COMMISSION STAFF WORKING DOCUMENT Macroeconomic Imbalances – Bulgaria 2014
Date: 2014-03-05
Institutions: European Commission
Subjects: Euro Group (euro area), Romania, budget deficit, competitiveness, economic growth, educational reform, financial institution, foreign investment, indebtedness, labour market, macroeconomics, stability pact













EUR-Lex - 52014SC0076 - EN











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52014SC0076

COMMISSION STAFF WORKING DOCUMENT Macroeconomic Imbalances – Bulgaria 2014 /* SWD/2014/076 final */









Results of in-depth reviews under
Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic
imbalances
Bulgaria continues to experience macroeconomic imbalances, which require
monitoring and policy action. In particular, the protracted adjustment of
the labour market warrants policy actions, while the correction of the external
position and corporate deleveraging are progressing well. 
More specifically,
Bulgaria experienced a period of very rapid accumulation of imbalances during
the boom phase that coincided with accession to the EU. High foreign capital
inflows contributed to the overheating of the economy and sustained increases
of fixed asset prices. The current account reversed since 2009 but the stock of
external liabilities, though a large share is FDI, remains high. The adjustment
appears to be mostly non-cyclical, but a further reduction in external
liabilities depends on sustaining external competitiveness and a strong export
performance. The ongoing deleveraging of non-financial corporations could limit
investments and growth in some sectors in the short and medium term. Also the
weak non-inclusive labour market limits the adjustment capacity of the economy
and is one of the reasons that holds back potential growth. Unemployment has
increased sharply, as the contraction in employment during the crisis has been
more pronounced than suggested by the contraction of output. The low-skilled
and young workers have been most affected by labour shedding. Despite relatively
low wage costs, after strong increases in recent years, wage floors may risk
pricing the most vulnerable out of the labour market. At the same time, active
labour market policies and the educational system have not been effective in
facilitating the adjustment process so far and hamper a broad-based
accumulation of human capital. 
Excerpt of country-specific findings on Bulgaria, COM(2014) 150 final,
5.3.2014
Executive Summary and Conclusions 7
1.       Introduction  9
2.       Macroeconomic
Developments 11
3.       Imbalances
and Risks 17
3.1.     External
imbalances 17
3.1.1.  External cost
competitiveness 17
3.1.2.  Sustainability
of the external position  17
3.1.3.  Current
account cyclicality  20
3.1.4.  Saving-investment
balance  20
3.1.5.   FDI and the
road ahead   21
3.2.     Labour
market and social developments 23
3.2.1.  Overview and
recent developments 24
3.2.2.  Social
consequences of unemployment 27
3.2.3.  Labour market
policies and education  32
4.       Policy
Challenges 35
References 37
LIST OF Tables
2.1.     Key
economic, financial and social indicators - Bulgaria   16
LIST OF Graphs
2.1.     Real GDP
growth by demand components 11
2.2.     Key labour
market data   11
2.3.     Components
of potential growth  11
2.4.     CA gross
components 12
2.5.     Private
sector debt decomposition  12
2.6.     Net assets
by sector, non-consolidated   13
2.7.     NFC
deleveraging  13
2.8.     House price
cycle  14
2.9.     House price
ratios 14
3.1.     Export
market shares 17
3.2.     Decomposition
of ULC growth by sector over 2008-2012, annualised   17
3.3.     External
financing needs 18
3.4.     Gross
external debt by currency  18
3.5.     Gross
external debt structure  18
3.6.     Gross
external debt by maturity  18
3.7.     NIIP
stabilizing CA   19
3.8.     Underlying
current account 20
3.9.     Saving -
investment balance  20
3.10.   NFC profit
margins 21
3.11.   Net
investment by sector 21
3.12.   NFC saving -
investment 21
3.13.   Net inward
FDI stock  22
3.14.   Inward FDI
stock by industry  22
3.15.   FDI inflows
2009-2013  23
3.16.   FDI inflows
2010-2013  23
3.17.   Employment
rate  24
3.18.   Unemployment
rate by duration  24
3.19.   Employment
rate by education in 2012  25
3.20.   Unemployment
rate by education level 25
3.21.   Average wage
growth by educational attainment (02-10) 25
3.22.   Minimum and
average wages (leva) 26
3.23.   Ratio of
minimum wage to average earnings (2012) 26
3.24.   Ratio of
minimum to average wage differentiated by education in 2010  26
3.25.   Number of
sectors with minimum wage as the MSST  27
3.26.   AROPSE  28
3.27.   Severe material
deprivation  28
3.28.   Deprivation
by number of items (economic strain dimension) 28
3.29.   In-work AROP  29
3.30.   AROP by
employment status 29
3.31.   Regional
poverty (2008-12 avg) 29
3.32.   Regional
unemployment 29
3.33.   Reduction in
the risk of poverty after social transfers 30
3.34.   Non
means-tested benefits 30
3.35.   Means-tested
benefits 31
3.36.   Labour market
policies by category (LMP expenditure) 32
3.37.   Lifelong
learning (age 25-64) 32
3.38.   Labour market
policies 33
3.39.   Expenditure
on education and early school leavers 34
LIST OF Boxes
3.1.     Roma
participation on the labour market 31
LIST OF Maps
No table of contents
entries found.
In April 2013, the Commission concluded
that Bulgaria was experiencing macroeconomic imbalances, in particular relating
to the high stock of external liabilities, the economic impact of deleveraging
in the corporate sector as well as the protracted adjustment of the labour
market. In the Alert Mechanism Report (AMR) published on 13 November 2013, the
Commission found it useful, also taking into account the identification of imbalances
in April, to examine further the persistence of imbalances or their unwinding.
To this end, this In-Depth Review (IDR) provides an economic analysis of the
Bulgarian economy in line with the scope of the surveillance under the
Macroeconomic Imbalance Procedure (MIP). The main observations and findings
from this analysis are:
·       A sustained current account adjustment has helped reduce the
country's external financing needs, but the stock of liabilities remains high. High foreign capital inflows contributed to the overheating of the
economy and the accumulation of external liabilities before the crisis. From
peak deficits in 2007-08, Bulgaria's current account has rapidly improved
during the crisis and turned into a surplus in 2013. The adjustment appears to
be mostly non-cyclical: it has been driven by a decrease in imports brought
about by the crisis but also by a strong export performance, as reflected in
Bulgaria's steady gains in world market shares. Thanks to this adjustment, the
net international investment position has improved and external financing needs
have decreased. Furthermore, the structure of external liabilities does not
suggest immediate risks, as it is mostly composed of long-term euro-denominated
intra-company loans, which also imply low foreign exchange risk. However, the
stock of liabilities remains high. Further unwinding of this vulnerability will
depend on strengthening further external competitiveness and a strong export
performance.
·       Foreign direct investment remains a key source of funding future
growth. Ample foreign investment inflows before the
crisis have benefitted some economic sectors but may have also inflated fixed
asset prices. Since then, the country’s saving-investment balance has improved,
helping deleveraging. Continuing to attract foreign capital, and its efficient
allocation, remains crucial for speeding-up growth and accelerating
convergence. 
·       Corporate indebtedness remains high and deleveraging pressures could
limit growth in some sectors, but immediate risks for the economy appear
contained. The debt stock of non-financial
corporations has been decreasing since 2010 but remains high as a share of GDP.
As a response to deleveraging pressures, companies have increased profitability
and saving, mostly through cost-cutting, including labour shedding. Going
forward, still high indebtedness and the build-up of large other accounts
payable (consisting of payments due to suppliers of goods and services,
including arrears) could threaten the viability of some firms, or deter
investment and growth. However, since most of the debt of non-financial
corporations is in the form of intra-company loans, potential spill-overs to
the financial and public sectors appear limited as already underlined in the
second IDR for Bulgaria.
·       The stability of the banking sector has been preserved and
consolidation seems to be under way. As described
in the two previous IDRs, the banking sector has weathered the crisis well and
continues to have strong overall capital buffers. Non-performing loans have
stabilised and remain well-provisioned. Credit growth has resumed in some
tradable sectors. Domestically-owned banks are expanding their portfolio faster
compared to subsidiaries of foreign banks, which is likely a sign of higher
risk appetite. The systemic importance of local entities has increased
following their gains in market share, including two acquisitions of
foreign-owned banks in the country in the last twelve months.
·       An underperforming labour market limits the adjustment capacity of
the economy and holds back its growth potential.
During the crisis, the contraction of employment has been more pronounced than
the contraction in GDP. Since 2008, unemployment has more than doubled,
reaching 13% in 2013, and the number of young and long-term unemployed has
increased drastically. The employment rate remains low and a large section of
the population faces major challenges to participate in the labour market,
which exposes them to the risk of poverty. The fact that unemployment is the
major driver of poverty in Bulgaria underscores the importance of a broad-based
labour market recovery.
·       Increased wage floors risk pricing the low skilled out of the labour
market. Wage floors, in the form of minimum wages
and in particular minimum thresholds for social security contributions, have
increased substantially in recent years, endangering the employment prospects
of low-skilled workers. 
·       Active labour market policies have not been effective in
facilitating adjustment, while weaknesses in the educational system hamper a
broad-based accumulation of human capital. Two
groups, the low-skilled and young workers, have been hardest hit by labour
shedding. So far, active labour market policies, including training, have not
succeeded in reintegrating even the more experienced workers, thus contributing
to skills mismatches and a high level of structural unemployment. Looking
forward, weaknesses in the educational system, including poor outcomes and a
high share of early school leavers, are a key concern for the employability of
future workers.
The IDR also discusses the policy
challenges stemming from the analysis and what could be possible avenues for
the way forward. A number of elements can be considered: 
·       Concerning the challenge of ensuring a smooth deleveraging of the
corporate sector, optimisation of the insolvency framework as well as strict
implementation of the rules on late payments could be explored.
·       As regards the challenge of sustaining the adjustment of the
external position, maintaining fiscal stability would be beneficial for
improving the business climate. Improved business environment would help attracting
foreign capital and innovations into productive sectors, which in turn would help
preserving competitiveness and safeguarding the strong export performance.
Ensuring effective and increased EU funds absorption would help potential
growth.
·       Concerning the complex challenges facing the labour market, several
policy avenues could be considered. Improving the effectiveness and increasing
the efficiency of active labour market policies seems warranted. Ensuring that
increased wage floors do not price the low skilled out of work would facilitate
labour market adjustment. Addressing the challenge of reducing skills
mismatches through advances in training and education could be beneficial for
growth in the medium and long term.
On 13 November 2013, the European
Commission presented its second Alert Mechanism Report (AMR), prepared in
accordance with Article 3 of Regulation (EU) No. 1176/2011 on the prevention
and correction of macroeconomic imbalances. The AMR serves as an initial
screening device helping to identify Member States that warrant further in
depth analysis to determine whether imbalances exist or risk emerging. According
to Article 5 of Regulation No. 1176/2011, these country-specific “in-depth
reviews” (IDR) should examine the nature, origin and severity of macroeconomic
developments in the Member State concerned, which constitute, or could lead to,
imbalances. On the basis of this analysis, the Commission will establish
whether it considers that an imbalance exists in the sense of the legislation
and what type of follow-up in terms it will recommend to the Council.
This is the third IDR for Bulgaria. The
previous IDR was published on April 10, 2013 on the basis of which the
Commission concluded that Bulgaria was experiencing macroeconomic imbalances,
in particular involving the impact of deleveraging in the corporate sector as
well as the continuous adjustment of external positions, competitiveness and
labour market. Overall, in the AMR the Commission found it useful, also taking
into account the identification of imbalances in April, to examine further the
persistence of imbalances or their unwinding. To this end this IDR takes a
broad view of the Bulgarian economy in line with the scope of the surveillance
under the Macroeconomic Imbalance Procedure (MIP).
Against this background, Section 2
overviews the general macroeconomic developments and section 3 looks more in
detail into the main imbalances and risks. Section 4 discusses policy
considerations.
Growth remains low on the back of a weak
labour market 
The recovery in Bulgaria has been slow
and the economy continues to operate considerably below potential. After a moderate rebound in 2011, growth has remained under 1% over
2012-13 and is projected to pick up only slowly over 2014-15 (EC forecast,
2014). In 2013 the output gap widened compared to 2011-12. The economy is forecast
to remain below its potential over the forecast horizon, with the recovery
depending on improvement of the labour market situation (See Graphs 2.1 and 2.3).
Inflation has decelerated sharply in 2013
and is projected to remain low. The low-growth
environment and decreases in the administratively-set energy prices in 2013
have kept the average annual rate of HICP inflation at a very modest 0.4%. The
expected moderate increase in economic activity over 2014-15 is projected to
lift inflation somewhat (EC forecast, 2014).
The labour market remains in distress. Employment has been significantly affected by the crisis and has
been declining since 2008(see Graph 2.2). First signs of stabilisation were seen
only in the second half of 2013. Unemployment has increased above the EU
average, with significant differences across regions and educational levels.
Going forward, the labour market is projected to stabilise and improve only
gradually in the coming years (see section 3.2. for a detailed analysis of the
labour market situation).
  
Fiscal stance remains stable
The fiscal position has stayed overall
strong, despite an increase in the budget deficit in 2013-14. After a period of strong consolidation over 2010-12, the deficit
has reverted to around 2% of GDP in 2013 due to a combination of revenue
shortfalls and a fiscal stimulus, including social spending and some current
expenditure. While increasing, the public debt level remains one of the lowest
in the EU and financing conditions have remained favourable.
Strong export performance supports current
account adjustment
The current account (CA) correction has
improved Bulgaria's external position. Following
deficits of over 20% of GDP over 2007-08, the CA has returned to balance in
2010-13. Growing exports and current transfers, together with a decrease in
imports, have contributed to the correction. Strong export growth has led to a
positive CA in 2013. The export of goods has performed especially well and
helped improve the traditionally negative trade balance in goods. The CA is
forecast to turn to remain balanced over 2014-15, with the recovery of domestic
demand and the associated increase in imports offsetting the growth in exports
(EC forecast, 2014). The trade deficit in goods, excluding energy, has decreased
since 2010 (see Graph 2.4). The deficit in energy trade remains
present, although it has been reduced to an average of 6% of GDP over 2009-12,
from 14% over 2005-08. Thus, balancing the CA is expected to depend on the
export performance as well as the recently increasing current transfers, mostly
due to higher remittances. Capital transfers, linked to EU funds absorption
have also contributed positively to the overall external position and will
remain important in the coming years. The structure of the CA and its
implications for Bulgaria's external position are further discussed in section
3.1.
Private sector deleveraging continues
The high level of leverage in the private
sector, more specifically of non-financial corporations (NFC), was identified
as a potential risk factor for the economy last year (IDR 2013). This section
examines the latest developments in the sector and their risk implications for
the overall economy.
Deleveraging of NFC is under way and
could limit growth in the short term. Private
sector debt in Bulgaria is mainly concentrated in the non-financial corporate
sector and is somewhat higher in comparison to the levels in peer European
countries. However, a large share of the liabilities is in the form of
cross-border intra-company loans, implying a lower-risk profile. In addition,
deleveraging has been on-going since 2009, resulting in a correction by 7pps.
in consolidated debt as well as an improvement of close to 30pps. in net
financial assets by 2012 (both as share of GDP, see Graphs 2.6 and 2.5).
 
Overall, indebtedness within the NFC
sector remains high. On a non-consolidated basis,
the sector continues to display a high level of overall indebtedness, including
a large 'other payables' account (consisting of payments due to suppliers, rent
on buildings and arrears, see Graph 2.7). The growth of this balance sheet item
during the crisis years suggests an increase in arrears, which could raise the
uncertainty between market participants.
Newly introduced rules on late payments
and revised bankruptcy procedures should facilitate the deleveraging process. In 2013, the government introduced stricter rules on late payments
into national legislation, in line with EU requirements. Strict implementation
of those rules would ensure a smooth settlement process. The same is valid for
the updated bankruptcy procedures, which have limited the possibility to
'backdate' insolvency during court proceedings. Data on the effects of those measures
will only become available in the coming years.
High NFC indebtedness does not suggest
significant spill-over effects to the banking sector. Most of the debt of NFC is in the form of cross-border
intra-company lending, which is also reflected in the high foreign direct
investment (FDI) stock. As a result, a relatively smaller share of capital has
been channelled through the financial sector, which implies a lower risk of
negative spill-overs from the NFC's deleveraging to the banks, than suggested by
the high level of non-consolidated debt.
The indebtedness of households remains
relatively low and decreasing. Households' debt has
decreased by 4.2pps. as a share of GDP since the 2009 peak, reaching 24.5% of
GDP in 2012, while their net financial assets have increased by 19pps. in the
same period. The improvement is largely explained by the accumulation of
deposits and other financial instruments, the latter most likely through the
pension funds system.
The drop in house prices has decreased
households' wealth. House prices have undergone a
correction of over 40% since the peak in 2008, with a negative impact on
household's wealth. However, prices appear to have stabilised in 2013 (see
Graph 2.8). House price ratios suggest a possible
undervaluation compared to historical averages (see Graph 2.9). However, those averages should be
viewed critically, as the available time series mostly cover the period of
peaking prices.
In conclusion, private sector
indebtedness does not entail significant risks for the overall economy through
spill-overs but could threaten the viability of some firms and be a limiting
factor to investment and growth in the short and medium term.
Financial sector maintains stability
The banking sector has maintained
macro-financial stability and witnessed some consolidation. The banking sector has weathered the crisis well due to strong
banking supervision, conservative provisioning and a build-up of capital
buffers. At the aggregate level, the banking system's capitalisation was little
changed relative to a year ago. The regulatory capital adequacy ratio reached
16.9% in Q3 2013, marginally up from 16.6% in Q3 2012. The average quality of
banks' loan portfolio also remained broadly unchanged, with the non-performing
loans (NPLs) ratio standing at 17.2% in Q3 2013. NPLs remain well-provisioned
for with the coverage ratio of all buffers in the banking system reaching 99.8%
of gross NPLs. ([1]) The second
part of 2013 has been marked by a significant deceleration of credit growth,
which fell down to 0.5% y-o-y in Q3 2013. As a result, the system's credit to
GDP ratio decreased slightly from 70% in Q3 2012 to 68.7% in Q3 2013. The
sector is undergoing a process of consolidation. Two acquisitions of foreign
banks’ subsidiaries by domestically-owned banks were announced in the past
year. According to the regulator, the consolidation is a welcomed step, which further
strengthens the capital base and does not affect competition.
Banks' aggregate balance sheet shows a
moderate overall expansion during the year prior to November 2013. The expansion consisted in the acquisition of foreign assets,
funded by a continued rapid increase in domestically-collected resources. Total
assets expanded by 4.5%. Domestic assets remained almost unchanged, given that
the expansion in fixed assets by almost 16% more than offset the decline in
banks' claims on the economy. On the liabilities side domestic deposits,
included in the money supply, grew by 9.4%. Longer-term liabilities and other
liabilities increased by 15.6% and 7.3% respectively. Banks' capital position
and retained reserves continued to grow, even though by a moderate 2.8% y-o-y
in November 2013. Given that the aggregate balance sheet expanded by less than
the increase in the domestically attracted resources, banks' foreign
liabilities declined by a non-negligible EUR 1.1 billion, or more than 15%.
The aggregate developments at the level
of the system hide major differences at individual level, notably with respect
to business development strategies and the underlying risk appetite. Foreign-owned banks continued their deleveraging process, which
resulted in a notable decline in their market shares. At the same time,
institutions owned by Bulgarian capital pursued an active expansionary policy,
especially in the segment of corporate clients. Thus, the market share of
domestic banks reached 27.3% in June 2013, up from 15.7% prior to the 2008
crisis and 25% in June 2012. As a result, an increasing number of
domestically-owned institutions could be considered systemically important now.
On the one hand, this marked expansion might suggest that the local
institutions are showing higher flexibility in their credit decisions by
seizing the opportunity to develop when others are leaving the market. The
positive implication thereof is that the supply of credit to the economy is not
restrained and future growth prospects could be supported financially. On the
other hand, however, this segmented credit expansion might be strongly
influenced by business decisions at a broader group or shareholder level,
without necessarily paying due attention to long-term viability implications of
credit decisions.
In conclusion, the banking sector has
managed to preserve its stability and no financial sector-related imbalance
could be identified. Nevertheless, credit expansion
by a limited number of domestically owned institutions warrants close monitoring
by the regulator, which has so far proved to be a conservative one, in order to
identify risks and take corrective measures early enough, should risks begin to
materialise.
3.1.      External
imbalances
Bulgaria's external position is highly
negative and can be considered a possible imbalance, largely formed during the
2005-09 period. This section analyses Bulgaria's external position in terms of
its net international investment position (NIIP) and gross external debt  in
order to evaluate the extent of the imbalance and the risks it poses to the
economy going forward. Contributing factors like the CA developments are examined
to evaluate external sustainability and the role played by the business cycle
in the observed outcomes. Finally, recent FDI developments are summarised and
identified as a key component for funding future growth.
3.1.1.   External
cost competitiveness
The export performance currently does
not seem to be harmed by competitiveness issues.
Bulgaria has consistently gained export market shares since 2000, with the
exception of the crisis years 2009-10 (see Graph 3.1). After a one-year dip in 2012, the
country is set to continue gaining world market shares in 2013 and 2014.
Unit labour cost (ULC) growth has
moderated but wage growth continues to outpace gains in productivity. Labour cost and unit labour cost (ULC) growth has slowed down
considerably in the last years, especially in the tradable sector (see Graph 3.2). Nevertheless, wage growth remains
somewhat higher than productivity advances, most notably in the services
sector. This higher growth may be harmful for cost competitiveness going
forward, particularly as wage pressure in the non-tradable sector can be
transmitted to the tradable sector and increase overall price levels or squeeze
profit margins. ULC growth is projected to remain moderate until 2015 (EC
forecast, 2014). Non-cost factors have been shown to reconcile the observed
gains in market shares and the losses in cost competitiveness. ([2]) 
3.1.2.   Sustainability
of the external position
External financing needs have decreased
since 2009. The balancing of the CA after the
crisis has helped reduce the country's net borrowing needs and consequently its
NIIP (see Graph 3.3). The NIIP has undergone a stable
improvement of over 20 pps. of GDP in the 2009-12 period. The improvement is
mainly driven by the reduction of net external debt (also by over 20 pps. of
GDP). Furthermore, a large portion of the NIIP is FDI stock, which has built-up
during the boom years and has remained stable since then.
The gross external debt is mostly
euro-denominated, implying low foreign exchange risk (see Graphs 3.4 and 3.5). At the sectoral level, the same holds
for government, corporate and banking debt alike. The share is expected to
increase even further in 2015, when a relatively large US dollar-denominated
government bond issue matures. The authorities have indicated plans to
refinance the bond in euro (National Reform Programme, 2013). The
currency-board regime in the country, under which the Bulgarian lev is pegged
to the euro, is stable and supported by sufficient currency reserves.
No short-term refinancing concerns are
observed. Short-term debt has decreased recently,
after peaking at close to 35% of the total in 2008 (see Graph 3.6). It is roughly equally distributed
between the financial and non-financial corporate sectors. The government's
external debt is entirely long-term. After a drastic reduction over 1999-2008,
both in absolute and relative terms, it has stabilised around 11.5% of the
total GED over 2008-12.
The net external position is mostly
influenced by liabilities developments but assets are gaining importance. Bulgaria still holds a relatively small stock of assets abroad and
its NIIP is mostly affected by changes on the liabilities side. Nevertheless,
assets are gaining importance since 2008 and will deserve more attention going
forward. Notably, holdings, other than the reserves held by the central bank,
are increasing their share in the asset mix mostly due to growing portfolio
investments and some FDI. Domestic banks and pension funds have been
increasingly buying foreign assets, mostly government bonds. With the
development of the financial market and growth of the pension funds, those
investments will play a larger role in shaping the country's NIIP.
Currently, the implied yield is higher
on liabilities than on assets. The implied yield on
foreign-owned domestic equity is almost three times higher than the return on
foreign equity. The yield on domestic debt is somewhat lower than on foreign,
which could be linked to the large amount of cross-border intra-company loans,
which are used by foreign investors to finance local operations. As assets held
abroad increase, a higher yield on those could benefit the income balance of
the current account.
NIIP improvement is expected to continue
in the short term. The in-house model, used to forecast
the development of the NIIP ([3]), indicates a continued improvement of the external position over
the forecast horizon. Stabilising the NIIP as a share of GDP at its 2012 level
would require a CA deficit of at most 3% of GDP (see Graph 3.7). This translates into a non-interest CA
(trade balance + current transfers) surplus of 1.5%. Reducing the NIIP as share
of GDP in half over the next ten years requires an average CA surplus of 1.3%,
equivalent to a non-interest CA surplus of 4.8% per year. Thus, the average
forecast CA balance of -0.1% of GDP until 2015 implies only a gradual
improvement in the NIIP.
FDI is expected to remain a key
component of funding future growth in the medium and long term. As discussed below (section 3.1.5.), the current increase in saving
is mostly a response to deleveraging pressures and is not expected to be
sufficient for fully financing growth going forward. The observed recent
improvements in the NIIP, which are forecast to continue in the short term,
could be reversed in the medium term. This once again highlights the importance
of FDI and improved EU funds absorption for increasing potential growth and
improving the NIIP through reducing net borrowing.
3.1.3.   Current
account cyclicality
CA balance correction over 2007-2013
appears mostly non-cyclical. The economic cycle can
only partly explain the large pre-crisis CA deficits. The average positive
output gap over 2004-08 is estimated at 4.4% of potential GDP, peaking at over
6% in 2008. At the same time, the CA deficit was exceptionally high only in
2007 and 2008. The rapid correction that followed does suggest a larger
cyclical component. Thus, non-cyclical drivers seem to have played the major role
in the post-crisis CA improvement. This conclusion is also supported by data
from an in-house model for adjusting the CA for the output gap and REER
movements (see Graph 3.8). ([4]) According to the model, the majority of the CA correction observed
over 2007-13 has been non-cyclical. This observation is supported by the gains
in world market shares seen over the past decade, and concentrated mostly in
tourism, agricultural goods, metals and mineral products.
CA deficits during the boom years can be
considered as a one-off event. For the Bulgarian
economy, the 2005-08 period was characterised by a remarkable combination of
global economic growth, financial markets deepening and positive confidence
effects in the build-up to the country's EU accession. The large current
account deficits were financed by FDI inflows and, to a large extent, driven by
those foreign investments requiring imports of goods and services, like
manufacturing and real estate. A repetition of this or a similar combination of
economic conditions seems unlikely. The current economic climate is
characterised by higher risk perception, resulting in more cautious investment
decisions and only modest capital inflows.
3.1.4.   Saving-investment
balance
Saving has increased in response to
deleveraging pressures. The saving-investment
balance of the total economy has stabilised since 2010, with saving moderately
outpacing investment (see Graph 3.9). This balance can be explained by the
rapid increase in leverage in the pre-crisis period, which resulted from the
high investment and low saving rates. With the economy slowing down, NFC faced
deleveraging pressures in order to remain viable. Investment has been reduced
and NFC profitability has increased markedly (see Graph 3.10). Despite those efforts, deleveraging
has only been moderate, implying a continued period of increased saving may
still be needed.
Investment contracted sharply and is
recovering only gradually. Investment peaked in
2008 and seems to have bottomed out over the following two years. The largest
contraction was in the construction and real estate sectors. Nevertheless, net
investment (excluding estimated depreciation) has been negative in all sectors
since 2009 (see Graph 3.11). At the same time, capacity
utilisation in industry has recovered somewhat but remains below the peak
levels of 2007 and 2008. Funding investments is unlikely to be secured by
domestic saving alone, highlighting the importance of FDI going forward (also
discussed later in this section). 
Corporate deleveraging pressures created
the need for increased profitability and may partly explain the steep drop in
employment. The high leverage resulted from a considerable
saving-investment imbalance both for non-financial corporations and the economy
as a whole (see Graph 3.12). Deleveraging pressures created the
need to increase saving through improved profitability and also seem to have
impacted employment negatively. The drop in employment in Bulgaria observed
since 2008 was higher than in other countries with similar drop in output. A
possible explanation relates to the rapid accumulation of corporate debt in the
pre-crisis years and the currently on-going balance sheet repair (Bakker and
Zeng, 2013). Adjustment seems to have relied on labour shedding and not on wage
adjustment. The labour productivity increased and firms' competitiveness may
have been preserved and even improved. ([5]) The strong current export performance supports this
observation.  
3.1.5.   
FDI and the road ahead
Bulgaria's net inward FDI stock is high
and likely to increase. The relatively large FDI
stock compared to other EU-10 countries has mostly been accumulated during the
2005-07 period through strong inflows in the manufacturing, construction and
real estate sectors (see Graphs 3.13 and 3.14). This result can be explained by the
potential of high returns, given the country's low labour costs and excellent
tourism potential and lower risk perception associated with the country's EU
accession. The high FDI stock, including a high share of parent company
lending, decreased the risk of swift capital outflows during the crisis, often
associated with portfolio investments and third-party lending. Cross-border
intra-company lending also limited the negative spill-over effects to the
financial sector. As a small converging economy, Bulgaria's future growth is
likely to require further FDI inflows. 
FDI appears to have benefitted parts of
the manufacturing and tourism sectors. Investments
in manufacturing have improved the sector's competitiveness and boosted the
county's export performance, which has been the only driver of growth after the
crisis. Capital flows in construction and real estate have increased Bulgaria's
tourism potential and the country has gained world market shares in travel
services. On the negative side, the rapid build-up of FDI has resulted in an
overheating with inflated fixed asset prices in the abovementioned sectors.
Corresponding corrections became necessary when FDI flows dried up. Economic
sectors which have not attracted significant FDI, including education and
healthcare, are among those most in need of transformation.
Foreign investors have shifted their
sectoral focus in the post-crisis period.
Statistics on recent FDI flows show a shift in the interests of foreign
investors. The energy sector, including renewable energy sources, has attracted
the most attention (see Graph 3.15 and 3.16). The FDI stock in energy has doubled
over 2010-13. Manufacturing has attracted 21% of the investment flows.
Transportation, telecom and financial services have more or less maintained
constant inflows. Construction investments have also continued but are likely
linked to infrastructure developments, given the sharp reduction in real estate
activity. The last strong inflow in real estate was in 2009, when the sector
attracted over 20% of the total. The sector has witnessed an outflow of
investments amounting to 6% of the total FDI flows since then.
Attracting FDI in the tradable sector
remains crucial. As mentioned before, foreign
investments in the tradable sector have improved competitiveness and increased
exports. Broadening the range of business activities that attract FDI within
the tradable sector would provide a strong base for continued exports growth.
Recent examples of increased activity include the automotive, pharmaceutical
and metal manufacturing industries. Thus, improving the business environment
and ensuring a well-functioning labour market remain vital for the
attractiveness of the country as an investment destination.
Attracting FDI in some non-tradable
sectors overlooked until now may also be beneficial. Strong FDI in telecommunications, financial and other business
services (e.g. advertising, marketing), which are key intermediary inputs have
played an indirect role in improving external competitiveness and strengthening
the tradable sector's export capacity. Sectors like education and healthcare,
which have received very little attention from foreign investors so far, could
also be beneficial for competitiveness and the overall development of the
country.
In conclusion, the previously-identified
risks related to the country's negative external position appear to be
decreasing. The CA balance adjustment has been
sustained over the last five years and is forecast to remain broadly balanced
over the forecast horizon (EC forecast, 2014). However, the stock of
liabilities remains high and further unwinding would depend on sustaining
external competitiveness and a strong export performance.
3.2.      Labour
market and social developments
Rising unemployment in Bulgaria and the
overall weakness of the labour market, discussed below, limits the adjustment
capacity of the economy in the short term and restricts growth in the medium
and long term. This section presents the main difficulties facing the Bulgarian
labour market as well as some underlying structural problems in the formation
and skill composition of the labour force. The possible impact of minimum wage
and social security threshold setting is explored. Also, the role played by
labour market and education policies in facilitating labour market adjustment
and addressing labour market exclusion is explored. The significance these
developments have for social outcomes is analysed.  
3.2.1.   Overview
and recent developments
The labour market has remained weak over
an extended period, with first signs of stabilisation visible only in the
second half of 2013. Part of the employment
weakness can be attributed to the strong decline in Bulgaria's working-age
population by about 1.5% per year due to negative demographic trends (low birth
rate, ageing population, emigration). However, even if corrected for the
population decline, the employment rate, as a share of the working-age
population, has declined strongly in Bulgaria by over 5 pps. from the peak in
2008 to 2012 (see Graph 3.17). The unemployment rate has also more
than doubled from about 5% of the labour force in 2008 to about 13% in 2013.
After the first signs of stabilisation in 2013, the recovery in the labour
market is forecast to remain modest also in 2014-15 (EC forecast, 2014).
Long-term unemployment has increased
markedly since 2008 and risks becoming structural.
The average unemployment duration grew between 2009 and 2013. Notably the share
of people out of job for more than four years increased from around 14% to over
20% of all unemployed between 2010 and 2013 (see Graph 3.18). This increases the risks of
unemployment becoming structural as the skills of the jobless are eroded or
become irrelevant with the changing demands of the labour market. High
structural unemployment would lower the economy's growth potential and its
adjustment capabilities.  
The crisis has affected the
lowest-skilled and the young the most. As
identified in previous studies (Maiväli and Stierle, 2013; IDR 2012 and 2013),
the unemployment rate is especially high and increased the most over the crisis
for the following labour market groups: people with low educational attainment,
the young and the country's Roma population. In terms of sectors, the largest
job losses have been in construction and manufacturing. Large regional disparities
in unemployment existed already before the crisis and have remained prominent.
Employment status depends strongly on
the level of educational attainment. Many of the
lowest educated are not active in the labour market. Only about 15% of the
lowest educated population group are employed, compared with 63% of the
population with upper secondary education and over 81% with university degree
(see Graph 3.19). Similarly, the unemployment rate of
those with primary or lower education is significantly higher and increased the
most during the crisis (see Graph 3.20). The weaker standing of lower-educated
people in the labour market is reflected in lower wages and also in lower wage
growth over the past decade (see Graph 3.21). 
The crisis has also affected some 'core'
groups of workers that are typically not excluded from the labour market. As discussed, relatively large shares of the low-educated workers
have become or remained jobless following the crisis. However, this group forms
a small share of the working age population, while workers with upper-secondary
or higher education account for close to 78%. ([6]) It is thus this latter group that defines the aggregate labour
market outcomes, making it the more problematic that also experienced
middle-skilled workers lost their jobs. A statistical profiling of the
out-of-work population reveals that a relatively large out-of-work group can be
characterised as middle-aged rural population with ample previous work
experience and medium educational attainment level (World Bank, 2014).
The existence of wage floors, through
the minimum wage and social security thresholds (MSST), ([7]) and their increase in recent years, risks pricing the low-skilled
out of the labour market and limiting labour market adjustment. While the aim of a wage floor is to support the incomes of low
paid, low productivity workers, it also raises the cost of labour for them and
might reduce their employment opportunities. Given the weak standing of the
low-skilled in the Bulgarian labour market, the impact of such floors can be
particularly important. In particular, wage floors may limit downward wage
flexibility in the face of a crisis and could potentially explain some of the
strong employment decline concentrated among the least skilled (and lowest
paid) worker groups.
Minimum wages have been raised strongly
since 2011. Over recent years, the Bulgarian
authorities seem to have changed their previously cautious policies on the
minimum wage and have raised it strongly (see Graph 3.22). Cumulative increases from 2011 to 1
January 2014 amount to about 40%. In spite of the recent strong increases, in
absolute levels the Bulgarian minimum wage per month remains the lowest in the
EU, even when taking into account price level differences. The ratio of the
minimum wage to average earnings is still relatively low compared to most other
EU Member States (see Graph 3.23), but is higher for the low skilled.
Already in 2010, i.e. before the strong increases, the ratio of the minimum
wage to the average wage approached 70% for the least educated workers (see
Graph 3.24).
Minimum wage policy is intertwined with
the MSST. This system was introduced by the
government in 2003 with a view to combating the shadow economy and improving
tax collection and sets over 700 different minimum-income thresholds across
about 85 sectors and 9 occupations for the calculation of social security
contributions. MSST has a strong impact on the lower end of the wage
distribution and can explain the low coverage of the minimum wage. While the
MSST are typically set higher than the national minimum wage, after the strong
increases in the minimum wage this does not hold anymore for many unskilled and
low-skilled occupations. In addition, the MSST could have an impact on wage demand
throughout the wage scale, given that they are also set by occupation.
The thresholds are considered by social
partners as indicative minimum wages by sector and occupation. Employee organisations have an incentive to ask for higher
thresholds as this indirectly leads to higher wages. The government also has
some incentives for increasing thresholds as this directly adds to tax revenues
and reduces the shadow economy. At the same time, the potential adverse impacts
on employment might be overlooked since these effects are less immediately
evident. Most of the thresholds were increased substantially also during the
crisis.
The growth of MSST has been
differentiated according to sectoral and occupational economic conditions but
remains strong for the low-skilled. The minimum
thresholds are agreed between social partners or, in case an agreement is not
reached for some groups, these thresholds were administratively set by the
government. As of 2013, contrasting to previous years, the government decided
to keep the limits for those professions unchanged where the employers and
employees were unable to reach an agreement. This has also resulted in a lower
average increase of the thresholds. However, the recently strongly increased
minimum wage has pushed up the lowest MSST, even though the average growth rate
of the MSST has subsided since 2011. Notably for unskilled and low-skilled the
minimum wage has become the MSST in most economic sectors (see Graph 3.25). Thus, increases in the minimum wage
since late 2011 administratively have raised the MSST for the unskilled and
low-skilled at a higher rate than the average MSST growth. ) MSST may also have
resulted in a compressed wage distribution. The declared wage of over one
quarter of all employees is just above their respective minimum threshold
(within 10% of the threshold). ([8])
The government has taken some action to
analyse the impact of MSST increases but policy implications remain unclear. In 2013, the Ministry of Finance completed a study on the
employment effects of the MSST, focusing on the low-skilled in several services
sectors. A second study is under way in 2014, examining the possible effects of
MSST growth on employment by region and firm size. Preliminary results point to
possible negative effects for small and micro firms but not necessarily on
regional level. The government has not specified the possible policy
implications of the results of those studies.
3.2.2.   Social
consequences of unemployment
As suggested in previously published
analysis, poor labour market outcomes and a non-inclusive labour market have
negative social consequences, through increased poverty and material
deprivation (Maiväli and Stierle, 2013, IDR 2013) Below we look at the main
social indicators for Bulgaria. 
Nearly half the population is at risk of
poverty or social exclusion. The composite
indicator, AROPSE ([9]) is close to
50% in Bulgaria (see Graph 3.26). The high level is mostly due to the
high share of people living in severe material deprivation. The share of people
living in severe material deprivation ([10]) in Bulgaria is more than double the EU-10 average and more than 4
times higher than the EU average (see Graph 3.27). This can partly be explained by the
differences in GDP per capita, as the indicator includes many tradable goods.
Nevertheless, the share of people constrained by their economic situation is
considerable (see Graph 3.28).
Employment income appears key for
reducing the risk of poverty, while the unemployed face the greatest risk of
poverty. While overall the risk of poverty is much
higher in Bulgaria than in all other EU countries, for the employed it's even
lower in Bulgaria than in the EU on average (see Graph 3.29). This underscores the importance of a
labour market recovery in Bulgaria and the importance of effective active
labour market policies (ALMP) in facilitating labour market adjustment. By
contrast, close to half of the unemployed are at risk of poverty, compared to
around a quarter of the retired and other inactive persons (see Graph 3.30). 
The link between unemployment and
poverty is also confirmed at the regional level. As
can be expected, regions with higher unemployment and lower GDP per capita also
have a higher share of their population at risk of poverty (see Graphs 3.31 and 3.32). The regional differences between the
capital region and the rest are significant. Differences between the five
regions (excl. the capital) are smaller.
Social spending has not been
sufficiently effective in reducing poverty (see
Graph 3.33). ([11])  Means-tested benefits have not increased noticeably since the
crisis, unlike non-means tested ones. Both types of benefits are lower than the
EU averages as share of GDP, with means-tested considerably lower (see Graphs 3.34 and 3.35). Recent research also suggests that
although means-tested benefits are well-targeted, their coverage is low (IMF
Country Report, 2014). Possible explanations include the strict eligibility
thresholds and the lack of indexation rules for those thresholds. Improving the
provision of means-tested benefits would also depend on developing sufficient
administrative capacity to manage them.
Consecutive governments have implemented
social stimuli in 2013. A number of measures,
targeted at low-income households and disadvantaged social groups were
implemented by the caretaker and post-election governments in 2013. The total
spending on those measures remained below 0.1% of GDP. Additionally, pensions
were increased by close to 10%. The effectiveness of those measures remains to
be seen.
3.2.3.   Labour
market policies and education
Overall labour market policy (LMP)
expenditure has increased mainly due to unemployment benefits. Unemployment benefits in Bulgaria are somewhat higher than the
EU-10 average both in terms of generosity (i.e., replacement rates) and
duration. As unemployment increased, unemployment benefit expenditure has
increased and acted as an automatic stabiliser with the deterioration of the
labour market after 2008. In turn, expenditure on active labour market policies
(ALMP) remained broadly stable and their share in total LMP expenditure has
decreased from 67% in 2004 to below 30% in 2011 (see Graph 3.36). Thus, the balance between active and
passive measures has been distorted since the start of the crisis.
Active labour market policies appear
insufficient. The government expenditure on ALMP
has declined over 2004-10. Despite a small increase in 2011, its share of GDP
is still considerably lower than in the pre-crisis years and has remained flat
in nominal terms until 2014, with the exception of a social stimulus following
the budget revision in 2013. In contrast, ALMP spending has increased in peer
EU-10 countries post-2008 (see Graph 3.38) In Bulgaria, this translates into a
decreased coverage of the ALMP caused by the strong increases in minimum wages
since 2011, as less people can benefit from subsidised employment. The share of
employed on temporary contracts is among the lowest in the EU and has remained
unchanged since the crisis (DG Employment, 2014). Programmes funded by the
European Social Funds (ESF) have increased in importance, given the limited
national funding. Funds absorption has increased over 2011-2013 and would
continue to depend on maintaining sufficient administrative capacity and
ensuring smooth public procurement procedures. Indeed, a preliminary assessment
of the impact of ESF funding over 2007-2012 indicates a net increase in
employment of 1.5% and decrease in the unemployment rate of 1 pp. over the
period. Clearly, the ESF will continue to play an important role for ALMP going
forward.
Lifelong learning practices in the country are considerably less
developed than in peer countries. The share of
population over 25 years old participating in education and training has
consistently been drastically lower than the EU average (1.5% vs. 9% in 2012).
In contrast with the improvements seen in peer countries over the past decade,
the number of participating adults in Bulgaria has remained unchanged (see
Graph 3.37). Lifelong learning is indispensable
for reducing skill mismatches, which have been identified as a problem in a
number of studies (Berkhout et al., 2012; Maiväli and Stierle, 2013). Excess
supply in construction and services and excess demand in the public sector have
been found to increase sectoral mismatches (Labour Market Developments, 2013).
A strategy on lifelong learning has been drawn up in fulfilment of the
2014-2020 Structural Funds ex-ante conditionality, with a target to reach 7%
participation by 2020.
The quality of schooling is low as measured in international
studies. According to the latest PISA study results
(OECD, 2013), 15-year-old students in Bulgaria had the lowest scores in
the EU in reading and mathematics and were among the worst performers in
science. Despite modest improvements compared to the 2009 study, 39.4% of
students do not possess the necessary skills in reading and 43.8% those in
mathematics. Another international study, focused on reading ability, found
that reading skills among 10-year-olds in the country have declined over the
last decade (PIRLS, 2011).  
The share of early school leavers has
decreased but remains high. The share of early
leavers from education and training has been reduced significantly, from over
22% in 2003 to 12.5% in 2012 (just below the EU average). The share of early
leavers remains higher in comparison with other EU-10 countries and increased
by 12% in 2012 compared to 2011 (see Graph 3.39). Moreover, the absence of life-long
learning practices means those who drop out early have little chance to improve
their qualifications in the future. Overall expenditure on education has been
somewhat lower than the EU and EU-10 averages. Total education expenditure is
lower by about 1pp. of GDP. Both the quantity and quality of spending remain
vital for improving the educational system.
The existence of an important disparity
between higher education outcomes and labour market demand worsens structural
unemployment and limits the adjustment capacity of the economy. Higher education faces persisting challenges in responding better to
labour market needs. Employment of young graduates was only 67.3% in 2012. The
lack of sufficiently-trained employees hampers the development of high-value
added, innovative sectors, most prominently the ICT sector. A strategy on
higher education has been published for public consultation in November 2013
and could be adopted in 2014. An immediate challenge is the identification of
the professions and qualifications which will be demanded by the labour market
over the next few years.
In conclusion, the reasons for the protracted labour market
adjustment appear deeply rooted. While it is
fuelled by the economic slowdown, institutional factors and policies pushing
labour costs up, the lacking related activating policy responses as well as
longer-term structural deficiencies of the labour force play a key role. The
adjustment process is thus likely to be protracted and presents policy
challenges in the labour market itself as well as in education and training
practices.
The analysis in sections 2 and 3 indicates
that macroeconomic developments in the areas of corporate deleveraging, external
indebtedness and especially distressed labour market are the main challenges in
Bulgaria. Deleveraging in the economy is on-going and could pose some limits to
growth in the short-term but is necessary for preserving competitiveness and
growth potential in the future. The external position has further improved
compared to last year and the analysis does not suggest significant risks of
repeating the imbalances that were accumulated through large CA deficits during
the economic boom years 2005-08. In turn, improving the situation in the labour
market, including reducing unemployment and increasing participation, stands
out as the most pressing current challenge.
It should be recalled that these challenges
were already identified under the MIP in the first and second IDRs and relevant
policy responses were reflected and integrated into the country-specific
recommendations issued for Bulgaria in July 2012 and in July 2013. The
assessment of progress in the implementation of those recommendations will take
place in the context of the assessment of the National Reform Programme and
Stability Programme under the European Semester. Against this background, this
section discusses different avenues that could be envisaged to address the
above challenges.
Concerning the challenge of ensuring a smooth
corporate deleveraging process, a number of avenues can be explored:
Continuing the efforts for strict
enforcement of rules related to late payments would facilitate deleveraging. Timely monitoring of strict implementation and impact of the
newly-introduced regulations on late payments, in line with EU Directive
2011/7/EU, can be beneficial for the business relations between the government
and the private sector as well as within the corporate sector. 
Enhancing the insolvency framework
remains important for smoothing the deleveraging process and increasing market
transparency. Evaluating the effectiveness of
recently introduced measures, including the removal of the possibility for
insolvency backdating, could be useful. Out-of-court settlements remain an area
which could be explored as an alternative source of dispute resolution. ([12]) Developing guidelines for out-of-court negotiations and speeding
up court proceedings has proven beneficial in other countries facing similar
challenges.
Concerning the challenge of sustaining the
adjustment of the external position, while continuing to attract productive
foreign capital, the following measures may be discussed: 
Improving the business climate, through
facilitating business operations and ensuring a level playing field is crucial.
This challenge has already been identified in the
2013 CSR on the business environment. Fighting corruption more effectively and
ensuring the independence of the judicial system are important and could be
useful for reducing uncertainty and increasing the attractiveness of the
country as an investment destination. Increasing the coverage of e-services
offered by the government and further reducing administrative costs could be
explored. Assessing the impact of recent administrative reforms in this regards
could be useful for the way forward.  
Further increasing EU funds absorption
in an effective way could help potential growth.
The challenge of accelerating EU cohesion, structural and agriculture funds
absorption is part of the 2013 CSRs and an improvement in this area in the last
three years is recognised. Ensuring the effectiveness of EU-funded investments,
including assessing the impact of policies implemented, could be beneficial for
better targeting of future programs and ultimately increasing the country's
growth potential. In this context, strengthening the public procurement
environment, introducing e-procurement tools and ensuring sufficient
administrative capacity for all sectors funded could have a positive effect.
Concerning the complex challenges faced by
the labour market, including rising unemployment, job losses concentrated in
the low-skilled segment and skill mismatches, the following actions could be
considered:
A major challenge relates to improving
the efficiency and effectiveness of active labour market policies. This challenge has already been identified in the 2013 CSR related
to enhancing active labour market policies. It involves targeting measures to
those most in need of activation and whose employability is highest. In this
regard, the inactive young and the long-term unemployed low-skilled people with
work experience as well as other vulnerable social groups identified in this
report could be considered. Specific measures for the young could include
programs aimed at increasing the educational attainment and improving their
qualifications through targeted training. Reintegration measures for the
long-term unemployed with work experience may include effectively linking social
benefits to participation in training and subsidised employment. Programs
relying on the social responsibility of businesses could also be examined.
Assessing the impact of existing ALMP as
well as introducing new measures could be useful.
Actions taken by the government, including the preparation of an Employment
Action Plan as well as the ALMP assessments planned for 2014 are recognised.
Further steps could include linking the outcomes of the evaluation to future
policy in a clear and concrete way. Regularly documenting the results of
different initiatives in a consistent way and prioritising policies which have
a proven track record could increase the efficiency of the policy measures.
Adopting successful practices from other countries could also be explored.
Finding the right balance between active
and passive measures is another important challenge. As demonstrated in the report, employment is a key ingredient for
addressing the problem of poverty. Thus, effective active policies could prove
beneficial for improving the social situation and reducing poverty in the
country. At the same time, increasing the effectiveness of social transfers
would be important to ensure adequate living standards for their recipients.
Reviewing policy on the minimum wage and
the minimum thresholds for social security contributions to ensure it has no
adverse side-effects for the labour market remains important. This challenge has already been identified in the 2012 and 2013 CSR
related to labour market policies. Initially introduced as a measure to combat
the shadow economy, the thresholds for social security contributions have
increased significantly, including during the economic downturn, and have come
very close to the average wage in some sectors and occupations. This is especially
the case for the unskilled and low-skilled workers, which were also hardest hit
by the rise in unemployment. The government's action, including limiting
administrative increases of thresholds and the reviews of the system undertaken
in 2013 and 2014 are recognised. Nevertheless, the recent strong minimum wage
growth has further increased the thresholds for the lowest-paid workers and
could potentially distort the labour market. Those policies may also have a
bearing on the coverage of ALMP as it increases the spending needed for
subsidised employment programs. 
Improving education and training
practices appears important for the labour market.
The challenge of ensuring access to education has already been identified in
the 2013 CSR on education. In addition, policies related to achieving
sufficient participation, translated into higher educational attainment could
be examined. Developing training and lifelong learning practices targeted at
specific skills, which are or would be in demand on the labour market could be
useful to address the existing skills mismatches in some sectors of the
economy. Those practices could also increase the ability of the economy to
adjust and ensure that the labour market does not limit its growth potential.
Bakker, Bas K. and Zeng, L., ʻDismal
Employment Growth in EU Countries: The Role of Corporate Balance Sheet Repair
and Dual Labor Marketsʼ, IMF Working Paper 13/179, 2013.
Benkovskis, K. and Wörz, J.,
ʻNon-Price Competitiveness Gains of Central, Eastern and Southeastern
European Countries in the EU Marketʼ, Focus on European Economic
Integration Q3/2012, Austrian Central Bank 2012.
Berkhout, E. et al., ʻInto the Gap:
Exploring Skills and Mismatchesʼ, SEO Economic Research Randstad, 2012.
DG ECFIN staff, ʻEuropean Economic
Forecast Winter 2014ʼ,  European Economy 2/2014, Directorate-General for
Economic and Financial Affairs, European Commission, 2014.
DG ECFIN staff, ʻLabour Market
Developments in Europe 2013ʼ, European Economy 6/2013, Directorate-General
for Economic and Financial Affairs, European Commission, 2013.
DG ECFIN staff, ʻMacroeconomic
Imbalances – Bulgaria 2013ʼ, Occasional Papers 132, Directorate-General
for Economic and Financial Affairs, European Commission, 2013.
DG EMPL staff, ʻEmployment and Social
Developments in Europe 2013ʼ, Directorate-General for Employment, Social
Affairs and Inclusion, European Commission, 2014.
Di Comite, F., ʻMeasuring quality and
non-cost competitiveness at a county-product levelʼ, European Economy –
Economic Papers 467, Directorate-General for Economic and Financial Affairs,
European Commission, 2012.
IMF staff, ʻBulgaria: 2013 Article IV
Consultation – Staff Reportʼ, Country Report 14/23, International Monetary
Fund, 2014.
Lakwijk, F., Gracia B. and A. Weber,
ʻBulgaria Selected Issuesʼ, IMF Country Report 14/24, International
Monetary Fund, 2014.
Maiväli, M. and M. Stierle, ʻThe
Bulgarian labour market puzzle: Strong wage growth    amidst rising
unemploymentʼ, Country Focus, Directorate-General for Economic and Financial
Affairs, European Commission, 2013.
National Reform Programme of the Republic
of Bulgaria, 2013 update, Ministry of Finance, 2013. 
Programme for International Student
Assessment (PISA) study based on 2012 data, OECD, 2013.
Progress in International Reading Literacy
Study (PIRLS), International Association for the Evaluation of Educational
Achievement (IEA), 2011.
Salto, M. and A. Turrini, ʻComparing
alternative methodologies for real exchange rate assessmentʼ, European
Economy – Economic Papers 427, Directorate-General for Economic and Financial
Affairs, European Commission, 2010.
World Bank staff, ʻPortraits of Labor
Market Exclusion: Latent Class Analysis of the Out-of-work Population in
Bulgariaʼ, The World Bank, forthcoming 2014.
([1])  See IDR 2013 for details on the
specific provisions used by the regulator.
([2])  See IDR 2013 as well as Benkovskis and
Wörz, 2012 and Di Comite, 2012 for more details.
([3])  The model has been developed by the
European Commission’s Directorate General for Economic and Financial Affairs.
The baseline scenario assumptions for GDP growth, inflation and external yield
are based on the Financial Sustainability Report 2012.
([4])  Graph produced using a horizontal model
for calculating underlying CA.
([5])  This is more likely the case for the
tradable sector. Job losses in construction have been matched by a reduction in
the number of active companies.
([6])  Data source: Commission services.
([7])  See IDR 2013 for a full overview of the
MSST.
([8])  Own calculations based on unpublished
data.
([9])  AROPSE – At risk of poverty or social
exclusion.
([10]) Living conditions severely constrained
by a lack of resources, they experience at least 4 out of 9 following
deprivations items: cannot afford i) to pay rent or utility bills, ii) keep
home adequately warm, iii) face unexpected expenses, iv) eat meat, fish or a
protein equivalent every second day, v) a week holiday away from home, vi) a
car, vii) a washing machine, viii) a colour TV, or ix) a telephone.
([11]) Pensions are considered as part of the
income before transfers.
([12]) This has also been mentioned by the IMF
Article IV consultation – staff report.