The International Monetary Fund (IMF) is preparing to withdraw from the active monitoring of Bulgarias macroeconomic stability.
This process will occur over the next nine months due to an agreement reached between the IMF and the Cabinet that will lead to a six-month extension of Bulgarias accord with the fund, starting from October 2006. The announcement was made by Finance Minister Plamen Oresharski at a news conference on May 17 marking the end of an IMF mission to Sofia.
The current stand-by agreement ends in September, leaving a three-month gap till Bulgarias expected entry to the European Union in January 2007, providing possibilities for macroeconomic insecurity and unclear fiscal policy.
We support the extension of the agreement and we consider that this bridge to the expected EU accession date of January 1 2007 would be met very positively, especially by the international markets, Bulgarian National Bank (BNB) governor Ivan Iskrov told a news conference at the end of an IMF mission to Sofia.
Since 1997, Bulgaria has operated under an IMF-advised currency board system, a strict straitjacket that deprives the central bank from its monetary policy functions and pegs the exchange rate of the Bulgarian lev to the euro, sheltering the currency from foreign exchange volatilities.
Effective implementation of the six-month extended arrangement will continue in the first three months of the extension period, until the end of 2006, and the next three months will be a time for drawing conclusions and for the IMF executive board to compile a report on the implementation of the programme for Bulgaria. The country is not receiving any financing from the IMF under the current arrangement.
The sides agreed to extend the deadlines for abolishing the transferability of seniority bonuses to a new job and for adopting a new Value-Added Tax Act, Oresharski said.
Current account trouble
The IMF says that Bulgarias current account deficit will widen this year to 12.4 per cent of the gross domestic product (GDP) from last years 11.8 per cent and advises the country to keep on running a tight fiscal policy next year to ward off external vulnerability risks.
The previous IMF forecast, released in April, projected Bulgarias 2006 external account deficit at 10.2 per cent of GDP.
The current account deficit widened further in the first quarter of 2006 and is now projected at 12.4 per cent of GDP for the year as a whole, the IMF said in a statement.
According to the fund, this deterioration is attributable to strong domestic demand pressures rather than to a loss of competitiveness.
IMFs new forecast is well above the projection of Bulgarias central bank, which has said it expects the current account deficit to fall below 11 per cent of GDP this year due to an expected slowing of the growth of imports and recovery of the growth of exports. The latest projection of the Government-run Agency for Economic Analyses and Forecasting put the current account gap at 11.3 per cent of GDP at the end of 2006.
The countrys external deficit rose to a preliminary 4.4 per cent of GDP in the first quarter from 2.6 per cent of GDP in the same period last year, due to a 47 per cent surge in trade deficit.
To contain the resulting external vulnerabilities and support the currency board arrangement, the authorities will need to continue to pursue prudent fiscal policy, close financial sector supervision and structural reform, the IMF said.
The IMF recommended that next year Bulgaria aim for a fiscal surplus equal to two per cent of GDP, a modest relaxation compared to the 2006 target of three per cent. Bulgaria ended last year with a budget surplus equal to 2.36 per cent of GDP.
Declines in the surplus in 2007 and beyond should be strictly limited, by identifying offsetting expenditure savings and substitution to compensate for the budgetary impact of EU-related flows, the fund said.
Oresharski responded that the Cabinet would aim for a budget surplus next year, but declined to set a target, saying a final decision would be made during the IMFs next mission to the country in autumn.
Inflationary pressure
The IMF said that the strong growth in consumer prices at the start of this year, fuelled by a sharp rises in excise duties on alcohol and cigarettes, would slow down and inflation should decline to 6.2 per cent by year-end.
Annual consumer price inflation slowed to 8.1 per cent in April from 8.7 per cent in March, according to the latest data from the National Statistical Institute.
Bulgaria ended 2005 with an annual consumer price inflation of 6.5 per cent, a five-year high fuelled by the surge in global oil prices and a rise in domestic food prices prompted by torrential rains in the summer that damaged farm produce and killed livestock.
The average annual inflation was five per cent last year against 6.2 per cent in 2004.
The Agency for Economic Analyses and Forecasting said earlier this month end-year inflation in Bulgaria in 2006 would reach 6.41 per cent, while the BNB has projected six per cent end-year inflation.
Bulgaria hopes to become a member of the eurozone in 2009. Recent reports, however, show that the country may not be ready for the pan-European currency before 2010 due to inflation threat.
This was shown back in March in a report on Central and Eastern Europe (CEE) by Bank Austria Creditanstalt (BA-CA). The bank is the CEE regions arm of the German HVB Group, and after the purchase of HVB by the Italian UniCredito, it became part of the newly formed UniCredit Group.
BA-CA said that Bulgaria almost completely covered the Maastricht criteria and the only thing the country still had to handle was inflation. The Maastricht convergence criteria envisages that inflation should be no more than 1.5 per cent above the average inflation rate of the three lowest-inflation countries in the EU. For 2005, the criteria average was 2.5 per cent.
The European Commission has also on several occasions warned that inflation will pose a serious obstacle for Bulgarias integration into the EU.
The IMF also said on May 17 it kept its economic growth forecast for Bulgaria at 5.6 per cent for 2006. The countrys economy expanded by a real 5.5 per cent last year.
According to James Roaf, IMF resident representative in Sofia, Bulgarias macroeconomic results are good.
The income policy threat
One of the biggest concerns of the IMF for Bulgarias future, however, rests with the countrys income policy. This was pointed out many times during the IMF mission, which ended on May 17.
In a series of meetings with top Bulgarian officials, mission leader Ajai Chopra, deputy director of the funds European department, said this countrys income policy should be as flexible as possible to ensure long-term competitiveness of the country.
Therefore, in Chopras view, wages should be only agreed on at the company level, because each company has different a competitiveness and productivity level. The IMF is against the serious wage hikes introduced by the Cabinet.
The Bulgarian authorities, however, are quite prone to resorting to such hikes, especially after the country joins the EU, when also price increases are expected. According to Labour and Social Policy Minister Emilia Maslarova, the Government would only stick to the inflation forecasts and the growth of labour productivity.
In the public sector, the Labour and Social Policy Ministry has proposed full adjustment of wages to inflation plus an increase, equivalent to 75 percent of the GDP growth, while in the private sector the ministry recommends adjustment of up to 65-70 percent of the growth of productivity of labour added to full adjustment to inflation on an annual basis.
The fund representatives again raised the issue of removing seniority and length-of-service bonuses, asking if the issue could be settled as soon as possible. However, Maslarovas ministry replied that this issue could be settled only by an agreement of the social partners (Cabinet, trade unions and employers).
In early 2006, relations between trade unions and employers in Bulgaria were strained by the issue of the statutory length-of-service and seniority bonuses employers are obliged to pay workers. The IMF has called on the Government to abolish the bonuses, a position supported by employer organisations but fiercely opposed by trade unions.
According to Bulgarias Labour Code, employers are obliged to pay employees a monthly length-of-service bonus, calculated as a percentage of the basic wage and representing at least 0.6 per cent for each year of service.
For more than 10 years, IMF and World Bank experts have argued that this regulation contradicts the freedom of collective bargaining between employers and trade unions, as well as being proof of the insufficient flexibility of Bulgarian labour legislation.
The Cabinets hands, however, are quite tied because the trade unions accuse it of having a jerry-rigged decision-making policy in the labour sphere, referring to the Labour and Social Policy Ministry calling into question the length-of-service allowance and its recent unilateral decision to end the system of compensation for hazardous working conditions, at a time when it has not yet resolved issues related to investments in the working environment and overall wage determination policy.
The trade unions argue that social dialogue principles are being attacked and that an attempt is being made unilaterally to impose IMF-proposed solutions that may be beneficial to the Government and the employers but affect issues that are vital for workers.
However unsolved this labour-relations issue remains, it is clear now that the IMF is preparing to pull out of Bulgaria (and not just symbolically, as Roaf, the funds resident representative, will also leave the country after the agreement expiration) with dignity. Furthermore, the fund will have in its records Bulgaria as a positive example of how the IMFs active involvement with a countrys macroeconomic policy could lead to good results.
Bulgaria - IMF relations
The International Monetary Fund and the International Bank for Reconstruction and Development (IBRD), better known as the World Bank (WB), were both established at the United Nations Monetary and Financial Conference, held at Bretton Woods, New Hampshire, on July 1-22 1944.
The two were created to oversee stability in international monetary affairs and to facilitate the expansion of world trade. Membership in the WB requires membership in the IMF, and they are both specialised agencies of the United Nations.
The WB was given domain over long-term financing for nations in need, while the IMFs mission was to monitor exchange rates, provide short-term financing for balance of payments adjustments, provide a forum for discussion about international monetary concerns and give technical assistance to member countries.
These functions are still generally true of both organisations, although the policies determining how they are carried out have been modified and amplified over time.
Bulgaria became a member of the IMF and therefore a WB member in 1991.
After several failed stabilisation attempts, Bulgaria introduced a currency board on July 1 1997. The IMF masterminded the idea for the currency board introduction and since then has been the strongest advocate for its preservation.
Under the arrangement, the Bulgarian lev was pegged to the German mark, and after January 1 1999, to the euro.
Controversial and difficult to implement because of Bulgarias serious structural problems, the currency board has been a crucial factor in the success of the countrys latest stabilisation programme.
Combining a traditional, rule-based exchange arrangement with legal and structural measures that address pressing banking sector and fiscal issues, it has been well designed for the task at hand credible but flexible enough to allow Bulgaria to tackle a systemic banking crisis.
Bulgaria is expected to remain under the currency board arrangement until 2009 or 2010, when it hopes to join the eurozone (the system of the countries that have introduced the euro as their currency).
Deficit still widening
A 47.3 per cent annual rise in Bulgarias trade deficit widened the countrys current account deficit for the first quarter to a preliminary 4.4 per cent of the projected gross domestic product, from 2.6 per cent for the same period last year.
This was shown in data published by the Bulgarian National Bank on May 17.
The current account deficit through March nearly doubled to 1.052 billion euro, from 550.6 million euro a year earlier, the central bank said.
Bulgarias trade deficit for the first quarter rose to 1.038 billion euro, or 4.3 per cent of GDP, from 704.8 million euro, or 3.3 per cent of GDP for the same period of 2005, as imports rose faster than exports.
Imports for the first quarter of 2006 rose 33 per cent on the year to 3.705 billion euro, while exports were 28.2 per cent higher on the year at 2.666 billion euro.
In March alone, Bulgaria had a current account deficit of 387.5 million euro against a deficit of 180.5 million euro in the same month of 2005.
Record-high foreign direct investments (FDI), however, helped to offset partly the rise in the current account deficit. The country attracted 755.4 million euro in FDI in the first quarter, a double increase from the same period of 2005.
Foreign cash inflows covered 71.8 per cent of the three-month current account gap, against 71.2 per cent a year earlier.
Remittances from Bulgarians working abroad also helped the country slow the rise in its current account balance. Remittances through March fell to 144.6 million euro from 171.7 million euro a year earlier.
