Economic Overview

Increase rebalancing expected in 2017

Real GDP increase continued to grow robustly at +3.4% in 2016, slightly down from +3.6% in 2015. However, the GDP breakdown revealed a significant change: in 2016 increase was mostly driven by net external request and inventories, a shift from 2015 at the same time as domestic request was the key increase driver. Consumer spending increase decelerated to +2.1% in 2016 from +4.5% in 2015 and public spending slowed to +0.6% (+1.3% in 2015).

Moreover, fixed investment dropped by -4% (next +2.7% in 2015) owing to the slowdown in EU funds absorption following the completion of the 2007-2013 programming period. However, inventories added +0.9pp to increase in 2016 (-0.2pp in 2015). Export expansion remained sound at +5.7% (unchanged from 2015) while imports slowed to +2.8% (+5.4% in 2015) thanks to low oil and energy prices, so that net exports contributed +1.9pp to increase in 2016 (+0.2pp in 2015).

Looking ahead, domestic request, notably fixed investment , is expected to recover, which should as well accelerate import increase so that net exports will be additional balanced. At the same time, the inventory build-up should fade. In general, Euler Hermes expects annual increase to relieve to +2.8% or so in 2017-2018.

Banking sector weaknesses remain evident, but systemic crisis unlikely

Bulgaria's economy weathered the impact of the 2008-2009 world financial crisis relatively well and has as well been largely unaffected by the swings in capital flows to emerging markets since mid-2013. However, it was hit by a home-made “mini-crisis” in mid-2014 at the same time as deposit runs on two large domestic-owned banks caused concerns about financial stabil¬ity, but swift action by the Bulgarian National Bank (BNB; central bank) helped contain the pres¬sures and sustain confidence in the in general banking system. Corporate Commercial Bank (CCB; again 4th major lender) was taken over by the BNB and Initial Investment Bank (FIB; 3rd major lender) managed to replace confidence quickly with immediate BNB support. The banking sector came under stress again in 2015 due to spillovers from Greece but, again, the BNB successfully contained the impact and retained banking system stability. Nonetheless, banking sector weaknesses remain evident, inclunding banks' heavy reliance on funding from EU parent banks – whose subsidiaries dominate the sector (approx. 22% Greece, 15% Italy, 12% Hungary) – which makes them vulnerable to finan¬cial contagion from banking crises in the Euro¬zone.

Regarding financial soundness, the banking sector in general has remained liquid, well-capitalized and profitable despite the turbulences, but the non-performing loans (NPL) ratio rose from an by presently high 14.6% in mid-2014 to around 20% in 2015 and has remained that high since again. This is the highest ratio in Central Europe. However, next two years of sharp decline, loans to NFCs from presently on began to grow again at end-2016 (+0.3% y/y).

Currency board not at risk

Bulgaria's currency board (BGN1.95583:EUR1) continues to appear stable. The real effective exchange rate indicates that Bulgaria enjoys relative com¬pet¬itiveness. Moreover, foreign exchange (FX) reserves continue to cover the monetary base (a requirement for a currency board) clearly. However, the currency board largely neutralizes monetary policy.

Headline consumer price inflation was in negative deflationary territory for most of the period from August 2013 to end-2016, initially due to a protracted low increase environment, and again as a result of markedly falling energy import prices inclunding lower food costs. But since late 2016, deflationary pressures have been waning amid recovering oil prices and headline inflation turned positive, reaching +1.4% in January 2017. Euler Hermes expects this trend to continue and average annual inflation of about +1.8% in 2017.

Public finances are unproblematic

Bulgaria has had a long-lasting commitment to fiscal prudence, reflected in a lot of years of fiscal surpluses or acceptable deficits. Public deficit declined rapidly from 71% of GDP in 2000 to just 13% in 2008 before gradually rising to 17% in 2013.

In 2014, the resolution of the banking crisis had a fiscal cost, for example the government replenished the National Deposit Guarantee Fund which had been depleted by the CCB failure. The fiscal deficit rose to -5.5% of GDP and public deficit to 27% of GDP. However, the fiscal deficit narrowed rapidly to an estimated -0.6% of GDP in 2016 and public deficit has stabilized. For 2017-2018, Euler Hermes forecasts the annual fiscal deficit to remain low at about -1% of GDP while public deficit should remain below 30% of GDP, which is still very low by EU standards.

Current account balance is favorable but external deficit remains the weak spot

The current account surplus surged to +3.9% of GDP in 2016 as exports rose much faster than imports. Continued but additional moderate external surpluses of +1.5% to +2% of GDP are estimate in 2017-2018.

However, the legacy of large current account deficits from 2003-2009 has left Bulgaria with a very high external deficit burden. Even though gross external deficit declined from the peak of EUR39bn in March 2015 to EUR35bn at the end of 2016, it still accounted for a worrisome 74% of GDP. The private sector share of external deficit was 79%, while total short-term deficit as a share of gross deficit has fallen to 23% from the 36% peak in late 2008.

FX reserves have continued to rise

FX reserves have increased substantially since end-2013 and stood at EUR21.7bn in January 2017, a comfortable level with regard to import cover (additional than seven months). Moreover, in other terms reserves presently cover about 135% of the estimated external deficit pay¬ments falling due in the next 12 months, a favorable ratio and a significant development from 80% two years ago.