Bulgaria Business Forecast Report Q4 2009

The Downturn Is Deepening

Having managed to notch up positive growth during the final quarter of 2008 at a time when the eurozone was in the midst of a deepening recession, the Bulgarian economy has finally lost a wheel as real GDP fell for the first time since Q398 during the first quarter of 2009. Though gross fixed capital formation (GFCF) and trade data have certainly been woeful, the key factor tipping the economy over the edge has been the collapse in household spending as the extent of consumer indebtedness, and the deteriorating outlook for the labour market, has finally dawned. While the first quarter GDP data has been worse than originally expected, we stress that given the structural importance of consumer spending in the national output, we stop short of calling an economic recovery until the decline in household spending starts to stabilise.

Confirming the view which we have been running since January 2008, Bulgaria's opposition Citizens for European Development of Bulgaria (GERB) party stormed to victory at the July 5 parliamentary elections. With the Bulgarian Socialist Party (BSP) previously skirting around the issue of the country's burgeoning economic woes and rapidly unfolding downturn, the new GERB-led government appears keen to swiftly implement targeted initiatives to soften the blow of the unfolding recession. To this end, GERB previously indicated that it would seek an IMF bailout as soon as possible after the elections, which would help bolster financial stability and foreign investor risk sentiment. We caution, however, that leading up to the elections, the BSP-led government ramped up public expenditures, leaving the public finances a little worse for wear for the incoming government.

Indeed, prime minister-elect Boyko Borisov indicated his concern over the fiscal position on July 5, suggesting that a budget deficit may emerge that could fuel a financial crisis.

Having long cautioned of the risks posed by Bulgaria's exorbitant current account deficit and the underlying risk of a balance of payments crisis, the latest data show that a rapid correction to the external accounts is now underway. While a conventional balance of payments crisis has not yet occurred (which we interpret to be a disorderly devaluation of the pegged exchange rate), we nonetheless believe that the rapidity with which the current account is contracting suggests that the domestic economy is in the midst of crisis. Indeed, the implosion of imports is reflective of the hiatus of cheap foreign lending and lack of refinancing opportunities, which combined with surging unemployment, and deteriorating expectations among households and firms over the economic outlook, has led to a collapse in domestic demand.

Despite acknowledging the relatively robust credentials of Bulgaria's currency board arrangement, we still hold to our view that a nominal devaluation of the lev will transpire at some point in order to boost competitiveness. Not only will this have significant implications for Bulgaria's foreign currency exposed debtors (and probably necessitate foreign debt restructuring), but it will also greatly elevate the cost of imports to domestic producers, in turn squeezing profit margins that have already suffered from declining export sales.