November 1990 (see Table 5). This happened even though banks also funded their lending by resorting to foreign exchange deposits and foreign exchange loans. In fact, banks like the BFTB, assumed a substantial risk by borrowing in foreign exchange and lending to enterprises in Levs. These foreign exchange loans accounted for a large proportion of the country's foreign public sector debt. In 1990, PSEs benefitted substantially because they were forgiven from the effect of a devaluation (in the official exchange rate) on the cost of serving these loans, i.e., the foreign exchange risk. The magnitude of this effect is evidenced in the large size of the item "Valuation Adjustment" (see Table 3) and in banks foreign exchange risk (see Table 5). Had enterprises assumed the foreign exchange risk, their credit stock would have increased by 44 percent of GDP. This would have had an immediate effect on enterprises' cash-flow since their interest axpenses also would have increased.

While in the early-1 980s enterprises benefitted from ready access to credit, in the late1 980s they benefitted from the very negative interest rates (see Table 6). In the early-1 980s, as explained, enterprises benefitted from a strong supply of credit. This enabled them to roll-over their loans. In late-1 980s, however, this situation changed. Enterprises start benefitting from the very negative real interest rates as a result of the increase in the inflation rate.

Table 5: Share of Enterprises Credits Denominated in Foreign Currency and Banks' Foreign Exchange Risk

|...<br>.|....<br>.<br>.<br>..<br>,<br>1986|.<br>.<br>..<br>,<br>.<br>1987|..<br>.<br>.<br>..<br>.<br>1988|.<br>.<br>..<br>.<br>.<br>._.<br>1989|.<br>.<br>.<br>Nov.<br>1990|
|---|---|---|---|---|---|
|Share of Enterprise FEX Loans<br>in Total Enterprise Loans 1/|1.8X|2.5X|2.9X|4.0X|10.4X|
|BanksForeign Exchange Risk 2/<br>|4.9<br>|4.8<br>|4.5<br>|3.7|4.8<br>|
|Of which: BFTB 2/<br>.......<br>............<br>_..........................................|6.8|6.5<br>.|6.3<br>..................................|i.1|8.5<br>...................................................|

Source: National Bank of Bulgaria.

Notes: (1) FEX stands for loreign exchange. (2) Banks Foreign exchange risk is defined as the ratio of total foreign exchange deposits to total enterprises foreign exchange loans, that is, excluding General Government*s FEX-denaminated loans. This ratio measures the effect on banks net worth of a nominal devaluation. For instance, in November 1990 a 1 percent nominal devaluation would increase the average bank liabilities in 5 percent more than their assets, thus a fall in banks net worth (a loss) equivalent to 5 percent of their FEX-denominated liabilities.

Interest rates in Bulgaria were fixed in nominal terms for a long period and the authorities only started adjusting them in 1988. While in 1986-88 the real interest rates on credits hovered Al Until 1991, howev6r, banks' accounts understated the true magnitude of foreign exchange transactions. By law banks had to convert these transactions Into lev at the official exchange rate, even though some of the foreign exchange transactions, in practice, were exchanged at the commercial exchange rate. The difference, even though a mere bookkeeping, were either covered by subsidies from the budget or, transferred to the budget as revenue from 'coefficient differences.' In recent years, the latter was the common practice.