Three factors may have a vital influence on a forecast for Bulgaria’s economic development in 2007.

These factors are the economic policy of the Government, which will be significantly influenced by the country’s EU membership, the stability of the governing coalition and the upcoming local elections.

Of course, we should not understate the potential of the private sector to generate growth, but this growth might be significantly hampered by Government economic policy.

The accelerated integration of Bulgaria’s economy with the economies of other EU member states, the increased volume of foreign trade, and the liberalisation of financial accounts will lead to increased dependency on European Commission and European Central Bank (ECB) decisions, while the influence of the International Monetary Fund will be considerably diminished. The steady increase of interest rates determined by the ECB, which is expected to continue in 2007, will reduce available liquidity funds and in turn limit investment opportunities in the Bulgarian economy.

After the relatively rapid increase of Bulgaria's Gross Domestic Product (GDP) in 2006, it is likely that in 2007 it will stabilise, but still reach about six per cent in real terms. The most important factor for the noteworthy increase in GDP is EU membership, which has led to increased investment in restructuring of Bulgarian companies to meet EU requirements, as well as the optimism arising from the expectation of being able to participate in the EU market.

Furthermore, in recent years, the business climate in the country has improved. This was caused not only by EU accession, but also by decreased direct taxation and the easing of some regulatory regimes. This is evident if international comparisons are made, but again Bulgarian business practices are still by far worse than the acknowledged world practices. A crucial success was the reduction of corporate income tax to 10 per cent, but the other components are still not well developed and more efforts are required to improve them.

The increase in investments will continue to be higher than the increase in GDP itself, but the differentiation between the two will not be as drastic in 2007. In any event, the investment share in GDP will remain about 30 per cent. Stabilisation of demand for goods and services will lead to an increase of savings up to 16 per cent of GDP values in 2007. The end result will be a current account deficit identical to that in previous years. Nevertheless, EU membership will influence domestic trade, which will affect official data, and in turn any forecast in the field will become merely hypothetical and tricky to make.

From the middle of 2006, Bulgarian National Bank (BNB) eased credit requirements for commercial banks. The ECB increase in interest rates made it less necessary for BNB to conduct a restrictive policy and this trend will continue in 2007. Moreover, with EU membership, the so-called single passport comes into force, which will allow legal financial intermediaries from any EU state to operate without restrictions in Bulgaria. This will lead to increased competition in the local financial market, which will have a positive influence on the economy as a whole.

After the significant increase of prices in 2006 (by almost eight per cent), in 2007 the increase will slow down to stabilise at about four to five per cent. A continued increase in prices, related to the increase in credits, the higher excise duties on fuels and alcoholic beverages, and the increase in administratively set prices create inflationary pressures. At the same time, higher interest rates on international markets determined by the ECB (and the Federal Reserve System) contributing to higher interest rates in the Bulgarian market together with the withdrawal of liquidity funds via the budget surplus will counteract these inflationary pressures.

The labour market is highly probable to maintain the trend towards job creation and a reduction in unemployment. The rationale behind such reasoning is first, private sector development as a generator of employment opportunities, and second, EU membership which eventually will lead to an increase need for personnel in the public administration. The intention of the Government to reduce the public administration by 10 per cent by the end of 2006 was not achieved, and 2007 will not be different in this respect.

The reduction of the payroll tax levels at the beginning of 2006 led to positive developments in the labour market and the wage levels in the country. Currently, though, it is not clear whether this trend will continue in 2007. Despite the lack of clarity regarding payroll tax, it is expected that increasing labour productivity will lead to higher wages in the private sector, while public sector wages will be used as a tool in Government income policy, by pushing private employers to increase salaries as well. Moreover, decreased inflation will assure an increase in salaries in real terms.

The efficiency of the public sector is still quite low, especially in important fields like education and health care. In 2006, some efforts were made to improve performance by introducing a single standard for high school education, and financing hospitals solely through the National Health Insurance Fund. Unfortunately, these efforts have been far from sufficient to solve the serious problems in the public sector. It is anticipated that partial reform will continue in 2007 without changing significantly the quality of the public service.

The change in the value added tax system will influence budget earnings, but there will again be a budget surplus. The budget surplus will be lower than that in 2006 because of the payment to the EU budget, meaning an additional expense, but probably it will be about two per cent of the GDP for 2007.

Overall, the Bulgarian economy will maintain its good performance in 2007. The main source for economic growth will be again the private sector, while the public sector will continue to display low efficiency. The positive changes in the Bulgarian economy in recent years increased economic freedom in the country and this in turn will lead to continuous economic growth, but without the prospect of catching up with the fastest developing economies in the world.