Council opinion of 10 March 2009 on the updated convergence programme of Bulgaria, 2008-2011
Date: 2009-03-10
Institutions: Council of the European Union
Subjects: Bulgaria, EU programme, budget estimate, economic convergence, economic forecasting, public finance

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I

(Resolutions, recommendations and opinions)

OPINIONS

COUNCIL

COUNCIL OPINION

of 10 March 2009

on the updated convergence programme of Bulgaria, 2008-2011

(2009/C 62/01)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveil-
lance of budgetary positions and the surveillance and coordination of economic policies (1), and in particular
Article 9(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1)

(2)

On 10 March 2009, the Council examined the updated convergence programme of Bulgaria, which
covers the period 2008 to 2011 (2).

Bulgaria has experienced strong economic growth at over 6 % on average over the past several years,
accompanied by widening macro-economic imbalances, such as high external deficits and inflation.
In the context of the currency board framework, monetary and credit conditions tightened in 2008
amid higher country risk perceptions and a continued appreciation of the real effective exchange rate.
As the adverse impact of the global economic slowdown and the financial crisis unfolds, GDP growth
is set to decelerate sharply and remain well below potential in 2009-2010, putting pressure on tax
revenues. Thus Bulgaria faces the challenge of sustaining growth in a severe and protracted global
economic downturn, while addressing the existing macro-economic imbalances through maintaining
tight fiscal and incomes policies. Against this background, the policy response in the programme
envisages measures aiming at strengthening the economy's resilience. Despite the starting position of
low public debt-to-GDP ratio and large fiscal surpluses, the high inflation and large current account
deficit have prevented the government from adopting a fiscal stimulus package for boosting domestic
demand. In the long term, the country is confronted with the need to improve the quality of public
finances while facing fast ageing population and worsening demographics.

(1) OJ L 209, 2.8.1997, p. 1. The documents referred to in this text can be found at the following website:

http://ec.europa.eu/economy_finance/about/activities/sgp/main_en.htm

(2) On 23 December 2008, the Bulgarian authorities submitted an addendum to the programme detailing the measures
adopted in response to the economic downturn. The addendum did not present any significant changes in the fiscal and
structural policies compared to those in the convergence programme and the budgetary projections remained unchanged.

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(3)

(4)

(5)

(6)

(7)

(8)

The macro-economic scenario underlying the programme envisages that real GDP growth will fall
from 6,5 % in 2008 to 4,7 % in 2009 before recovering to an average rate of 5,5 % over the rest of
the programme period. Assessed against currently available information (1), this scenario appears to
be based on markedly favourable growth assumptions for 2009 and thereafter. This reflects high
domestic demand, in particular investment growth, and acceleration in real exports throughout the
programme period, which are inconsistent with the slowdown in both foreign direct investment
inflows and world trade. However, due to a much higher import growth assumed in the programme,
in line with domestic demand, the external deficit would narrow only gradually in 2009-2011. Based
on the assumption of a milder slowdown, the programme projects inflation in 2009 to be on the
high side,
implying limited progress towards nominal convergence. The inflation outlook for
2010-2011 appears realistic.

For 2008, the general government surplus is estimated at 3 % of GDP in the most recent update of
the programme, which is in line with the original target. The budgetary outcome reflects a better
starting position (after correcting for an unanticipated one-off debt cancellation measure in 2007,
amounting to 3,5 % of GDP). Despite the significant import growth and high inflation in 2008,
revenue collected from indirect taxes was 1,5 % of GDP lower than initially projected. Following the
introduction of a 10 % flat personal income tax rate, direct tax revenues collection was 0,5 % of GDP
less than anticipated in the December 2007 update. On the expenditure side, discipline has not been
fully maintained, as additional social and infrastructure spending of around 1,75 % of GDP was
adopted. Nevertheless, thanks to higher-than-expected nominal GDP growth, the expenditure-to-GDP
ratio was lower than envisaged in the previous programme.

The 2009 budget law targets a general government surplus of 3 % of GDP. The law includes some
discretionary measures, which would have an overall neutral budgetary impact. On the revenue side,
the impact of the reduction of the contribution rate to the public pension fund by 4 % would be
offset by the increase in the healthcare contribution rate by 2 % and in the average mandatory
minimum insured income thresholds by 26,5 % in nominal terms. On the expenditure side, primary
expenditure is set to grow, mainly due to higher social payments and compensation of employees.
Pensions will be increased by almost 20 % in two steps from 1 April and 1 July. The wage bill in the
general government sector is envisaged to grow by 10 %. To ensure meeting the budgetary targets,
the rule limiting the disbursement of non-interest expenditure (excluding social security transfers) to
90 % of budgeted allocations in case of a worse-than-budgeted revenue outcome has been re-intro-
duced. The 2009 budget law provides for even lower disbursements if the underperformance in the
consolidated general government revenues falls to a level that would result in a negative budget
balance.

The budgetary strategy outlined in the program projects the medium-term objective (MTO) of a
1,5 % of GDP surplus to be respected throughout the programme period. The current update envi-
sages the general government balance to remain in surplus of 3 % of GDP and the primary balance
to stay unchanged at a surplus of almost 4 % of GDP until 2011. In structural terms (i.e. cyclically-
adjusted net of one-off and other temporary measures), the budgetary balance is projected to remain
in surplus of around 3,5 % of GDP over the programme period. While the negative output gap is
projected to widen, the underlying fiscal policy stance appears to be broadly neutral in the medium
term.

The programme budgetary outcomes are subject to significant downside risks. The main risk stems
from the underlying macro-economic scenario, which is based on markedly favourable growth
assumptions for 2009 and 2010. On the revenue side, risks for public finances in 2009-2010 are
higher than in previous years and are associated with a sharper contraction and rebalancing of
economic growth towards less revenue-rich growth composition. In view of the expected economic
slowdown and pressures to increase demand-enhancing expenditure, controlling expenditure growth
through the 90 % budget execution rule might prove to be difficult in 2009.

In the absence of
long-term projections of age-related expenditures, based on the common
macro-economic assumptions as carried out by the EPC/Commission, it is not possible to assess the
impact of population ageing in Bulgaria on a comparable and robust basis as it is currently done for
the previously acceded 25 Member States. The budgetary position in 2008, with a large structural

(1) The assessment notably takes into account the Commission services' January 2009 forecast, but also other information

that has become available since then.

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surplus, contributes significantly to debt reduction before considering the long-term budgetary
impact of ageing. Maintaining high primary surpluses over the medium-term would contribute to
limiting the risks to the sustainability of public finances, which are currently at a low level.

(9)

(10)

(11)

Bulgaria's budgetary framework has so far demonstrated a very good track record by meeting the
budgetary targets, although in a context of buoyant economic growth. In the recent past, it has been
improved by streamlining the budgetary procedure, enhancing reporting requirements, and including
a more comprehensive macro-economic analysis and assessment of the fiscal risks in the budgetary
documents. However, the framework is binding only in the first year of the three-year budgetary plan-
ning horizon and allows for certain discretionary spending powers of the government which under-
mines the fiscal transparency and accountability. Despite these weaknesses, the programme does not
envisage any substantial changes to the budgetary framework apart from further progress with the
implementation of performance-based budgeting. The re-introduction of the 90 % budget execution
rule into the 2009 budget law aims at ensuring the budgetary target through limiting the general
government expenditure growth. However, the implementation of the rule is not clearly defined in
the law, which might leave some room for discretionary execution.

The Bulgarian government has not adopted any specific package to stabilize the financial sector.
However, in order to enhance the confidence in the banking system the deposit guarantee level was
raised to BGN 100 000 and the government increased the capital of the State-owned Bulgarian
Development Bank to facilitate financing to SMEs.

In view of the economic imbalances, fiscal policy is geared towards maintaining investor confidence
and preserving macro-economic stability. The Bulgarian government has therefore not adopted a
short-term stimulus package in response to the economic slowdown, which is in line with the EERP
agreed in December by the European Council. Related to the medium-term reform agenda and the
country-specific recommendations proposed by the Commission on 28 January 2009 under the
Lisbon Strategy for Growth and Jobs, the programme foresees structural measures which aim at
strengthening the economy's resilience, such as those aimed at sustaining employment, enhancing
business capacity to adapt to the crisis environment,
improving market functioning, providing, if
needed, capital support to commercial banks, boosting lending to SMEs, promoting export perfor-
mance, and improving EU funds absorption. These measures represent a timely and adequate
response to the main policy objectives in terms of the short-term outlook. The update also includes a
series of other structural reform measures, which are part of the longer-term strategy for improving
the quality and sustainability of public finances, such as the reform in the pension system, the imple-
mentation of next steps under the education reform strategy, including through further optimization
of the school network and strengthening the schools' delegated budget system, and the implementa-
tion of the recently adopted healthcare strategy.

(12)

The consolidation programme of the Bulgarian government would help contain the economy's high
external and internal imbalances. More specifically, the programme envisages a structural consolida-
tion of 1 % of GDP over the period 2008-2011. The overall fiscal stance, as measured by the change
in the structural balance,
in 2010-2011. The
programme's objective of maintaining a cyclically adjusted surplus of 1,5 % of GDP would be
achieved throughout the programme period.

is restrictive in 2009 and remains broadly neutral

(13) As regards the data requirements specified in the code of conduct for stability and convergence

programmes, the programme has some gaps in the optional data (1).

The overall conclusion is that the programme aims at maintaining a sound budgetary position throughout
the period, reflected in the planned high general government surpluses. The structural measures foreseen in
response to the economic slowdown aim at strengthening the economy's growth potential and are in line
with the EERP. Subject to the downside risks stemming from the uncertainty at the current economic junc-
ture and its impact on revenues, the budgetary stance would imply that the medium-term objective of 1,5 %
of GDP surplus would be achieved throughout the programme period. Bulgaria faces the challenge of
sustaining growth in a severe and protracted global economic downturn. Moreover the country should
implement firm policies to correct the large external deficit, including through maintaining a tight fiscal
policy and containing public sector wage growth. In addition, the country is confronted with the need to
improve the quality of public expenditure by improving administrative capacity and stepping up structural
reforms.

(1) In particular, some long-term sustainability data are not provided.

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In view of the above assessment and also given the need to ensure sustainable convergence, Bulgaria is
invited to:

(i) continue pursuing tight fiscal policies and maintaining a sound fiscal position by restraining expenditure
growth, with a view to helping contain existing external imbalances and counteract possible revenue
shortfalls;

(ii) contain public sector wage growth in order to contribute to overall wage moderation and improve

competitiveness;

(iii) further strengthen the efficiency of public spending,

in particular through full

programme budgeting, reinforced administrative capacity and reforming the areas of
product markets, education and healthcare in order to increase productivity.

implementation of
labour and

Comparison of key macro-economic and budgetary projections

2007

2008

2009

2010

2011

Real GDP
(% change)

HICP inflation
(%)

Output gap (1)
(% of potential GDP)

Net lending/borrowing
vis-à-vis the rest of the
world
(% of GDP)

General government
revenue
(% of GDP)

General government
expenditure
(% of GDP)

General government
balance
(% of GDP)

CP Dec 2008

COM Jan 2009

CP Dec 2007

CP Dec 2008

COM Jan 2009

CP Dec 2007

CP Dec 2008

COM Jan 2009 (2)

CP Dec 2007

6,2

6,2

6,4

7,6

7,6

7,2

1,5

2,7

0,7

6,5

6,4

6,4

12,4

12,0

6,9

1,1

3,0

4,7

1,8

6,8

6,7

5,4

4,4

5,2

2,5

6,9

4,7

4,8

3,7

5,8

n.a.

n.a.

4.0

n.a.

n.a.

– 0,7

– 1,8

– 1,4

– 0,3

– 2,3

n.a.

n.a.

– 0,1

– 0,6

n.a.

CP Dec 2008 (3)

– 20,6

– 22,9

– 20,7

– 18,4

– 16,6

COM Jan 2009

– 21,3

– 23,3

– 19,1

– 17,6

CP Dec 2007

– 19,9

– 20,7

– 19,5

– 18,6

n.a.

n.a.

CP Dec 2008

41,6

41,3

43,4

43,4

43,7

COM Jan 2009

41,6

41,4

40,8

40,9

CP Dec 2007

42,2

43,7

43,9

43,9

n.a.

n.a.

CP Dec 2008

41,5

38,3

40,4

40,4

40,7

COM Jan 2009

41,5

38,2

38,8

38,9

CP Dec 2007

39,1

40,7

40,9

41,0

CP Dec 2008

COM Jan 2009

CP Dec 2007

0,1

0,1

3,1

3,0

3,2

3,0

3,0

2,0

3,0

3,0

2,0

3,0

n.a.

n.a.

3,0

n.a.

n.a.

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Primary balance
(% of GDP)

Cyclically-adjusted
balance (1)
(% of GDP)

Structural balance (4)
(% of GDP)

Government gross debt
(% of GDP) (5)

CP Dec 2008

COM Jan 2009

CP Dec 2007

CP Dec 2008

COM Jan 2009

CP Dec 2007

CP Dec 2008

COM Jan 2009

CP Dec 2007

CP Dec 2008

COM Jan 2009

CP Dec 2007

2007

2008

2009

2010

2011

1,1

1,1

4,3

– 0,4

– 0,8

2,8

2,9

2,5

2,9

18,2

18,2

19,8

3,9

4,1

4,0

2,6

2,2

3,1

2,6

2,2

3,1

15,4

13,8

18,3

3,9

2,8

4,0

3,2

2,1

3,3

3,2

2,1

3,3

15,4

12,2

17,4

3,9

2,7

4,0

3,6

2,8

n.a.

3,6

2,8

n.a.

15,3

10,7

16,9

3,9

n.a.

n.a.

3,5

n.a.

n.a.

3,5

n.a.

n.a.

15,2

n.a.

n.a.

Notes:
(1) Output gaps and cyclically-adjusted balances according to the programmes as recalculated by Commission services on the basis of the

information in the programmes.

(2) Based on estimated potential growth of 5,0 %, 6,3 %, 6,0 % and 6,0 % respectively in the period 2007-2010.
(3) The different net borrowing position in 2007 in the current update of the programme and the Commission services' January 2009

interim forecast reflects a discrepancy in the balance on goods and services component.

(4) Cyclically-adjusted balance excluding one-off and other temporary measures. Cyclically-adjusted balances according to the programmes
as recalculated by the Commission services on the basis of the information in the programmes. The most recent update envisages no
one-off and other temporary measures for the programme period according to the Commission services' January 2009 interim forecast;
there are one-off measures amounting to 3,3 % of GDP (expenditure side) in 2007.

(5) The differing projections about the debt-to-GDP ratio in the programme compared to the Commission services' January 2009 interim
forecast are due almost entirely to the higher projected accumulation of financial assets, which is not considered by the Commission
services under a no-policy-change scenario.

Source:
Convergence programme (CP); Commission services' January 2009 interim forecasts (COM); Commission services' calculations.