Crash Course for Bulgaria?

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Crash Course for Bulgaria?

Bulgaria entered the EU a year ago to great fanfare, but its ever increasing inflation and current-account deficit numbers suggest the party may now be over, reported RGE Monitor.

Bulgarian annual price rises have jumped from the single-digits in 2006 to 12.6% year-on-year in November 2007. Meanwhile, the current-account deficit came in at a whopping 17% of GDP for the year to October and will likely top 20% of GDP for 2007 as a whole.

Not long ago a current account deficit of 7% of GDP sent alarm bells ringing. Not surprisingly, analysts have started sounding warnings.

Meanwhile, Danske Bank, in a recent report, classified Bulgaria in the “danger zone”, along with the Baltic states and Romania, saying they are the most likely emerging European countries to face an economic hard landing.

On the surface, Bulgaria appears very similar to the overheating Baltics and looks set for a hard landing, but things might not be as dire as they seem. While analysts agree that Bulgaria’s current account deficit is the country’s chief risk and that its trajectory is unsustainable, not all seem as willing as Danske Bank to place Bulgaria in the same “danger zone” as the Baltic states.

Some analysts have dissected the capital inflows funding Bulgaria’s current-account deficit, providing insight into the country’s true level of vulnerability. In a recent report, the IMF points out that Bulgaria’s capital inflows are primarily a private investment, rather, than a consumption, story.

At the very least, this suggests Bulgaria’s current-account deficit is not the result of a consumer spending binge that would provide no boost to the country’s longer-term productivity.

Between 2002 and 2007, (Bulgaria’s) gross domestic investment as a share of GDP surged by 15 percentage points, mainly due to rising private investment. This sharp increase in investment stands out in the cross-country comparison, not only relative to the neighboring countries but also with fast-growing emerging countries in the other regions.

At the same time, the private consumption-GDP ratio has in fact trended downward somewhat—despite the rapid rising retail sales and high household credit growth—while consumer goods imports only picked up moderately.

The IMF concludes Bulgaria’s deficit is largely the result of a one-off private investment boom, triggered by its strong macro stability record and a marked reduction in microeconomic risks (anchored by EU accession).

Once the boom tapers off, as the IMF expects will happen, the current account deficit is projected to approach equilibrium levels estimated to be around 8% of GDP, with a range of 5–10% reflecting different estimation methodologies and whether or not future EU capital grants are taken into account.

So while the IMF notes that the present trajectory of Bulgaria’s current-account deficit is unsustainable, its assessment does not suggest an abrupt or painful current-account adjustment is imminent or a given.

To fund its sky-high current-account deficit, Bulgaria relies heavily on continuing capital inflows. That means Bulgaria is vulnerable to any shock or loss of confidence that could stop them. But looking at the structure of Bulgaria’s capital inflows mitigates some of the concern that there will be an abrupt unwinding.

Unlike many of its emerging Europe peers, Bulgaria’s FDI in recent years has more than fully financed its current-account deficit. Because FDI is generally longer-term and harder to unwind than portfolio investment, a sudden capital reversal is unlikely, as Fitch notes in a March report.

And depending on the destination of the FDI, the current-account deficit could be self-correcting if the FDI boosts Bulgaria’s export capacity, helping it generate revenues to close the trade deficit in the future.

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