-  47  -

period, whereas the share of Cyprus rose to 24 percent and 20 percent in respective years. Cyprus was by far the largest investor in 1998 (US$ 131 million), with the US distant second (US$ 50 million). In 1999 investments originating in Cyprus amounted to US$ 162 million well above the second Holland with US$ 106 million and third Russia with US$ 100 million. On the one hand, this was a positive development signaling the reversal of capital flight in response to the improvements in business climate. On the other hand, however, considering the local expertise of investors, these were probably mostly investments targeting domestic markets or already well established external ones.

Third, FDI going to sectors producing tradable goods (agriculture, mining and manufacturing) accounted for a relatively low share of the total FDI. In terms of FDI cumulative over 1998-2003 sectors producing tradable goods attracted 26 percent of total FDI inflows in this period (Table 36). In contrast, manufacturing alone accounted for almost half of FDI inflows to Czech Republic and Slovakia. Services sectors have attracted almost two thirds of total inflows. The most prominent among them was the banking sector almost completely wiped out in years preceding the outbreak of the financial crisis in 1996.

**Table 36** : _Sectoral composition of FDI flows in 1998-2003 (in percent)_

||1998|1999|2000|2001|2002|2003|Cumu<br>1998-2003|lative<br>2000-2003|
|---|---|---|---|---|---|---|---|---|
|Tradable goods sectors|35.3|53.7|19.9|31.7|9.7|18.4|26.1|19.5|
|Of which: manufacturing|34.1|53.5|17.9|31.0|8.4|18.2|25.3|18.5|
|Services:|58.4|37.7|72.5|60.8|72.6|70.2|63.6|69.4|
|Of which financialsector|28.0|11.9|44.9|15.1|14.8|34.6|26.3|28.9|
|Others|6.3|8.7|7.6|7.5|17.7|11.4|10.3|11.1|
|TOTAL|100|100|100|100|100|100|100|100|

Source: BNB and WB staff calculations.

Last but not least, the time needed to establish a viable export operation was probably longer in the late 1990s than it would have been during the initial stages of transition in Bulgaria had Bulgaria stayed the reform course as other early radical reformers of Central Europe. Although with the change of government in 1997, triggered by the financial crisis of 1996, Bulgaria’s path of transformation converged to that shared by most advanced reformers, initial opportunities were irreversibly squandered. For instance, a good example of opportunities that were either lost or subsequently could not be tapped relatively quickly is electrical engineering and computers. Products of electrical engineering and electronics industry in total exports accounted for 28 percent in 1989. Without FDI inflows to provide access to quickly evolving technologies and effect restructuring, the chance of their survival in truly competitive markets was practically nonexistent. Thanks to FDI, this sector survived and expanded in CEEC-10, in particular Hungary, but stagnated and devolved in Bulgaria (Zsanyi 2004).

But there are multiple signs pointing to the reversal in industrial devolution including electrical engineering. First, FDI accounted in 1998-2003 for between 25 percent and 48 percent of Bulgaria’s Gross Domestic Investment (Table 37). On average, more than one third of total investments in the Bulgarian economy were foreign investments in 2000-03. As mentioned earlier, in contrast to FDI inflows in 1998-1999, these came mainly from highly developed countries. A recent surge of high quality FDI inflows into sectors of the Bulgarian economy— both services and manufacturing—that are critical to integration into pan-European markets for higher value added products.

Second, the share of Gross Domestic Investment in GDP significantly increased over 1998-2003. So did the share of FDI in 2001-2003 increasing to almost 50 percent in 2003. On average in 2000-03, foreign investments in manufacturing amounted to 1.4 percent of the GDP. Given a small size of Bulgarian markets, a significant portion of them went into activity with