BULGARIA - INDUSTRY IS GROWING AGAIN BUT ACCELERATED RESTRUCTURING HAS BOOSTED UNEMPLOYMENT:
GDP rose 2.5% in 1999 according to a preliminary report from the National Statistical Institute, compared with 3.5% growth in 1998. This was despite a decline of 12.5% in the gross value of industrial output for the year as export sales contracted sharply. The January 2000 industrial performance statistics were more encouraging, but clearly benefit from the very low base in January 1999 following the Russian financial crisis. Industrial sales in January were up 4.4% compared to the same month of 1999 and industrial output increased 5.2%.
While the decline in exports for the full year proved to be much less dramatic than in the first and second quarters, the trade deficit broke the billion-dollar mark as imports surged with the recovery of domestic demand. Fortunately, foreign direct investment remains strong and the IMF remains a steadfast supporter. Balance-of-payments support from official sources in connection with the impact of the Kosovo crisis on foreign exchange earnings has also come in handy.
Privatization and restructuring are gathering steam, but the Kostov administration's mandate for accelerating reform may be fading. The approval rating of the current government sank to a new low according to a poll taken in mid-March. Only 28% of respondents thought the Kostov administration has been doing a good job compared with 34% a year earlier. In apition to the soaring unemployment rate, corruption and non-transparency in privatization were cited as the key criticisms.
A critical factor in coping with the large trade imbalance is a continued strong inflow of direct foreign investment to offset payments pressures. For this reason, as well as due to implications for the upcoming privatization of the rest of Bulgaria's infrastructure the sale of a 51% stake in the Bulgarian Telecommunications Company, which has proved a tortuous process, is taking a very high profile.
size="3" face="Times New Roman">KEY MACROECONOMIC TRENDS
GDP rose 2.5% in 1999 according to a preliminary report from the National Statistical Institute, compared with 3.5% growth in 1998. This was despite a decline of 12.5% in the gross value of industrial output for the year as export sales contracted sharply. Agriculture, although accounting for a relatively small share of GDP (18.7% in 1998), probably contributed to growth in gross value aped last year. Most of the increase "was concentrated in the service sector, which accounted for 44.7% of GDP in 1998. Aggregate output was pushed up by recovering aggregate demand in 1999, but there was a strong import component in demand for manufactures both from consumers and for investment goods. The merchandise trade deficit hit over $1 billion in 1999 from $381 million in 1998. Retail trade turnover in 1999 fell by 6%. Retail sales of food, beverages and tobacco products declined 6.9% while sales of non-food items were down 5.5%.
Data are now available on industrial branch sales and gross output for 1999 as well as for January 2000. Overall for industry in 1999, the gross value of output fell 12.5%; sales by industry declined 10.5%. The sharpest contractions among major branches occurred in ferrous metallurgy (output down 27.4%), metalworking (-15.9%), textiles (-28.3%), and chemicals (-18.4%), all of which are typically major exporters. The only branches reporting increases in sales and output last year were petroleum refining (output up 16.3%) and radio, television and telecommunications equipment (up 8.2%).
The January 2000 industrial performance statistics were more encouraging, but clearly benefit from the very low base in January 1999 following the Russian financial crisis. Industrial sales in January were up 4.4% compared to the same month of 1999 and industrial output increased 5.2%. This represented an acceleration relative to the Decem- ber result, when industrial output was up 3% year-on-year. The best news was that exports by industry in January were up 28% year-on-year, although domestic sales fell 5%. This marked the fifth consecutive increase in industrial export sales. Export receipts for industry rose by 8.7% year-on-year in September 1999, 2.3% in October, 1.2% in November, and 8.9% in December. Total sales by petroleum refining surged 32.2% thanks to the improved financial situation at Neftokhim following the purchase of a controlling stake by LUKoil. One of the worst performers in 1999 showed one of the strongest upturns in January of this year, as sales by ferrous metallurgy rose 33.1% year-on-year. Sales by chemicals were also up, but by a more moderate 9.1%. Textile sales, on the other hand, were still down 21.7%.
The privatization and restructuring of industry are 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 reached 16.0% by December 1999 before surging to 17.2% in January 2000 and 18.1% in February. The government is predicting that the rate of unemployment will ease in the course of 2000 to hit 13.5% again by year-end. However, with the completion of further privatizations and liquidations this year, it would seem over-optimistic to expect expansion in the private sector to soak up so many redundancies so quickly. We are projecting an end-year rate closer to the 15-16% range. This is especially true since state-funded contributions for the new health insurance program will be linked to official registration for unemployed workers this year.
Data are available on developments in consumer prices through February 2000. December-on-December inflation came in at 6.1% last year with modest increases in prices largely due to higher energy costs in the second half following an extended period of deflation. Sharp increases, in the costs of home heating and electricity (including rents) and more modest increase in average food prices (3.2%) offset slight declines in most other categories of consumer goods and services to produce a 3.1% rise in the CPI in January, bringing year-on-year inflation up to 7.8%. In February, however, the monthly rate was down to only 0.5%, but due to the falling level of consumer prices in February-June 1999 the rate was up to 9.0% year-on-year. Our forecast is that consumer price inflation will remain low in the remainder of this year as moderating world energy prices offset further increases in remaining administered prices. The year-on-year rate is forecast to remain at 9.0%, although it will rise and then subside over the course of 2000 due to the unusual trends that prevailed in the first half of last year.
size="3" face="Times New Roman">EXTERNAL ACCOUNTS
Foreign trade numbers are now available for the full year 1999. While the decline in exports for the full year proved to be much less dramatic than in the first and second quarters, the trade deficit broke the billion-dollar mark as imports surged with the ongoing recovery of domestic demand. Fortunately, foreign direct investment remains strong and the IMF remains a steadfast supporter. Balance-of-payments support from official sources in connection with the impact of the Kosovo crisis on foreign exchange earnings also have come in handy. With the currency board in place, a drain of foreign exchange reserves to finance a burgeoning merchandise trade deficit could result in a reduction of the money supply and a consequent dampening of the economic recovery.
Bulgarian exports for full year 1999 amounted to $3,958.8 million, a decline of 5.6% relative to the same period of 1998. This was a considerable improvement over the result for the first nine months of the year when cumulative exports were down by a troubling 10.7%. Bulgarian imports, in contrast, increased 9.9% to $5,449.8 million on a C.I.F. basis, $5,027 million on an F.O.B. basis. For the first nine months of 1999, imports had been up by 7.4% over the corresponding 1998 period. The resulting deficit (F.O.B.-F.O.B.) for 1999 amounted to $1,068.1 million compared with $380.6 million in 1998. The trade deficit increased by $330 million in the course of the fourth quarter of 1999, nearly equivalent to the deficit for all of 1998.
While most commodity categories of exports registered considerable downturns last year, the steepest declines took place in industrial raw materials. Exports of base metals dropped 19.0%, exports of chemicals, plastics and rubber fell 22.8% and other raw materials exports declined 14.0%. These declines were a good deal less drastic than the more than 30% drops in metals and chemicals exports registered for the first nine months of the year. In the fourth quarter of 1999, metab exports were actually up 9.3% and chemicals, plastics and rubber exports rose 7.7% compared with the final quarter of 1998. Industrial raw materials remain the most important category of Bulgarian exports, but this category's share in the total slipped to 35.9% in 1999 compared with 41.4% a year earlier.
Exports of food and raw materials for food dropped by a more modest 8.0% while exports of capital goods fell 10.0%. Exports of fuels and lubricants were up a startling 19.5% in 1999, having registered an increase of only 1.8% for the first nine months. This reflected the sharply higher price of oil in the fourth quarter of 1999 compared with a year earlier as well as the improved financial situation at the NeftokJdm Refinery at Burgas, the country's only major refinery, in which Russia's LUKoil now has a 58% stake. Consumer goods were the only other commodity category of exports that experienced an increase in 1999 after having consistently registered positive growth over the year. Consumer goods exports now constitute 25.5% of the total compared with 20.7% in 1998 and grew an impressive 16.4% last year.
The rebound in aggregate demand in 1999 clearly explained developments among the various commodity categories of imports. Imports of investment goods and consumer goods were up very significantly. Imports of transport equipment (including automobiles) were up 119.3% while imports of capital goods rose 31.5%. The upturn in imports of consumer goods came to 32.4%. The only other category of imports that increased in dollar value terms in 1999 was fuels and lubricants, up 2.5%. However, given the sharply higher price of oil in the second half of 1999, in physical terms this category is likely to have declined.
Other categories of imported industrial inputs reflected the decline in Bulgarian industrial output in 1999 that was concentrated in the traditionally high priority branches of heavy industry, where large scale state-owned enterprises were restructuring and export sales faltered badly. Imports of metals fell 21.3% in 1999 and imports of chemicals, plastics and rubber declined by 19.6%. Imports of other types of raw materials held up far better in 1999, dropping a mere 0.7%. Imported food and raw materials for food, including beverages and tobacco, dropped a substantial 11.7% due to improved crop results, reflecting both above-average growing conditions and productivity gains from privatization.
Bulgarian exports were disappointing with respect to the EU countries last year (down 1.7%). These countries remained Bulgaria's most important partner region by far, accounting for 66.3% of total exports compared with 63.4% in 1998. Declines were particularly noteworthy in exports to Germany (-11.9%) and Greece (-7.3%) while exports were up sharply to several countries that were home to important strategic investors in export-oriented Bulgarian enterprises. Exports to France increased by 25.9% and exports to Belgium by 16.4%. Exports to the United States were also up sharply in 1999, by 32.2%.
Exports to Eastern Europe were also up in 1999, by 20.8%, but this was more than explained by increased shipments to neighboring Macedonia and Serbia. Some of the boost in exports to those countries was connected with reconstruction activities in the wake of the Kosovo conflict Exports to Macedonia increased 37.7% while exports to Serbia and Montenegro more than doubled. It was particularly disappointing to note that in the first year of Bulgaria's accession to the CEFTA group, exports to these countries fell 18-7%. Exports to Romania and Slovenia were up 7.8% and 14.3%, respectively, but shipments to the remaining CEFTA countries declined. The sharpest decline took place with respect to Slovakia (-63.4%) where aggregate demand was restrained to achieve a trade and payments adjustment last year. Exports to Poland and Hungary declined very substantially as well, however, by 46.4% and 24.3%. respectively.
Exports to the former Soviet republics fell by 31.4% in 1999, but the downturn was steeper with the non-Russian CIS countries. Owing in part to the industrial recovery in Russia this year, particularly in the fourth quarter compared with the immediate post-crisis period in 1999, Bulgarian exports to Russia fell at only about half the pace (-15.5%) as exports to the region as a whole. Exports to Ukraine declined by 37.9% and to Georgia by 40.8%. The decline in the importance of this region as a market is dramatic. Exports to the former Soviet republics as a whole represented only 9% of the total last year; Russia ranked behind Greece as an export destination.
Bulgarian imports were higher in 1999 from all partner regions with the exception of developing countries. Imports from the European Union continued to be the most dynamic, rising 18.5% to account for 48.7% of the total, up from 45.2% in 1998. Except for Russia, Germany is the single most important source of Bulgarian imports, accounting for 15.0% last year. Russia, as the supplier of the overwhelming share of Bulgaria's energy imports as well as a number of other key raw materials, still accounted for 20.5% of total imports, unchanged from 1998. The trends in imports from Eastern Europe ran directly counter to those in exports in 1999. While imports from Serbia and Montenegro and Macedonia were down sharply (-55.4% and -30.7%, respectively), imports from me CEFTA countries were up significantly (26.7%). Imports from Poland surged 73.9% while imports from Hungary rose 35.9%.
The deficit on the current account yawned ever wider in the course of 1999 on the basis of the growing imbalance in merchandise trade. Following a 1998 deficit of just $61.4 million, the current account gap for last year reached $663.4 million, a deterioration of just over $263 million in the fourth quarter. The current account balance had been nearly stable over me course of the third quarter when the service balance benefited from the seasonal peak in tourism earnings. The balance on services moved from a surplus of $264 million in the third quarter to a deficit of $11 million in the last three months of 1999. The balance on income from factor services was a positive $14.8 million in the fourth quarter. This item is typically a significant outflow only in the first and third quarters, as interest payments on outstanding Bulgarian Brady bonds fall due in January and July. For 1999 as a whole, the balance on income from factor services amounted to an outflow of $212.7 million. This was more than offset by a net inflow from current transfers of $299.7 million.
Direct foreign investment in Bulgaria reached $739.2 million last year despite the postponement of the sale of a 51% stake in the Bulgarian Telecommunication Company until this spring. This represented a gain of $200 million compared with the total for 1998 of $537.3 million in direct foreign in vestment On the other hand, outflows on portfolio investment came to $207.7 million, compared with $129.4 million in 1998. Portfolio investment in Bulgaria inched up $8 million last year compared with a decline in portfolio holdings of foreigners in Bulgaria in 1998 of $112 million. The capital account reflected a transfer of $2.4 million in aid to Macedonia in connection with the Kosovo crisis, while the financial account was in surplus by $628 million last year. The overall balance was in surplus by $86.4 million compared with a 1998 deficit of $94.7 million.
Together with a net increase in drawings from the IMF of $161.5 million, including a tranche of $71.7 million in December, and $259.5 million in exceptional balance-of-payments support the overall surplus afforded an increase in foreign exchange reserves of the Bulgarian National Bank of $517.4 million in the course of 1999, excluding changes due to exchange rate fluctuations. This reflected net purchases of foreign exchange from commercial banks of $455.5 million as well as increases in the balances in the foreign exchange accounts of budgetary organizations. Including the changes due to exchange rate movements, however, brings the increase in official foreign exchange reserves for the year down to $161.5 million.
The value of official reserves excluding monetary gold was $3,083 million at the end of December 1999. By the end of January 2000, those reserves had declined by $256 million to $2,827 million, reflecting in part the payment of the interest on Brady bonds at the end of January. Outstanding Brady bonds amounted to $4.96 billion at end-1999 out of a total gross foreign indebtedness of $9.98 billion. In the course of 1999, Bulgaria paid $975.3 million in debt service, of which $480.4 million was for interest New credits amounted to $1.17 billion, $723 million officially guaranteed. Debt service payments are expected to amount to $1.4 billion this year.
size="3" face="Times New Roman">POLITICAL DEVELOPMENTS
As privatization and restructuring have gathered steam in Bulgaria in recent months, the government is getting strong signals that the Kostov administration's popular mandate for accelerating reform is fading. Since the UDF coalition took the reins of government in April 1997, im- plemented the currency board and won the support of the international financial institutions, opposition forces have been unable to take a coherent stand against the government's program, a program that resonated with the electorate. It is true that the UDP slate did not draw the anticipated degree of support in the municipal elections last autumn, but it seemed that many of the voters who withheld their support from the UDF candidates were not voting against the government's program at the national level. The most important issues to these voters were the overly bureaucratic style of the Kostov-era UDF and the perception that insufficient inroads had been made by the government against corruption among local officials. The setback of the election results was modest and soon overshadowed by the welcome news in December that Bulgaria had been invited to apply for accession to the EU.
The succeeding months, however, have not served to prop up popular support for the government. The privatization of the Bulgarian Telecommunications Company has dragged on for months and threatens to become a political football. Should the transaction fail to be completed this time, the government will be at some pains to prove that the winner of a new tender would provide a better deal for Bulgaria. As the first attempt to privatize a major component of the country's infrastructure, the telecom deal is being carefully watched as Bulgaria enters a two-year period of the final stage of the privatization process: the sale of stakes in the restructured electric power and gas utilities and other infrastructure assets.
On the other hand, due to the privatizations and liquidations that have already been carried out, restructuring enterprises are sheping labor. In seven brief months, the rate of unemployment in Bulgaria has risen from 13.0% to 18.1% of the economically active population. In the latter part of March, more than 6,000 people demonstrated in Sofia against high unemployment Peter Zhotev, deputy prime minister in charge of the economy, is urging Bulgarians to stay the course. He has promised that the rate of unemployment will fall back to a more tolerable 13.5% by the end of 2000.
It will be important for the government to demonstrate that the expansion of private sector activity will provide the necessary jobs in fairly short or der, judging by recent popularity polls. The next parliamentary elections are currently scheduled for April 2001. The approval rating of the current government sank to a new low according to the results of a poll taken in mid-March. Only 28% of respondents thought the Kostov administration has been doing a good job compared with 34% a year earlier. In apition to the soaring unemployment rate, corruption and non-transparency in privatization transactions were cited as the key criticisms. Rostov's personal approval rating at 48% continues to be higher than that of the rest of the party. The UDF-dominated parliament garnered a mere 24% positive rating. President Peter Stoyanov continues to be the most popular Bulgarian politician with a nearly 76% approval rate.
The poll also assessed the likely pattern of voting if the parliamentary election were to be held now. The UDF would still draw 30% of the hypothetical votes to 17% for the Bulgarian Socialist Party (BSP) while 39% of respondents indicated that they were so discouraged by the choices that they would forego voting. Despite the plurality indicated for the UDF, a greater percentage of those polled, 38%, favored a government formed by a coalition that would be left of center. For its part, the UDP may be hoping to extend its base of popular support through an apitional coalition partner. Ivan Kostov and Akhmed Dogan, leader of the Movement for Rights and Freedom (MRF), have recently held talks, although Dogan indicated publicly that while the meeting was a new beginning for the relationship between the two parties, it was far too soon to speak of any partnership. The MRF has typically represented the interests of Bulgaria's ethnic Turkish minority. Relations between the current government and Dogan in particular have been strained in recent years over accusations that he had been heavily involved in corrupt activities. The UDF is also waging a campaign against the left by means of a bill introduced in the parliament at the end of March and passed on initial reading to declare the Communist Party illegal and lift the statute of limitations on crimes committed by the old regime. The debate was presented live on Bulgarian television as a number of BSP deputies walked out. The bill was passed 137 to 60, mostly on party lines, with the BSP deputies and one member from the Euro-Left voting nay.
size="3" face="Times New Roman">POLICY OUTLOOK
Because the currency board mechanism limits the availability of monetary policy and exchange rate policy, the most important determinants of Bulgarian economic performance going forward are really privatization and foreign investment flows. Most Bulgarian economic poli-cymakers have given public assurances that economic growth will take off this year after the slowdown in 1999. Last year's results are blamed on an unfavorable economic environment. The key to accelerating growth in 2000 will be improved export performance. Because expanding aggregate demand has such a strong import component, the trade deficit could become very troublesome if Bulgarian exporters are unable to compete effectively in the improving situation in key markets. Another critical factor in coping with the large trade imbalance is a continued strong inflow of direct foreign investment to offset payments pressures. For this reason, as well as due to implications for the upcoming process of privatizing the rest of Bulgaria's infrastructure, the current headline privatization, the sale of a 51% stake in the Bulgarian Telecommunicatons Company (BTC), which has proved a tortuous process, is taking a very high profile.
The sale of the BTC had been scheduled for completion in November 1999 for a sum of $510 million. The biper is 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 government had asked the consortium to revise its bid before a final consideration in hopes of improving the price and terms from the Bulgarian standpoint. The political opposition maintained that a better price could be obtained, especially if the stake in the BTC and the mobile license were to be offered separately.
A revised bid was submitted in January that did not increase the initial price, but offered to share with the government gains from floating BTC shares on foreign stock exchanges. The government made it clear that the initial cash contribution was the issue and asked the consortium to reconsider. The Dutch-Greek consortium came back in early March with what they maintain is their best and final offer. The price was raised to
$600 million but with a proviso that specified amendments to the Public Orders Act and the Telecommunications Act must be passed within three months of the sale or the price will fall by $120 million. The amendments allow the consortium to establish a separate entity to operate the GSM system and clearly delineate the BTC monopoly over voice communications through the end of 2002. As part of the BTC stake, the consortium would also control a majority stake in the existing analog mobile telephone operator Mobikom. KPN plans to take the larger share of the mobile operation while OTE takes the complementary shares in the fixed line system. In apition, the Bulgarian government must provide guarantees against further changes in legislation or interference in the management of the BTC over the next decade with compensatory payments required of up to $250 million,
Already highly politicized, this transaction is now being characterized by the government as a test for Bulgaria in the eyes of foreign investors. The proposed amendments to the legislation were passed to the parliamentary committees on economic, legal and budget issues by the competition committee with a negative recommendation. The government is lobbying hard in parliament for approval of the legislation. It is possible that still another ratification would be necessary for a contract on the compensatory penalties. The BSP is opposed to the deal and the Euroleft has refused to support the legislative changes. Certainly if the vote took place along party lines, the outcome would not be in doubt. The major concerns of the opposition, however, resonate with voters and probably with members of parliament as well: the impact on the cost of telecom services for Bulgarians.
The BTC has made it known for some time that it is necessary to restructure phone tariffs to insure the utility a decent return. Local calls currently cost one-quarter to one-half of the typical West European rate, while international calls are up to seven times as expensive as in Western Europe. The BTC proposes to increase the cost of local and domestic long distance calls and reduce the costs of international calls and business services and renegotiate its agreements with the mobile phone and pay-phone operators. A recent trial balloon on raising local calling charges 28% while reduc- ing the cost of international calls 14%, however, was opposed by the government Another issue is that ETC, a sizeable employer with a workforce of 26,000, is significantly overstaffed by international standards. It is not surprising that the potential investors are concerned that in the future a Bulgarian government may attempt to interfere in the operation of the company and use the leverage over the regulatory regime to restrict profitability.
Prime Minister Kostov has acknowledged that should the transaction fall through, there would be other foreign telecommunications companies that have said they would be interested in ETC. However, he feels that after the collapse of the KPN/OTE negotiation, the prices offered would be lower and foreign investors in general would draw the conclusion that it is too difficult to do business with Bulgaria. The need to negotiate special legislative arrangements and guarantees may well characterize other infrastructure investments as well if the government is interested in attaching hefty price tags. Investments in electric power
The government has already put together an In-ter-Ministerial Group that is charged with supporting and coordinating the responses to the requirements of investors in the three major power projects in the Maritsa coal field and a liquid fuel terminal project to serve the copper smelter at Pirdop.
Charles Movit
e-mail: cmovit@plaiiecon.com
tel.: (202) 898-0471