BULGARIA'S FIRST EU BUDGET CONTINUES FISCAL DISCIPLINE

UNCLAS SECTION 01 OF 02 SOFIA 001718

SIPDIS

DEPT FOR EUR/NCE MNORDBERG

SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON PGOV SOCI BU
SUBJECT: BULGARIA'S FIRST EU BUDGET CONTINUES FISCAL DISCIPLINE

Ref Sofia 1495


1. (U) SUMMARY: Parliament approved the 2007 state budget on
December 19 - Bulgaria's first as a full EU member state. It is a
fiscally disciplined plan with an expected surplus of 0.8 percent of
GDP (well above the Maastricht requirement of a 3 percent deficit or
better for Euro entry.) This conservative stance - with Bulgaria's
traditionally understated revenue estimates - is likely to lead to
budgetary over-performance again as well as a relatively high
government share of the domestic economy. Local business has
praised the reduction of the corporate tax to 10 percent, and after
intense debate within the ruling coalition, the defense budget will
be 2.5 percent of GDP in order to meet NATO obligations. Still a
concern to the IMF and others is the high current-account deficit -
projected at 11.8 percent of GDP next year by the government and
around 15 percent by the IMF. END SUMMARY

ANOTHER SURPLUS BUDGET/GROWTH OF GOVERNMENT CONTINUES


2. (U) The 2007 budget maintains fiscal discipline through a surplus
of 0.8 percent of GDP, following an expected 3.5 percent surplus at
end-2006. The 2007 budget is based on expected real GDP growth of
5.8 percent due to increases in investment and exports, and expected
annual inflation of 4.4 percent. Investment is expected to reach 23
percent of GDP in 2007. The Ministry of Finance predicts that
sustained growth in exports and weaker import growth should narrow
the current-account deficit to 11.8 percent in 2007 from a
government estimated 14 percent in 2006 (the IMF claims the gap may
reach 15 percent both this year and next). The 2007 budget will
continue to support a relatively high government share of the
economy with revenues and expenditures of 41.7 and 40.9 percent of
GDP, respectively. Despite the budgeted 0.8 percent surplus, the
government - after talks with the IMF - agreed to aim for a 2
percent surplus by year-end using revenues that it hopes will be
larger than estimated.

REVENUES UNDERSTATED/RECORD LOW CORPORATE TAX RATE


3. (U) The government has continued its conservative practice from
previous years of projecting low revenues, which is likely to lead
to budgetary over-performance in 2007. Critics complain this harms
parliament's ability to give proper budgetary oversight, while
others claim it is the best way to ensure a sizable surplus (and in
some years, extra end-of-year funds for the government's pet
projects). Planned tax revenues will grow 16.3 percent to reach BGN
17.5 Billion (USD 11.8 Billion). Recognizing the need to stimulate
the private sector for higher investment and employment, the GOB
reduced the corporate tax rate by 5 percentage points to an EU-low
10 percent (Ref A). By lowering the corporate tax rate, the GOB
hopes to transfer part of the grey sector to the regular economy and
increase tax collections, as well as give Bulgaria a more effective
tool in recruiting foreign companies.

EXCISE TAXES RISE


4. (U) The government increased excise taxes on tobacco, alcohol,
coal and fuel, mainly to harmonize with EU tax policies. The GOB
argued that this increase is taking place ahead of a pre-agreed time
schedule because of its efforts to temper inflationary pressures
before (projected 2010) Eurozone entry. According to the Finance
Ministry, the rise in excise taxes will increase the annual
inflation rate 0.3 percentage points and will not pose a threat to
financial and macroeconomic stability. The GOB recognizes possible
reductions to the budget from lower VAT collection following EU
entry. The suspension of customs duties in intra-community trade,
particularly at the Greek and Romanian borders, has led the
government to estimate reduced VAT revenues by BGN 450 Million (USD
300 Million) next year. Possible VAT fraud due to slower
integration of EU tax practices may incur additional VAT losses of
BGN 550 Million (USD 370 Million).

GENEROUS EXPENDITURES IN SOCIAL SECURITY


5. (U) Current expenditures will go up 10.7 percent - a significant
increase of BGN 1.6 Billion (USD 1.1 Billion) - to reach BGN 16.5
Billion (USD 11.2 Billion) in 2007. Capital expenditure will grow
23 percent to reach BGN 2.7 Billion (USD 1.8 Billion). As in the
previous year's budget, social security will draw most of the public
funds - 33 percent out of total expenditures - followed by defense
and security (13.4 percent),public investment and services (12.3
percent),health care (10.9 percent),and education (10.5 percent).
Pensions will be increased by 8.5 percent from July 1 2007. The
minimum monthly age pension will go up from BGN 85 (USD 57) to BGN
92.23 (USD 62.32). The highest pension will reach BGN 490 (USD
330). Public-sector salaries will rise by 10 percent despite the
IMF recommendation for a lower increase.

MONEY FOR DEFENSE AND HEALTH SPARKED DISAGREEMENT


SOFIA 00001718 002 OF 002



6. (U) Defense spending created disagreements within the ruling
coalition. Defense Minister Bliznakov grounded his ministry's call
for increased spending on obligations to modernize the military
under NATO. After protracted negotiations, the 2007 budget will
allow defense expenditures estimated at 2.55 percent of GDP. Health
care expenditures will be BGN 2.22 Billion (USD 1.5 Billion) or 4.33
percent of GDP. This has sparked vocal protests inside professional
groups. Medical associations contend this is not enough to
guarantee quality health services and provide a much-needed
modernization of the sector.

2007 BUDGET - THE FIRST EU BUDGET


7. (U) Finance Minister Plamen Oresharski described this first
EU-era budget as one of Bulgaria's EU integration that will provide
an effective start in the absorption of EU funds. Oresharski also
said the budget will aim at securing greater employment and a higher
standard of living for all Bulgarian citizens. The government will
pay its first annual EU budget contribution, estimated in 2007 at
BGN 634 million (USD 430 million).

IMF CONCERNS UPON THEIR DEPARTURE


8. (U) During their fourth and final visit in December, the Head of
the IMF mission, Robert Hagemman, commended the 2007 budget as
adequate and prudent. The IMF remains concerned with the budgetary
risks related to the cut in the corporate tax rate and the increase
in public sector wages. The IMF will continue to insist on
conservative implementation of the 2007 budget and at least a two
percent fiscal surplus to cover against risks of low tax revenue
collection. The Fund is also worried about the high current account
deficit and urges authorities to maintain their restrictive fiscal
stance even after its departure. After March 2007, when the
agreement with the GOB officially expires, the IMF will provide only
technical assistance upon request.

COMMENT:


9. (SBU) Over the past three years, the government has fairly
closely followed IMF recommendations for tight spending and surplus
budgets. Politicians have invoked the specter of the IMF to reduce
spending, control inflation, promote economic growth, and give
confidence to international markets. The government has been
successful in these efforts, and is further ahead than many other
countries in qualifying for Euro entry - which will not happen until
2010 at the earliest. Upon the IMF's departure from Bulgaria, the
goal of Euro entry is the next carrot to force politicians to
continue the virtuous fiscal practices of the past two governments.
While the current account deficit and an increasing inflation rate
(the only potential pitfall to early Euro adoption) are notable
macro problems, the GOB has done a very commendable job of keeping
its fiscal house in order.
KARAGIANNIS