Economic Information
Domestic sources of growth remain subdued
Once again, the main risks to growth and financial stability to the EEMEA region seem to emanate from the global picture, and in particular from the developments in Europe and the rest of the advanced economies. Europe is still in the throes of a debt crisis, where concerns about the sustainability of public finances and about the health of the banking sector risk feeding on each other.
So far the Eurozone sovereign debt crisis has manifested itself in a sharp depreciation of the EUR, wider bond spreads and a diverging growth differential between core and periphery countries. Although a full-blown crisis would certainly have negative implications for capital flows (and hence on the EEMEA region) we believe till the growth divergence of core and periphery Eurozone economies holds, the EEMEA region will continue to perform relatively well.
In Bulgaria, the more benign GDP growth figure in 1Q10 (-3.6% yoy) compared with 4Q09 (-5.9%) was almost entirely due to stronger external demand. But while export looks set to expand at a healthy pace, it will not be enough to generate a sustained revival. Unfortunately, there are still no signs that the external upturn, endangered by the sovereign debt crisis in Europe, is feeding through to stronger domestic demand. Recent retail sales and confidence indicators provide further evidence of the weakness of the consumer sector. Fundamental determinants of households’ consumer spending also bode ill: the rebalancing of the labor market does not look to be over with wages and employment still under downward pressure. What’s more, belt-tightening measures related to public administration are likely to enfeeble the already weak household recovery. Rebalancing of the external position, on the other hand, has progressed at a faster than expected pace (the 12M current account gap as of April shrunk to 5.6% of GDP, from 9% in the end of 2009 and 24% in 2008), but still looks some way off.
To counter monetary tightening and to buy the time needed for the structural measures to kick start growth, the authorities decided to temporarily steer the fiscal balance into deficit. The budget revision (to be passed by the Parliament soon) envisages a budget deficit target of 3.8% of GDP this year, which is just a notch below the 3.9% deficit posted in 2009 (according to the Eurostat methodology). Given the healthy fiscal fundamentals (public debt well below 20% of GDP and budget deficit very close to the 3% Stability Pact ceiling) this policy response seems justified to us. It is further vindicated by the fact that under the currency board, the Bulgarian authorities have very limited control of the local monetary conditions. The quantity of money in circulation is a function of the balance of payments development and when investors move capital out of the country this automatically translates into monetary contraction which threatens to sink the economy into even deeper recession. This leaves fiscal policy the only policy instrument in the short-to-medium run to deal with the external shocks caused by the global financial and economic crisis.
Against this backdrop, we stick to our longstanding GDP forecast for 2010 (-1%), while we revise marginally downward our forecast for 2011 to 1.8% (from 2.2%). Adverse shifts in the sentiments of international investors, which threatens to exacerbate deleveraging in the debt-laden private non-financial sector, remains the key downside risk for our baseline scenario. On the other hand, risks for the implementation of domestic reforms have eased, as despite suffering caused by the ongoing recession, public support for reforms remains strong.
