BULGARIA - OVERHEATING ECNOMY OR JUST GETTING WARMED UP?

UNCLAS SECTION 01 OF 03 SOIA 000828

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E.O. 12958: N/A
TAGS: EFIN ECON GOV EINV BU
SUBJECT: BULGARIA - OVERHEATING ECNOMY OR JUST GETTING WARMED UP?



1. (U) SUMMARY: Strong domestic consumption in Bulgaria has sparke
a large trade deficit and led to a current-accont (CA) deficit of
15.8% in 2006. Internationalanalysts have warned that Bulgaria's
growing extrnal deficits render its economy vulnerable to exoenous
shocks. While booming domestic credit has upplied money for an
under-capitalized economy, t also has heated up certain sectors of
the econmy, such as the real estate market, while at the sme time
increasing debt levels. In the absence f effective monetary
authority given Bugaria's currency-board arrangement, tight fiscal
policies remain the principal working instrument to control public
wages, inflation and further deterioration of the external sector.
END OF SUMMARY

INTERNATIONAL ANALYSTS RING THE BELL

2 (U) According to a recent World Bank report, in some
countries--most notably Latvia but also the other Baltic countries,
Bulgaria, and Romania--booming domestic demand is leading to
overheating and current growth rates are unlikely to be sustainable.
Danske Bank earlier said it is expecting a less optimistic outlook
of the Bulgarian and Romanian economies by international credit
agencies due to a lack of progress in EU-related reforms and
"continued rise in the external imbalances." The IMF has similarly
drawn attention to Bulgaria's rising external debt, which reached
around 80 percent of GDP last year.

EU-PHORIA DRIVES HIGH GROWTH AND CURRENT ACCOUNT DEFICIT


3. (U) Euphoria related to Bulgaria's EU accession has led to high
and steady economic growth--over 5 percent on average in the last 7
years--driven by buoyant consumption and investment activity. While
the strong domestic demand reflected expectations for deeper EU
integration and rising incomes, it also caused a large exQnsion of
trade and current account (CA) gaps. The CA deficit tripled over
the last three years to 15.8 percent of GDP in 2006, while the trade
gap rose to 21.5 percent of GDP. The first quarter of 2007
reconfirmed this negative trend with CA deficit growth of 5.6
percent of GDP. The deficit in April grew even further to 8 percent
of GDP for the quarter. Government officials and some analysts
argue that a new EU requirement has led to a notable underreporting
of exports.

CA DEFICIT PROJECTED TO GROW


4. (U) The IMF projected further growth of the CA deficit to 16.6
percent of GDP this year, slowing to 16.2 percent in 2008. Finance
Minister Oresharski was less optimistic, saying the deficit this
year might grow to 18 percent of GDP. Local media speculated that
Oresharski, who is known for his conservative fiscal positions,
might have intentionally over-stated the figure in an effort to stem
some ministers' demands for increased budget spending.

LARGE DEFICITS FED BY MORE FOREIGN INVESTMENT


5. (U) As is typical for an open and undercapitalized economy,
Bulgaria's growing CA deficits have been increasingly financed by
outside money and capital. This has been facilitated by a
liberalized investment regime and higher investor confidence in the
run-up to EU membership. Foreign direct investments (FDI) grew to a
record high in 2006, adding to a strong financial account that
managed to cover last year's CA deficit (103.2 percent). The
growing foreign investments help build up a stock of investment
goods--a third of last year's imports--which while exacerbating the
trade balance, is helping the higher capitalization and more
sustainable growth of the economy. According to analysts from the
Institute for International Finances, based in Washington, D.C., new
capital growth has been too strong in recent years--over 18 percent
on average in the last three years--and the need for some "cooling"
has already arrived.

OVERHEATING OF REAL ESTATE - QUITE STRONG AND RISING


6. (U) The level of corporate and household credit reached 39.6
percent annual growth in April. This concerns the central bank,
which removed administrative barriers to credit growth at the
beginning of this year and has no intention to re-impose them. The
increased money supply created more liquidity and strong
inflationary potential in some sectors of the economy, most notably
real estate. While consumer prices saw an average annual increase
of 7.3% in 2006, housing prices rose 14.7 percent. Prices in the
real estate market are likely to surge as demand for housing remains
stable, while there is ample room for mortgage loans to grow. This
could lead to the accumulation of new household debt, which has
grown 40.1 percent year-on-year in the first quarter of 2007. The
level of corporate debt is also raising concern, as it increased to
49.1 percent year-on-year in May reflecting local firms' increased
needs for financing their investment activities.



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