising creditors’ claims, and weak adherence by market participants and courts to the prescribed deadlines are some of the major impediments to cost-effective and timely access to insolvency proceedings. There is also a lack of adequate rules on the protection of post-petition financing that would enable debtors to meet their ongoing business needs by facilitating access to commercially sound forms of financing upon commencement of the insolvency procedure. Rules on the stay of enforcement actions also need an overhaul. Moreover, a diverse interpretation of rules on avoidance actions causes legal uncertainty and prevents an orderly distribution of funds to creditors. Insufficient training in the field of insolvency and restructuring for both trustees and judges further exacerbates all these problems. Insolvency proceedings are not perceived as an effective collection mechanism. There is a lack of electronic access to insolvency files and insufficient transparency in the cashing-out process carried out by trustees. Combined with the lack of effective control of asset appraisals, this has led to sales of assets within the insolvency estate at exceptionally low prices or in ways that are very disadvantageous to many creditors.

A lack of adequate monitoring tools makes it difficult to assess the efficiency of insolvency and restructuring proceedings. This is also the case for intercompany debt analysis and enforcement in general. Within the judicial system, data are available on the number of pending and completed cases, the average length of proceedings and the terms for issuance of court acts, but they are mainly used to report on the workload of courts. The Supreme Judicial Council and the National Statistical Institute also gather data on insolvency and restructuring proceedings, but they are also not used for analytical purposes. 4.2.6.Access to finance Access to finance for small and medium-sized enterprises in Bulgaria is in line with the EU average and has further improved, backed by EU measures. Access to finance is the most important concern for only 6 % of Bulgarian small and medium-sized enterprises compared to 7 % at EU level (ECB, 2018). Small and medium-sized enterprises have benefited from the overall improvement in the banking environment but also from EU funding through programmes such as Innovation and Competitiveness (EUR 1.27 billion) and Small and Medium-sized Enterprises Initiative (EUR 102 million). The centrally managed banking instruments of the Investment Plan for Europe were successfully used by Bulgarian banks and provided further support (EUR 256 million under the COSME Loan Guarantee Facility) ( ). The equity funds selected by the European Investment Fund in 2007-2013 gave an impetus to the start-up ecosystem in Sofia, particularly in the information and communication technology sector. However, the rest of the county is lagging behind. The EU financial instruments provide a good alternative to grants for investment in both innovation and technical modernisation, but the awareness of these types of funding opportunities is still low. Venture capital and business angels' financing are still limited. The small size of the market is an obstacle to attracting large equity investors, hence public support has played a decisive role for developing this ecosystem. The Fund Manager of Financial Instruments in Bulgaria (the Fund of Funds) is in charge of implementing all the EU-funded innovation and competitiveness financial instruments. Despite some delays, positive developments from the previous programming period are expected to continue. At the end of 2018, the Fund of Funds signed the first operational agreement for the management of a Seed/Acceleration and Start-Up Fund. The deployment of the remaining EU-funded equity instruments of the Fund of Funds remains crucial for the venture capital market. In addition, the focus of financing needs is shifting from the early stage towards scale-up financing. 4.3. Labour market, education and social policies 4.3.1.Labour market Sustained economic growth is having a positive impact on the labour market, although labour and skill shortages are increasing. The employment rate reached 73.5 % in Q32018, 2.8 pp. above its highest level before the crisis (70.7 % in 2008). The unemployment rate fell to 5.2 % in Q42018, below its pre-crisis level (Q4 2008) and below the EU average of 6.8 %. In absolute figures, however, the labour force has 200 000 fewer people than in 2008. This decline of the active population and the scarcity of skilled workforce are tightening the labour market. Meanwhile, some disadvantaged groups still face difficulties in entering employment, and the education and training systems are not well equipped to respond to evolving labour market needs. Prioritising investment in training, upskilling and reskilling and in better aligning education to labour market needs would support long-term growth. Regional disparities in the labour market remain significant. The most densely populated regions, South-West and South-Central, also had the highest employment rates in 2017, of 76.7 % and 71.3 % respectively. By contrast, since 2013 the regional dispersion of wage levels has been decreasing. The median value of the wage gap relative to Sofia fell by 2 pp. (from 57.7 %) in 2017. However, in some regions (Vidin and Blagoevgrad) wages are still less than half of the Sofia levels and the catching-up process is weak. There are also considerable divergences in the unemployment rate — from 3.3 % in the South-West to 11.3 % in the North-West in 2017. This divide points to a need for more comprehensive economic development policies and coordinated measures to support balanced internal mobility. Demographic developments are having a strong impact on the labour market. Bulgaria is one of the few Member States in which the rates of natural population change and of net migration are both negative( ). It is estimated that the low birth rates coupled with the highest mortality rates in Europe and negative migration flows will reduce the population to 5.424 million in 2050, or by 0.8 % annually (UN, 2017). The working-age population (aged 15 to 64) is set to contract at even faster annual rates (1.2 %) (see Graph 4.3.1). Graph 4.3.1:Population pyramid Source: European Commission The level of labour shortages has reached a historical peak in 2018, following a decline during the crisis. The greatest shortages are in industry and construction, but the increasing shortages in services have been equally steep in recent years (see Graph 4.3.2). As a response, Bulgaria has signed or is negotiating agreements with non-EU countries to enable the recruitment of foreign workers. The number of workers arriving from outside the EU is still limited and mostly concentrated in a few economic activities; however, no comprehensive forecasts or evaluation of the potential impact by sector or type of employment seems to exist at present. The lack of teachers and nurses is also having an impact on public service delivery. Measures are under way to increase the attractiveness of these professions, including noteworthy salary increases for teachers, but their results will most probably be seen only in the medium term. Box 4.3.1: Monitoring performance in light of the European Pillar of Social Rights The European Pillar of Social Rights is designed as a compass for a renewed process of upward convergence towards better working and living conditions in the European Union. It sets out 20 principles and rights in the areas of equal opportunities and access to the labour market; fair working conditions; and social protection and inclusion( I ). Bulgaria faces challenges with regard to a number of indicators of the Social Scoreboard supporting the European Pillar of Social Rights. It has still one of the highest numbers of people living at risk of poverty or social exclusion as well as high levels of income inequality. Social transfers have a low impact on poverty reduction. Major challenges for the education and training system remain, including providing quality inclusive education and tackling early school leaving. The level of digital skills of the population remains very low. Despite improvements in labour market performance, the low skilled, the Roma and people with disabilities still face significant difficulties in finding work. The very low enrolment rate of young children in formal childcare continues to be a challenge. Only 9.4% % of children aged 0 to 3 are enrolled, significantly below the EU average of over 30 %. It is due to the significant shortages of nurseries and/or other appropriate arrangements. This situation translates into poor labour market outcomes for young women. In 2017, the gender employment gap in Bulgaria (8 %) was below the EU average (11.5 %) for the general population, but significantly above the EU average for the 20-29 age group. Bulgaria has made significant progress in the deinstitutionalisation of children. There has been an 80 % decrease in the number of children placed in institutional care, to below 1 000 in 2017. All specialised institutions for children with disabilities have been closed following the implementation of the national ‘Vision for Deinstitutionalisation’ strategy and its action plans. EU funds catalysed this change from institutional to community-based care, but it certainly would not have been achieved without national political commitment. Monitoring the implementation of deinstitutionalisation reforms and continuous training and supervision of staff is also important to guarantee good quality services. Sustained efforts are also being made on prevention, family support and early intervention with integrated service provision, but these efforts need to continue. Graph 4.3.2:Labour shortage index (1) Source: European Commission Inequalities of opportunity are limiting access to the labour market for large groups of the population, which could hinder sustainable and inclusive growth. People living in rural areas, the low-skilled and the Roma still have very low levels of activity and employment. Around 55 % of Roma are unemployed; only 26 % are engaged in any form of paid work and 65 % of young Roma continue to be neither in work nor in education or training (FRA, 2016)( ). In view of the adverse demographic trends, the Roma community will represent a significant share of the working-age population in the short term, making activation, outreach, upskilling and reskilling measures essential. The co-financed programmes of the European Social Fund provide a wide range of labour market reintegration initiatives. These include training opportunities for low-skilled young people and the support of psychologists and Roma mediators for public employment services. Job creation, as well as improvement of knowledge and training in rural areas, is among the main objectives of support provided through the European Agricultural Fund for Rural Development. Positive results are expected in the coming years. The number of young people not in education, employment or training is still high but steadily decreasing. In 2017, the rate for young people aged 15-29 in Bulgaria fell to 18.9 % (from 25.7 % in 2013), but was still well above the EU average of 13.4 %. While the rate of people not in education, employment or training in cities is lower (11.2 %) than the EU average (12.5 %), in rural areas it is much higher (31.1 % against 14.2 %). The majority of those people are inactive, which contributes to the low participation in the Youth Guarantee (in 2017, this included only 13 % and 18.8 % of the population not in education, employment or training in age groups 15-24 and 25-29, respectively). Nevertheless, more than two thirds of participants reported being in employment, education or training 6 months after leaving the scheme. The youth unemployment rate has also been decreasing steadily and reached 12.9 % in 2017, below the EU average of 16.8 %. In addition, the share of young people unemployed for longer than 12 months shrank rapidly from 8 % in 2016 to 4.7 % in 2017. Educational attainment is a major factor in determining employment prospects for young people. The unemployment rate among low-skilled young people (24.8 %) is nearly three times higher than for the medium-skilled (8.7 %) and this difference has widened in the last 3 years. Several measures co-funded by the Youth Employment Initiative and the European Social Fund provide tools for people to access the labour market, including incentives for employers to hire young people after their training and supervised internships. Investment in traineeships and apprenticeships could help to make young people more employable.

The overall inactivity rate decreased sharply, partly reflecting positive dynamics in the labour market. With the inactivity rate declining from 31.3 % in 2016 to 28.7 % in 2017, Bulgaria came close to the EU average of 26.5 % (see Graph 4.3.3). Inactivity levels are highest in two gr