PLANECON - QUARTERLY OVERVIEW ON BULGARIA
(With the courtesy of PlanEcon-Sofia office), February 17th 2000
BULGARIA - SURGING AGGREGATE DEMAND SPURS ROBUST GROWTH, PUSHES UP IMPORTS AS TRADE GAP WIDENS
GDP increased at 4.5% in the third quarter after an increase of 1.6% in the second, consistent with the earlier government forecast of 1.5% GDP growth for the year. The most encouraging trends are sa-vealed in the aggregate demand figures. Growth in individual consumption slowed to 3.7% in the third quarter, but still posted a rate of 8.7% for the first nine months of the year while collective consumption fell 2.0%. Growth in gross investment in fixed capital accelerated to 63.5% in the third quarter bringing growth for the first three quarters to 28.9%.
Bulgarian exports in January-September 1999 amounted to $2,826 million, a decline of 10.7% relative to the same period of 1998. This was a considerable improvement over the result for the first half of 1999 when cumulative exports were down by a staggering 21.7%. Bulgarian imports, in contrast, increased 7.4% to $3,568 million on an F.O.B. basis. For the first half of 1999, imports had been 1% lower than in the corresponding 1998 period. The resulting nine-month deficit amounted to $742 million, compared with $453 million for the first six months of 1999 and only $172 million for the first three quarters of 1998.
A poorer-than-cxpected showing by the UDF-Ied coalition in the October local elections was followed by successful negotiations to secure a formal invitation from the EU to apply for membership, a major achievement for the government. Kostov indicated publicly that he was aware that his cabinet as currently constituted was not up to the task of proceeding apace with accession talks. He proposed a revamped cabinet to parliament on December 21; it was approved the same day. The change involved the dismissal of 10 of 16 sitting ministers. The new cabinet includes a merged portfolio for industry and trade that will be held by Petar Zhotev, former head of the Bank Consolidation Company who will serve both as minister of the economy and deputy prime minister. He should accelerate privatization.
The international financial institutions have been concerned that the simultaneous reforms of the health and pension systems might be too much of a strain on Bulgaria's fiscal resources in 2000. The first year of operation of the health insurance system alone is projected to cost the state 4.5% of GDP. At the same time, the budget law directs that 14.8% of GDP be targeted for pensions and other social support. In light of the sharp upturn in registered unemployment in 1999, resources required for social support payments may be underestimated, which would mean additional pressure on the state budget in the coming months.
GDP rose strongly in the third quarter of 1999, up 4.5% relative to the same quarter of 1998. While exports sales continued to lag, a particular problem for the shrinking state-owned sector, output of the private sector was boosted as aggregate demand soared. THE NATIONAL Statistical Institute released national income account data for the third quarter of 1999. Several trends revealed in the data are most encouraging for the Bulgarian economy, especially the further boost in investment and the momentum provided to the expanding private sector by rebounding domestic demand. The data show a robust upturn of 4.55% in GDP relative to the same quarter of 1998, which brought growth for the first nine months of 1999 to 2.0%. However the third quarter of 1998 was the only quarter that did not register GDP growth in that year. Thus the results published to date for 1999 are still consistent with the earlier government forecast of 1.5% GDP growth for the year.
The most encouraging trends are revealed in the end-use figures. Growth in individual consumption slowed to 3.7% in the third quarter, but still posted a rate for the first nine months of the year of 8.7% while collective consumption fell 2.0% in me same period. Growth in gross investment in fixed capital accelerated to 63.5% in the third quarter, bringing growth for the first three quarters to 28.9%. Gross fixed capital investment rose by 16.0% in the full year 1998, from a very low base. The increment in aggregate demand clearly had a strong impact on the trade balance, with the 4.5% rise in GDP generating an 8.1% increase in imports in the constant price national income statistics for the third quarter. The quarterly national income data also reveal widely differing results across producing sectors and a sharp dichotomy between developments in the private and state-owned sectors. While total gross value added in the economy increased 4.7% relative to the third quarter of 1998 and 1.6% for the first nine months, this reflected strong performance by agriculture and an acceleration in output growth in the service sector, but a continued decline in net industrial output. Favorable growing conditions plus productivity gains due to the privatization of agriculture resulted in an increase in gross value added by agriculture of 6.7% in quarter. three and 6.8% in the first three quarters of 1999. Gross value added in the service sector grew a robust 6.3% in the third quarter, pushing the increase for the first nine months to Z7%. Gross value added by industry (including construction) fell 1.0% in quarter three of 1999 and 4.0% in the first nine months of the year. The downturn in industry, however, has been concentrated in the state-owned sector where large-scale heavy industrial enterprises have suffered most from difficulties in key export markets. The contribution of the industrial sector (including construction) to total gross value added in the economy declined to only 28.0% for the first nine months of 1999, compared with 54.0% in the service sector and 18.0% in agriculture. The statistics on developments in the private versus the state-owned sector are most revealing, hi the third quarter of 1999, the private sector produced 72% of aggregate gross value added in the entire economy, up two percentage points compared with the previous year. The private sector produced 60.5% of the gross value added originating in the industrial sector, an increase of ten percentage points. This reflects several factors, including the decline in industrial activity, the privatization of state-owned enterprises and relatively better Performance of the private industrial sector. The private sector of the economy as a whole registered an increase in gross value added in the third quarter of 7.8%, compared with a decline for the state-owned sector of 3.1% in that period. For the first nine. months of the year, net output of the private sector rose 6.8% while for the state sector there was a drop of 7.5%. The correction to total gross value added in the national income accounts, which can be viewed as a measure of developments in the grey economy, increased by 2.4% in the third quarter and 5.6% in the first three quarters of 1999. This correction represents 12.0% of GDP.
The disparate performance of the state and private sectors is illustrated as well by the data available on industrial branch sales and gross output for the first ten months of 1999. Overall for industry, the gross value of output fell 13.9% in the first ten months of 1999 while total sales declined 11.6%. The sharpest contractions occurred in ferrous metallurgy and textiles where gross output dropped 35.0% and 31.3%, respectively. In contrast, in petroleum refining and non-metallic mineral products, where foreign strategic investors are now operating the major enterprises, gross output increased by 116.8% and 135.6%, respectively for the ten months.
The reported developments in retail trade turnover in the first ten months of 1999 are difficult to reconcile with the personal consumption trends reported in the national income statistics. The narrowest definition of retail trade turnover was reported to be 4.7% lower in October 1999 than in the same month a year earlier, while for the entire January-October period, the comparable figure was a decline of 6.9% (7.3% down for food, beverages and tobacco and 6.6% for non-food items). A broader series, for sales by enterprises in the trade and automotive and household repair sectors, registered a decline of only 2.1% for the same period. It is clear from these data that official statistics miss a considerable share of consumption activity that takes place through the gray economy.
The privatization and restructuring of industry is also having a clear impact on the headline rate of unemployment From a 1998 low of 10.7% of the labor force reached in September, the unemployment rate reported by the National Labor Exchange (NLE) remained at or near 13% in January-August 1999 and climbed to 14.2% in September, 14.7% in
October, and 15.6% in November 1999. The November rate is higher than any reported since early 1994, but some caution is necessary in interpreting the data, particularly in light of the continued strength of aggregate demand. The NLE acknowledges that there is a seasonal factor as tourism winds down in the autumn. More importantly, a change in the health insurance system has been a factor. The state has now begun to make payments on behalf of registered unemployed persons into the health insurance system, replacing the former system of provision of free health care services by the state. This is likely to have motivated significant numbers of workers employed in the grey economy to register as unemployed.
After mid-year, the continued recovery of aggregate demand, together with increases in administered prices, particularly for electric power and fuels, resulted in an end to the extended period of deflation. While monthly declines in the consumer price index were registered in February-June 1999, an upward adjustment of energy prices in July produced an increase of 3.2% in the CPI. Monthly increases remained in the range of 1.0%-1.5% in August through October and decelerated to 0.6% in November. We estimate the December-on-December increase in consumer prices at 7.0%, a number remarkably dose to the 6.8% assumption incorporated in the state budget law for 1999. Because we anticipate further increases in administered prices and continued robust domestic demand, we are projecting a modest acceleration of consumer price inflation in 2000, with the December-on-December rate coming in at 8.1%.
Export numbers (or the first three quarters were . down, but less so than in the first half, while imports are surging due to the very strong rebound in Bulgarian aggregate demand. While the statistics on foreign trade developments in the first three quarters of 1999 indicated that the slide in export performance for the full year would be more moderate than the alarming figures for the first and second quarters would have suggested, exports for the first nine months of the year were still well down from 1999. Moreover, the recovery in Bulgarian aggregate demand had begun to boost imports substantially, with a concomitant widening of the trade and payments deficits.
Bulgarian exports in January-September 1999 amounted to $2,826 million, a decline of 10.7% relative to the same period of 1998. This was a considerable improvement over the result for the first half of 1999 when cumulative exports were down by a staggering 21.7%. Bulgarian imports, in contrast, increased 7.4% to $3,868 million on a C.I.F. basis, $3,568 million on an F.O.B. basis. For the first half of 1999, imports had been 1% lower than in the corresponding 1998 period. The resulting deficit (F.O.B.-F.O.B.) for January-September 1999 amounted to $742 million compared with $453 million for the first six months of 1999 and only $172 million for the first three quarters of 1998.
Among the individual commodity categories of Bulgarian exports, the sharpest declines took place in industrial raw materials in the first three quarters of 1999. Exports of base metals dropped 30.3%, exports of chemicals, plastics and rubber fell 31.7% and other raw materials exports declined 17.5%. Industrial raw materials remain the most important category of Bulgarian exports, but the category's share in the total slipped to 36.1% in this period compared with 43.6% in the same period of 1998. Exports of food and raw materials for food dropped by a more modest 9.0% while exports of capital goods fell 8.4%. Exports of fuels and lubricants were flat in the first three quarters. Consumer goods remained the sole category of Bulgarian e<-ports that consistently registered increases in the course of 1999. Consumer goods exports, which now constitute 26.4% of the total, increased 15.7% compared with the first nine months of 1998.
The pattern of developments in imports across commodity categories in the first three quarters of 1999 dearly reflected reported trends in aggregate demand and domestic economic activity. With industrial output sagging, imports of industrial raw materials dropped 12.4%, with much steeper declines for the subsets of metals (-24.6%) and chemicals (-24.1%). For similar reasons, imports of fuel and lubricants fell 11.7%. Thanks to improved domestic availability, imports of food and raw materials for food also declined in this period, by 8.8%. Developments in the remaining commodity categories of imports looked very different, however. The sharp increase in gross investment in fixed capital in 1999 had a concomitant impact on demand for imported capital goods: imports of investment machinery soared by 40.0% in the first nine months. Imports of transport equipment which includes automobiles, rose a staggering 146.2%. Together, imports of investment goods and transport equipment accounted for 31.2% of total imports in this period compared with only 21.2% in the first nine months of 1998.
The increase in imports of non-food consumer goods in the first three quarters of 1999 amounted to 35.7%, far in excess of the growth in personal consumption in the period. This clearly indicates the strong import component of incremental consumption expenditures and, in light of the very low levels of average dollar wages, implies that salaries earned in the official economy explain only a small share of actual household money income. Bulgarian exports declined with respect to all partner regions in the first three quarters of 1999, but the strongest contractions continued to take place with the former Soviet republics. Exports to this region fell 38.3% in January-September 1999. Bt-ports to Russia fell by a somewhat more modest 22.8%, but exports to Ukraine and Georgia, the other significant partners in that region, fell in access of 40%. While exports to Central and Eastern Europe sustained the smallest decline, only 1.1%, a recovery of exports to Balkan countries offset sharp downturns in exports to CEFTA countries, despite Bulgaria's accession to the group in 1999. Exports to Macedonia rose 30.2% and exports to Yugoslavia increased 29.1%, solely on the basis of developments in the third quarter following the end of the NATO air campaign against Serbia and in connection with aid and reconstruction efforts in the region. These developments almost offset the cb-cline of 30.4% in exports to the CEFTA countries. The sharpest downturns in exports occurred to Slovakia (-61%), where macroecononic adjustment was under way, and to Poland (-58.4%), where industrial output slowed markedly in this period.
Declines in exports to OECD countries were much less severe in this period (-4.9%), but exports to Bulgaria's single most important market, the European Union, fell 6.2%. Nevertheless, the share of the EU in total Bulgarian exports increased to 53.5% in the first three quarters of 1999. Declines in exports took place with respect to almost all of the important EU trade partners with the exceptions of Belgium and France, the home bases of major strategic investors in privatized Bulgarian enterprises in the chemicals, construction materials and food processing industries, among others. Exports to France increased by 30.2% and to Belgium by 24.3%. The only other increase in exports registered among major OECD trade partners took place with respect to the United States, an increase of 32.1%. U.S. firms have been gaining in importance as strategic investors in Bulgaria recently.
As the merchandise trade gap yawned in the course of 1999, the current account deficit widened further to $468.6 million compared with a surplus of $87.0 million in the first nine months of 1998. The balance of payments deterioration was more than explained by the $584 million dollar increase in the deficit on the merchandise trade account in the same period of 1999. There was only a deficit of $16 million in the current account in the third quarter of 1999, however, despite a trade deficit for the quarter of $215 million thanks to a strong surplus on services of $227 million. Third-quarter inflows on services were boosted by the seasonal peak in tourism, although third-quarter earnings on travel and tourism were modestly down in 1999 to $388 million from $405 million a year earlier. The surplus on services will shrink in the fourth quarter while the trade gap typically widens, particularly in December because of increased consumer spending due to year-end bonuses and the holiday season. We project a current account in excess of $800 million for the full year, around 6.5% of GDP.
Direct foreign investment in Bulgaria in the first three quarters of 1999 amounted to $374 million, only $16 million higher than in the same period of 1998. This is according to the narrow balance of payments definition, which considers only cash payments by investors. The financial account was in surplus by $165 million and the overall balance amounted to -$221 million compared with -$73 million in the same period of 1998. The deficit was financed by net drawings of IMF credits of $117 million over the nine-month period and the receipt of $133 million in extraordinary credits for balance of payments support As a result, there was an increase in the foreign exchange reserves of the Bulgarian National Bank by $29 million by end-September compared with end-year 1998. The level of these reserves remained unchanged in October at a level of $2,689 million.
The keys to maintaining the momentum of the recovery this year will be to continue sensible fiscal management in the face of costly reforms of government operations and to ensure continued inflows of revenues from accelerated privatization and foreign direct investment to help offset the budget and external deficits. In December, the Bulgarian parliament approved the cabinet's draft budget for 2000. The draft incorporated an assumption of 4% growth in GDP and annual inflation of only 2.8%. The deficit targeted for 2000 is equivalent to 1.5% of projected GDP. More than 84% of targeted revenues of BGN10.13 billion are to come from taxation. Expenditures are targeted at BGN10.48 billion and include substantial sums that will be required in the scheduled reforms of the health insurance system and the pension system. Therefore, the 2000 budget is an austere one despite the planned widening of the deficit. The 1999 budget law targeted a deficit for the year of 1.8% of GDP. As of the end of November, there were very small deficits in both the central government and the consolidated state budgets. We estimate that the cash deficit on the consolidated state budget will not exceed 0.3% of GDP.
The international financial institutions have been concerned that the simultaneous reforms of the health care and pension systems might be too much of a strain on Bulgaria's fiscal resources in 2000. The first year of operation of the health insurance system alone is projected to cost the state 4.5% of GDP. At the same time, the budget law directs that 14.8% of GDP be targeted for pensions and other social support. In light of the sharp upturn in registered unemployment, the resources required for social support payments may be in-underestimated, which would mean additional pressure on the state budget in the coming months. A loan from the World Bank is to be provided by mid-2000 in support of the health care reform. The $60.6 million will go to help establish the infrastructure for the National Health Insurance Bank ($40.6 million) and for the conversion of the health care system itself.
Privatization revenues will play a key role this year in financing the fiscal deficit. At the same time, a number of developments will make it more difficult to generate cash from privatization of state-owned assets. While the projected price tag for the whole enterprises on the approved list for the Privatization Agency in 2000 is BGN530 million, only 20% of the price is required to be paid in cash this year, down from the earlier 50% requirement. The remainder of the agreed price is likely to be defrayed by means of compensation vouchers, which have been distributed in lieu of property restitution, and investment vouchers : issued in connection with the mass privatization program. Furthermore, a good deal of the state's most attractive enterprises have already been privatized. Only 45 entire enterprises remain on the Privatization Agency's list, the most important being Bulgartabak Holding, Balkancar Holding, Inscom-Telecom Holding and the 22 hydroelectric plants.
There was already a shortfall of privatization revenues relative to the 1999 plan because of the unanticipated delay in the privatization of the country's telecommunications monopoly. The sale of the Bulgarian Telecommunications Company (BTC) had been scheduled to be completed in November 1999 for a sum of $510 million. A 51% stake in BTC is being sought by a consortium of the Dutch KPN and Greece's OTE. The consortium would also receive a license for a second GSM mobile phone network as part of the transaction. The delay was publicly explained by a requirement to assure approval by EU regulators. However, there was a concurrent management shuffle in the Greek firm and some indication that financing of the acquisition was not proceeding as planned. At the same time, some prominent Bulgarian politicians again publicly questioned the adequacy of the bid from the consortium. If the delay is prolonged it increases the probability that the government will request that the bid be upped. The Dutch-Greek consortium had been the only bidder in the March 1999 tender, but there was hope that foreign tele-corns would now be interested in stepping in if the preliminary agreement signed in October is not finalized. Responding to anticipated concern at home and abroad due to the widening payments gap and fiscal pressures in 2000, the Bulgarian National Bank issued a statement at end-1999 that the BTC privatization was not critical to meeting the country's obligations in either 1999 or 2000.
Nevertheless, if the program for 2000 is to be implemented, the Bulgarian government will have to be more businesslike and realistic in privatizing remaining enterprises. Some of the enterprises on the list are in difficult financial circumstances due to the market situations they face and past mismanagement. The next step, the planned privatization of the country's infrastructure enterprises, including the electric power utility, will be a more difficult process and presents significant legislative and regulatory challenges. For example, the initial position of the international financial institutions was that the electric power market should be transformed by the end of 2000 through the breakup of the National Electric Company. But there is now a realization that the process of preparing for the breakup in terms of legislation, regulation and 1-censing will mean that the goal is at least 18 months away. Given these challenges and the e<-treme importance of the privatization process at this juncture, the new approach of the Kostov government typified by the creation of the National Consultative Consul under Zhotev will be most welcome.