Stagflation fears

Bulgaria’s public finances will remain unproblematic despite some impact from the recent crises. The country has had a long-lasting commitment to fiscal prudence, reflected in many years of fiscal surpluses or acceptable deficits. Following annual surpluses in 2016-2019 (+1.3% of GDP on average), fiscal stimulus measures, lower revenues and declining nominal GDP in the wake of Covid-19 resulted in annual fiscal deficits of around -4% of GDP in 2020-2021, and gross public debt rose from 20% of GDP in 2019 to 24% in 2021. Another fiscal shortfall of approximately -4% of GDP was posted in 2022 as a consequence of fiscal stimulus in order to mitigate the impact of the war in Ukraine on the Bulgarian economy. Looking ahead, we forecast the annual fiscal deficit to fall to just below -3% of GDP in 2023-2024 as rising financing costs will contain fiscal stimulus while nominal GDP will surge in line with high inflation. The public-debt-to-GDP ratio should stabilize around 24%. However, this will still be a very favorable ratio by EU standards.

As a result of its long-standing prudent economic policies, Bulgaria was admitted to the Exchange Rate Mechanism II (ERM-II), the “waiting room” for eventual adoption of the EUR, in July 2020. In conjunction with ERM-II membership, Bulgaria also joined the European banking union in October 2020. We expect the country to adopt the EUR in 2025 at the earliest.

Bulgaria’s external finances will remain favorable. After seven years of current account surpluses from 2013 to 2019, reflecting a continued solid export performance, Bulgaria posted small annual external deficits in 2020-2022, mainly as a result of lower exports of services (tourism). Softening external goods demand also played a role in 2022. We forecast the annual external shortfalls to widen moderately to the range of -1% to -2% of GDP in 2023-2024 as the projected sharp economic slowdown in Western Europe will additionally weigh on Bulgaria’s exports while the country’s import demand (especially for energy and food) will remain more stable. Meanwhile, the steady downtrend in the gross external debt-to-GDP ratio was only briefly interrupted in 2020 in the wake of the Covid-19 crisis. It has declined from a peak of 107% of GDP in 2009 to 58% in 2021 and is on course to fall further in the coming years. While this ratio is still relatively high compared to the median of all emerging markets, Bulgaria now has one of the lowest ratios among the 11 EU member states in CEE.

Bulgaria’s FX reserves have increased substantially since end-2013 and stood at EUR33bn at end-2022, a comfortable level with regard to import cover (more than six months). Moreover, in other terms, reserves cover about 170% of the estimated external debt payments falling due in the next 12 months, a favorable ratio and a significant and steady improvement from 80% in 2011.