Identifier
Created
Classification
Origin
06SOFIA1495
2006-10-30 06:51:00
UNCLASSIFIED
Embassy Sofia
Cable title:  

BULGARIA WOOS INVESTORS WITH 10 PERCENT CORPORATE

Tags:  EFIN ECON PGOV EINV BU 
pdf how-to read a cable
VZCZCXRO3491
RR RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHSF #1495/01 3030651
ZNR UUUUU ZZH
R 300651Z OCT 06
FM AMEMBASSY SOFIA
TO RUEHC/SECSTATE WASHDC 2743
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUCPDOC/USDOC WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
UNCLAS SECTION 01 OF 02 SOFIA 001495 

SIPDIS

SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON PGOV EINV BU
SUBJECT: BULGARIA WOOS INVESTORS WITH 10 PERCENT CORPORATE
TAX; CONTINUED STRONG GROWTH

UNCLAS SECTION 01 OF 02 SOFIA 001495

SIPDIS

SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON PGOV EINV BU
SUBJECT: BULGARIA WOOS INVESTORS WITH 10 PERCENT CORPORATE
TAX; CONTINUED STRONG GROWTH


1. SUMMARY: The Bulgarian government's recent decision to
lower the corporate tax rate to 10 percent was a bold act to
put the country in the lowest bracket in Europe, attract
foreign investors and encourage domestic growth. During its
recent mission visit, the IMF commended continued strong
economic growth and the government's prudent fiscal
policies. The widening current account gap of 14.2 percent,
however, remains a point of concern for the Fund. Inflation
of 5.6 percent, well above the Maastricht criteria for
eventual eurozone entry, is also a potential problem. The
IMF argued against a corporate tax reduction because of its
affect on next year's budget, which currently enjoys a more
than three percent surplus. END SUMMARY

BUSINESS PRAISES CORPORATE TAX CUT, WHILE IMF OPPOSES


2. In proposing to cut the tax rate, Bulgaria seeks to win
"the race to the bottom" and establish itself in Europe as a
tax champion. Through the lower rates, officials hope to
attract more investments, encourage further business
development and reduce the level of the gray economy.
However, the IMF sees potential risks to the budget due to
the expected 10 percent growth in public sector wages and
the payment of 624 million BGN (USD 405 M) in EU membership
fees in 2007, and called on authorities to abolish as
"groundless" the introduction of the new rate. The decision
for the tax abatement was agreed to by the three-party
coalition, and must now go to parliament where it is likely
to pass without significant opposition. Parliamentary
budget committee chairman Petar Dimitrov said the decision
is final and is part of the draft budget for 2007.

IMF PRAISES GOOD MACROECONOMIC INDICATORS


3. During its October 18-25 mission, part of the fourth and
final performance review under the precautionary standby
agreement expiring in March 2007, the IMF commended
Bulgaria's strong economic performance so far in 2006. The
Fund projected 6 percent growth for this year, higher than
the previous estimate of 5.5-5.6 percent. The Fund pointed
to buoyant domestic demand, especially in the investment

sector, and praised the government's tight fiscal policies,
with an expected budget surplus for 2006 at around 3.3
percent of GDP.

CURRENT ACCOUNT DEFICIT GROWS EVER LARGER


4. Despite tight fiscal policies, the risk from the rising
current account deficit remains high, according to the IMF
and others. The Fund estimates that the current account
deficit is likely to grow to over 14 percent of GDP this
year, versus 11.8 percent in 2005, and this expansion is
expected to continue in 2007. The Fund attributes the
current account deficit to strong private domestic demand --
particularly in the import sector -- fueled by a substantial
resurgence of bank credit growth. Foreign Direct Investment
(FDI) covers around 90 percent of the current account
deficit, which when combined with strict bank regulation
gives most observers confidence that this will not become a
serious problem in the short term. After a complete
standstill of privatization in 2005, this year the process
has regained momentum, which should bring more FDI to
Bulgaria. The IMF remained critical of progress in
implementing structural reforms, calling it "uneven."

INFLATION TO FALL FROM LAST YEAR, BUT STILL HIGH


5. Conservative fiscal policies will help bring the
expected end-year inflation down to 4.8 percent from last
year's 6.5 percent, according to the Fund. Although this
projection seems rather optimistic, especially compared to
official estimates of 6.6 percent for 2006, it follows the
recent deflationary trend. Inflation remains the only
macroeconomic parameter under the Maastricht criteria for
eurozone entry that the GOB has failed to achieve at this
point. EU membership may provoke some upside pushes on
domestic prices in early 2007, but the GOB argues that there
are no economic reasons for a price boom after 2007. The
Finance Ministry is optimistic that Bulgaria will be fit to
enter the eurozone in 2010. Prime Minister Stanishev called
on business to be cautious about raising prices.

IMF DRAFTS THREE POLICY RECOMMENDATIONS


6. The IMF encouraged authorities to maintain the
deflationary trend of the past quarter while sustaining
strong growth and containing the current account risks. To
this end, the IMF drafted three policy recommendations:
--Maintain a minimum budget surplus of two percent of GDP in
2007 based on realistic budget projections and without

SOFIA 00001495 002 OF 002


relying on within-year conditional caps on discretionary
spending;
--Moderate wage increases in the public sector to secure an
affordable wage bill;
--Intensified efforts in the implementation of structural
measures in the remainder of this year.


7. COMMENT: Bulgaria faces tough decisions over the next
few months on its fiscal outlook. Budget hawks will push to
maintain a substantial surplus in order to reduce inflation,
cut the current account deficit, and qualify for early
eurozone entry. Threats to the strong fiscal picture will
come chiefly from the new tax cut, political pressure to
raise social spending, additional payments to the EU for
membership and to finance Bulgaria's share of EU-sponsored
projects, and increased price expectations due to EU entry.
In our view, the coalition government understands the
competing needs and will do what is needed to keep it all in
balance. As Finance Minister Oresharski told the Ambassador
recently, "we've worked too long to rebuild our fiscal
reputation internationally" to allow populist or political
pressures to weaken macro discipline." END COMMENT

BEYRLE