state-owned enterprises for privatization, and to bail out failing banks. Bulgaria was unable to access international capital markets, and its official lending has been limited ever since. Striving to return its debt below the Maastricht threshold of 60 percent of GDP, the government generated sizeable primary surpluses of 6.4 percent of GDP annually over 1994-1999, reducing its debt to 82 percent of GDP in 1998 (chart 2). This level on gross basis, as well as 59 percent of GDP on net basis is still among the highest of the EU accession countries.

As Bulgaria had to regularize its relations with its external creditors, it had to cope with a negative transfer of resources, that averaged 5 percent of GDP during 1994-1998. Meanwhile, the budget deficit was financed from domestic sources. Domestic deficit financing averaged 6.7 percent of GDP annually during 1994-1995, peaking at 14.9 percent of GDP in 1996. Investors' confidence eroded quickly, and average maturity of the of Treasury bills collapsed from ten months to mere two weeks at the peak of the crisis.

Introduction of the CBA brought confidence back. The burden of interest payments eased to around 5 percent of GDP, but foreign debt service is projected to remain substantial<sup>6</sup> . In absolute terms it is expected to exceed US$1 billion in 2001 and stabilize at about 21-22% of exports of goods and services (Chart 3). This level is uncomfortably close to the empirical crisis threshold of 25 percent and will continue to constrain Bulgaria's flexibility in the use of debt financing to dampen fiscal shocks.

<!-- Start of picture text --> Chart 3. Projected external debt service<br>US$ million<br>1500<br>1000<br>principal<br>500<br>interest<br>0 I I<br>1998 1999 2000 2001 2002 2003 2004<br><!-- End of picture text --> Since the introduction of the CBA, the government has been cautious in its borrowing policies. It prudently refused repeated offers from the commercial creditors in the Eurobond market in 1998. Aftershocks of the Russian and Kosovo crises that have shifted the yield curve substantially upwards in 1999 prove that this prudent stance was well grounded. Net financing from the domestic market has been negative since mid-1998, while the external debt has been reduced by two successful debt buyback operations in 1998-99 at deep discounts. The total face value of debt eliminated via buybacks is estimated at well over US$1 billion. Bulgaria was rewarded for its responsible borrowing strategy by a 1999 rating upgrade (to B+) and by a steady increase in the average maturity of the Treasury bills from 13 to 21 months as of end- 1999.

_Debt structure has stabilized but remains rigid._ The share of foreign debt dropped briefly after the Paris and London Club restructuring deals. Rapid erosion of the value of domestic currency during 1995-1997, however, wiped out the lev-denominated debt and brought the external debt burden back to unsustainable level of 90 percent of GDP. The 1998 share of domestic debt was 17 percent of the total public debt, with about two thirds (mainly associated 6 Projections include new identified borrowing and gapfill financing. Source: IMF staff estimates.

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