3Q GDP data (0.3% qoq and 1.6% yoy from 0.3% qoq and 2.0% yoy in 2Q11) suggest that the economy is beginning to suffer from the global risks’ escalation. Despite some one-offs, such as the solid harvest and summer tourism output, GDP growth failed to impress on the positive side. Most alarmingly, GFCF was a hefty 13.5% down qoq (-2.8% yoy) after three consecutive positive qoq readings. It is true that this series is volatile and in yoy terms growth is negative only marginally, but it dented hopes that the raising share of highly liquid assets in the consolidated balance sheet of the corporate sector will soon translate into acceleration of capital spending and jobs. We think that the marked slowdown in GFCF can be primarily attributed to the escalation of the euro zone sovereign debt crisis, which prompted companies to take a more defensive stance by putting investment plans on hold and building cash reserves to meet more comfortably their elevated external funding needs. As expected, 3Q11 GDP data has reconfirmed the frustratingly slow pace of the final consumption recovery (up 0.3% qoq but still 7.1% below its pre-crisis mark). Apparently, final consumption expenditure has drawn some support from easing inflation but this was broadly balanced by a continued weak housing market recovery and rising concerns that slowing growth in Europe would affect negatively the number of jobs at home. The combination of all these has added to the evidence that households remain reluctant to put an end to cash hoarding and raise spending soon. After five consecutive quarters of double digit yoy growth, export slowed to just 2.0% yoy (from 12.2% yoy in 2Q11), as output growth of electricity and basic metals sharply lost momentum in September. On the positive side, net export contributed positively to GDP as import growth (up 1.1% qoq) was less modest than those of export (up 1.7 qoq). The upshot is that the corporate sector’s deleveraging in combination with the persistent housing market weakness has put a lid on the domestic demand recovery in 3Q11, while at the same time export has lost ground even before the expectations for growth softening in Bulgaria’s key trading partners have started to materialize.
Mounting evidence that the euro zone debt crises may worsen has boosted political zeal for addressing the long-term risks for Bulgarian public finances. The government announced plans to implement earlier (existing law stipulates the process to start in 2021) the already enacted rise in the retirement age (65Y and 63Y for men and women from 63Y and 60Y currently) and to tighten the access to disability pensions and early retirement privileges for some professions. Also, authorities stepped up efforts to restructure and privatize, where possible, the few remaining state-owned loss-makers, in the rail road transportation and post services sectors. Importantly, public sector employees are now likely to start making contributions to the state funded pillar of the pension system (while only private sector employees make such contributions now), thus helping to cut persistently the hefty deficits in the state pension fund, which in the context of the rapidly aging population represents the key downside risk for the long-term sustainability of Bulgarian public finances.
What’s more, the MinFin intends to base 2012 Budget revenue projections on more conservative macro assumptions and build additional buffers (via raising contingency reserves) on the spending side, to ensure that the fiscal deficit target (set at 1.3% of GDP) remains under reach. We think that tight fiscal policy and accelerated implementation of some long-delayed structural measures should help the government to consolidate its position, by narrowing the platform for criticism from its political opponents at home. With fiscal consolidation likely to have already reached very advanced stage in the end 2011 (deficit seen at 1.7% of GDP), only a small extra push would be needed in 2012 (deficit target set at 1.3% of GDP), suggesting that the public sector would have either a neutral or small negative contribution to GDP growth next year. Also on the positive side, constantly improving absorption of EU funds should open up more room for investments in public infrastructure, offsetting the fall in the private sector’s capital spending.
But this, in our view, is unlikely to prove enough picking up the anticipated slump in export next year. In response, we now see GDP up 2.0% this year (previously 2.3) and 1.5% in 2012 (previously 2.6%). Fundamentally, the headwinds the Bulgarian recovery faces remain the same as the ones we already stressed in our September’s forecast. These include the slowing external demand in combination with the corporate sector’s deleveraging and weak housing market recovery. However, given the recent deterioration in the outlook for the euro zone economy and unexpectedly steep fall in private sector’s investments in 3Q11, we now expect to see more pressure on corporate sector to shrink its balance sheet next year. In addition to that, deteriorating external conditions will not only cutback exports, but are also likely to put in jeopardy the process of labor market stabilization that started taking shape in mid 2011. The rational for avoiding a full-blown recession (defined as two quarters of negative qoq growth) is that the balance sheets of both public and household sectors remain strong, while external demand is slowing but is still far from falling off a cliff as in early 2009.
Capital flows have come under renewed pressure. Portfolio and FDI flows failed to impress in 3Q11 (EUR 159mn), while other sources of financing (including net errors and omissions) posted their second largest quarterly outflow (EUR 1.1bn) since the economic downturn began. But continued positive momentum in CA dynamics (EUR 1.4bn surplus) helped add EUR 470mn to the central bank reserves in 3Q11. Nevertheless, concerns over capital outflows seem justified to us because Bulgaria remains extremely dependent on external financing to rollover its maturing external liabilities in the corporate non-financial sector. Data on other sources of financing (including net errors and omissions) show that EUR 1.8bn left the country in the 9M to September, the largest capital outflow via this channel in more than a decade. Moreover, escalation of the euro zone debt crisis could cause further deterioration in the already quite tight monetary conditions at home. On the positive side, official reserves now stand at the comfortable 34% of GDP (see the chart below) as compared to 42% in their pre-crisis peak. What’s more, their coverage is relatively high – FX reserves stand at EUR 13.2bn, while external debt maturing overt the next 12M amounts to EUR 15.8bn. While pressure is likely to remain in the near term, an improvement in the situation in EMU and in particular passage of the PSI and bank restructuring plan in Greece would be a clear positive for Bulgaria.
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