BULGARIA'S EU ENTRY HELPS MANY - BUT NOT ALL

UNCLAS SECTION 01 OF 02 SOFIA 000593

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TAGS: EUN ECON EINV BU
SUBJECT: BULGARIA'S EU ENTRY HELPS MANY - BUT NOT ALL

REF: SOFIA 0473


1. (SBU) SUMMARY: Bulgaria entered the EU in strong macroeconomic
and fiscal shape with 5 percent annualized GDP growth over the past
7 years and three years of budget surpluses. Foreign investors are
piling in to take advantage of cheap prices and labor, much as they
did in the EU-10 a few years ago, seeing - or hoping to see -
Bulgaria as a more stable business environment under Brussels' wing.
Increased free trade with the EU brings more competition to
Bulgarian companies, improving quality and lowering prices for
customers, but will also force weaker firms out of the market. U.S.
business interests will benefit on-the-whole from a larger, more
transparent, and better-regulated market, but EU-specific non-tariff
barriers will adversely affect U.S. agricultural sales here. In the
"victim-of-their-own-success" category, excess demand for
high-skilled labor is already creating a shortage of specialists in
the high-tech sectors. EU membership is clearly positive overall
for the Bulgarian economy, but not everyone will win. END SUMMARY

INCREASED EU INTEGRATION TO BENEFIT MANY. . .


2. (U) Bulgaria's current trade with the rest of the EU is over 50
percent of its total trade, and will grow significantly given the
new tariff-free environment. New companies and imported goods and
services will bring more competition to the local market, benefiting
local customers and producers with higher-quality products at lower
prices. Bulgarian exporters are expected to take advantage of new
opportunities in the EU to improve export growth even further over
last year's record 26.6 percent increase. Bulgarian citizens will
also benefit from new safety regulations for goods in food and
non-food sectors.

. . . BUT ONLY THE FITTEST WILL SURVIVE INCREASED COMPETITION AND
REGULATION


3. (SBU) EU structural aid in the pre-accession period tried to
prepare local industries and companies for the challenges of EU
competition. While the bigger companies took advantage of this to
replace old equipment and technology to meet EU market criteria,
many smaller companies lacked the necessary resources. Those that
manage to restructure will be able to utilize economies of scale.
But the smaller, and often unprepared, companies will face serious
hardships from rising EU competition. The regulatory changes will
also cut both ways; some will meet the new requirements and attract
further investment, while others will be swamped by EU red tape and
its Bulgarian corollary, corrupt officials taking advantage of new
laws and regulations. There are concerns about the potential for
biased enforcement of environmental standards - already a problem
here. The new European energy strategy aimed at greater efficiency
and competition will increase the compliance cost for many local
businesses. Farmers in the heavily subsidized agricultural sector
are likely to be most squeezed by the growing EU competition, and
many will struggle to survive by relying on EU funds.

GROWING NUMBER OF U.S. INVESTORS, AGRICULTURAL HARDSHIPS


4. (U) U.S. investors continue to find new opportunities to invest
in Bulgaria, with U.S. FDI increasing 63 percent to $116 million in
2006 over $71 million in 2005. (Bulgarian government statistics do
not reflect true U.S. investment levels as many are made through
another European subsidiary, i.e. Austria has appeared as a much
larger investor in terms of FDI because U.S. companies used Austrian
holding companies to invest in Bulgaria - usually for tax reasons.)
Much of U.S. investor interest was pre-EU accession money trying to
get in early, but we have seen continuing interest from U.S.
players, including the recent AIG purchase of a controlling stake in
the national telecom provider for $1.4 billion. An additional
stimulus comes from the February 2007 signing of the bilateral
double taxation treaty, which will create a more favorable tax
situation for American investors. While the general tariff level
for U.S. imports to Bulgaria has decreased due to EU accession, U.S.
agricultural exports will continue to face high heavy non-tariff
barriers, especially EU standards on imported meat and nuts. In
addition, EU food safety standards will hit hard U.S. beef and
poultry exporters.

LABOR SHORTAGES FOR MOST SKILLED


5. (U) Bulgaria's labor costs are cheap enough -- reflecting
relatively low productivity and salaries -- to attract new foreign
companies. The Bulgarian economy can capitalize on this competitive
edge for some time, but the need for high-skilled workers and
mid-level managerial staff has become a problem already for some
high technology and innovative companies. Excess demand has pushed
company owners to significantly increase remuneration packages and
recruit qualified personnel from abroad. Tourism, construction, and
retail have also started to report shortages of trained staff.
Given the already large movement of labor out of Bulgaria in the

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past 15 years, the gradual liberalization of the EU labor market is
not expected to lead to another mass migration of domestic
specialists. But some sectors, such as health and textile, could
lose qualified workers to other EU countries due to higher wages.

GRADUAL, BUT UNEVEN, INCREASE IN PRICES


6. (U) Economic and monetary convergence with the EU will likely
lead to an increase in domestic prices, but their rise will be
gradual, reflecting a relatively low base of household incomes and
purchasing power, according to the National Statistics Institute.
The duty-free import of fruit and vegetables from the EU and their
seasonal domestic supply will keep prices relatively low. Prices of
meat and milk will see some increase in the short run due to the
shortage of domestic supply (for meat) and quality (for milk) and
the increasing cost of modernization to meet EU standards. Prices
of some industrial goods (clothing, home appliances) will fall due
to reduced tariffs and third-country competition (China, India).
Prices in education and healthcare, the two most unreformed public
realms, will increase. The 4.2 percent rise in prices since January
suggests that control over inflation will remain the government's
major economic concern prior to adoption of the euro. The
government will be keeping a close eye on reports from private
sector analysts that the economy is heating up too quickly.
Pensioners, on fixed-income, and those in small rural settings will
particularly be hard hit as inflation eats at their small monthly
intake.


7. (SBU) Bulgaria is expected to hew fairly close to the EU party
line on issues such as the Doha round, Common Agricultural Policy,
and geographic indicators. Although the current center-left
government (and most of the non-reactionary rightist opposition)
tends to be more liberally-minded on economic issues than some of
the more senior Member States' leaders, Bulgaria - as the poorest EU
Member State - will not be biting the hand that feeds it. We are
trying, however, to encourage Bulgaria to take a more active role on
energy security issues, taking advantage of their location as a gas
and oil pipeline crossroad, and their historical, cultural and
business relationships with Russia.


8. (SBU) Uliana Bogdanska, the head of the Foreign Ministry's EU
directorate, told us recently that energy issues are a high priority
for Bulgaria and that Sofia is trying to be an active participant in
forming the EU's common energy policy. She said Bulgaria agreed
with most of the decisions taken at the GAERC meeting in March,
which focused on a forging a common energy strategy. Bulgaria was
particularly happy to see that nuclear energy was recognized as
reducing greenhouse gases given the large role nuclear power plays
in the country. Vladimir Stariradev, the Director for Energy
Strategy at the Economy and Energy Ministry, explained to us that
Bulgaria welcomes "in principle" the EU's target of using 20 percent
of renewables by 2020, but believes this should be done in a
"cost-effective" way. Stariradev expressed Bulgaria's concern that
an excessive share of renewables could reduce the country's economic
growth, noting that such targets should not be binding "because
different countries are starting from different places." According
to Bogdanska, Bulgaria was pleased the Nabucco pipeline was
identified as one of four key priority projects that the EU intends
to explore for increasing energy diversification. Bogdanska
expressed hope that the EU will put funds forward for the project.



9. COMMENT: (SBU) Bulgaria's stable macro-economic indicators,
low-risk profile, and mainly successful transition to the European
market will benefit U.S. investors who are increasingly eyeing the
Balkan state following its EU accession. But Bulgaria's economy
will suffer competitive pressure long after its accession due to low
productivity and relatively low export level. Key to a successful
export promotion strategy will be the use of high-skilled and more
efficient labor, now producing at only a third of the EU average.
EU accession can be a great opportunity for Bulgaria if it takes
full advantage of improved oversight, EU support mechanisms, and the
real chance to show its citizens that there are better, cleaner and
more efficient ways to improve their quality of life. They won't be
leading the charge in Brussels, but they will work on a few issues,
some of which dovetail with our interests. END COMMENT
KARAGIANNIS