BULGARIA
GDP GROWTH SLOWS MODESTLY WHILE TRADE AND PAYMENTS GAPS WIDEN

• GDP growth slowed to 4.5% in the third quarter of 2001 from 5.1% in the second due to worsening external economic factors and stagnant consumption by domestic households. Industrial sales growth slackened further in the third quarter but was buoyed somewhat by continued strong exports of manufactured consumer goods and surging domestic investment. Sharp increases in enterprise profitability produced much stronger growth in value added by industry than in gross output. Agricultural performance was hampered by the second consecutive year of insufficient rainfall.

• Continued strong growth of the domestic economy fostered sharp increases in demand for imports of raw materials and intermediate goods in January-October 2001. Moreover, the strong preference of Bulgarian consumers for imported goods resulted in a surge in imports of consumer goods despite stagnant personal consumption. While exports grew 7.3% in the first ten months of 2001, imports grew even faster, by 12.3%. As a result, the merchandise trade deficit reached $1,246.6 million, up from $935.1 million for the same period of 2000.

• Following the presidential election in November 2001, the country's top elected officials now include a prime minister who was formerly king and a president who was the leader of the exCommunist party. Georgi Parvanov, the leader of the Bulgarian Socialist Party (BSP) won the runoff election against the incumbent Petar Stoyanov. Parvanov is from the centrist faction in the BSP and has declared his full support for Bulgaria's initiatives to join the EU and NATO.

• The cumulative deficit of the consolidated state budget for the first three quarters of 2001 amounted to 0.8% of GDP. The budget law established a target for 2001 of 1.5% of GDP. The government and the national bank jointly published a well-reasoned memorandum prepared for the IMF on economic policies in 2002-2003, setting out ambitious programs that must be implemented without endangering the target of a deficit of 0.8% of GDP in 2002 and the goal of a balanced budget in 2003.

KEY MACROECONOMIC TRENDS

GDP growth slowed in the third quarter of 2001 according to preliminary figures released by Bulgaria's National Statistical Institute. The lower growth was due to worsening external economic factors and stagnant consumption by domestic households. Industrial sales growth slackened further in the third quarter but was buoyed somewhat by continued strong exports of manufactured consumer goods and surging domestic investment in fixed capital. Value added by industry continued to rise dramatically in the third quarter, as restructuring and injections of capital by both foreign and domestic investors brought higher productivity and higher profits for industrial enterprises. Agriculture performed poorly as a result of protracted drought.

GDP grew 4.5% in the third quarter of 2001, compared with 5.1% growth in the second quarter of the year and 4.5% in the first quarter. For the first nine months of 2001, GDP was up 4.7% year-onyear. While domestic investment growth remained quite strong in the third quarter, consumption declined compared with the same quarter of 2000: personal consumption fell 1.0% and government consumption dropped by 5.8%. Aggregate consumption fell by 1.5% in the first quarter and was nearly stagnant for the first nine months as government consumption rose 3.4% but was nearly offset by the 0.2% decline in personal consumption. Household consumption contracted in the first three quarters of 2001 due to very modest gains in real wages and a decline in household incomes in real terms relative to a year earlier. For the first three quarters of 2001, the average wage was only 3.9% higher than a year earlier in real terms. Per capita, household income increased only 3.6% year-on-year in nominal terms while consumer prices increased 5.2%.

Export growth was respectable in lev terms, 13.8% in the third quarter and 12.5% in the first nine months, but just over half of the rate of increase in exports in lev terms in all of 2000. Import growth quickened, however. Imports rose by a whopping 22.9% in lev terms in the third quarter and 15.8% in the first three quarters of 2001, compared with 14.6% in full-year 2000. The import component of aggregate demand remains very substantial.

Table 1-Aggregate Output and Demand

Investment in fixed capital remained the most impressive component of aggregate demand and a key driver of aggregate output growth through the third quarter of 2001. Gross fixed capital investment increased by 15.9% in the third quarter and 18.2% in the first nine months of the year, compared with 8.2% growth for all of 2000. Foreign direct investment as a result of privatization was lower in 2001 than in 2000, thanks to the impact on privatization transactions of the mid-year election and the ensuing change in government. Greenfield investment and follow-on investment in subsidiaries by foreign enterprises, however, were sharply higher, helping to boost overall capital investment.

Aggregate gross value added grew 4.4% in the third quarter of 2001 and 5.0% in the first nine months of the year. Although growth of value added in the third quarter was higher than average in the first nine months both by agriculture and by services, it was the impressive growth of value added by industry that continued to buoy aggregate output growth. Value added by industry rose 8.7% in the third quarter and 9.0% in the first nine months of the year despite sluggish growth in industrial sales and gross industrial output. For the first 11 months of 2001, industrial sales grew only 1.4% and industrial output increased 2.4%. Industrial sales to the domestic market increased by 2.3% in the first 11 months, but sales for export declined by 1.3%. The much stronger growth of the net output of industry in this period reflects the effects of restructuring and the surge of investment, including substantial foreign direct investment. As loss-making enterprises in Bulgaria have become profitable, strong gains in value added have been made possible despite modest increases in industrial activity.

While the growth of overall industrial activity was sluggish in 2001, output of the electricity, gas and water supply sector rose 9.5%. Electric power generation was boosted by substantial increases in electricity exports and colder than normal temperatures during the heating season. Electric power production in 2001 reached 43.884 billion kilowatt-hours (kWh), an increase of 7.3% compared with 2000 and a level unequaled since the peak years of 1988-1989, prior to the economic transition. But according to the National Electric Company, domestic electric power consumption rose by only 2.2% in 2001 to 36.901 billion kWh, while electric power exports reached 7 billion kWh, an increase of 42% over the 2000 level. Exports to Turkey alone accounted for 3.8 billion kWh. Additional electricity exports went to Macedonia, Yugoslavia, Albania and Greece in 2001. The contractual price for electricity exports to Turkey is only 3.4 cents per kWh, very competitive by international standards. Bulgarian electricity exports are profitable at this price solely due to the key role of the Kozloduy nuclear power station in domestic electricity generation. Kozloduy is responsible for more than 40% of domestic electric power output. However, Bulgaria is committed to an agreement with the EU to decommission in 2002 the two oldest of the six reactor units and to set a schedule this year for the decommissioning of two additional units by 2006. This would leave only the more recent vintage Soviet-designed 1000 MW units 5 and 6 and cut installed capacity at Kozloduy from 3,760 megawatts to only 2,000 megawatts over the next five years or so. Some Bulgarian energy planners have been trying to portray the country as the logical electric power hub of Southeastern Europe and have encouraged potential foreign investors to build additional generation capacity. With little in the way of domestic fossil fuel resources and a reduction in nuclear generation capacity looming, however, it seems clear that investment in the Bulgarian electric power sector should be aimed at meeting domestic demand. Given existing capacity and modest projected growth in domestic electric power requirements, the rational locus of investment in the electric power sector would be in rehabilitating and re-powering existing capacity and reducing the environmental impact of thermal electric power generation.

The government has recently upgraded the responsibility for the energy sector to the ministerial level. New Minister of Energy Milko Kovachev plans to submit a long-term energy strategy to the cabinet by the end of January. The first public statements with regard to the new minister's strategy were not encouraging, however. Kovachev announced that Bulgaria would insist on keeping the third and fourth 440 megawatt reactors on line at least until 2008 and 2010. The units were originally to reach the end of their operational lives in 2010 and 2012. Kovachev emphasized that he regarded the nuclear generating capacity in question to be critical not only for Bulgaria, but for the region as a whole because Bulgarian exports now cover one half of the power deficit there. The EU insisted that Bulgaria live up to its commitment on the first two units as a condition for the offer of candidacy to accede to the union. The issue of the second two units of the same design is likely to be a major source of tension with the EU and an obstacle to progress on eventual accession for Bulgaria.

The output of the small extractive sector declined 6.6% in January-November 2001 as coal output fell 12.0%. Bulgaria has been closing unprofitable mining operations in order to limit the burden of subsidies to the sector on the state budget. The government has pledged to complete the process this year and privatize all of the remaining mining enterprises. Manufacturing output rose only 1.8% in the first 11 months of 2001 and sales of manufactured goods increased by only 0.4%. Output and sales for most industrial branches registered very modest increases or even declines in January

November 2001. Poor agricultural performance and stagnating household income brought a decline in sales of food products of 1.1%. Unfavorable developments in international markets for key export commodities were also responsible for declines in sales. Sales of metals fell 9.0%. On the other hand, there were some bright spots. Sales of apparel increased by 18.2% and sales of leather and fur products rose 14.4% as exports in these categories remained strong. Bulgaria's comparatively low cost of labor has made it possible for these goods to continue to find markets abroad, even in the face of a global economic slowdown. Increasingly budget-minded consumers abroad are turning more to lower cost items such as clothing assembled in Bulgaria.

Value added in agriculture rose 2.4% in the third quarter of 2001 but declined 2.1% for the first nine months of the year. Agriculture did not see a rebound as the extremely dry conditions of 2000 extended into 2001. The protracted drought affected the levels and assortment of crop output as farmers switched acreage to crops that better tolerate dry conditions and other crops were severely damaged. The impact was greatest on corn and sunflowers. While the corn crop was a record low, less than 50% of the 2000 result, and the harvest of sunflower seeds was cut nearly in half, the switch into barley as a result of the drought increased barley output by almost one-fifth. Because of the increased sowing of barley in 2000 and 2001, Bulgaria's exports of barley have surged from a typical average of 20,000 tons annually to 175,000 tons in 2000 and more than 250,000 tons in 2001. The two dry years have also had a negative impact on the availability of foodstuffs, and therefore the livestock sector also suffered. Livestock herds, particularly swine, experienced culling and output of livestock products declined. At the end of the first half 2001, the numbers of cattle were down 6.8%, sheep and goats down 8.8% and swine down 20.8%. Output of milk fell 2.9% and egg production declined 3.3% in that period

Part of the reason that real wage gains were modest in 2001 and household incomes fell was the continuing high rate of unemployment. In November 2001, the official rate of unemployment was 17.2%. This figure is reported by the National Labor Exchange as the share of officially registered unemployed in the economically active population. The official unemployment rate peaked in February 2001 at 18.7% and only showed substantial improvement beginning in May as seasonal jobs opened up in tourism, agriculture and construction. The unemployment rate fell to a low of 16.5% by September as school-age job seekers returned to classrooms. The average rate of unemployment in 2001 is likely to be reported at just under 17.5%, a very modest improvement over the 18.1% recorded in 2000. Further progress on bringing down unemployment is likely to be similarly very modest in the coming months due to ongoing restructuring. The elimination of redundancies in Bulgaria's infrastructure enterprises will contribute to the jobless contingent in the course of 2002. The layoffs have been necessitated by the requirement to reduce budgetary subsidies and to restructure these enterprises in the course of privatization.

Consumer price inflation jumped in December as the overall index rose by 0.6% compared with the previous month and 4.8% compared with December 2000. The increase in the level of consumer prices in December would have been much sharper except for a decline in the costs of household heating and electricity. Food prices were the main source of inflation in December, rising 2.5% that month. Declines in food prices had kept consumer prices nearly flat or even falling in the late spring and summer months as fresh produce became more available. Food prices typically surge again in December as stocks of moderately perishable food items from the harvest season dwindle. This last December, however, a decision by Bulgaria's Supreme Administrative Court offset much of the impact of higher food costs on the CPI for the month by rolling back 10% increases in the cost of heat and electric power for householders that had been introduced in October.

The court ruling on the price increases for heat and electric power was based on the failure of the government to consult with employer and labor organizations before issuing a decree that had an impact on living standards. Following the court decision on December 5, Bulgaria's two central labor unions stalled the mandated consultation process on a technicality. The decree raising the tariffs for heat and electricity was nevertheless reissued at the end of December. A schedule of further utility rate increases for 2002 is being prepared as the current tariffs are still far below cost recovery levels. Because of these and other planned hikes in administered prices this year, we maintain that the government's forecast of 3.5% inflation by end-2002 is unrealistic. We project a December-on-December rate of consumer price inflation of 6.1% in 2002.

EXTERNAL ACCOUNTS

The merchandise trade deficit yawned wider in the first ten months of 2001. While export growth was only just over a third of the achievement in the full year 2000, it was still respectable in light of the global economic slowdown. Exports grew 7.3% to $4,254.3 million. Imports grew even faster, however, by 12.3% to $5,967.2 million on a c.i.f. basis and $5,501 million on an f.o.b. basis. As a result, the merchandise trade deficit for the first ten months of 2001 reached $1,246.6 million, up from $935.1 million for the same period of