Cyclopedia Of Economics 3rd edition

Bulgaria is proof that not all currency boards are destined to an Argentine denoument. Having witnessed its GDP plunge by one third between 1989 and 1997, it has risen by 11% in the three years since, driven by net exports and domestic demand, in equal measures. This was achieved as hyperinflation was reduced to an annual rate of 1.7% in 1998. It has since worryingly climed back to 11.4% last year and has come down to only 8% since, due to higher energy prices and a severe draught. Bulgaria also re-paid its sovereign debt so that it now constitutes less than 70% of its GDP. This is often attributed to strict fiscal policies (the budget deficit amounts to c. 1% of official GDP and wage bills in most loss making state enterprises have been frozen) and to a successful implementation of a currency board. The boards is very popular with the Bulgarian: it gave them a stable currency, increased exports, liquified banks and halved interest rates, among other benefits. After years of crony privatizations ("management and employee buyouts") financed by criminal groups and followed by widespread asset stripping and a botched voucher cum investment funds scheme - more than 80% of bank assets and 50% of state enterprises have been genuinely privatized (often through the stock exchange). A series of well publicized and government sponsored raids by police ands tax authorities on the likes of "Multigrup", the penumbral holding company, have gone a long way towards decriminalizing the economy. And corrupt Ministers are being given the boot as a matter of course. The authorities have also been making the right noises regarding health care, pensions and bank supervision. Real investment, depressed wages, and restructuring led to higher productivity and enhanced competitiveness.

All sectors experienced growth. The failed transition from communism to a market economy forced many Bulgarians to go back to agriculture. This process has reversed and re-industrialization commened. Gross fixed investment almost doubled itself to 16% of GDP. Though most foreign direct investment (FDI) comes from poor and non-sophisticated non-EU countries and is plunged into labour-intensive greenfields, FDI (half of it in privatization proceeds) climbed 10-fold to $1 billion. The FDI stock (and with, sorely needed technology, intellectual property, knowledge and management) reached $3 billion at the end of 2000.

Surprisingly, these macro-economic achievements had little effect on the business climate. Bulgarian businessmen have remained largely sceptical of the economic prospects of their country. Enterpreneurship is still obstructed by insufficient infrastructure, inefficient, arbitrage-orientated and lending-averse banks, and over-regulation (e.g., in the energy sector). Venal red tape deters investors. There is no central revenue authority, for instance, and no functioning treasury system. Labour taxes are stratospheric and drive people into the thriving informal economy (estimated to be about one third of the total). And, despite being a trading nation, Bulgarian customs duties and tariffs are both complex and high.

The lot of simple people has not discernibly improved either. Output is 30% below the communist-era peak. Unemployment is high by European standards (between 16 and 18%). The average monthly income in  southern Bulgaria (an agricultural and textile area that borders Greece) is still $50 or less, one of the lowest in any economy in transition. Wages are one fourth the EU's. Cheap labour has its advantages, though. It attracts "foreign direct" investment (shoes and textile sweat shops) and generates foreign exchange (seasonal workers).

The pace of structural reform has slowed to a halt in the latter part of 2000. The presentment of important bills (such as the Energy Law) has been postponed. Lucrative but growth retarding monopolies (from tobacco to telecom) have been left untouched, despite a revamped Privatization Law. Should this continue, Bulgaria may find it harder to attract the FDI that, last year, covered its gaping current account deficit (equal to 6% of GDP). Foreign exchange reserves (at $3.6 billion, or almost 6 months of imports) are sufficient to offset a run on the lev - but rising inflation does take its toll on the competitiveness of Bulgarian products. In real terms, the lev has appreciated by 20% since the end of 1996 (1 lev equals 1 DM).

Bulgaria is still too dependent on handouts or multilateral "investments" from the likes of the IMF, the World Bank, and the Stability Pact. It claims to have lost over $6 billion in export proceeds during the Danube-blocking 1999 Kosovo crisis and its aftermath. The war affected rail transport and tourism as well. Bulgaria may be adversely affected by fighting in its tiny neighbour, Macedonia, and in Bosnia. The meltdown of Turkey's economy - one of Bulgaria's important trading partners - and a looming recession in the USA and Japan - may also have an impact. Should inflation or the current account deficit worsen, the government will have to tighten its fiscal stance and, thus, induce a recession. Elections in June may make it difficult to maintain fiscal discipline, though.

Can Bulgaria continue to grow by 5% a year? Not if its investment rate doesn't. It needs to increase by 20%. Human capital needs to be better exploited (unemployment needs to drop). The IMF reckons that "total factor productivity (TFP) growth rates of around 2% p.a. will be required" (IMF Country Report 01/54, p. 6). This cannot be achieved without non-comprmising and socially dislocating structural reform. Bulgaria faces now the tough choices that post-communist countries such Hungary, Poland and Estonia faced years ago.

Bulgaria has only one political voice: the voice of the aspiration to prosperity. The lure of EU membership coupled with the need to comply with IMF and World Bank conditions served to homogenize party platforms across the spectrum. A national consensus regarding free markets, protection of property rights, civil society, EU and NATO membership, institution building, and cautious macroeconomic policy renders the political parties virtually indistinguishable.

Bulgaria experienced one of the most difficult periods of transition among the post-communist countries. Poverty reached a nadir in the years 1993-1998 with food rationing and shortages of basic subsistence goods. The government of the barely reformed Communists ("Bulgarian Socialist Party"), headed by Jan Videnov, wrought total devastation on Bulgaria. Hyperinflation, rising unemployment, a dysfunctional financial sector, cronyism, organized crime, an unrestructured and crumbling industrial sector brought it down in the 1997 elections, won by the UDF (United Democratic Forces) coalition.

The UDF is led by the SDS (Union of Democratic Forces) and incorporates most of the conservative wing of Bulgarian politics: the Democratic Party (DP), a few agrarian splinters and the BSDP (Bulgarian Social Democratic Party). It is led by the energetic Ivan Kostov. His appeal rested with his (relatively) clean record - but mainly with his experience in economic management. Chairman of the Economic Commission and finance minister in two post transition governments, he was perceived to be the right man for the job of reviving Bulgaria's moribund economic fortunes. The UDF espouses a form of free marketry tampered by (rather imperceptible) tinges of "social responsibility". It is ardently pro-EU, pro-privatization and, in short, pro IMF. The introduction of a currency board was a master stroke which served to stabilize the lev and maintain macro-economic and monetary stability. Anti-corruption campaigns enhanced the government's modernizing image. It all had little effect on the quotidian life of the average Bulgarian and disaffection and disillusionment are rampant. But a palpable strengthening of Bulgaria's international posture (visa free travel to the EU, accession talks) ameliorated the national mood of disappointment for a while. Recently, though, a series of corruption and wiretapping scandals and criminal shootouts have tarnished the UDF's image. The war in Macedonia has the potential to scare away foreign investors and embroil Bulgaria in a third Balkan War. Anxiety is high.

On the right, a new and surprising force has emerged.

Simeon Borisov Koburgotski, also known as King Simeon II has lived in exile, in Spain for over 50 years. But in 1996, he visited his homeland. He provoked an hitherto unrequited wave of messianic economic and social expectations. In April 2001, Mr. Koburgotski established the "National Movement". Apart from a few unrealistic ad populist promises, its economic platform is virtually indistinguishable from the UDF's and much vaguer at that:

"...Three essential goals: first, immediate and qualitative change in the standards of living, by turning the economy into a working market economy in accordance with the European Union criteria for membership, as well as by an increase of the flow of global capital. I am ready to propose a system of economic measures and partnerships which, within 800 days and based on the well known Bulgarian work ethic and entrepreneurial skills, will change your life. Second, by abandoning the political partisanship and unifying the Bulgarian nation along historical ideals and values that have preserved its glory for all its 1300-year history. Third, by introducing new rules and institutions to eliminate corruption, which is the major enemy of Bulgaria, causing poverty and repelling vital foreign investments."

The Bulgarian left provides for a very disheartening political landscape.

The Bulgarian Socialist Party is now the nucleus of an emerging 16-member opposition, the New Left Alliance. The Alliance is made up of parties which support old socialism, labour orientated policies, and the maintenance of a social safety net. This is very akin to other European left and social democratic parties. the parties of the Alliance are intent on merging into a single entity after the elections, though the diversity of the group - nationalists, communists, socialists, agrarians, feminists and Roma - renders this nigh impossible. The Turkish minority is Bulgaria (one tenth of the population) spawned the other opposition grouping, the Movement for Rights and Freedoms and has been excluded from the Alliance. The Alliance's leader, Georgi Parvanov, is making distinctly pro-Western and anti-"archaic Communism" noises. This did not prevent a power sharing pre-election agreement with the unreformed Communist party. Many regard these astonishing twists and turns as sheer opportunism. Other simply ridicule these improbable bedmates. Yet, they may still surprise. They derive hope and courage from the Romanian precedent, where the socialists surged ahead and won the elections. To adopt Romania as a model one truly needs to be desperate, retort many Bulgarians.

Last year (2003), Bulgaria, currently sitting on the Security Council, was one of ten east and southeast European countries - known as the Vilnius Group - to issue a strongly worded statement in support of the United States' attempt to disarm Iraq by military means. This followed a similar, though much milder, earlier statement by eight other European nations, including Hungary, the Czech Republic and Poland, the EU's prospective members in central Europe.

The Vilnius Ten - including Albania, Bulgaria, Croatia, Estonia, Latvia, Lithuania, Macedonia, Romania, Slovakia and Slovenia - called the evidence presented to the Security Council by Colin Powell, the US Secretary of State - "compelling". Iraq posed a "clear and present danger" - they concluded.

Bulgaria and Romania pledged free access to their air spaces and territorial waters. The first US military plane has landed today in the Safarovo airport in the Black Sea city of Burgas in Bulgaria. Other members are poised to provide medical staff, anti-mine units and chemical protection gear.

Such overt obsequiousness did not go unrewarded.

Days after the common statement, the IMF - considered by some to be a long arm of America's foreign policy - clinched a standby arrangement with Macedonia, the first in two turbulent years. On the same day, Bulgaria received glowing - and counterfactual - reviews from yet another IMF mission, clearing the way for the release of a  tranche of $36 million out of a loan of $330 million.

Partly in response, six members of parliament from the ruling Simeon II national Movement joined with four independents to form the National Ideal for Unity. According to Novinite.com, a Bulgarian news Web site, they asserted that "the new political morale was seriously harmed" and "accused the government of inefficient economic program of the government that led to the bad economic situation in the country".

Following the joint Vilnius Group declaration, Albania, Croatia, Bulgaria and Macedonia received private and public assurances that their NATO applications now stand a better chance. Bulgaria started the second round of negotiations with the military alliance yesterday and expects to become full member next year. The head of the US Committee on NATO Enlargement Bruce Jackson stated: "I'm sure that Bulgaria has helped itself very much this week."

Yet, the recent rift in NATO (over Turkish use of the Alliance's defense assets) pitted Germany, France and Belgium against the rest of the organization and opposite other EU member states. It casts in doubt the wisdom of the Vilnius Group's American gambit. The countries of central and east Europe may admire the United States and its superpower clout - but, far more vitally, they depend on Europe, economically as well as politically.

Even put together, these polities are barely inconsequential. They are presumptuous to assume the role of intermediaries between a disenchanted Franco-German Entente Cordiale and a glowering America. Nor can they serve as "US Ambassadors" in the European corridors of power.

The European Union absorbs two thirds of their exports and three quarters of their immigrants. Europe accounts for nine tenths of foreign direct investment in the region and four fifths of aid. For the likes of the Czech Republic and Croatia to support the United states against Germany is nothing short of economic suicide.

Moreover, the United States is a demanding master. It tends to micromanage and meddle in everything, from election outcomes to inter-ethnic relations. James Purdew, America's ambassador to Sofia and a veteran Balkan power broker, spent the last few weeks exerting pressure on the Bulgarian government, in tandem with the aforementioned Bruce Jackson, to oust the country's Prosecutor General and reinstate the (socialist) head of the National Investigation Services.

Bulgaria is already by far the most heavily enmeshed in US military operations in Asia. It served as a launch pad for US planes during the Afghanistan campaign in 2001-2. It stands to be affected directly by the looming war.

Bulgaria is on the route of illicit immigration from Iraq, Palestine and Iran, via Turkey, to Greece and therefrom to the EU. Last Friday alone, it detained 43 Iraqi refugees caught cruising Sofia in two Turkish trucks on the way to the Greek border. The Ministry of Interior admitted that it expects a "massive flow of (crossing) refugees" if an armed conflict were to erupt.

The Minister of Finance, Milen Velchev, intends to present to the Council of Ministers detailed damage scenarios based on a hike in the price of oil to $40 per barrel and a 3-4 months long confrontation. He admitted to the Bulgarian National Radio that inflation is likely to increase by at least 1-1.5 percentage points.

The daily cost of a single 150-member biological and chemical defense unit stationed in the Gulf would amount to $15,000, or c. $500,000 per month, said the Bulgarian news agency, BTA. The Minister of Defense, Nikolai Svinarov, told the Cabinet that he expects "maximum (American) funding and logistical support" for the Bulgarian troops. The United States intends to base c. 400 soldiers-technicians and 18 planes on the country's soil and will pay for making use of the infrastructure, as they have done during operation "Enduring Freedom" (the war in Afghanistan).

Bulgaria stands to benefit in other ways. The country's Deputy Foreign Minister, Lyubomir Ivanov, confirmed in another radio interview that the Americans pledged that Iraqi debts to Bulgaria will be fully paid. This can amount to dozens of millions of US dollars in fresh money.

Is this Bulgaria's price? Unlikely. Bulgaria, like the other countries of the region, regards America as the first among equals in NATO. The EU is perceived in east Europe as a toothless, though rich, club, corrupted by its own economic interests and inexorably driven by its bloated bureaucracy. The EU and its goodwill and stake in the region are taken for granted - while America has to be constantly appeased and mollified.

Still, the members of the Vilnius Groups have misconstrued the signs of the gathering storm: the emerging European rapid deployment force and common foreign policy; the rapprochement between France and Germany at the expense of the pro-American but far less influential Britain, Italy and Spain; the constitutional crisis setting European federalists against traditional nationalists; the growing rupture between "Old Europe" and the American "hyperpower".

The new and aspiring members of NATO and the EU now face a moment of truth and are being forced to reveal their hand. Are they pro-American, or pro-German (read: pro federalist Europe)? Where and with whom do they see a common, prosperous future? What is the extent of their commitment to the European Union, its values and its agenda?

The proclamations of the European eight (including the three central European candidates) and the Vilnius Ten must have greatly disappointed Germany - the unwavering sponsor of EU enlargement. Any further flagrant siding with the United States against the inner core of the EU would merely compound those errors of judgment. The EU can punish the revenant nations of the communist bloc with the same dedication and effectiveness with which it has hitherto rewarded them. Ask Israel, it should know.

There is something worrying about a neophyte politician who promises to improve the living standards of his electorate "in 800 days" - less than 80 days after he returned to his country following an absence of 50 years. There is an eerie similarity between the promises made by the UDF upon its ascendance to power four years ago - and those made by the ex-King's party on the election trail. Ivan Kostov, the former Prime Minister, also came to power surrounded by eager, reform-touting, Western minded, business-orientated young geeks. They were all co-opted by corrupt interests within the year. Kostov lost power because he failed to improve the economic lot of ordinary citizens while displaying a suspicious reluctance to tackle virulent corruption in high places. Curiously, the economic advisor to the President of Bulgaria is the PM's son - Cyril Koburgotsky.

After taking an oath of loyalty in parliament, the new PM attended a special prayer service. Prayers are called for. The Bulgarian economy is sputtering. After a spectacular recovery of 11% between 1998-2000, growth has stalled, unemployment is close to 20%, and inflation shot up to 8%. Half the population is under the official poverty line. A sham privatization of state assets allowed criminal business groups to infiltrate the Bulgarian economy. The private sector is encumbered by venal red tape and inflexible labour laws. These problems are further compounded by the deteriorating economic outlook of Turkey, one of Bulgaria's largest trade partners - and the political strife in Macedonia, its neighbour and vital transport route.

The new Minister of Finance, Milen Velchev, 35, is an expert in the restructuring of sovereign external debt and has worked for Merril Lynch in London. In an interview he granted to "The Economist" (July 21st-27th issue) he had nothing original to say. "Our economic philosophy is much the same as the UDF's". But he did promise to be "more radical" in implementing it. No wonder the UDF pledged it "would co-operate with the new government on issues that would continue the reformist programme of the past four years". Mr. Saxe-Coburg already vowed to preserve the crowning achievement of the previous government, the DM-pegged currency board. To fight corruption, he promised to streamline procedures in investor-friendly "one stop shops".

How is all this related to the rampant poverty of the PM's constituency? It is not. In the heat of the campaign, the Royal did not hesitate to dole out promises of interest-free loans (5000 levs - c. 2200 US dollars - per household), coupled with massive increases in pensions and pay. There is not the slightest chance or intention to keep these profligate undertakings. The new economic ministers are fiscal conservatives, aiming at zero public borrowing. Interest free loans? To small businesses only, mumble the embarrassed former stock broker, Velchev: "Don't expect miracles. We would hope that things start improving by the third year. The king himself talks of 800 days." The PM made clear that "The Bulgarian economy cannot grow without growth of the income of the population", and that he intended to attract back Bulgarian flight capital by revamping the banking system, introducing international accounting standards, and attracting foreign investors to buy shares in Bulgarian firms.

In December 1999, in an interview to the BBC, Velchev said: "In 1999 Bulgaria consolidated the macro-economic stability that it achieved in 1997 and 1998. (It was) a successful step by the Government the fact that the World Bank and the IMF guaranteed the balance of payments and the gradual increase in Bulgaria's foreign exchange reserves. This gave the necessary political courage to carry out the redenomination of the lev... (Yet) no successful deals were completed in 1999... There has been talk of successful deals in the energy sector for quite a long time, but there is still no information that any of them has been finalized. ... Giving grounds for even greater concerns is the small interest in the pearl of the Bulgarian banking system - Bulbank - which means that very few Western banks find business in Bulgaria promising. The key deal which we are all following at the moment is the privatization of the Bulgarian Telecommunications Company, whose completion is still not certain. As a consultant to one of the potential buyers I do not want to comment on why the talks took so long," said Velchev.

Macro-economic stability, privatization of key state assets, and a restructuring of the baking sector are still the main concerns of the new Minister of Finance.

His colleague, US educated Deputy Prime Minister and Minister of the Economy, Nikolai Vassilev, 32, is an emergent market analyst. His economic agenda includes the tired - and hitherto vague - recipes of privatization, fighting corruption, reinforcing capital markets, and tax reform to encourage re-investment by firms. Vassilev and Ljubka Kachakova (a PriceWaterhouseCoopers Brussels employee) authored the inventory of free-market slogans that passes for the economic platform of National Movement for Simeon II. Kostov immediately pointed out the incompatibility of said platform with Bulgaria's current and future obligations to the EU.

"We are going to finish the process... within 2-3 years. Everything that should be privatized will be privatized." - said Vassilev recently, referring mainly to the tobacco monopoly, the telecom, and one or two major banks.

In a debate about the recent issuance of Eurobonds by Bulgaria, Vassilev made these comments:

"Each country has its good and bad moments. If a state like Bulgaria bears problems and then decides to emit for the first time Eurobonds, it is not necessary to sell them. The emission of eurobonds is required because afterwards private companies may enter the international markets ...  The budget deficit must be next to 0 per cent and the currency board must remain unconditionally".

He suggested a reduction of profit tax and income tax and predicted that such a cut will prove to be conducive to economic growth.

On another occasion, as a member of the "Bulgarian Easter" initiative of the previous government, he expressed concern regarding the decline in Bulgaria's foreign exchange reserves due to the need to repay 1.3 billion US dollars of foreign debt this year. He warned against a negative tendency in the trade balance of Bulgaria as imports far exceeded exports in the last few years. In the same event, he opinionated that the capital markets should be completely liberalized. He argued for free purchases of land - including agricultural land - by foreigners. He identified these restrictions as the cause of the decline in the value of Bulgarian assets and its divergence from the EU. Bulgarians - he exclaimed - underestimate the potential role and contribution of capital markets. "In the updated 'Program 2001' of the Bulgarian Government, the economic and financial policies of the incumbents are reduced to envisioning support for the commercial banks of the most elementary type" - he accused. Foreigners - he added - "have no confidence" in the Bulgarian capital markets. He succeeded to attract the attention of Kostov himself, who responded to him at length.

But the emerging eclectic political maelstrom that coalesced around the former King does not include only Wall Street whiz kids. Some distinctly unsavoury characters have crept into the lists fielded by the party in Russe and Burgas. Foreigners are worried. Gunter Verheugen, EU commissioner for enlargement remarked, undimplomatically, that there are "reasons to be concerned about some of the promises" made by the campaigning King. Georgy Ganev, a leading Bulgarian liberal economist, summed it up neatly in an interview in the "Financial Times": "Either there will be an economic crisis because the new government will try and meet these expectations. Or there will be a political crisis because it will not." The consolation prize? "The myth of the king will fill a big hole in the lives (of the Bulgarians)." - says Andrey Raichev, Director of Gallup Bulgaria, to the same paper.