- Despite the strong 3.8% GDP growth, convergence is slow, the structure of the economy is worsening and growth is driven mainly by consumption.
The effects of Commercial Corporate Bank's (Corpbank) default in 2014 have subsided. This in brief is the summary of the European Commission's assessment of Bulgaria's reform progress. The so called European Semester report, published last Wednesday, provides an overview of the economic and social challenges in the Member States as well as policy action taken by them.
Bulgaria is emerging from the risky group of countries with excessive macroeconomic imbalances, helped by the good global environment and some progress in addressing the European Commission's specific recommendations from 2017. Apart from Bulgaria, France and Portugal are also coming out of the group with excessive imbalances, and thus only Italy, Cyprus and Croatia still remain therein.
Brussels' general tone is softer, but there are still some outstanding weaknesses in the financial sector despite the efforts to improve oversight in the banking and non-banking sectors. Bulgaria was included in the group of countries with excessive micro-imbalances because of the problems revealed after the closure of (Corpbank) and remained there for three consecutive cycles of the European Semester from 2015 to 2017. Nevertheless, financial sector continues to be the main negative factor and without the problems therein, the country would rank in the group of countries without imbalances.
The other persisting problem is the relatively high corporate indebtedness, while the labor market is no longer considered an imbalance because of the declining unemployment and improving conditions.
A step towards the euro
The more favorable assessment is highly welcome in light of Bulgaria's request to apply for ERM II accession by the middle of the year, which precedes its entry into the euro area. There is no formal link between the two, but excessive imbalances are a frequent argument stated by the ECB and the finance ministers of the Member States, on which the admission to the currency mechanism depends.
"Over the recent years, convergence reports explicitly state that a country with imbalances cannot apply because it is assumed to be unsustainable," said the economist Georgi Angelov from Open Society. "In this sense, in view of Bulgaria's desire to move closer to the euro area, its exit from the group with excessive imbalances is a mandatory condition," he added.
Moving one step up in the procedure is good news in terms of attracting capital. According to Angelov, the commission’s report is one of the most profound documents that are being written about Bulgaria. Accordingly, foreign investors and analysts pay attention to the estimates contained therein. "From the point of view of the desire to attract investors, gaining easier access to funding and higher economic growth, it is important to leave the worst group," the economist explained.
The financial problems seen from another angle
The report shows there is progress in implementing banking and non-banking sector oversight plans. European officials also made a positive assessment of the legal changes introducing a "somewhat" tightened risk management of exposures to related parties, as well as of the broader definitions of related parties in the non-banking sector adopted with the amendments to the Social Security Code. Specifically for pension funds, attention is once again drawn to the concentration of investments in relatively illiquid traded and non-traded instruments at the local market and "complex property and cross-ownership structures" that require additional monitoring.
The new, stronger accent of the Commission after the past asset quality reviews is addressed to assets difficult to measure. In particular, there is an analysis of the problem with the abuse of independent valuations that allow financial institutions not to allocate adequate provisions (they are required only for the unsecured portion of the problem exposures, and this may be circumvented by keeping overestimations of pledged assets). The problem has been known for years, and self-regulation in the valuation sector so far has not produced any particular results.
Chance for reforms
According to the EC, Bulgaria's steady economic growth and stable fiscal position can now facilitate structural reforms. This is a chance for the country to accelerate catching up with the rest of the EU and to reduce the levels of poverty and inequality. Currently, however, the assessment shows that, despite the strong GDP growth of 3.8%, convergence is slow and the structure is worsening and growth is driven predominantly by consumption. That is why there are concerns that upon exhausting the scarcely increasing available capital and labor resources, the growth potential is limited.
Public finances account for continued strong performance and a balanced budget, which is even projected to reach a surplus by 2019, and there are recommendations to improve cost-effectiveness. Improvements are also reported in the private financial sector and one of the lowest levels of household indebtedness is noted as a counterpoint to high corporate indebtedness rates.
The main areas where there is insufficient progress, are education, healthcare and the introduction of a transparent minimum wage setting mechanism.
According to the IME economist Kaloyan Staykov, the report repeats old problems. "Only 10% of the recommendations are fully operational, while structural reforms are being constantly postponed," he said. "Such indecisiveness can be explained by political instability - there has not been a single government with more than two years of mandate since 2013. And due to the government changes every reform starts from the very beginning," added Staykov.
On the labor market, which due to the drop in unemployment to 6.3% is no longer considered an imbalance, the risk of a rapid rise in wages is also noted. While it improves the low-income situation, if not accompanied by increased productivity, the country may lose competitiveness.
The new focus on social policy
From this year the country reports also include monitoring of the indicators on the European Social Rights Pillar adopted at the end of 2017. This package sets out basic principles and rights that address issues such as aging, digitalization and should ensure convergence to better working and living conditions. Similar to the economic scoreboard with indicators, here a social one is used, which is currently monitoring 12 indicators.
As it could be expected, Bulgaria’s grade as the poorest member of the EU, is low. Based on five of the indicators, the country falls in the "Critical Situation" column, and for three others the recommendation is "monitoring". Some of the most problematic ones are the indicators for equal opportunities and access to the labor market. Income inequality (measured as the difference between the top 20% of the highest earning population and the lower 20% with the lowest wages) is 7.9-fold and continues growing. Despite the improvement, according to the EC the share of people at risk of poverty and youth unemployment remain alarmingly high.
Another column of critical values is the one for the social protection and inclusion indicators. The most significant problems Brussels sees there, are the weak effect of social transfers on reducing the risk of poverty (this includes only benefits, not pensions) and the low share of people with at least basic digital skills.
What remains out of order
According to Kaloyan Staykov, it is now hard to say that the country has a problem with the banking sector or the labor market. Georgi Angelov points out that there are two remaining indicators for macroeconomic imbalances. The first one is the net investment position, which is negative in Bulgaria, but the trend is to improve. "The other factor is real estate prices, which grew by 7% in 2016, while the requirement is 6%," Angelov commented. According to him, however such an increase is typical for the region, it is not unique to Bulgaria.