Do They Have Parachutes In Bulgaria? (Updated)

With capital inflows to the CEE economies slowing to a trickle in Eastern Europe, a sharp correction is now underway in most countries’ external imbalances and in particular in their current-account deficits. For the CEE-6 (Poland, Czech Republic, Hungary, Romania, Bulgaria, Turkey), net private capital flows are forecast to slow to $59.5 billion in 2009, down from an estimated $161.9 billion in 2008, according to estimates from the Institute For International Finance. The basic concern is that those countries with significant external deficits are extremely vulnerable to foreign capital reversals, especially in the current environment of global credit tightening.

FDI flows (which are generally considered more stable and less susceptible to rapid outflows than other capital flows) have been the main form of financing for current-account deficits in recent years, but such inflows are set to slow sharply in 2009. The Economist estimates that between 2003 and 20007 FDI inflows (on average) covered almost 100% of the current-account deficit in the ten EU member states. In 2008, this coverage fell to an estimated 55%

As FDI has fallen back, debt – particularly intra-bank lending – has become the main financing vehicle for the current-account deficits. Nevertheless, intra-bank lending – that is, lending between foreign parent banks and their subsidiaries in the region – is falling back sharply in 2009, with nett bank lending to emerging Europe, excluding Russia, being projected at around $22 bn in 2009, down from $95 bn in 2008 (according to the Institute for International Finance)

Now the central issue is that such corrections in external imbalances can take pplace in one of two ways – either domestic demand drops sharply and/or the currencies weaken significantly. In the case of those countries with an exchange rate peg the second route is not open, hence what we are likely to see is a very sharp contraction. Such contractions are already evident in the Baltics, but what about Bulgaria. How sharp will the correction in Bulgaria be? Only today capital economics have come in with a forecast of 5% contraction over the year. But how realistic is this, let’s look at some data.

Well, we could start with this little deatil: retail sales down 25.7% month-on-month in January, according to the national statistics office. For an economy which has been driven by a consumer borrowing and lending boom, that looks like dramatic evidence of some kind. It looks like dramatic evidence, but it isn’t really quite so dramatic as it appears at first sight, and the first warning I would issue to anyone who wants to study the Bulgarian economy is never to believe anything you see at first sight.

The data came from a Bulgarian press source (see extract below), but they evidently had no idea what they were talking about, since they confused the basics of year on year and month on month, and obviously non seasonally adjusted sales are down massively January over December, every year. Actually according to Eurostat, seasonally corrected sales were down only 0.15% month on month, and were even still up 4.79% year on year, although this is still a very large drop from the 20% rate of increase registered earlier in the year. So the basic point would seem to hold, that Bulgaria’s economy is now in freefall, but I have learnt something: never, ever, cite material from direct Bulgarian sources without checking.

Retail sales revenue in Bulgaria declined by 25.7% in January from the same month of last year, the National Statistical Institute ( said in a statement. The slump was attributed to a sharp decrease in retail sales of larger consumer goods, although a decline is normal for the beginning of each year. A major 31.5% drop was reported in sales of vehicles and technical maintenance. Revenue generated by non-food sales went up by 3.0% year-on-year, the data showed. Revenue from food, beverages and cigarettes sales showed a minor increase of 0.5%

So there is evidence of a sharp slowdown in retail sales, but at present that is all it is, a slowdown. So what about the rest of the economy? Well, if we come to look at industrial output, the situation is a lot clearer, since production is falling rapidly.

Bulgaria’s industrial output fell by 19% in January 2009 month-on-month, after rising by a monthly 1.7% in December, preliminary data of the National Statistics Institute (NSI) showed on Tuesday. This is the fourth drop in a row, causing the index to go below the 2006 levels. The industrial output index is mainly determined by the indicators of the processing industry, which dropped by 21,4% in January, compared to December 2008. There is a 66,5% decrease in the production of metal goods, excluding machines and appliances. In the production of non-metal goods the drop is by 42,1%, and in the food processing industry by 24,8%.

As can be seen in the chart below, the output index is now somewhere round the level of summer 2006, and falling.

Construction is also falling, and has been slowing all through 2008.

Unemployment Rising and GDP Slipping Back

Bulgaria’s unemployment rate has not spiked dramatically upward yet, but it is continuing to rise, and was up for the fifth consecutive month in a row in February, with 248,000 Bulgarians registering as unemployed, up by 7,000 over January. The average jobless rate for Bulgaria is now 6.69%, up by 0.9% since September.

And while Bulgaria’s gross domestic product still seems to be growing, it was at the very best a close shave in Q4 2008 grew, since the economy grew by a preliminary 3,5% year on year, down from the 6.8% rate registered in the previous quarter. This is sharp enough to mean that the economy may actally have contracted on a seasonally adjusted quarter on quarter basis, but since the statistics office don’t publish this level fo data we simply don’t know (that is, an educated guess would be that it did contract, but I certainly couldn’t swear to the fact).

Sharp Current Account Contraction

According to the Bulgarian National Bank last week Bulgaria’s current account deficit was EUR 439.7 M in January 2009, down from EUR 806.8 M in January 2008.

PM Sergey Stanishev said “the country’s deficit has begun rapidly shrinking which means that the economy has unsurprisingly slowed down,” Bulgarian National Radio reported.

The current and capital account deficit was EUR 288.7 M in January compared to EUR 806.2 M recorded in the previous year.And January’s trade deficit was EUR 339.3 M, narrowing from EUR 607.8 million in 2008. All this is consistent with a very sharp and rapid contraction of the economy, as imports collapse and fund flows dry up, rather than any positive news on exports. Exports fell by 27.2% to EUR 811.8 billion in January, while imports dropped by 33.2% to EUR 1.1 billion.

Inflation Still A Problem

Bulgarian inflation slowed again in February for the eighth consecutive month and hit 6 percent – down from the 7.1 percent registered in January, but prices are still rising far too fast for an economy which is slowing rapidly. Consumer prices gained 0.1 percent in the month.

And the core index – taking out food, energy, alchohol and tobacco – has almost stopped rising but has yet to fall. So we have had a significant period of price deflation, but we have yet to see price reductions, and these of course, as in the case of the Baltics, are vital for a country operating a currency peg which has seen a substantial loss in competitiveness.

Moody’s Review

The credit ratings agency Moody’s this week affirmed Bulgaria’s Baa3 local and foreign currency ratings, with a stable outlook, but said that Bulgaria’s economy faced tough times this year.

“Bulgaria is likely to experience a difficult recession in 2009 as the economy suffers from shrinking exports and slowing inflows of foreign capital,” Moody’s sovereign risk group analyst Kenneth Orchard said in a statement. “Nevertheless, many years of prudent fiscal policy and low debt mean that the government is well positioned to cope with the situation.”

Having averaged Budget surpluses of 2.7 per cent of gross domestic product (GDP) since 2004, the Cabinet has strengthened its financial position, but the main threat did not come from the Government debt, which was a very low 14 per cent of GDP. Moody’s argued Bulgaria’s most pressing problem comes from the large quantity of private sector debt that has been accumulated and needs refinancing in 2009. Short-term external debt totalled around 13 billion euro at the end of 2008, which is equivalent to 40 per cent of GDP. Much of this debt is likely to be rolled over, but automatic re-financing can no longer be assumed in the current financial environment. The low Government debt is seen as a safety net, because it allows Bulgaria (like Latvia) to borrow funds to support the private sector and the currency board without immediately threatening the government’s creditworthiness. The debt-to-GDP ratio could rise and still remain well below the EU average, according to Moody’s.

And as if to prove Moody’s point Bulgaria announced during the week that it was going to borrow a further 50 million euros from the European Bank for Reconstruction and Development in 2009 than it did in 2008, in order to cope with the impact of the global financial crisis. Half of the 250 million euros total 2009 borrowing will go to local banks to spur corporate borrowing, EBRD President Thomas Mirow said. The rest will go toward energy efficiency projects, municipalities and direct lending to “sound companies.”

So, to return to the start of this post, and the correction in the external imbalance, I would say there is plenty of evidence building up now that this is taking place, and that the process is starting to hurt. In which case I think the 5% GDP contraction Capital Economics forecast not only looks realistic, there seems to be significant downside risk attached to it.

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

9 thoughts on “Do They Have Parachutes In Bulgaria? (Updated)

  1. I am following BG myself and the January data does not look good. But remember, that BG was out of gas in January. Hard to conclude a trend from this.

  2. Oh, and Poland is in talks with IMF. Of course not because they need it, Poland’s situation is quite different from other countries in CEE, its just a precautionary measure… 😀

  3. What I’m really curious about:

    Bulgaria has a fiscal surplus – good.

    Bulgaria has the biggest C/A deficit in CEE, almost 25% and a fixed exchange rate and free movement of capital flows.

    FDI appear to decrease in 2009.

    The gross external debt as of 31.12.2008 is 108% of GDP. Short term debt as at 31.12.2008 is almost 13 bln EUROS.

    BNB reserves in Feb 09 were almost 12 bln EUROS, or 10 months of imports.

    Of course, consumption will decrease in 2009.

    My biggest question is: how do they manage to keep the peg? Where do they get enough euros from and will Bulgaria get enough euros in 2009?

  4. Mihai: if I remember properly, each lev issued is covered by more than a euro. This means it is a proper currency board and they can keep the peg however long they want. This still leaves as a hypothetical option that all leva will be converted to Euros. This would of course leave the country without any cash, a swelling of the lev (with unimaginable consequences) if you want.

  5. Hello, sorry, I was trying to resist getting caught up in this one, since I am all over the place with work at the moment, and can’t really get to involved in Bulgaria.

    As we are noting, shortage of reliable data would be one reason. It really is totally unpresentable for them to produce so little that is considered valid and comparable by Eurostat while making so many claims about the soundness of the economy there.


    “My biggest question is: how do they manage to keep the peg? Where do they get enough euros from and will Bulgaria get enough euros in 2009?”

    Well, in principal this doesn’t differ from countries like Spain and Greece within the euro who run large and continuing current account deficits. They can continue to do so as long as people are willing to lend them the money, for something.

    In the past people were lending the money for a construction boom in Spain, and for a mixture of construction and government debt in Greece. The same was probably the case across SEE until October, then the flow was suddenly stopped, just like someone turned the lights out.

    So private lending virtually dries up, and this is where the government needs to go quickly to the IMF, and start borrowing money, since if they don’t the CA has to drop to zero virtually overnight, with very nasty consequences for all concerned. This is then called “balance of payments” help, but as I keep pointing out the issue is really all the defaults which then pile up for the banks who were previously doing the short sighted lending to finance the deficit.

    This is why I think Angela Merkel has all this very wrong.

    If we look back at Spain, the taps were turned off in September 2007, and the crisis still hasn’t reached its peak. In SEE we can expect events to be quicker and more dramatic, but still, we are some way from seeing the full force of the blast, especially if IMF lending comes in the plug the gap (as it will).

    As Wolff points out on his East Europe in Crisis blog, the downturn is also accelerated in some countries by the presence of a flat tax, and the lack of “automatic stabilisers” during the contraction. Basically since spending is harder hit than income, and system which depends on VAT for government income during a sharp contraction ends up with a cycle of cut backs and more contraction like the ones we are seeing in the Baltics.

    Well, I hope that makes things a bit clearer. Cheers.


  6. Very insightful. It’s clear a correction is needed; let’s hope the IMF will how the same leniency to the peg as they did in Latvia.

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