Bulgaria’s economy is facing the risk of a hard landing after years of strong growth, mainly due to continued external imbalances, which tight fiscal policies have not managed to offset, Fitch Ratings said on August 15.

The international credit ratings agency re-affirmed Bulgaria’s investment grade credit ratings, BBB for long-term debt instruments in foreign currency and BBB+ for long-term debt in local currency, but gave them a negative outlook.

“The negative outlooks signal Fitch’s concern that Bulgaria’s booming economy, now running a current account deficit of around 22 per cent of gross domestic product (GDP), is on an unsustainable path and risks a hard landing, despite rigorously disciplined macroeconomic policies,” analyst Andrew Colquhoun, director in Fitch’s Sovereigns Group, said in a statement. “Even if Bulgaria achieves a smoother adjustment, its gross and net external debt levels are starting to look stretched, relative to its rating peers, and further deterioration could trigger a downgrade.”

Should Bulgaria’s economy slow down, it would have a negative impact on Fitch’s ratings, which are currently well inside investment grade territory. So far, there is little ground to expect GDP growth to slow down, with the economy growing by seven per cent in the first quarter of the year, and a flash estimate of Bulgaria’s statistics board for the second quarter forecasting a growth rate of 6.3 per cent. The bumper harvest this year, compared to last year’s flood-ravaged fields, is expected to contribute to a strong quarter.

Still, there were a number of factors that put pressure on the economy – the booming domestic demand that fuelled the rise of imports, which in turn took the current account deficit to 21.7 per cent of GDP in 2007; the soaring growth of lending, which grew by 63 per cent in 2007; and inflation, which averaged 14 per cent over the first seven months of this year.

Existing evidence shows that the current account deficit has not been driven up by diminishing competitiveness, but by strong domestic demand growth, coupled with an imbalance between savings and investment, which Fitch believes to be an inevitable part of convergence with the richer Western European countries.

“The composition of Bulgaria’s growth looks increasingly frothy, with construction, real estate, and financial services contributing 3.4 percentage points of the 6.3 per cent growth in the economy’s gross value-added in 2007,” Fitch said.

External finances are a strong weakness and should they get worse, that would also pressure the ratings downward. Bulgaria’s gross external debt was 105 per cent of GDP in 2007, compared to the 45 per cent median among other countries rated at BBB. Fitch noted, however, that the external debt of Bulgarian banks, estimated to be worth 21 per cent of GDP at end-2007, is likely to have come mostly from banks’ foreign parents and therefore should be “relatively stable”.

Figures for foreign direct investment (FDI), which reached $5.2 billion in 2007, the equivalent of 13 per cent of GDP, remain strong but the worsening prospects of the economy in the eurozone may dent FDI flows, according to the credit rating agency.

Although the sustainability of external finances is not an immediate concern for Bulgaria, the country needs to continue to attract strong FDI inflows to cover its current high account deficit or it risks experiencing a surge in external debt, Fitch said earlier this year in a special report on current account deficits in three South-Eastern European countries, which included Bulgaria. The country’s already high debt could leave it little room to manoeuvre if investments fell sharply while the current account deficit remained high, Fitch then said.

The silver lining for the clouds that are getting increasingly dark above Bulgaria are its “exceptionally strong” public finances. “Fitch expects Bulgaria will become a net general government creditor to the tune of two per cent of GDP by end-2008 as fiscal surpluses bolster the fiscal reserve account,” the agency said, also noting that the country paid back a further 300 million euro loan from the World Bank in March, long before it was due.

Even though the European Union froze hundreds of millions of euro in pre-accession funds in July 2008, Bulgaria’s membership in the bloc would help ensure fundamental political stability and long-term economic prospects, Fitch said.

The funding suspension “poses no immediate fiscal risk for Bulgaria, although it highlights the weaknesses in public institutions and a serious corruption problem,” according to Fitch. “Wholesale withdrawal by the EU of the 11 billion euro of structural and cohesion funding over 2008/2011 could damage Bulgaria’s long-term prospects, but Fitch does not consider this to be likely.”