Proposal for a Council Decision providing macro- financial assistance to Bulgaria
Date: 1997-05-22
Institutions: European Commission
Subjects: Bulgaria, aid policy, economic policy, financial aid

COMMISSION  OF THE EUROPEAN  COMMUNITIES 

•ir 

* 

Brussels,  22.05.1997 
COM^l)  234  final 

97/0143 (CNS) 

Proposal  for a 

COUNCIL  DECISION 

providing macro-financial  assistance 

to Bulgaria 

(presented  by the Commission) 

EXPLANATORY MEMORANDUM 

1. 

INTRODUCTION 

Following several preliminary contacts with the Commission, Bulgaria presented its 
request  for  macrofinancial  assistance  from  the  Community  and  the  Group  of 
Twenty-four  industrial  countries  at  a high  level  G-24/Consultative  Group  meeting 
which  took  place  in Brussels  on April  8 jointly  organized  by the  World  Bank  and 
the  European  Commission.  The  request  for  assistance  is  in  support  of  the 
government's  economic  programme  which  is  the  basis  for  a  14-month  Stand-By 
Arrangement  approved  by  the  International  Monetary  Fund  (IMF)  board  on  April 
11. 

The purpose of the G-24/Consultative  Group Meeting was to review Bulgaria's past 
and future  stabilization and reform path and to secure the external funding  needed to 
ensure that the government's programme was adequately financed.  In the light of an 
agreement in principle from  the Council, the Commission announced at the meeting 
its  intention  to  propose  Community  macro-financial  assistance  of  up  to  ECU  250 
million  in  favour  of  Bulgaria.  Other  bilateral  donors  also  gave  indications  of 
support. 

Bulgaria's  relations  with  the  European  Union  are  governed  by  the  Association 
Agreement  which entered  into force  on  1 February  1995. Bulgaria  submitted  on  14 
December  1995 an application to become a member of the Union. This  application 
is currently being considered by the Commission. 

The Council has decided two previous macrofinancial  loans in favour of Bulgaria, in 
each  case  in  the  context  of  IMF-supported  economic  adjustment  programmes.  A 
first loan  of  290  MECU  was  decided  in  1991  and  disbursed  in two  instalments  in 
1991 and  1992. A second  loan  was decided  in October  1992. However,  because  of 
repeated  policy  slippages, disbursement  was much  delayed.  A first instalment  was 
disbursed in  1994, while the final instalment was only disbursed in 1996. 

2. 

ECONOMIC SITUATION  AND PROGRESS WITH STABILIZATION  AND REFORM 

Bulgaria  is  beginning  to  emerge  from  its  severe  economic  and  social  difficulties. 
Following  a period  of acute instability  in  1996 when GDP fell  by  almost  10% and 
the  first  weeks  of  1997, when  the population  suffered  hyperinflation,  considerable 
and  rapid  progress  has  been  made  in  restoring  a  degree  of  both  economic  and 
political stability. 

Bulgaria's  transition  to  a market  economy  has  been particularly  difficult  Bulgaria 
started economic reform under exceptionally unfavourable  conditions. The legacy of 
central planning included an excessively developed heavy industrial sector, based in 
part  on  artificially  cheap  energy  and  lax  regulation  of  pollution,  and  systematic 

neglect of the traditionally competitive agricultural  sector. From  1990, the country 
also suffered a number of serious external shocks: 

-  the  collapse  of  trade  with  the  CMÉA,  and  in  particular  the  USSR,  on  which 

Bulgaria was particularly dependent 

-  the need to import energy at world prices to replace cheap Soviet supplies 

-  the lack of access to commercial credit as a result of the unilateral moratorium on 

external debt declared in March 1990 

-  the effect of international embargoes on Iraq and Serbia. 

In these  difficult  circumstances,  Bulgaria made  a late  but bold  start to  economic 
reform.  Prices  of  most  goods  were  liberalized,  subsidies  were  sharply  reduced, a 
floating exchange rate was introduced, and the state monopoly on foreign trade was 
abolished.  Good progress was made also in establishing  the  legislative  basis for a 
market economy: by mid-1992 much of the legal framework was in place. 

However,  structural  change  was  slow.  Initial  progress  in  restructuring  state 
enterprises stalled as the political and social consensus surrounding reform began to 
break  down.  Nevertheless,  agreement  reached  in  1994  between  Bulgaria  and  its 
commercial bank creditors on a Debt and Debt Service Reduction (DDSR) operation 
appeared to have a healthy effect  on confidence,  and. Bulgaria enjoyed two years of 
relatively good economic performance.  Gross Domestic Product grew in real terms 
by  1.8% and 2.6% in  1994 and  1995  respectively.  By early  1996  annual  inflation 
had fallen to under 30%. 

The macroeconomic recovery did not have a solid structural base, due to a lack of 
structural  reform.  From  the  second  half  of  1995,  signs  that  the  recovery  was 
unsustainable  began to  appear.  Industrial  output  slowed,  the balance  of  payments 
weakened,  and  in  early  2996  the  national  currency  came  under  pressure  on  the 
foreign  exchange  market.  Individuals  lost  confidence  in  the  banking  system, 
withdrew their savings and converted them into dollars. A steep depreciation of the 
leva got underway. This continued until February this year, by which time the leva 
had lost approximately 95% of its April 1996 value against foreign currencies. 

Hyperinflation  reduced  the  real  value  of  wages  and pensions  to  pitiful  levels:  in 
early  1997,  the  average  monthly  wage  was  less  than  US$15,  while  the  average 
pension was worth no more than US$4. In response to this desperate situation, the 
European Union decided to allocate 20 MECU from the PHARE programme to a 
special programme in support of the social safety net. 

3. 

THE MEDIUM-TERM ECONOMIC PROGRAMME OF BULGARIA 

In the wake of the deep economic crisis of winter 1996/97, a new consensus behind 
market  reforms  has  emerged.  Exceptionally,  the  interim  government  formed 
pending parliamentary elections on April  19 was mandated to negotiate agreement 
with the International Financial  Institutions and other lenders to obtain support for 
an economic reform programme. 

The government's  economic programme  which formed  the basis for  the  agreement 
with  the  IMF  commits  Bulgaria  to the  adoption  of  a  currency  board  arrangement, 
probably  in June of this year. The introduction  of the currency  board  entails fixing 
the  exchange  rate  and  limiting  the  amount  of  domestic  currency  in  circulation 
through  a  central  bank  guarantee  to  exchange  domestic  currency  for  foreign 
currency, at the fixed exchange rate. The success of this policy crucially depends on 
adherence  by  the  government  to  a  responsible  fiscal  policy.  The  programme  also 
includes  ambitious  targets  for  the rapid  privatization  of the  enterprise  and  banking 
system,  price  liberalization,  and  reform  of the  agriculture  sector.  This  far-reaching 
package  of  structural  reforms  is  expected  to  be  supported  by  the  World  Bank 
through a Financial and Enterprise Sector Adjustment  Loan. Additional World Bank 
lending  will  cover  support  to agricultural  restructuring  and  for  the improvement  of 
the social safety net. 

It is planned to complete the privatization of state enterprises and banks by the end 
of  1998.  As  confidence  in  the  health  of  the  banking  sector  is  another  key  to 
successful  operation  of  a  currency  board  arrangement,  capital  adequacy 
requirements are to be gradually strengthened, so that all banks will have to meet the 
Basle  requirements  on  capital  adequacy  by  mid-1998.  Foreign  investment  in  the 
banking and enterprise sectors will also be encouraged. 

Implementation of the programme has begun with liberalization of almost all prices, 
other  than  five  basic  foodstuffs,  for  which  strict  ceilings  have  been  placed  on 
budgetary  subsidies.  The authorities  have implemented  steep increases  in fuel  and 
utility prices, in order to stem losses of public enterprises in these sectors. 

In  the  agriculture  sector,  land  restitution  will  be accelerated.  Combined  with  price 
liberalization  and  extensive  privatization,  this  is  expected  to  contribute  to  the 
development of a land market and a recovery in agricultural output. The land market 
will  also  be  promoted  through  legislative  reform  which  will  facilitate  leasing  and 
mortgaging of farmland. 

4. 

BALANCE OF PAYMENTS DEVELOPMENTS AND FINANCING NEEDS 

Since the DDSR operation, Bulgaria has serviced its external obligations promptly. 

In 1996, the current account of the balance of payments is provisionally estimated to 
have recorded  a small  surplus. This  is expected to continue to  be the  case  in  1997 
and  1998. Bulgaria's balance of payments difficulties  are concentrated in the capital 
account.  In  1996,  a  large  capital  outflow  was  recorded  linked  to  the  loss  of 
confidence  in  the  banking  system.  While  this  should  not  recur,  Bulgaria  is  faced 
with  a net  outflow  of capital  in the coming years due to foreign  debt  amortization, 
which  is expected  to  be only partly  offset  by  inflows  of foreign  direct  investment. 
Bulgaria  is  at  present  unable  to  raise  funds  on  the  international  capital  markets. 
Combined with the need to rebuild the central bank's foreign reserves, this yields an 
external financing  gap for  1997-98 of some US$1.9 billion. 

In  support  of  Bulgaria's  reform  programme  the  International  Monetary  Fund  on 
April  11  granted  Bulgaria  a  fourteen-month  Stand-by  Arrangement  of  SDR  372 
million  (US$510  million)  and  a  proposed  drawing  of  SDR  107  million  (US$148 

million)  under  the  cereals  component  of  the  Compensatory  and  Contingency 
Financing Facility. In addition, the World Bank is expected to commit in excess of 
US$250  million  in  the  form  of  two  Financial  and  Enterprise  Sector  Adjustment 
Loans, an Agriculture  Sector Adjustment  Credit, and  support  for  the reform  of the 
social security system. An additional US$400 million is projected  to be raised  from 
privatization.  Taking  this  and  the  contributions  of  the  IMF  and  World  Bank  into 
account,  the remaining  residual financing gap is estimated  at US$  550 million  for 
the programme period. 

Unless  this  remaining  gap  can  be  closed,  Bulgaria's  ability  to  implement  its 
structural  adjustment  programme  and  to  meet  its  external  financial  commitments 
would be put under  severe  strain. Indeed, attempts to relaunch economic  reform  in 
Bulgaria could  be derailed  almost before  they had begun. Pro-reform  forces  would 
have their position seriously undermined. 

The success of the Bulgarian government's programme depends in the first instance 
on  its  vigorous  implementation  by  the  national  authorities.  But  it  also  requires  an 
appropriate  response  by  the  international  community,  and  in  particular  from  the 
Community.  It  is  important  for  the  Union's  credibility  that  it  provide  adequate 
support to an Associated Country and potential future member of the Union. 

5. 

PROPOSED  FURTHER  MACRO-FINANCIAL  ASSISTANCE  TO  BULGARIA  AND  MAIN 
FEATURES OF THE LOAN 

The  Commission  is  proposing  that  the  Community  would  make  available  to 
Bulgaria  a balance  of payments  loan  of up to  ECU  250  million  with  a  maximum 
duration  of  ten  years.  The  proposed  duration  of  the  loan  is  consistent  with  the 
medium and long-term balance of payments outlook for Bulgaria, which is expected 
to face substantial financing needs for the years to come. 

The assistance would be granted in the context of the present Stand-by  Arrangement 
with the IMF and would complement  resources made available by the International 
Financial Institutions and bilateral donors. 

The assistance  would  be released  in two  instalments  subject  to  a satisfactory  track 
record of the country's economic programme agreed with the IMF and progress with 
respect  to  structural  reforms.  This  will  include  observance  of  a  number  of 
performance  criteria which would be agreed  between the Bulgarian  authorities  and 
the  Commission  in  consultation  with  the  Monetary  Committee.  Its  effective 
implementation would take place on the understanding that Bulgaria will continue to 
remain current with respect to all its external financial obligations. 

As  in  the  case  of  similar  operations  in  favour  of  other  partner  countries,  the 
Community would provide the funds through market borrowing with a guarantee by 
the general budget. Bulgaria would subsequently  borrow from the Community. The 
borrowing  and  lending  operations  would  be  perfectly  matched  and  without  any 
commercial risk for the Community. 

£* 

In accordance with the Guarantee Fund mechanism, the budgetary  implications of a 
decision  to make available  assistance  of up to ECU 250 million  to Bulgaria  would 
imply an ECU 37.5 million provisioning of the Fund. 

Proposal for a 

COUNCIL DECISION 

providing macro-financial  assistance 

for Bulgaria 

THE COUNCIL OF THE EUROPEAN UNION, 

Having regard to the Treaty establishing the European Community, and in particular 
Article 235 thereof, 

Having regard to the proposal of the Commission1, 

Having regard to the opinion of the European Parliament2, 

Whereas the Commission has consulted the Monetary Committee before  submitting 
its proposal; 

Whereas  Bulgaria  is  undertaking  fundamental  economic  reforms  and  is  making 
strenuous efforts to implement a market economy model; 

Whereas  Bulgaria  and  the  European  Union  have  concluded  a  Europe  Agreement 
establishing a relationship of association; 

Whereas, by Decision 91/311/EEC3, the Council decided to grant Bulgaria medium-
term financial assistance for an amount of ECU 290 million, to ensure a sustainable 
balance  of  payments  by  that  country,  and  whereas, by  Decision  92/511 /EEC4,  the 
Council  decided  to  grant  Bulgaria  further  assistance  for  an  amount  of  ECU  110 
million; 

Whereas  however  additional  adjustment  and  reform  measures  are  necessary  in 
Bulgaria to strengthen the financial  sector and to accelerate privatization; 

Whereas  Bulgaria has reached  an agreement  with the  International  Monetary  Fund 
(IMF)  in  April  1997 on  an  economic  programme  which  would  be  supported  by  a 
Stand-By Arrangement; 

Whereas  the  authorities  of  Bulgaria  have  requested  financial  assistance  from  the 
international  financial  institutions,  the  Community  and  other  bilateral  donors,  and 
whereas,  over  and  above  the  estimated  financing  which  could  be  provided  from 
private  sources  and  by  the  IMF  and  the  World  Bank,  a  residual  financing  gap  of 

l 

2 

3OJ  No L 174, 3. 7. 1991, p. 36 

4OJ  No L 317, 31.  10. 1992, p. 94 

some US$550 million remains to be covered during the programme period  in order 
to strengthen  Bulgaria's reserve position and support the policy  objectives  attached 
to the government's economic programme; 

Whereas the provision by the Community of a new long-term loan to Bulgaria is an 
appropriate  measure  to  support  the  balance  of  payments  and  to  strengthen  the 
country's reserve position; 

Whereas the Community loan should be managed by the Commission; 

Whereas, for  the adoption of this Decision, the Treaty does not provide for powers 
to act other than those of Article 235, 

HAS DECIDED AS FOLLOWS : 

Article 1 

1.  The  Community  shall  make  available  to  Bulgaria  a  long-term  loan  facility  of  a 
maximum  principal  amount  of ECU 250 million,  with a maximum  maturity  of ten 
years,  with  a  view  to  ensuring  a  sustainable  balance-of-payments  situation  and 
strengthening the country's reserve position. 

2.  To this  end,  the  Commission  is empowered  to  borrow,  on  behalf  of the  European 
Community, the necessary  resources that will  be placed  at the disposal  of Bulgaria 
in the form of a loan. 

3.  This  loan  will  be  managed  by  the  Commission  in  close  consultation  with  the 
Monetary  Committee  and  in  a  manner  consistent  with  any  agreement  reached 
between the International Monetary Fund and Bulgaria. 

Article 2 

1.  The  Commission  is  empowered  to  agree  with  the  authorities  of  Bulgaria,  after 
consultation with the Monetary Committee, the economic policy conditions attached 
to the  loan. These conditions  shall be consistent with the agreements referred  to  in 
Article 1(3). 

2.  The Commission shall verify  at regular intervals, in collaboration with the Monetary 
Committee  and  in  co-ordination  with  the  International  Monetary  Fund,  that 
Bulgaria's economic policy is in accordance with the objectives of this loan and that 
its conditions are being  fulfilled. 

S 

ArtickS 

1.  The loan shall be made available to Bulgaria in two instalments. Subject to Article 2 
the first instalment is to be released on the basis of the completion of the first review 
of the "stand-by arrangement" agreed with the International Monetary Fund. 

2.  Subject  to  Article  2  the  second  instalment  shall  be  released  on  the  basis  of  a 
satisfactory  continuation  of the "stand-by  arrangement" and not before  one  quarter 
after the release of the first instalment. 

3.  The funds  shall be paid to the Bulgarian National Bank. 

Article 4 

1.  The borrowing  and  lending  operations  referred  to  in Article  1 shall  be  carried  out 
in  the 
using  the  same  value  date  and  must  not  involve  the  Community 
transformation  of  maturities,  in  any  exchange  or  interest  rate risk, or  in  any  other 
commercial risk. 

2.  The  Commission  shall  take  the necessary  steps, if  Bulgaria  so requests, to  ensure 
that an early repayment clause is included in the loan conditions and that it may be 
exercised. 

3.  At the request of Bulgaria, and where circumstances permit  an improvement  in the 
interest  rate  on  the  loans,  the  Commission  may  refinance  all  or  part  of  its  initial 
borrowings  or  restructure  the  corresponding  financial  conditions.  Refinancing  or 
restructuring  operations  shall  be  carried  out  in  accordance  with  the  conditions  set 
out in paragraph  1  and shall not have the effect  of extending the average duration of 
the  borrowing  concerned  or  increasing  the  amount,  expressed  at  the  current 
exchange rate, of capital outstanding at the date of refinancing  or restructuring. 

4.  All  related  costs  incurred  by  the  Community  in  concluding  and  carrying  out  the 

operation under this Decision shall be borne by Bulgaria. 

5.  The Monetary Committee shall be kept informed  of developments in the operations 

referred to in paragraphs 2 and 3 at least once a year. 

Article 5 

At  least  once  a year  the Commission  shall  address to the European  Parliament  and  to 
the  Council  a report,  which  will  include  an  evaluation,  on  the  implementation  of  this 
Decision. 

Done at 

, 

For the Council 

The President 

FINANCIAL RECORD 

1.  Title of operation 

Macro-financial  assistance to Bulgaria 

2.  Budget heading involved 

Heading BO-2132 reflecting  the budget guarantee for the Community loan facility to 
Bulgaria (to be created through an amending and/or a supplementary budget). 

3.  Legal basis 

Article 235 of the Treaty 

4.  Description and Justification for the action 

a)  Description of the action 

Provision of a Community loan (to be financed  by Community borrowing on the 
international  capital  markets)  in  the  amount  of  up  to  ECU  250  million  with  a 
view to supporting Bulgaria's adjustment  and reform  efforts. 

b)  Justification  for the action 

The  viability  of  Bulgaria's  external  accounts  heavily  depends  on  external 
financial assistance from official  sources. 

5.  Classification  of the Expenditure 

Obligatory 

6.  Nature of the expenditure 

Potential activation of budget guarantee for the Community borrowing aimed to fund 
the loan to Bulgaria. 

7.  Financial Impact 

a)  Method of calculation 

A  token  entry  is proposed  given that  the  amount  and  timing  of  any  call  on  this 
budget  line  cannot  be  calculated  in  advance  and  because  it  is  expected  that  this 
budget guarantee will not be called. 

b) Effect  of the action on intervention credits 

Only in the case of an effective  call on the guarantee. 

4o 

c)  Financing of intervention expenditure 

In case of call on the budget guarantee: 

-  Recourse  to  the  Guarantee  Fund  established  by  Council  Regulation  (EC, 

EURATOM) n° 2728 of 31 October 1994. 

-  In case the Guarantee Fund did not contain sufficient  resources,  additional 

payments would be called up from the budget by transfer: 

•  of any margin remaining in the Reserve for guarantees; 

•  of any late payments to the budget for which the budget guarantee 
the  Financial 

has  been  activated  (under  article  27(3)  of 
Regulation); 

•  of  any  margin  available  under  the  ceiling  of  category  4  of  the 

financial  perspectives or redeployment therein. 

-  In order to fulfil  its obligations, the Commission  can provisionally  ensure 
the debt service with funds  from  its treasury. In that case. Article  12 of the 
Council Regulation (EEC, Euratom) n°  1552/89 of 29.5.1989 will apply. 

8.  Fraud prevention measures 

The  funds  will be paid  directly  to the  Central  Bank  of the beneficiary  country  only 
after  verification  by  the  Commission  Services,  in  consultation  with  the  Monetary 
Committee  and  in  liaison  with  the  IMF  and  World  Bank  Services,  that  the 
macroeconomic  policies  implemented  in  this  country  are  satisfactory  and  that  the 
specific conditions attached to this assistance are  fulfilled. 

9.  Elements of cost-effectiveness  analysis 

a)  Grounds for the operation and specific  objectives 

By  supporting  the  beneficiary  country's  macroeconomic  reform  efforts  and 
complementing  financing  by  the  International  Community  provided  to  this 
country  in  the  context  of  an  IMF  agreed  programme,  this  assistance  would 
underpin  its transition towards a market economy, improve growth prospects and 
alleviate social unrest. 

b)  Monitoring and evaluation 

This assistance is of a macroeconomic nature and its monitoring and evaluation is 
undertaken  in  the  framework  of  the  IMF-supported  adjustment  and  reform 
programme that the beneficiary  country is implementing. 

The Commission services will monitor the action on the basis of a genuine system 
of  macroeconomic  and  structural  policy  indicators  to  be  agreed  with  the 
authorities of the beneficiary  country. They will also remain in close contact with 

•ii 

the IMF  and  World  Bank  services  and  will  benefit  from  their  assessment  of the 
recipient country's stabilization and reform achievements. 

An annual report to the European Parliament and to the Council is foreseen  in the 
proposed  Council  decision,  which  will 
the 
implementation of this operation. 

include  an  evaluation  of 

10.  Administrative  expenditure 

This action is exceptional  in nature and will not involve an increase in the number of 
Commission  staff. 

U 

ANNEX 

BUDGETARY  RESOURCES NECESSARY  FOR THE PROVISIONING OF THE 
GUARANTEE FUND IN 1997 AND MARGIN UNDER THE RESERVE FOR LOANS 

AND LOANS GUARANTEE IN FAVOUR OF THIRD COUNTRIES 

(IN ECU MILLION) 

Operations 

Decided operations -

Project-related  assistance 

EIB/MED 
EIB/PVDALA 
EIB/SOUTH AFR. 
EIB/Renewal of mandates 4 

Macro-financial  assistance 

Slovakia  (Cancellation) 
Belarus  (Suspension) 

Proposed operations 

Project-related  assistance 

EIB/Turkey 5 
EIB/FYROM 6 
EIB/ Croatia 7 

Macro-financial  assistance 

Georgia, Armenia and, if appropriate, Tajikistan ' 
FYROM 9 
Bulgaria 9 

Basis of the 
Calculation 

Provisioning of 
the  Fund1 

Reserve 
Margin 

329.0 

2 

330.7 
336.0 
327.8 
97.3 

115.5 
119.3 

103.5 
98.3 
90.9 

65.4 
59.4 
21.9 

-14 
-38 
55 
1536.5 

-130 
-25 

105 
35 
49 

170 
40 
250 

-1.71 
-5.32 
8.25 
230.48 

-18.20 
-3.75 

15.75 
5.25 
7.35 

25.50 
6.00 
37.50 

According  to  the  provisioning  rules  provided  in  the  Council  regulation  (EC,  Euratom)  n°  2728/94  of  31 
October  1994.  After  a  first  drawing  of  the  Guarantee  Fund,  and  in  compliance  with  Article  5  of  the 
Regulation,  the  rate  of  provisioning  for  new  operations  has  been  increased  from  14  % to  15%  in  1995. 
New macro-financial  assistance operations  have been provisioned with a 15% rate. 
Reserve amount in 1997 under the financial perspective. 
Corrections  of the amounts to be transfered to the Fund in compliance with annex to Council regulation  n° 
2728/94. 
Council Decision of 14 April 1997. 
Proposal  for  a Council  regulation  relative to  a special  action  of  financial  cooperation  in favour  of  Turkey 
(COM(95) 389 final). 
Proposal  for  a  Council  decision  concerning  the  conclusion  of  a  cooperation  agreement  with  FYROM 
(COM(96) 533 final) of 25 November 1996. 
Cooperation  agreement  EC/Croatia  (SEC(95)  180/final).  Negotiations  suspended  since  Summer  1995.  It 
is therefore unlikely that this operation would be implemented in 1997. 
Commission  proposal for a Council decision (COM(97) 24 final) of 3 February  1997. 
Commission proposal. 

n 

ISSN 0254-1475 

COM(97) 234 final 

DOCUMENTS 

EN 

01  11 

Catalogue number  :  CB-C0-97-225-EN-C 

ISBN 92-78-19800-5 

Office  for Official  Publications of the European Communities 

L-2985 Luxembourg 

/¥-