Bulgaria struggles with Europe’s problem

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By:
Nathan Collins
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According to one foreign survey, Bulgaria has the most business-friendly environment on the continent. However, it is burdened by stagnant capital markets and a reliance on the debilitated economies of western Europe.

Bulgaria’s economy has been hit hard in the past four years, initially by the crisis ensuing from the collapse of Lehman Brothers and then by the sovereign debt crisis that is damaging the eurozone. It is not a eurozone member state but its currency, the lev, is pegged to the euro, and eurozone members make up the bulk of its export market. The nation, perhaps more than many others on the European Union periphery, is eager for the eurozone to get its act together.

Membership of the EU has brought prosperity to Bulgaria, but the close links mean that when Europe sneezes, it gets a cold. "EU membership has brought many positives for Bulgaria, such as promoting economic and political stability," says Maria Rousseva, head of corporates and markets at Société Générale Expressbank. "Bulgaria is part of the EU, and any problems in Europe have their influence on the Bulgarian economy. On the whole, the impact is rather balanced,.

Maria Rousseva, head of corporates and markets at Société Générale Expressbank
Maria Rousseva, head of corporates and markets at Société Générale Expressbank
The damage to Bulgaria’s economy is largely indirect. It’s about what’s not done as much as what is: growth is predicated on investment and support from other European states – the unstable atmosphere that has pervaded for the past four years has been a hindrance.

"The impact from the situation in the eurozone stems from the uncertainty it creates," says Levon Hampartzoumian, chief executive of UniCredit Bulbank. "Appetite for investment is reduced – we need technical solutions to be implemented at the European level."

Association with Europe hasn’t been all bad for Bulgaria, however. European subsidies have enabled the country’s small and medium-sized enterprises to thrive, and are helping to keep the sector buoyant at a time of falling domestic demand: in the fourth quarter consumption fell by 1.3%. Both the local banks and the ministries in Bulgaria that distribute the subsidies would be in favour of allowing banks to administer their allocation.

"If the EU would outsource the management of the subsidies then efficiency would improve," says Hampartzoumian. "Banks have a lot of knowledge of assessing risk and suitability of the projects. However, Europe complains about a lack of administrative capacity – which is eurospeak for corruption and incompetence."

Foreign direct investment in Bulgaria has also declined sharply. Research from Raiffeisen Bank shows that FDI for 2011 stood at €940 million, down around €650 million on 2010 – which itself was far from a good year. Pre-crisis, investment flowed in, particularly boosting sectors such as real estate, construction and financial services.

"The crisis came to Bulgaria in the fourth quarter of 2008. Foreign investments froze: until then foreign investment had been over €6 billion a year," says Anthony Hassiotis, chief executive of Postbank.

Bulgaria may have to wait out the crisis in Europe and hope that its supporters come back on stream quickly. Certainly there is no magic wand that the country can wave to reinstate these flows. The perception in Bulgaria is that there is not one big internal issue driving off foreign investment but rather a mess of minor issues: red tape, petty corruption and anti-business sentiment are all frequently cited.

"Foreign investment needs to be encouraged but unfortunately we aren’t in a situation where only one or two areas need to be reformed," says Hampartzoumian."There are many small issues that need to be dealt with to create a more business-friendly environment."

Yet research from Eurochambres, the association of European chambers of commerce and industry, found that businesses surveyed thought Bulgaria had the most business-friendly environment in Europe; a result most likely of Bulgaria’s low personal and corporate tax rates (both flat at 10%) and the lowest labour costs in the EU. Nevertheless, Bulgaria is not competing only with other countries in Europe – it must convince investors that it is competitive on a global scale too.

"Attention has shifted away from eastern Europe towards other markets, particularly Asia and Latin America," says Hampartzoumian. "The government needs to take steps to deal with this. We are not competing with our past, we are competing with the rest of the world to be more attractive for investors."

This lack of investment will need to change for the situation to improve in Bulgaria. The country had a tough fourth quarter in 2011, with growth plummeting to 0.3% from an average 2.2% over the rest of the year.

One possible way of encouraging foreign investment is to stimulate the country’s capital markets and hope that growth there will attract interest from abroad. The capital markets in Bulgaria have struggled in the past few years. Turnover on the Bulgarian Stock Exchange has fallen sharply: in February 2012 it came in at slightly under Lev6.5 million ($4.4 million), whereas in February 2007 it had been almost Lev103 million. The fall comes mainly from declining equity values rather than a drop in volume.

The government is hoping that its plan to privatize the exchange – announced on March 15 – will be the stimulus that the capital markets need. It has set down some restrictive requirements on who can bid for the majority stake on offer: prospective buyers must be a privately owned stock exchange or exchange operator with an average monthly turnover of at least €2 billion.

"There will be strong expectations of the buyer; they must contribute extensively to the development of the capital markets in Bulgaria," says Georgi Bylgarski, director of trading, listing and membership at BSE.

However, the poor performance of the capital markets over the past few years might make it difficult to find players willing to take on ownership. "Privatization is happening now purely because the political will is present," says Bylgarski. "Economically, it actually would have made more sense a few years ago when the capital markets were booming."

Privatization of the remaining state-owned companies, particularly in energy, might also offer a welcome boost to the capital markets. As much as a quarter of Bulgaria Energy Holding – an entirely state-owned energy company that owns the Bulgarian energy grid among other assets – could be up for sale. Former economy minister Traicho Traikov estimates that would raise as much as Lev1 billion.

Last August Bulgaria’s privatization agency approved the sale of the government’s 79.83% stake in tobacco producer Bulgartabac to BT Invest, a subsidiary of Russian bank VTB, for €100.1 million. There are plans to privatize the state-owned freight rail service by the end of the year in a deal worth around €200 million.

However, some critics say that privatization is not moving fast enough. They claim that more sell-offs would boost efficiency in the privatized companies, stimulate the capital markets and serve to prop up the country’s falling fiscal reserve, which fell to around Lev4 billion in January. Bulgarian law stipulates that the reserve must be approximately Lev4.5 billion at year-end.

"We need to see more privatization of state-owned companies. This would top up the fiscal reserve and stimulate the capital markets. The government should be privatizing every quarter what they’ve managed in nearly four years," says Nikolay Vassilev, chief executive of Expat Capital, an investment and asset management company based in Sofia. Vassilev has previously served as deputy prime minister and minister of the economy.

Privatization isn’t the only area where government policy has been subjected to criticism. The minister of finance, Simeon Djankov, has been reluctant to use external means to finance the repayment of a Bulgarian Eurobond set to mature in January 2013. So far the minister has been in favour of using internal methods of repayment: domestic bond issuance, the fiscal reserve and the use of the Silver Fund to purchase government securities. The Silver Fund is a state-managed pension fund that makes up part of the country’s fiscal reserve.

"The ministry of finance is spending money from the Silver Fund to buy government bonds with the aim of reducing its debt," says Vassilev. "However, this means that the fiscal reserve – which the Silver Fund represents half of – is falling, and ultimately purchasing government bonds is not an investment of the money."

The common consensus is that Djankov is reluctant to engage in further foreign borrowing for two reasons: first, that a large influx of money would be unlikely to effectively stimulate growth when the rest of the EU is in turmoil; secondly, that the current yield on Bulgarian government debt is at such a level that he is wary of having to pay a hefty coupon on any money borrowed.

"The minister of finance is very frugal: while [Djankov] can afford to raise money abroad, he prefers to do so at a lower cost locally," says a senior banker in Sofia. "While this is cheaper, it also means there is less new money coming into Bulgaria."

Perhaps the biggest concern about Bulgaria’s banking sector is the number of big banks with parents in countries on the eurozone’s periphery – particularly Greece. Three of the country’s larger banks are Greek-owned: United Bulgarian Bank is a subsidiary of National Bank of Greece and Postbank is a subsidiary of Eurobank EFG. Piraeus Bank and Alpha Bank also have sizeable operations in Bulgaria.

Despite this, bankers in Bulgaria are surprisingly sanguine on the matter – insisting that whatever the shape of the mother country – or the mother company – the Bulgarian subsidiaries are in good financial shape. Banks in Bulgaria are conservatively regulated; the average capital adequacy ratio stands at 17.7% – although in their last annual reports Postbank and Eurobank reported ratios substantially below this average at 13.34% and 12.73% respectively.

"The Greek banks are, of course, an issue that has to be followed," says Hampartzoumian. "However, banks here are regulated very conservatively: capital adequacy ratios and liquidity are both high; these banks are stable."

However, if foreign inflows fail to resume – and the government fails to find some other method of kickstarting the capital markets – the capital adequacy of a small section of the banks would be the least of Bulgaria’s worries.