FISCAL DISCIPLINE KEEPS FINANCIAL CRISIS AT BAY,

C O N F I D E N T I A L SECTION 01 OF 02 SOFIA 000679

SIPDIS

E.O. 12958: DECL: 10/23/2018
TAGS: ECON EFIN PGOB BU
SUBJECT: FISCAL DISCIPLINE KEEPS FINANCIAL CRISIS AT BAY,
BUT BULGARIAN-OWNED BANKS ARE WEAK LINK

Classified By: Ambassador Nancy McEldowney for reasons 1.5 (b) and (d).


1. (C) Summary: The Bulgarian financial system's relative
lack of sophistication, along with the Government's policy of
fiscal discipline, are insulating the country from the
current international financial crisis. The global credit
crunch will have an impact on the real economy, in terms of
reduced FDI, access to credit, and lower growth, but these
could also serve to mitigate Bulgaria's two key imbalances:
the current account deficit and inflation. Bulgaria's
largely foreign-owned banking sector is well-capitalized and
strong, but the Bulgarian-owned segment of this sector is the
dark cloud on the economic horizon. Turbulence in the
banking sector, if it appears, will not be a direct result of
the international financial crisis -- it will be home-grown.
End Summary.


2. (C) Foreign and domestic analysts, including from the
EBRD, Central Bank, Ministry of Finance and leading banks are
expressing confidence that Bulgaria will emerge from the
current international financial crisis with lower growth, but
otherwise largely unscathed. Citing the Bulgarian financial
system's relative lack of sophistication ("we don't use
derivatives here"),Minister of Finance Plamen Oresharski
told us the Bulgarian banking sector is well-insulated from
the current crisis. In addition, the Socialist-run
government has been pursuing a policy of strict fiscal
discipline, running surpluses of one to three percent for the
past five years. These surpluses have been accumulating in a
fiscal reserve now totaling more than 10 billion leva (6.7
billion USD). This prudent fiscal policy will continue, as
leaders from across the political spectrum agree that it is
needed as a hedge against external shocks that might put
pressure on the country's currency board, now it its 11th
year.


3. (C) The growth rates Bulgaria has enjoyed for the past
seven years will undoubtedly take a hit. This growth has
been fueled by robust domestic demand and supported by easy
credit and strong foreign direct investment (plus speculative
bursts in an overheated property market, now ready for
contraction.) With the global financial crisis, FDI has
already slowed (preliminary data shows FDI down 12 percent in
the first eight months of 2008) and access to bank credit is
tightening. As a result, the Ministry of Economy reduced its
2009 GDP estimate to between 4.7 to 5.5 percent compared to
2008's estimated 6.5 percent growth. Our financial
interlocutors point out that the upside to this slowdown is
an eventual expected decrease in the high current account
deficit (21.5 percent of GDP in 2007) and a projected
lowering of inflation. At 11.6 percent in 2007, inflation is
the only indicator preventing Bulgaria from joining ERM-II.


4. (C) The foreign-owned segment of the Bulgarian banking
sector is strong. Nine of the top ten banks in Bulgaria are
foreign-owned, and bankers have said money is still flowing
from European parent banks but the cost of lending is higher.
The Bulgarian National Bank, which operates a currency
board, has few levers at its discretion to inject liquidity
into the market. It has already decided to increase deposit
guarantees to 50,000 Euro (up from 20,000 Euro). Reluctant
to decrease reserve requirements directly, the Central Bank
has started to allow banks to count 50 percent of bank cash
deposits held at the Central Bank into the basis upon which
the deposit reserve requirement (currently 12 percent) is
calculated. This measure is good for 90 days, but it may be
extended.


5. (C) Comment: While Bulgaria's relative lack of
sophistication does insulate it somewhat from the current
financial turbulence and fiscal discipline is serving the
country well, there is a dark cloud on the horizon. Large
foreign investors who depend on syndicated loans say credit
is tightening dramatically across Europe. This will delay
large infrastructure projects in Bulgaria. The U.S. energy
giant AES, the largest foreign investor in Bulgaria, says it
does not expect to be able to raise credit for several major
Bulgarian projects for the next 11 months. In addition, the
Bulgarian-owned bank First Investment, the sixth largest bank
in the country with a major retail presence, experienced a
mini-run in May after liquidity rumors spread on the
internet. On September 23, the global credit rating agency
Fitch revised its outlook on First Investment to negative,
citing the current market environment. Smaller
Bulgarian-owned banks may also be at risk. Several appear to
be boutique entities created only to finance and launder
projects of various Bulgarian oligarchs and well-connected
businessmen. With lax anti-money laundering oversight on the
part of the Central Bank and other financial supervision

SOFIA 00000679 002 OF 002


entities, Bulgaria may find that it survives the current
international financial crisis, only to fall victim to
home-grown banking instability.
McEldowney