SOCIALISTS CONTINUE MACROECONOMIC PROGRESS, BUT

UNCLAS SECTION 01 OF 03 SOFIA 001017

SIPDIS

USDOC FOR 4232/ITA/MAC/EUR/OEERIS/SAVICH

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN EINV BU

SUBJECT: SOCIALISTS CONTINUE MACROECONOMIC PROGRESS, BUT
REFORMS ARE SLOW AND INCOMES REMAIN LOW

REF: A) Sofia 810; B) Sofia 741; C) 05 Sofia 1925

SOFIA 00001017 001.2 OF 003



1. (SBU) SUMMARY: Almost one year into its tenure, the
Socialist-led government has succeeded in preserving
macroeconomic stability, growing the economy and preparing
the country to meet EU convergence criteria. The coalition
government has maintained the key elements of the previous
government's economic policy, hinged on adhering to the
Currency Board Arrangement and a conservative fiscal policy.
While the Bulgarian economy continued to grow strongly in
the first quarter of 2006 (5.6 percent),the balance of
payments position is the single macroeconomic indicator
which has been deteriorating (7.3 percent in Jan.-May 2006.)
The government has significantly curtailed its election
promises in the area of social spending, while PM Stanishev
introduced measures aimed at sustaining economic growth --
cutting social security insurance payments by six percent --
and providing real tax relief for low income citizens and
moderate increases in public wages and pensions. End
Summary.

GROWTH CONTINUES . . .
--------------


2. (U) Resisting calls for populist measures, the Socialist-
led coalition government has held to an IMF-backed tight
fiscal policy. It has also introduced cuts in the social
security insurance payments (from 42 percent to 36 percent)
that have injected 600 million leva (USD 387 million) into
the economy, and brought in more green-field investments.
This approach has led to strong results applauded by the EU
and the international financial institutions:

-- GDP increased by 5.6 percent in the first quarter of

2006. While the GOB recently revised downward the estimated
GDP growth for 2006 from 5.5 percent to 5.3 percent, other
independent observers estimate a lower growth of 4.6 percent
due to the central bank's restrictions on bank lending,
higher inflation and slower wage growth;

-- The government is committed to a further fiscal
tightening in 2006 to reach a surplus of 3 percent (about
1.4 billion leva or USD 903 million). The Finance Ministry
has reported that the general budget surplus stood at 1.3
billion leva (USD 839 million) in May. The macroeconomic
framework for 2007-2009 envisages a budget surplus of 0.8
percent of GDP for 2007;

-- Despite the initial price push earlier this year, the
inflation outlook remains benign at an estimated rate of 5
percent for 2006. Inflation stood at 2.9 percent for the
period January-June 2006.

-- The unemployment level fell to a record low level of 9.2
percent (340,059 registered unemployed) in June;

-- Declining government debt of 6.4 billion euro or 27.5
percent of GDP in May 2006 (far below the euro-zone
requirement of 60 percent of GDP);

-- Comfortable foreign exchange reserves of 7.9 billion
euros.

. . . BUT CURRENT ACCOUNT DEFICIT WIDENS
--------------


3. (U) Bulgaria's current account deficit has been widening
on the back of strong economic growth, driven by high import
demand for industrial inputs, oil and consumer goods. The
most recent balance of payment data show that the current
account deficit rose sharply to 1.7 billion euro or 7.3
percent of GDP in the first five months of 2006 compared to
one billion euro or 4.7 percent of GDP for the same period
last year. The current account deficit is expected to widen
to 12.4 percent by the end of the year.


4. (U) However, financial inflows in the form of foreign
direct investment (FDI),tourist revenues and remittances
remained steady, helping the deteriorating current account
deficit. For instance, new FDI in the period of January-May
2006 increased by 67 percent--to 1.2 billion euro--compared
to the same period last year covering 68 percent of the
existing current account deficit. The InvestBulgaria Agency
(IBA) estimates FDI of 2.3 billion euro for 2006 thanks to
the expansion of existing foreign investment, green-field
investment projects to be completed by the end of the year

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and reestablished momentum in the privatization process.

REINVIGORATING THE PRIVATIZATION PROCESS
--------------


5. (SBU) The privatization process considerably slowed down
in 2005. The Privatization Agency (PA) reported that a
total of 31 minor deals involving the sale of majority
ownership were concluded in 2005 compared with previous
projections of 46 privatization deals for 2005. The failure
to complete a single major privatization transaction in
2005, however, underscores the government's difficulty - at
times - in attracting respected foreign investors through
privatization and finalizing already negotiated deals.


6. (U) The GOB is working on reinvigorating the
privatization process and completing the sell-off of large
state-owned enterprises (SOEs) in 2006. The privatization
program of the government envisages the sale of majority
stakes of 24 state-owned enterprises, 164 residual stakes in
previously privatized companies and 10 detached units from
existing SOEs for the equivalent of 600 million leva in 2006
(USD 387 million.) While the PA will continue the sale of
residual minority stakes through public offering on the
stock exchange, the main goal of the 2006 privatization
program is the quick sale of the remaining majority state-
owned stakes, including:
--the national carrier Bulgaria Air;
--the sea transportation company Bulgarian Maritime Company;
--five district heating companies;
--thermo-power plants in Varna and Bobov Dol; and
--plants and trading companies in the military industry.

MARGINAL INCOME GAINS
--------------


7. (SBU) The BSP could not realistically deliver on many of
the party's generous election promises, but the GOB's
economic policy has still placed a special emphasis on
social policy with a focus on reforms of the personal income
tax and public sector salary and pension increases (Ref. C).
The thrust of the government's social program is to change
the structure of the personal income tax brackets and raise
the amount of non-taxable income. The GOB is currently
contemplating its income policy for 2007-09 highlighted by a
minimum monthly salary between 170-219 leva (USD 110-141)
and roughly a 10 percent increase in salaries and pensions.


8. (U) Specific social policy measures include:

--simplifying the personal income tax regime through cutting
the four income tax brackets to three and raising the non-
taxable monthly income threshold by almost 40 percent, from
130 leva (USD 84) to 180 leva (USD 116);
--an increase in the monthly minimum wage by seven percent
to 160 leva (USD 130);
--an increase in the public sector salaries by six percent
effective July 1, 2006 resulting in an average public
monthly wage of 460 leva (USD 297);
--an increase of five percent in pensions effective January
1, 2006; and
--the Council of Ministers decided April 2006 to extend an
additional 500 million leva (USD 323 million) for the
implementation of its poverty reduction program geared
towards education and vocational training. Initially, the
GOB budgeted 2 billion leva (USD 1.3 billion) for this
program.

IMF AGREEMENT
--------------


9. (U) Bulgaria's relations with the International Monetary
Fund (IMF) are good, and are often described as a success
story (Ref. B). The Socialist-led government has
reinforced its eagerness to institute the right economic
policies and commitment to undertake necessary structural
reforms by agreeing to extend until March 2007 the two-year,
USD 146 million stand-by arrangement due to expire in
September.


10. (SBU) COMMENT: The overall macroeconomic policy of the
Stanishev-led government has been strong. While keeping the
budget well under control and continuing the pattern of
growth, the current government seems also to be committed to
raising incomes and the standard of living through tax cuts
for low incomes and mandatory increases in public salaries

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and pensions. However, with an average monthly salary of
329 leva (USD 212),incomes continue to be inadequate to
cover the cost of living. Much will depend on the GOB's
progress in stepping up structural reforms, including
creating a better business environment (Ref. A),which will
allow private businesses to create more well-paid jobs.

LEVINE