BULLETIN BULGARIA ANALYTICA - PlanEcon Trade and Finance Revue February 2002

PlanEcon Trade and Finance Revue
February 2002

BULGARIA

DESPITE ARGENTINEAN DEBACLE, BULGARIA'S CURRENCY BOARD NO THREAT TO EXPORTS,
EXTERNAL BALANCE, AS LONG AS BUDGET WELL BEHAVED

We project continued growth of exports to run between 8 and 9 percent annually over the course of the forecast period, rising to $7.8 billion by 2006 from $5.2 billion in 2001. The rise in exports will be driven by substantial increases in exports of manufactured goods, especially consumer goods. We project one more year of hefty rises in imports in 2002 of 11.1 percent after increases of 18.0 and 12.3 percent in 2000 and 2001, respectively. The rise in 2002 will reflect continued buoyant aggregate demand. Import growth decelerates thereafter as Bulgaria narrows its current account deficit through tighter fiscal policies. By 2006, imports are projected to hit $10.8 billion, up from $7.3 billion in 2001
Bulgaria's current account deficit is projected to rise from an estimated $870 million in 2001 to $1,022 million in 2002, before declining to less that $600 million in 2006. Because of substantial increases in financial assistance from EU and large increases in the surplus on services, the current account deficit falls sharply in the final three years on the forecast period. Tourism in particular, will serve to ease balance of payments pressures. We project that receipts from sales of services to foreigners will rise from $2.5 billion in 2001 to $4.0 billion in 2006.
Large net inflows of direct foreign investments result in large financial account surpluses throughout the forecast period on the order of $1 billion annually. However net inflows on portfolio investments and borrowing remain small, even though gross flows are fairly large. We project gross repayments on Bulgarian debt, including bond debt, on the order of $436 million to $577 million annually over the course of the forecast period. However, these payments will be balanced by borrowing from international financial institutions, especially the World Bank and the European Investment Bank, and inflows from periodic Eurobond issues.
Debt service, including all interest as well as repayments on medium and long-term debt, is estimated to run $1.2 billion annually through the forecast period, down from the $1.3 billion that Bulgaria paid in 2001.This is a result of improvements in Bulgaria's creditworthiness, which keep interest payments relatively manageable, and of the shift from debt to FDI as the principal means of financing the current account deficit. Because of the projected improvements in creditworthiness, we see no medium-term threat to Bulgaria's currency board. By 2003 or 2004, Bulgaria should receive an investment grade rating from the major rating agencies.

Overview
In the aftermath of the Argentinean crisis, a country with a currency board, which is experiencing rapid economic growth, slowing growth in exports, widening trade and current account deficits, and real effective appreciation of its currency, raises some cause for concern. All these characteristics apply to Bulgaria.
As in Argentina in the mid-1990s, Bulgarian aggregate demand has been rising rapidly. After increasing 6.5 percent in 2000, it rose an estimated 5.8 percent in 2002. This rapid growth in aggregate demand has sucked in imports. Although not as strong as the 18.0 percent rise in 2000, we estimate imports rose a solid 12.3 percent in 2001. Exports, up an estimated 7.2 percent, did not do as well. Consequently, the trade deficit widened to an estimated $2.1 billion compared to $1.7 billion in 2000; the current account deficit widened as well.
GDP rose an estimated 4.8 percent in 2001 after 5.8 percent growth in 2000. The slowdown had much to do with the drop in the rate of export growth in 2001 compared to 2000, when exports surged 20.4 percent. The slowdown in export growth could be worrisome, as the first sign of overvaluation of the exchange rate in pegged regimes is usually a slowdown in export growth.
Bulgaria has experienced very substantial real effective appreciation of its currency, the lev, since its introduction in 1997. the lev has appreciated 23 percent since 1996, the year before the board was introduced. Over the course of 2001 the lev appreciated by 4.7 percent in real effective terms against the euro, although just 1.7 percent against the dollar. As half of Bulgaria's exports are priced in euro and the other half in dollars, on a trade-weighted basis the lev appreciated by just 3.2 percent in real effective terms in 2001. Thus, although the lev has appreciated substantially immediately after the introduction of the currency board, this appreciation had sowed greatly by 2001. Thus, the threat that the real effective appreciation of the lev will dramatically reduce the competitiveness of Bulgaria's exporters did not loom large in 2001.
The slowdown in export growth in 2001 had a more prosaic cause. All of the countries in Central and Eastern Europe, not just Bulgaria, reported slower export growth in 2001 than 2000.The slowdown is not all that surprising: slackening growth in aggregate demand in the EU, Eastern Europe's and Bulgaria's largest export market, created a less friendly environment for exporters. In fact, the continued solid export growth out of the region, including from Bulgaria, attests to the increasing competitiveness of local exporters.
Despite some auspicious signs, a key question for continued economic growth and stability in Bulgaria is whether export growth can continue and external balance be maintained in the context of Bulgaria's currency board.
Foreign Trade
Value of Trade.
The last two years have been good for Bulgarian exporters. After rising 20.4 percent in 2000 and an estimated 7.2 percent in 2001, Bulgarian exports hit $5.2 billion last year. We are projecting an 8.1 percent rise in 2002 to $5.6 billion as slow growth in Western Europe prevents a more rapid surge.
While the rate of growth in exports exceeded that of imports in 2000, the situation was reversed in 2001. Imports rose an estimated 12.3 percent last year to hit $7.3 billion, a transition peak, following an 18.0 percent increase in 2000 to $6.5 billion. The large increases in imports were a consequence of surging aggregate demand in Bulgaria.
Similar to developments in other transition economies earlier in their development, growth in aggregate demand has had a large import component in Bulgaria. The income elasticity of demand for imports tends to vary greatly depending on which components of aggregate demand are growing most rapidly and which income segments of the population are benefiting from economic growth. Growth in personal consumption has not boosted imports to the same extent. Although the income elasticity of demand for imports in high for upper income households, lower income households appear to have a lower income elasticity of demand for imports and their consumption basket is more heavily weighted towards domestically-produced foodstuffs, housing and market services, including utilities, all of which tend to lave relatively low import content.
Bulgaria's merchandise trade deficit ballooned to an estimated $ 2,132 million in 2001 (16.3 % of GDP), up 26.5 percent from $1,682 million in 2000 (14.0% of GDP). Bulgaria has run persistent trade deficits throughout the course of transition, although the deficits of the last three years are by far the largest that have been reported by the country. Trade deficits widened after growth in aggregate demand took off in 1998 and import financing became available again after Bulgaria stabilized its economy in the second half of 1997.
Direction of Trade
Bulgaria's major export markets differ somewhat from those of Central Europe, although they are similar to those of the Balkan states. As in Central Europe, the European Union is the most important destination for Bulgarian exports, taking 55.0 percent of the total 2001, up from just 39.1 percent in 1996. However, this figure is still far less than in Central Europe, where the EU takes three-quarters of total exports. Italy is Bulgaria's largest export market taking 15.1 percent of the total. Germany runs a relatively distant second, taking 9.5 percent of Bulgarian exports, a quarter of its share for the Central European states.
In contrast to Central Europe, the Balkan states are very important export markets for Bulgaria. Growing investments by Greek enterprises in Bulgaria has resulted in a rapid expansion in Greek-Bulgarian trade. Greece is now Bulgaria's third largest export market, taking 9.0 percent of the total, almost as much as Germany. Turkey, is Bulgaria's fourth largest export market. Macedonia, Romania, Yugoslavia are all important export markets as well, ranking in the top 15 export destinations.
In contrast to Central Europe, Bulgaria has sizeable export markets outside the EU. The Balkans, including Romania, took close to 12.7 percent of Bulgarian exports in 2000. An additional 6.1 percent of Bulgarian exports go to the former Soviet republics and another 11.5 percent to developing countries.
This breakdown reflects the structure of Bulgarian exports, which depend much more heavily on industrial intermediates and raw materials than do exports from Central Europe. Producers of these products are price takers on the world market; they seek markets wherever they can find them.
At one time, the former Soviet Union took over half of Bulgarian exports. Despite very strong growth in aggregate demand in Russia in 2000 and 2001, Bulgarian exporters have not benefited. Exports to Russia fell 37.4 percent in 2000 and another 1.2 percent in 2001.
Although Russia is no longer an important export market for Bulgaria, taking just 2.2 percent of total exports, it remains Bulgaria's most important supplier of imports, especially of energy. Russia supplied Bulgaria with a fifth of its imports in 2001; most of this consisted of crude oil, natural gas and raw materials. Bulgaria imports all of the crude oil and natural gas consumed in the country. Imports from Russia soared 42.5 percent in 2000 as energy prices rose, but imports fell an estimated 6.6 percent in 2001 as energy prices dropped.
Germany came in second, providing Bulgaria with 15.1 percent of total imports. Sources of the remainder of Bulgaria's imports are relatively diffuse. Italy, France, Greece, Turkey, Ukraine and the US are all important suppliers The European Union as a whole now provides Bulgaria with 49.3 percent of its imports, up from44.1. percent in 2000.
The very substantial growth in Bulgarian imports in 2001 came primarily from the EU. Imports from the EU rose an estimated 25.3 percent in 2001, following a rise of just 7.3 percent in 2000. Imports rose from all major EU countries, including Germany, Italy, France, and the United Kingdom. Growth in imports from other regions was more subdued. Imports from CEFTA countries were up just 2.8 percent because a 14.1 percent decline in imports from Romania. Hungary and Poland boosted exports to Bulgaria.
Commodity Composition of Trade
Despite an increase in exports of machinery and equipment, this category only accounts for 12.0 percent of total exports. Bulgaria's largest export category is raw materials and semi-manufactures (31.1 percent of the total), followed by consumer goods (29.5 percent). Exports of industrial consumer goods have been the most dynamic export sector over the course of the transition. Their level in 2001 -$1,5 billion, was more than three times their level in 1994. They have risen every year and were up an estimated15.9 percent in 2001.
In contrast, exports of raw materials and semi-manufactures have fluctuated. Exports peaked in 1997 at a little over $2.0 billion. In 2001, poor performance by this category explains much of the weakening in overall export growth. The increase in raw materials exports slowed to only 0.1 percent in 2001 after soaring 41.0 percent in 2000. These products are generally exported on the basis of price. Distorted input prices, especially for electric power, resulted in substantial exports of energy-intensive goods in the mid-1990s that would not have been exported if power prices had been set at cost-recovery levels. Since Bulgaria has begun to raise utility prices to cost-recovery levels, exports of these products have suffered. Exports of chemicals, especially fertilizers, fell by a third in 1998 and another quarter in 1999.
More recently, Bulgarian exports of industrial inputs have fluctuated because of shifts in world market prices. In 2001exports off metals fell an estimated 9.7 percent, primarily because of declines in prices for steel, aluminium, copper and zinc. Supply-side factors also play a role in export performance however.
Exports of refined oil products and electricity have risen sharply over the last two years, up 90.0 percent in 2000 and an estimated 7.2 percent in 2001. the share of energy in total exports has risen from 6.7 percent in 1996 to 14.6 percent in 2000 and 2001. Lukoil has boosted exports from its Bourgas refinery. NEC, the state-owned electric-power company, has increased exports to Turkey. Bulgarian electric power has been cost-competitive because so much of it is generated at the Kozloduy nuclear power plant. With the closure of two of Kozloduy's six operating units this year and another two in the near future, electric power exports are destined to fall in the coming years.
Bulgaria, like Romania, is creating a European niche for itself in clothing and footwear. Two-thirds of the value of consumer goods exports consist of clothing and shoes - with rapid increase in 2000 by 18.6 percent and another 30.0 percent in 2001.
The most disappointing export sector over the transition has been food and agriculture. These products exports showed little sign for recovery in 2001 as they rose just 3.8 percent and remained under $500 million, less than half their level of the first half of the 1990s.
Bulgarian exporters of agricultural products have been hurt by barriers to trade imposed by the EU and by competition from other suppliers on former CMEA markets.
On the import side, industrial raw materials were the fastest growing component, up an estimated 23 percent in 2001, despite declines in world market prices of a number of key industrial inputs. The increase in imports of intermediate goods reflects higher demand from manufacturers. Part of this stems from increased industrial output, although increases in 2000 and 2001 were anemic, up just 2.3 and 2.0 percent, respectively. The major reason for the increase was the greater integration of Bulgaria's economy into international supply chains.
Imports of industrial intermediate goods have not only been the most rapidly growing commodity group, but are also the largest, accounting for a third of the total. In contrast to Central Europe, energy imports also loom large. They accounted for 23 percent of the total in 2001 and 27 percent in 2000. some of these are re-exported as refined oil products. Refined oil products accounted for 14.8 percent of total exports in 2000 and 9.3 percent in 2001. because of the fall in oil prices in 2001, imports of fuels fell 5.8 percent last year, after rising 43.8 percent in 2000.
Imports of machinery and equipment and industrial consumer goods, although rising rapidly, are still relatively small, compared to the size in Central Europe. These imports rose an estimated 11.7 percent in 2001, they only accounted for 26.6 percent of total imports in 2001.
Large increases were recorded in imported consumer goods in 2001, close to a third. A declining population and a low dollar incomes have kept growth in food imports very modest.
Terms of Trade
Bulgaria's terms of trade improved by an estimated 0.7 percent in 2001, relative to 2000. The improvement was not as dramatic as for most developed market economies because refined oil products form such a substantial portion of Bulgarian exports.
Bulgaria was partially cushioned from the shock of higher energy prices in 2000, because metals prices rose in that year. Metals accounted for 18.3 percent of total exports in 2000. Consequently, the country was not hit as hard as other energy importers by the ramp up in energy prices.
In 2002, we project little change in Bulgaria's terms of trade as a continued decline in oil prices in once again offset by falls in prices of key Bulgarian commodity exporters.