This article was downloaded by: [Kungliga Tekniska Hogskola]On: 11 October 2014, At: 09:38Publisher: RoutledgeInforma Ltd Registered in England and Wales Registered Number:1072954 Registered office: Mortimer House, 37-41 Mortimer Street,London W1T 3JH, UK

Southeast European andBlack Sea StudiesPublication details, including instructions forauthors and subscription information:http://www.tandfonline.com/loi/fbss20

BulgariaKrassen Stanchev aa Executive director of the Institute for MarketEconomics , SofiaPublished online: 17 Apr 2008.

To cite this article: Krassen Stanchev (2001) Bulgaria, Southeast European andBlack Sea Studies, 1:1, 140-157, DOI: 10.1080/14683850108454627

To link to this article: http://dx.doi.org/10.1080/14683850108454627

PLEASE SCROLL DOWN FOR ARTICLE

Taylor & Francis makes every effort to ensure the accuracy of allthe information (the “Content”) contained in the publications on ourplatform. However, Taylor & Francis, our agents, and our licensorsmake no representations or warranties whatsoever as to the accuracy,completeness, or suitability for any purpose of the Content. Anyopinions and views expressed in this publication are the opinions andviews of the authors, and are not the views of or endorsed by Taylor& Francis. The accuracy of the Content should not be relied upon andshould be independently verified with primary sources of information.Taylor and Francis shall not be liable for any losses, actions, claims,proceedings, demands, costs, expenses, damages, and other liabilitieswhatsoever or howsoever caused arising directly or indirectly inconnection with, in relation to or arising out of the use of the Content.

This article may be used for research, teaching, and private studypurposes. Any substantial or systematic reproduction, redistribution,reselling, loan, sub-licensing, systematic supply, or distribution in anyform to anyone is expressly forbidden. Terms & Conditions of accessand use can be found at http://www.tandfonline.com/page/terms-and-conditions

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

Bulgaria

KRASSEN STANCHEV

Bulgaria represents a case of interrupted market reform in the mid-1990s, which had been preceded by peaceful transition to a pluralisticdemocracy and successful constitution making in 1989-91, and followedby hyperinflation and a political crisis in 1996-97. The crisis wasresolved through new elections and the introduction of a currency boardarrangement. Consequently, Bulgaria's economic performance in the lastten years has been uneven: a sharp decline followed by a modest artificialrecovery in 1995 and a new sluggish decline in 1996-97. The country isagain in a recovery period and likely to register growth for the secondconsecutive year in 1999. Politically, Bulgaria has remained stable andsuccessfully reoriented itself towards the EU and NATO. Its constitutionproved capable of overcoming political tensions, and Bulgaria's foreignpolicy established itself as a factor in domestic and regional stability. Inthe future, EU accession could serve as the background for the recoveryprospects of Bulgaria's economic policies.

INITIAL CONDITIONS

Prior to the start of economic reform in the 1990s, Bulgarian exportsdemonstrated the highest share of all ex-Comecon countries to theCouncil for Mutual Economic Assistance (CMEA) market. Bulgaria,along with Czechoslovakia, was the last to contract CMEA export effortsin 1989; other countries had already begun reducing this trade in 1986.While Bulgaria exported mostly to the ex-Soviet Union, the othercountries traded among themselves. Bulgaria's CMEA trade in thesecond half of the 1970s and 1980s averaged around 60 per cent of thetotal. Czechoslovakia averaged 51-52 per cent, Romania had less than a30 per cent CMEA share, and Hungary and Poland hovered between 40per cent and 50 per cent.1 Bulgaria has held an intermediary positionbetween the East and the West, importing cheap raw material andresources from the former Soviet Union (FSU) that it sells recycled tointernational markets, while trying to resell high-tech products back tothe East.

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

BULGARIA 141

This feature of Bulgaria's initial condition has been misinterpreted,underestimated or forgotten, but it had a long-term impact. First,Bulgaria's economic structure (in 1989: 59.4 per cent industry, 29.7 percent services, 12.9 per cent agriculture2), although similar to those ofother Eastern bloc countries, was more artificial and less competitive,dependent on the FSU for 90 per cent of its energy supply, with energybased on wasting technology foundations and lower value added.Second, international lending institutions perceived Bulgaria's rent-seeking position as that of a good borrower, so it was easy for thegovernment to borrow from the London Club. At the outset oftransition, the structure of the foreign debt was 80 per cent to privatelenders and 20 per cent to official lenders.3 Third, its structural economiclegacy necessitated slower policy and political change, because oldcommand positions were difficult to dismantle or at least reshuffle.

Bulgarian economic reforms began in February 1991, a 15-monthdelay after the fall of the Communist regime. Expert consensus wasachieved on the following reform targets:

• monetary and fiscal policies: financial stabilization, inflation curbing,money aggregates and budget deficit regulation;

• structural reform: changing patterns of economic behavior throughprompt privatization;

• effective economic governance: exercising pressure on enterprises toadjust to the changing economic environment and setting upfundamental market economy institutions; and

• effective general economic policies: attempting to follow coherenteconomic policy.4

The philosophy of this agenda, and even its wording, was very similarto that of the Polish government's October 1989 programme foreconomic stabilization.5 The difference between the two stems from theirpolitical setting. Bulgaria's reform goals have never been included in awritten government statement. The initial consensus attempted toovercome effects of the 1990 moratorium on Bulgaria's foreign debtpayments, and market reforms proceeded successfully until the October1991 elections. Table 1 summarizes the political changes. Thedemocratic minority cabinet of 1991-92 tried to follow the samephilosophy without daring to scrap price controls and promptlyprivatize, a delay that caused corruption in public sector management.The emerging private sector grew on the decapitalization of state-ownedenterprises, especially the large, constitutionally protected6 monopolies.

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

142 BALKAN RECONSTRUCTION

TABLE 1

SEQUENCE OF BULGARIAN GOVERNMENT CHANGES, 1989-99

Month/Year

11/89

06/90

08/90

12/90

10/91

01/92

12/92-09/94

09/94-01/95

12/94

10-11/96

02/97

04/97-present

Event

BCP Coup

Election of theConstituent Assembly

- BSP wins

Parliament appointsnew President1

Coalition government

General & municipalelections - Noclear majority

Presidential elections

Government oftechnocrats

Caretaker cabinet

General elections -BSP wins

Presidential elections

Caretaker cabinet

General elections- UDF wins

President

Mladenov (BCP, BSP)11/89-7/90

Zhelev(UDF)08/90-01/92

Zhelev (UDF)01/92-01/97

Stoyanov (UDF)01/97-present

Cabinet (PM)

Atanasov (BCP)02/87-02/90

Lukanov (BCP/BSP)02-10/90

Popov (unaffiliated) i12/90-10/91 \

Dimitrov(UDF minoritygovernment) •11/9110/92 1

Berov (unaffiliated)

Indjova (unaffiliated)

Videnov (BSP)01/95-12/96

Sofianski (UDF)02/97-05/97 •

Kostov (UDF)05/97-present

Legend

O Socialist© DemocratO Unaffiliated Prime Minister +

socialists represented in thecabinet

Abbreviations

BCP - Bulgarian Communist PartyBSP - Bulgarian Socialist Party (renamed BCP)UDF - Union of Democratic Forces

Note: 1 Following the 1991 Constitution, the President is directly elected by the people ofBulgaria.

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

BULGARIA 143

The democratic cabinet resigned, succeeded by a cabinet of expertswho in mid-1994 signed a Brady plan that restructured the country'sforeign debt by 47 per cent. Backed by ad hoc parliamentary majorities,the experts failed to promote the private sector and an investment-friendlyenvironment. Their successors, the socialists, abandoned 1991 reformideas and attempted a second version of central planning. This might beillustrated by the restoration of price controls in the mid-1990s (see Table2). They supported the loss-making public sector at the price of drainingthe banking sector and causing severe macro-economic disequilibrium,which brought the country again to the brink of default in mid-1996, evenwith a Brady deal in place. Thus, Bulgaria has had neither an economicagenda nor a majority stable enough to proceed with reforms.

EXTERNAL SHOCKS

The external impacts on Bulgarian economy comprise the followingshock waves: the disappearance of the CMEA market; the embargoes onex-Yugoslavia and the Former Yugoslav Republic of Macedonia(FYROM); the 1997 capital market turbulence; the 1998 Russian crisis;and the Kosovo crisis of 1999.

The longest-lasting impact came from the first shock. Thedisappearance of the FSU and the Eastern bloc as a market led tounderinvestment and contraction of gross domestic product (GDP) by 31per cent in 1991 compared with 1989.7 In 1990, the FSU still accountedfor 52 per cent of Bulgaria's exports (down from 56 per cent in 1989)and 49 per cent of the imports (down from 54 per cent the previousyear). As reported by Bulgarian National Bank (BNB), the total exportvolume contracted by 34.6 per cent in 1991.

TABLE 2

SHARE OF CONTROLLED PRICES AS PERCENTAGE OF CONSUMER BASKET,1991-2000

Year

1991199219931994199519961997199819992000

Share

14.0%13.4%16.5%18.9%49.0%52.4%45.0%15.8%14.0%13.2%

Source: National Statistical Institute (NSI) and Institute for Market Economics (IME)calculations

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

144 BALKAN RECONSTRUCTION

The impact of the ex-Yugoslavia and FYROM embargoes was more ofan institutional nature rather than purely structural. It contributed to thepreservation of high port fees at Varna and Bourgas, making them non-competitive after 1995. From 1992 to 1994, FYROM doubled its sharein Bulgaria's trade, compensating for the lost markets in the FederalRepublic of Yugoslavia (FRY). Violation of the UN embargo on FRYencouraged informal and semi-legal economic activities in Bulgaria, thuscultivating a longer-term tendency toward corruption.

The Bulgarian economy remained virtually untouched during theOctober-November 1997 crisis in the global capital market, the Asiancrisis and the Russian financial collapse of summer 1998. In the firstcase, this was due to the underdeveloped nature of Bulgaria's stockmarket, its unclear supply and doubtful demand. The directconsequences of Russia's crisis were minor as well, since the share ofBulgarian exports (of total exports) to Russia was only about 6.6 per centin the first half of 1998. Bulgarian products had already had difficultyaccessing Russian markets because of the low level of competitiveness ofBulgarian industries and high import tariffs that verged ondiscrimination. Imports from Russia in the first half of 1998 accountedfor around 28 per cent of all Bulgarian imports, mainly energy resourcesand mineral products. Since Russia was interested in achieving a stablesupply of hard currency, imports went unaffected as well.

The most interesting external shock is probably the Kosovo crisis.8

Direct costs of the crisis for Bulgaria were negligible: $700,000 in aid tothe FYROM government. Officially registered Yugoslav refugeesnumbered 317. They were granted temporary asylum and have all nowreturned home. The war was a shock to Bulgarian foreign trade and theentire economy, but it highlighted inherited weaknesses rather thanserved as the sole reason for Bulgaria's poor economic performance in1999. Compared with other countries, notably Albania and FYROM,Bulgaria emerged relatively unscathed. In 1999, exports of goods andservices dropped by 16 per cent, while imports decreased by only 3 percent. During the first three months of 1999, essentially before the war,export industrial sales had already fallen by 26 per cent. Domestic saleshad fallen by 12 per cent for the same period, and GDP was down by 0.7per cent compared with the same period in 1998. Thus, poorperformance existed before the NATO air strikes. The immediate shockwas perhaps most obvious in April 1999, when exports dropped to$283.7 million from $335.1 million9 in March. Imports for the sameperiod went down as well, but at a much slower pace, from $453.7million to $442.9 million. The aggregated decline in imports for the firsthalf of 1999 is only 1 per cent, while exports decreased by 21.7 per cent.

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

BULGARIA 145

This difference suggests that physically interrupted trade routes were notthe only reason for Bulgaria's worsening competitiveness, although therewere delays in deliveries. In fact, exports improved between April andJune 1999, and GDP picked up by 1.6 per cent compared with the samequarter in 1998. Evidently, it was for purely domestic reasons thatBulgaria hit bottom in its economic performance before the Kosovocrisis and, in its aftermath, behaved relatively independently fromexternal shock waves.

REFORM POLICIES

Between 1991 and 1999, the Bulgarian governments pursued twodistinct sets of reform policies. The initial approach, between 1991 and1997, is partially described above, and the economic background for thefailure of these policies is provided in some detail in the section oneconomic performance. In its monetary policies, Bulgaria used aninterest rate anchor and the floating exchange rate mechanism markedby frequent interference by the central bank in the forex market. Realinterest rates were negative, except for the beginning of the period, wheninterest rates were determined by BNB, and in 1995 (see Table 3).

Privatization in Bulgaria since 1989 has been carried out mainly inthree ways: restitution of land and urban property; cash sales of state andmunicipal assets; and mass, or voucher, privatization. Restitution isregulated by restitution laws (four in 1992 and one in 1998), the 1991Land Restitution Act and implementing provisions. The restitutionprocess preceded privatization, thus contributing to delays due toproperty disputes until 1996 when an amended framework requiredsome 5 per cent of all state-owned assets to be set aside for restitution

TABLE 3

LENDING/DEPOSIT RATES, 1992-98

1992 1993 1994 1995 1996 1997 1998

Interest rates

Nominal deposit rate, cumulative 55.70 51.94 64.98 42.39 103.8 2.8 5.17from the beginning of year

Real deposit rate, cumulative -13.33 -7.27-25.67 7.14 -50.4 1.1 12.39from the beginning of year

Nominal lending rate, cumulative 73.87 78.29 102.30 77.67 218.5 14.1 13.59from the beginning of year

Real lending rate, cumulative from -3.13 8.82 -8.87 33.68 -22.5 13.1 23.51the beginning of year

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

146 BALKAN RECONSTRUCTION

claims. The 1992 Transformation and Privatization of State-Owned andMunicipal-Owned Enterprise Act, amended 24 times since, regulatedother privatization methods. There was no existing privatization planthat Bulgaria did not try. These methods were applied simultaneously, invarious combinations and with a lack of transparency. The privatizationprocess in general was delayed until 1995 (see Table 4) but acceleratedin 1996 due to voucher privatization and again in 1997 because of'conventional' methods such as distributions to management-employeebuyout (MEBO) companies. During that period, 45 per cent of the saleson average went to MEBOs, although only in 1998 did they receive 73.6per cent of the sold enterprises.

Capitalization of the private sector was easy in financial and bankingservices but hampered by administrative barriers in the non-financialsector. In the early 1990s, the guiding principle appeared to be: noregulation when using other people's money but over-regulation whenpeople were using their own funds. Establishment of private banks beganin 1990 and continued until 1993. They emerged in a regimecharacterized by low capital requirements and almost no entry barriers.There was no requirement to justify origins of founding capital, andmost private banks started with borrowed funds. The number of privatebanks increased significantly, from two in 1990 to 70 in 1993,consolidated to 26 in 1995. Their share in total bank assets was 3.1 percent in 1992, 22.4 per cent in 1995 and 19 per cent in 1999 (18 bankswent bankrupt in 1996-97). At the same time, entry barriers, hightransaction costs and private sector orientation kept the share of smallfirms, especially microfirms, extremely high. About 95 per cent of thebusinesses in operation employed nine or fewer people (see Table 5).Companies with more than 100 workers represented less than 1 per centof the total even in 1997, when privatization accelerated and many largeenterprises were for the first time deemed private. Companies with fewerthan 100 employees provided jobs to 77 per cent of all those employed

TABLE 4

NUMBER OF PRIVATIZATION DEALS BY YEAR: 1993-1999

Total No. of Privatization

All Ministries

Privatization Agency

Deals

1993

62

51

11

1994

165

129

36

1995

309

240

69

1996

515

369

146

1997

590

507

83

1998

1,110

931

179

1999

1,224

993

231

Total

3,975

3,220

755

Source: Privatization Agency

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

BULGARIA 147

TABLE 5

PRIVATE SECTOR BY NUMBER OF COMPANIES AND LEVEL OF EMPLOYMENT,1995-97

Firm Sizeby # employed

1995number share ofof firms employed

1996number share ofof firms employed

1997number share ofof firms employed

1-910-4950-99100 +

Total

96.1%3.1%0.5%0.3%

100.0%

42.6%22.5%11.2%23.7%

100.0%

95.3%3.8%0.5%0.4%

100.0%

37.8%24.3%11.7%26.3%

100.0%

94.0%4.6%0.7%0.7%

100.0%

30.6%20.2%10.5%38.8%

100.0%

Source: NSI and IME calculations

by the private sector in 1995, with the share down to 62 per cent in1997.

Other institutional reforms have a similar history. Capital marketsemerged unregulated in 1992; by 1994 there were 19 stock exchangestrading mostly Ponzi-type schemes. Anti-fraud and disclosure regulationin 1995 caused pyramid schemes to collapse. The newly establishedsecurities and exchange commission was required to regulate two massprivatization funds. Operation of the regulated capital market wasdelayed until its formal opening at the end of 1997, but actual trade isstill negligible due to lack of protection for minority shareholders, highentry costs and predominant offerings of minority shares of state-ownedenterprise. Bankruptcy regulations were adopted in 1994 but rarely wereapplied to loss-making state-owned enterprises until 1998. Creditors'rights have been protected on paper but are difficult to enforce forpolitical and institutional reasons. In 1995 the Ministry of Industry, aprincipal of state-owned 'sacred cows', banned its enterprises frompaying debts to the banking sector. By law, foreclosure may take 19months, a term that makes no sense in a high inflationary environment(see Table 3 on interest rates and Table 6 on key economic indicators).This motivated banks to distribute credits to inner circles believed to beunder informal control and to develop their own or use availableenforcement services. Delayed privatization and restructuring of the realsector, lack of financial discipline and extensive possibilities for state-owned enterprises to use soft credits and thus transfer their losses to thebanking system, combined with poor lending practices and the BNB'sattempts to alleviate the situation with 'measured' issues of notes,gradually led to the decapitalization of banks and transfer of the costs tothe general public.10 The banking sector's net loss in 1993 amounted to

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

148 BALKAN RECONSTRUCTION

TABLE 6

BASIC ECONOMIC INDICATORS, 1992-98

1992 1993 1994 1995 1996 1997 1998

Nominal GDP 200,832(BGL mln)

Real GDP growth -7.3

GDP percapita - USD

Industrial output- Share of GDP

298,934 550,514 867,691 1,660,237 17,103,433 21,577,020

-1.5 1.8 2.1 -10.9 -6.9 3.5

1,008 1,276 1,147 1,537 1,129 1,234 1,480

35.0 32.1 33.6 30.2 29.5 38.340.5

Agricultural output 12.0- Share of GDP

Services - Share ofGDP (%)

TOTAL

47.5

100.0

79.5

10.6 12.3 13.9 15.4 26.2 20.5

54.4 55.6 52.5 55.7 44.3 41.2

Inflation (ConsumerPrice Index, %)

Money supply - 37,833M1 (BGL mln)

Money supply- 158,567Broad Money(BGL mln)

BNB's Forex 0.9Reserves(USD bin)

Exchange rate 24.5(BGL/USD)

100.0 100.0 100.0 100.0 100.0 100.0

63.9 121.9 32.9 310.9 578.6 1.0

48,303 75,131 107,886 236,628 2,290,316 2,826,129

234,072 418,009 583,663 1,310,275 5,750,728 6,328,788

0.7 1.0 1.2 0.5 2.1

32.7 66.0 70.7 485.4 . 1,776.5

2.7

1,866

Source: NSI, BNB

5 billion Bulgarian lev (BGL); in 1994 it rose to nearly BGL 7 billion.The problems were aggravated in 1995, when the net loss increased toBGL 30 billion by mid-year and about BGL 100 billion by the year end.In 1996, nine of the ten state-owned banks, which held 80 per cent ofbanking sector assets, reported negative capital. The direct fiscal transfercost for resolving the banking crisis of 1996-97 amounted to 14 per centof GDP.11

The government's second set of reforms is based on the introductionof the fixed exchange rate and the currency board arrangement (CBA) in1997. The Bulgarian lev was legally fixed to the reserve currency, theDeutschmark, and became automatically convertible into reservecurrency. After 1 January 1999, the BGL was pegged to the Euro at a rateof 1.956. The monetary base is fully covered by foreign reserves. Money

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

BULGARIA 149

supply is determined by money demand and is outside the BNB'scontrol. In other words, money supply became dependent on capitalmovements and the balance of payments status.12 Thus, money supplyalready reflects the health of the financial sector. The BNB became muchmore independent, since it was prohibited from extending credits to thestate or to any state agency. It has been endowed with a new structuremade up of three departments:13 the Issue Department, BankingDepartment and Bank Supervision Department. Each is allowed greatindependence in its operations and in passing resolutions. However, theCBA made it impossible to respond to external shocks through exchangerate adjustments, necessitating further liberalization. In 1998, Bulgariasigned Article VIII of the IMF Status of Current Account Convertibilityand in 2000, as an IMF member, it undertook the Article's obligationson convertibility. Acceptance of Article VIII allows Bulgaria to retainsome restrictions on capital account flows and domestic regulations todetermine the degree of capital movements. The adoption of a fixedexchange rate regime and the CBA was sufficient not only to achieveinternal macro-economic stability but also to foster reforms in manyother areas, discussed in the next section.

ECONOMIC PERFORMANCE

After 1989, Bulgaria faced a post-socialist recession. In the ensuing nine-year period, only three years registered growth in real GDP (1994, 1995and 1998). Since 1989, real GDP has lost more than one-third of itsinitial volume (see Figure 1).

It is generally accepted that the decline resulted from the loss of theformer CMEA markets and the official foreign debt (plus the 1990default), restricting the economy's overall investment capacity. Thesecauses, however, are relevant only for the period before 1994, when theeconomy registered its first positive real growth since the beginning oftransition. The costs of this upward move were a significant delay inrestructuring the real sector and a sharp decline in the central bank'sforeign reserves.

Structural reforms had barely begun when the economy turneddownward once again in 1996. By early 1997, the country faced ahyperinflation shock combined with a steady decline in real GDP. Aremedy was found with the introduction of the CBA, which broughtmonetary and financial stability. In 1998 the economy recovered to agrowth rate of 3.5 per cent. In fact, the limiting of government discretionvia the CBA coincided with the recovery. By 1996 (see Table 7), Bulgariahad already overcome its initial dependence on Eastern markets, trading

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

150 BALKAN RECONSTRUCTION

FIGURE 1

REAL GDP INDEX (1989 = 100)

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

Source: NSI and IME calculations

TABLE 7RELATIVE SHARE OF BULGARIA'S EXPORTS/IMPORTS TO SOME GROUPS OF

COUNTRIES, 1996-99

Exports

7996

USD sharemln

1997

USD sharemln

1998

USD sharemln

6 months1999

USD sharemln

EUOther OECDEuropean Free Trade

Association (EFTA)Central European Free

Trade Agreement(CEFTA)

Balkan countries

1,912.5 39.1% 2,128.7 43.3% 1,083.8 49.7%% %554.0 11.3%

49.5 1.0%661.7 13.5%44.3 0.9%

249.0 12.0%15.5 0.8%

971.7 55.6%219.9 12.5%

31.6 1.8%

94.8 1.9% 137.1 2.8% 119.9 4.8% 72.6 4.1%

514.2 10.5% 291.9 5.9% 397.6 5.4% 80.2 4.5%

Source: NSI, BNB

Imports

EUOther OECDEFTACEFTABalkan countries

Source: NSI, BNB

7996

USDmln

1,780.3275.486.4

159.9163.3

share

35.1%5.4%1.7%3.2%3.2%

7997

USDmln

1,823.1343.886.8

231.795.2

share

37.3%7.0%1.8%4.7%1.9%

1998

USDmln

1,044.9227.1

34.0120.068.4

share

45.2%8.1%1.5%6.0%1.6%

6 months1999

USDmln

1,243.4203.045.6

150.923.2

share

54.3%8.8%1.9%6.5%1.0%

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

BULGARIA 151

more than 50 per cent of its foreign trade turnover with EU and OECD(Organization for Economic Cooperation and Development) markets.

GDP per capita (in current year USD) dropped even moredramatically than real GDP, from $2,513 in 1989 to $946 in 1991 (seeFigure 2). However, it was not until 1991 that the exchange rate used forofficial statistics caught up with the market rate.

The overall economic performance of the first seven reform years isillustrated by the parallel dynamics of GDP and inflation for that period(see also Table 6). From Figure 3 it is obvious that Bulgaria was once atextbook example of the negative impact of inflation on growth andprosperity.

Before the introduction of the CBA in March 1997, the central bankbegan behaving as if there were a formal rule that restricted moneysupply to the level of forex reserves. It stopped financing the governmentand refinancing the banking sector. This policy brought inflation downto below 0 per cent in less than two months, maintained a single-digitmonthly inflation for another four months and limited the rate to 1 percent for all of 1998.

The CBA has allowed authorities to practice prudent fiscal policies,especially since 1998. In 1999, they virtually closed or sold all loss-making state-owned enterprises. By mid-1999 only seven exceptionsremained. The most significant were three monopolies: the railway, thestate gas company and the National Electric Company (NEC).

From 1998 to 1999, the government introduced several reforms. Itseparated its health care and pension system from the central budget,streamlined non-tax revenues, closed off-budget accounts, which in1997 and 1998 had channelled sums equal to one-eighth of the 1997GDP, and consolidated the budget. Government debt and budgetstatistics improved and are currently available on a bi-weekly basis.

The overall debt dynamics are as follows: 114 per cent of GDP in1996 and 1997; 80 per cent of GDP in 1998; and a forecasted 73 percent of GDP in 1999. The official foreign debt fell significantly after1993, from $12.3 billion at the end of 1993 to $8.7 billion in mid-1999,virtually a 45 percentage point decrease of foreign governmental debt asa percentage of GDP. Foreign debt payments in 1998 were at the level of6.8 per cent of GDP and 20.6 per cent of exports for that same year.

Budget deficit was reduced from 13.4 per cent of GDP in 1996 to 2.6per cent in 1997 and 1 per cent in 1998. Fiscal subsidies were at 2 percent of GDP in the first half of 1999. There are no signs that this budgetdeficit will not meet the target of 1.5 per cent of GDP. Quasi-fiscalsubsidies (tax arrears and indebtedness to suppliers, mostly the NEC andthe gas monopoly) are concentrated in the short-term liabilities of the

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

152 BALKAN RECONSTRUCTION

FIGURE 2

GDP PER CAPITA (CURRENT YEAR US$)

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

FIGURE 3

INFLATION /GDP DYNAMICS, FEB. 1991-FEB. 1997

-10.00% -L

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

BULGARIA 153

ten largest state-owned enterprises. Their total amount is as high as 1.4per cent of 1999 GDP. They contribute to two-thirds of the losses, 38 percent of the 'bad loans' and 73.6 per cent of the tax arrears (holding 53.2per cent of the remaining state-owned assets and 33 per cent of totalemployment). The government is solving this problem throughprivatization (of metallurgy and chemical industries), through priceincreases for monopolies, and through some sort of commodity credit tostate railways from the NEC. This policy proved successful: state-ownedenterprise losses have been reduced 2.5 times from the first to the secondquarter of 1999.

In 1998 and 1999, the pension system's deficit was reduced to 3 percent and 1 per cent of GDP, respectively, but the system is undergoing aprofound reform.

The impact of this constellation of factors on savings, investment andearnings is diverse. As a percentage of GDP, savings decreased two timesfrom 1996 to 1997 (from 40 per cent to 21.1 per cent of GDP,respectively). Since 1997, there is 0.5 per cent increase, and for the lastthree quarters, there has been no sign of change. Investment droppedfrom more than 30 per cent of GDP in 1990 to 11 per cent in 1993,remaining at that level until 1996, when it sank again by 2 per cent.From 1997 to the first half of 1999, it picked up to 14.3 per cent of GDP.Real wages stabilized at 110 per cent of the pre-crisis 1995 level.

For the last seven years, foreign investment inflows in Bulgaria haveconstantly increased, from $34.4 million in 1992 to $620 million in1998. Nevertheless, they are quite insufficient to compensate for the lackof domestic investment potential, since foreign direct investment (FDI)per head was about $35 a year. This is due to internal factors, namely,the institutional obstacles that existed before privatization, the unstablelegal environment of business, the underdeveloped capital market andthe previous restrictions on the capital account.

Banks were slow to react to the introduction of the CBA. In 1999,they met the Bank for International Settlements' capital adequacy ratio,but they did not fulfil service quality standards because of the limitedvariety of products offered. The total assets of Bulgaria's banking sectorequalled about 43.4 per cent of GDP in 1997 and dropped to 34.9 percent of GDP in 1998, far below standards in developed countries(normally more than 100 per cent). The sector is dominated by a fewlarge state-owned banks. Four out of seven of the largest Bulgarianbanks, which represent 70.7 per cent of banking system assets, are stillstate-owned, though they are scheduled for privatization by the end of2000. One state-owned bank, Bulbank, holds 26.8 per cent of totalbanking system assets. State ownership continues to negatively influence

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

154 BALKAN RECONSTRUCTION

the banking sector's operations. Privatization, however, is underway: thecountry's second and third largest banks have been privatized, and thepolicy is to sell banks to institutions with the best possible brand nameand service quality, ie to foreign institutions.

During the reform years, the demand-side structure of GDP (seeTable 8) changed in the direction of an increased share of householdconsumption and a decreased share of the government's finalconsumption and investments, by about one-fifth on either side. In pre-reform years, the share of net exports varied from -7.4 per cent to 5.5per cent. Between 1991 and 1998, it contracted roughly five times,indicating the low competitiveness of Bulgarian products. Although theshare of the government's expenditures for final consumption hasdropped from 17.2 per cent to 15.1 per cent, the state retains adominant share in the economy, since more than 40 per cent of GDPgoes through the budget. Moreover, state companies still own a hugechunk of the economy's assets.14

The sector structure of aggregate output is most accuratelyrepresented by gross value added (GVA). Table 9 shows a significantdecline for industry share and an equivalent increase in the shares ofservices and agriculture. Several factors led to this change in GVA

TABLE 8

DEMAND-SIDE STRUCTURE OF GDP (shares)

Private consumptionGovernment consumptionInvestmentsNet exports

Source: NSI

STRUCTURE

IndustryAgricultureServices

Source: NSI

1991

55.9%17.2%22.6%

4.3%

TABLE 9

OF GVA* (shares in

1991

42.814.243.0

1999

71.3%15.1%14.7%-1.1%

per cent)

1998

26.817.355.9

Note: *GVA represents GDP minus adjustments, which are the financial intermediationservices indirectly measured, nondeductible value-added tax, excises and importduties.

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

BULGARIA 155

structure: the industrial sector's restructuring through privatization andliquidation of state-owned enterprise; the restitution of lands, whichincreased the share of agriculture; and the emergence of the privateservice sector.

Privatization and liquidation of state-owned companies contributedto the change in the ownership structure of GVA, since the share of theprivate sector reached 63.7 per cent, starting from almost zero in 1989and almost tripling its share between 1992 and 1998.

In the last six years, the private sector has tripled its share in GDP,compensating for the declining output of state-owned enterprises, oftenloss makers. In the last ten years, private sector output shrank only once(June 1996 to February 1997), by 8 per cent, but still less than the publicsector for the same period. This can be attributed to sharp currencydepreciation and hyperinflation. In the first half of 1999, the privatesector generated 54 per cent of GDP and increased its share in industrialoutput. It produces twice as much (measured as a share of GVA) asgovernment-owned enterprises, while employing only 40 per cent morepeople (or 59 per cent of the labor force). In 1999, the private sector alsodemonstrated 75 per cent higher productivity than public sectorenterprise. It accounts for 60 per cent of long-term bank credit and,along with households, dominates the new borrowing; the governmentsector has had no new borrowing since September 1998. A comparisonbetween the private sector in GVA and credit (see Table 10) suggests thata robust private sector may become the major force driving the Bulgarianeconomy.

CONCLUSION

Several major reasons account for the long-lasting misperformance of theBulgarian economy. First, the transition period relatively quicklyremoved the institutional framework of the centrally planned economy,

TABLE 10

PRIVATE SECTOR - DYNAMICS OF SHARE OF EXTENDED CREDIT IN CVA(% OF TOTAL), 1993-98

Share of credit extendedShare of enterprise investments

(expenditures for purchasingfixed assets)

Share of CVA

1993

12.4022.76

35.40

1994

13.9039.04

39.40

1995

25.9044.45

48.00

1996

21.2138.53

52.50

1997

57.4954.40

58.80

1998

63.3n/a

63.7

Source: NSI, BNB

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

156 BALKAN RECONSTRUCTION

while the establishment of the free market institutional frameworkturned out to be a long trial-and-error process. The first years after 1989brought about a gap in the 'co-ordination of the economy',15 resulting ina delay in the reallocation of resources previously employed by thesocialist industry. Unclear property rights, the non-functioning legalsystem and the underdeveloped financial system may be viewed as majorcharacteristics of this framework.

Second, the restructuring of the real sector required the political willto privatize and liquidate loss-making enterprises. In turn, administrativebacking was needed to implement and sustain the will to lift thatresponsibility off the government's shoulders. Either a lack of politicalwill or misconceptions about privatization and liquidation allowed theeconomy to lose seven years.

Finally, government-retained control over state-owned assets slowedthe liberalization of economic life (in terms of domestic and foreigntrade controls and permissions, and procedural and tariff barriers,combined with unstable tax regulations) and has kept the businessenvironment rather unfriendly.

The following policy lessons seem relevant. First, the transition couldhave been much less costly in terms of lost wealth and economicopportunities if the state had concentrated on establishing the freemarket institutional framework, rather than over-regulating the newbornprivate sector. For nine years, the private sector has often compensatedfor decline in the government sector.16 It has constantly increased its rolein different segments of GDP creation, and in the first half of 1999,compensated for the sharp decline of government-owned former exportleaders. Second, monetary stability has proven to be a crucial factor fordevelopment. The best way - in Bulgaria's case - to achieve it wasthrough the CBA, which restricted the government's monopoly on themoney supply and tied the central bank's monetary 'policies' to itsforeign reserves. Thus, the envisioning of competitiveness and flexibilityof economic entities seem to have become a key condition for prosperity.

NOTES

1. R. Dobrinski (1997): Transition Failures: Anatomy of the Bulgarian Crisis, Vienna:Vienna Institute of International Economic Studies, p.7.

2. Bulgarian National Bank (BNB) (1991): Annual Report, p.17.3. For the sake of comparison, Poland's foreign debt was 80 per cent to the Paris Club

and 20 per cent to the London Club; this made Poland's debt restructuring much easierfor purely technical reasons. In addition, it is noteworthy that in March 1990 Bulgariaunilaterally announced a moratorium on its foreign debt payments, and in 1991, thefirst reform year, the Bulgarian foreign debt amounted to 150 per cent of GDP and 271per cent of exports. See BNB (1991): Annual Report, p.30.

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014

BULGARIA 157

4. See V. Antonov and R. Avramov (eds.) (1992): The Year of the Iron Sheep: BulgarianEconomic Reform in 1991, Sofia: Agency for Economic Coordination andDevelopment (AECD).

5. See W. Wilczynski (1996): 'Five Years of the Polish Transformation: 1989-1994', inFive Years After June: The Polish Transformation, 1989-1999, J. Winiecki (ed.)London: The Centre for Research into Communist Economies, p.24.

6. Article 18 of the Bulgarian Constitution establishes 12 exclusive governmentmonopolies on energy, communications, mineral, natural and water resources, andcoastal area and transportation. The constitution, however, stipulates that execution ofthese exclusive rights should be regulated by a specific law. Such a law, the ConcessionsLaw, was adopted in November 1995 but has still not been implemented.

7. Source: National Statistic Institute (NSI).8. The views of the author differ from those of the majority of Bulgaria economic

observers.9. March was an exceptionally good month for 1999 exports, the only month equalling

the average monthly export volume of 1998; April represents the rough averagemonthly export for the first half of 1999.

10. A detailed description of the money transfer mechanism may be found in R. Avramovand K. Guenov (1995): Rebirth of Capitalism in Bulgaria, Sofia: AECD.

11. See G. Caprio and D. Klingebeil (1996): 'Bank Insolvencies: Cross-CountryExperience', unpublished, Washington, DC: The World Bank.

12. See R. Avramov (1999): 'The Role of a Currency Board in Financial Crises: The Caseof Bulgaria', BNB Discussion Paper 6.

13. See for details, Banking Sector Management Under the Currency Board (1999), Sofia:Institute for Market Economics.

14. Even after the largest privatization deals are completed (expected in the first half of2000), about 35 per cent of the assets will remain state property.

15. The term is used by Janos Kornai.16. An exception is the period from mid-1996 to early 1997, when private sector output

also declined, though at a slower pace.

Dow

nloa

ded

by [

Kun

glig

a T

ekni

ska

Hog

skol

a] a

t 09:

38 1

1 O

ctob

er 2

014