An International Monetary Fund (IMF) mission arrived in Sofia on Tuesday to negotiate a possible new agreement with Bulgaria. Fiscal and income policy were certain to be the two toughest issues in the talks with the Bulgarian government that will be conducted in secrecy.

The IMF has shown readiness to sign a stand-by agreement with Bulgaria. However, both sides will certainly have to make compromises.

In August, Simeon Saxe-Coburg's cabinet announced a package of economic measures aimed at improving conditions for business and the living standards of common people. The measures included introducing a zero tax rate for reinvested profit, reducing income tax rates and raising the non-taxable minimum by 10 per cent. The prime minister also pledged to increase the minimum wage from October 1 and freeze wages in the budget sector until the end of 2001. The state administration will be reduced by 10 per cent and the prices of heating and electricity will rise by 10 per cent.

The new leader of the IMF mission for Bulgaria, Gerald Schiff, has already said the fund was concerned about the tax reforms suggested by the government. According to him, if the tax changes are introduced from next year Bulgaria will find it very difficult to achieve a minimal budget deficit. The new IMF resident representative, Piritta Sorsa, also voiced concerns about the proposed measures. The fund does not look favourably on the combination of measures that reduce revenue through increased spending.

The promised zero tax rate for reinvested profit has attracted most criticism. According to Sorsa, it will support companies operating in this country, rather than new investors because the latter do not make profit in the first one to two years. The fund would rather see a reduction in social security contributions. According to Schiff, the tax burden in Bulgaria is very heavy and its reduction may lead to the creation of more jobs. Sorsa believes that the promised minimum wage rise could have a negative effect on job numbers.

Economy Minister Nikolai Vassilev and Finance Minister Milen Velchev have often stated that Bulgaria needs a new agreement with the IMF in order to legalize the Cabinet's policy for the investment community. An agreement is also necessary in view of the upcoming considerable foreign debt payments.

Failure of negotiations would force Bulgaria to float a eurobond issue to meet debt payments over the next couple of years. At the same time the lack of agreement would reduce Bulgaria's credit rating and create worse conditions for future discussions. In addition, the IMF and the World Bank would probably reduce financing for Bulgaria. For these reasons the negotiations are unlikely to fail.

The Cabinet is most likely to stand by its commitments concerning profit tax and gross income tax. It may try to persuade the fund that the reduction will be compensated by increased revenue from other sources. The promised improved collection of customs duties is not a real source of extra revenue so compensation will probably be sought in higher patent taxes and excise duties.