By Juan J. Fernandez-Ansola IMF regional representative for Bulgaria and Romania and Albert Jaeger IMF mission chief for Bulgaria
Bulgaria’s gross domestic product growth (GDP) has averaged around 6 percent over the past four years, and unemployment has declined from 13 percent to less than 7 percent over the same period. While Bulgaria starts convergence from the bottom of the European Union per capita income league, these are solid achievements, attesting to good policies that have given confidence to the Bulgarian public and to foreign investors.
In our view, one key component of these policies has been the achievement of increasingly larger fiscal surpluses. However, we know these budgetary surpluses are controversial in Bulgaria. The question often asked is whether a relatively poor EU country like Bulgaria can afford running budget surpluses given its infrastructure and social spending needs, as well as its relatively high tax burden. However, we believe that the right budget prioritisation will allow spending on these pressing needs and keep the tax burden at a reasonable level, while maintaining the fiscal buffers needed for macroeconomic stability. Such fiscal buffers are essential to ensure that citizens’ living standards continue to improve, particularly under the present adverse conditions we observe in international capital markets, and to support a strong currency board.
We start from the observation that the present budget surpluses are really the consequence of an unprecedented but unsustainable boom in Bulgaria’s spending on goods and services. As noted, the economy’s income has grown at respectable rates during recent years, but the economy’s spending has by far outpaced income growth. To illustrate, we estimate that nominal GDP in 2007 amounted to 56 billion leva, while Bulgaria’s overall spending amounted to 69 billion leva. In other words, Bulgaria in 2007 spent about 12 billion leva in excess of its income. And the huge gap between spending and income has increased rapidly over recent years.
Obviously, the counterpart to the widening domestic spending-income gap has been Bulgaria’s ballooning trade deficit, which in turn is financed by massive capital inflows, with foreigners either acquiring Bulgarian assets or Bulgarians borrowing from abroad. For a relatively poor country like Bulgaria, running a temporary external deficit of some 20 percent of GDP may make sense, particularly if the capital inflows finance investment projects that raise future GDP. But external deficits of this magnitude can only be temporary; otherwise the country’s future capacity to service its external obligations would not be credible.
What does all of this have to do with the rising budget surpluses? The missing link here is that budget revenue does not only depend on the economy’s GDP, but also on the economy’s spending, mainly through indirect tax collections. Budget revenues have been soaring in large part owing to Bulgaria’s unsustainable spending boom. In fact, we estimate that once the economy’s spending returns to more sustainable levels, most of the present budget surplus would automatically disappear.
But should the government not simply “give back” the temporarily high revenue to the economy, either through increasing spending or cutting taxes? The answer is clearly no given the following considerations.
First of all, such a “give back policy” would further add to the already unsustainable spending boom, increasing the external deficit further, feeding into higher inflation pressures, and undermining external competitiveness.
Second, when the private spending boom comes to an end, as it inevitably will at some point, the budget would automatically shift into deficit as tax collections decline. To prevent a large budget deficit, public spending would have to be cut or taxes be raised at the exact time the private sector is cutting back its spending.
And third, fiscal surpluses are instrumental to preserving the sustainability of the currency board. By helping maintain the substantial balances of the fiscal reserve account at the central bank, surpluses ensure that international reserves more than cover currency in circulation and domestic currency reserves of commercial banks at the central bank. This cushion provides essential support to the credibility of the currency board at a time of turmoil in international markets.
Where does this leave us? Fiscal policy needs to be based on a forward-looking strategy that does not contribute to exacerbate imbalances. If policies are not kept on a sensible course, particularly in the fiscal area, internal and external imbalances could easily start feeding on each other, undermining the sustainability of the currency board arrangement.
What is needed now is macroeconomic stability to ensure that Bulgaria can reap the benefits of sustained growth. For fiscal policy, this is a time to stay a policy course that counteracts private sector spending by maintaining and building up counter-cyclical buffers, particularly taking into account the ongoing financial turmoil in mature financial markets and prospects for slowing global growth. From a longer-term perspective, this policy course also prepares Bulgaria to deal with the most unfavourable demographic trends in Europe. Bulgaria is in a league apart in Europe for a responsible fiscal policy, and this distinction should help ensure that Bulgarian living standards continue to improve even under the current adverse external conditions. The authorities deserve praise for a forward-looking policy stance that stands to benefit all Bulgarians.
