June 24, 2022
Washington, DC:
On Friday, June 17, 2022, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Bulgaria and considered and endorsed the staff appraisal without a meeting. [1]
The Bulgarian economy showed resilience through the pandemic. Owing to policy support, the economy rebounded in 2021 despite the health crisis and protracted political uncertainty that weighed on investment. GDP surpassed its pre-crisis level by mid last year, and growth reached 4.2 percent in 2021, thanks to strong consumption supported by significant fiscal support and buoyant wage growth, on the back of a strong labor market recovery. However, as in many other countries, inflation accelerated significantly, pushed by, rising commodity prices, global supply-chains disruptions, increasing labor costs, and strong domestic demand. It reached double-digit in March 2022 and was broad-based.
Executive Board Assessment [2]
In concluding the Article IV consultation with Bulgaria, Executive Directors endorsed the staff’s appraisal as follows:
The war in Ukraine has clouded the outlook, heightened uncertainty, and increased downside risks. While the economic recovery from the COVID-19 crisis was gaining momentum, the war is dampening growth and accelerating inflation. High energy dependance from Russia is a significant vulnerability. With events unfolding rapidly, uncertainty is high. Key risks include stronger spillovers from the war, including disruptions in energy supply, a resurgence of COVID-19, protracted supply-chain disruptions, and faster-than-anticipated tightening of global financing conditions.
Fiscal policy needs to be flexible given the large uncertainty. The 2022 budget adopted in February strikes a reasonable balance between supporting the recovery, which is still incomplete and faces strong headwinds from the war, and not fueling inflation further. The planned mid-year budget revision should be approached flexibly as new needs and priorities may emerge, warranting further reprioritization of spending and, if activity disappoints significantly, possibly also a looser fiscal stance.
A review of the composition of public spending is needed already this year. The budged reorientation of spending toward more public investment is welcome. However, the magnitude of the planned increase may run against absorption capacity and requires phasing in new projects more gradually. Conversely, the nominal freeze of the wage bill is no longer desirable with inflation running high. The mid-year budget revision should also account for new needs emerging from the war, such as supporting refugees. To help the economy and the population cope with high energy prices, existing subsidies to companies and price caps should be gradually shifted to direct support to vulnerable households. Also, the reduction in VAT rates should be discontinued, as the measure is regressive and no longer needed.
The planned medium-term fiscal consolidation is broadly appropriate and should be accompanied by expenditure and revenue-management reforms. An aging and shrinking population, the currency board arrangement, and the need to preserve buffers considering the uncertain external environment call for fiscal prudence. Fiscal space to address long-term social and investment needs could be expanded by increasing the efficiency of public spending and reviewing taxation to increase revenue and redistribution. These reforms would enhance physical and human capital and foster higher and more inclusive growth. Furthermore, a holistic review of the pension system would help design reforms that target both its sustainability and an adequate level of pensions.
The authorities need to continue watching for possible increases in credit risk. Macroprudential measures during the pandemic strengthened banks’ balance sheet and helped maintain credit flows. Also, considering the accelerating credit growth to households, the authorities have recently rightly tightened macroprudential policy. Overall, the banking sector remains well capitalized and liquid, and the financial sector has very little direct exposure to Russia or Ukraine. Therefore, systemic risks appear low. However, credit risk may rise because of the impact of surging commodity prices and supply-chain disruptions on corporates, rising interest rates, the lagged impact of withdrawing COVID-19 related support, or an emergence of imbalances in the housing market. Hence, the authorities should continue to monitor asset quality and ensure that banks proactively manage risks and maintain strong capital positions.
Accelerating structural reforms is crucial to raise living standards and promote more a competitive, inclusive, and green economy. With the euro area accession in sight, policies that help foster income convergence with EU partners are even more important. The government’s focus on strengthening governance and fighting corruption is welcome. Steadfast efforts to improve the effectiveness of the judicial and anticorruption systems are essential to strengthen the rule of law. Ongoing efforts to harness digital technologies and foster innovation are needed to raise productivity. The effective implementation of planned investment in renewables and energy efficiency will strengthen energy security and reduce carbon footprints. When energy prices decline, incentives for green transition could usefully be supported by price-based mechanism and fiscal tools. NGEU funds have a key role to play to support efforts in these areas.
[1] Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team normally visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. In this case, discussions were held from headquarters through videoconferencing.
[2] The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.