Massive capital inflows fail to boost productivity
Overview:
Bulgaria has thus far proved resilient to the global financial crisis and has enjoyed strong growth and massive capital inflows over the last few years. However, while the combination of fiscal prudence and a currency board regime have provided a sound anchor for policies they have not prevented a rapid accumulation of private sector debt. FDI inflows have more than financed the huge current account deficit over the last few years. However, they have not succeeded in raising productivity sufficiently and have been accompanied by debt-creating inflows. Indeed, the latter inflows have raised economic vulnerabilities given that a high proportion of this debt is both short-term and denominated in foreign currencies. Bulgaria has considerable work to do to improve the rule of law in order to ensure the resumption of EU funds.
Recommendation:
We are underweight on Bulgarian external debt. The currency board regime is stable and the public sector in a sound financial position. Fiscal policy can be eased slightly to ameliorate what is likely to a sharp slowdown. But the government may ultimately need to re-finance some private sector obligations although it is well placed to do so given its low debt and large deposits held at the central bank. Political noise will rise ahead of parliamentary elections in the summer.