Cause and Effect in European Politics and Law

Bulgaria expects rating upgrade in July

Dessislava Dimitrova, May 14, 2011

Just around a year ago Bulgaria’s economy was shaken by two announcements. On May 12 (2010) the European Central Bank published its regular convergence report, according to which Bulgaria definitely did not meet all the criteria to adopt the euro. The same day, the European Commission said it had launched an excessive deficit procedure (EDP) against Bulgaria, just a few weeks after the country’s Finance Minister Simeon Djankov admitted that, due to "hidden" procurement deals, the 2009 budget deficit was actually higher than first estimates indicated.

Inbetween Djankov’s announcement and the Commission's warning, the global credit rating agency Moody’s said that a rating upgrade for Bulgaria was still possible in the next 12-18 months, despite the recent announcement that the 2009 budget deficit was much higher than previous estimates, but it was conditional upon fiscal consolidation that stabilises the government debt burden, as well as the re-emergence of sustainable economic growth. A year later, the situation seems rather optimistic, at least based upon Moody’s latest report on Bulgaria’s economy, which was issued in the beginning of May.

Before taking a look at the report itself, I should mention that soon Bulgaria might remain without such reports as just within a year the government (calling it cost-cutting), cancelled the contracts with two of the four rating agencies it used to work with in the past few years. So far, however, Moody’s and Standard and Poor’s will continue to monitor what is happening in Bulgaria’s economy.

The other point that we have to bear in mind while reading Moody’s latest report, is that, as the document itself reads, it is an annual update to the markets and is not a formal action to alter the credit rating of the issuer. I needed to mention that, because some Bulgarian media have the habit to report that the country’s rating was confirmed in cases of a rather analytical report, which does not include formal action.

In this sense, the official statement, released by Bulgaria’s Finance Ministry, this time says indeed what Moody’s has actually claimed - that the ratings are currently on review for a possible upgrade. All in all, according to the analysts, the government finances are extremely healthy, with low debt, the general government deficit shrank last year to just over the Maastricht limit of 3% of GDP from 4.7% in 2009, which has been important for the restoration of market confidence and the government’s official target of 2.5% looks realistic, based on the first-quarter results and the dynamism of economic recovery.

The report highlights four main areas and here are some details about each of them:

Economic strength:

The conclusion here is not unexpected: On a per capita basis, Bulgaria is the poorest country in the EU (although roughly equal to Romania). Still, this means that Bulgaria has a lot of converging ahead, after gradually narrowing the income gap with the EU during the pre-crisis era. At the same time, however, according to the report, the pace of convergence is likely to decelerate between some of the lower-income countries in Europe and the European average. This partly reflects the fact that the fastest-growing countries won’t necessarily be those with lower incomes, as witnessed by the growth registered the past year in Germany, for instance.
What Moody’s recommends, in spite of those examples, Bulgaria to go ahead with its efforts to narrow the gap with EU average with growth rates of 4%-4.5% annually.

Institutional Strength

Here we can find the well-known issue we have seen in other reports too. Moody’s reminds us that Transparency International still ranks Bulgaria as the second-most corrupt EU country after Greece, and close to Italy and Romania. ”The current administration has made the reduction of crime and corruption and the improved absorption of EU funds – two key institutional weaknesses – a top priority, and signs point to advancements in the past year,” the report reads.

As for another priority – joining the Schengen area, the analysts say that surveillance of the Turkish border seems to be the last impediment to Bulgaria’s entrance, but even this is likely to be satisfied this year, perhaps as early as June. Bulgaria’s institutions are very strong when it comes to prudent fiscal policies, monetary policy and banking system regulation, and these strengths and the superior quality of the information provided by a highly competent professional bureaucracy, offset the weaknesses stemming from the rule of law in the overall assessment of institutional strength, the report adds.

Government Financial Strength:

Currency boards are both a strength, from the standpoint of macro stability, and a potential vulnerability representing tail risks from an external/financial standpoint, Moody’s says. If external pressures become inordinately strong, the currency board would not hold without exerting extreme stress on the real economy and corresponding pressure on the fiscus. Alternatively, if the currency board ‘breaks’ and the exchange rate peg is changed or abandoned, this would inevitably lead to a large depreciation and worsen the external debt metrics by the extent to which the system is euroized and government debt is foreign currency-denominated.

Speaking about the euro and the eurozone, the report also mentions Bulgaria’s decision to join the Euro+ Pact, also adding that there was some controversy about this domestically, since wage moderation included in the pact could be seen as precluding faster-than-average wage increases in Bulgaria, which still has a lot of income convergence ahead of it. Another issue, according to the agency, is the harmonisation of tax rates, since Bulgaria has such low income tax rates and wants to maintain them to help boost growth potential.

The main reasons for assessing susceptibility to event risk are the euroization of the economy and the currency peg, which drive financial risk, and the economy’s and banking system’s close ties with Greece as far as economic event risk is concerned, Moody’s also says.

The ratings review is set to be completed in three months time and Moody’s can "hopefully" upgrade Bulgaria's credit rating in early July, senior Moody's analyst Anthony Thomas said, quoted by Reuters.