Fitch Affirms Bulgaria at 'BBB

Bulgaria's ratings balance its strong external and public balance sheets and credible policy framework, underpinned by EU membership and a long-standing currency-board arrangement, against weak potential growth, partly due to unfavourable demographics, which could weigh on government finances over the long term. Governance indicators and income levels are slightly above peers.

The Positive Outlook reflects the dissipation of macroeconomic risks stemming from the Covid-19 pandemic, underpinned by a more resilient economy, as well as continued gradual progress towards euro adoption. In Fitch's view, short-term downside risks tied to the coronavirus pandemic and prolonged electoral uncertainty are more than offset by prospects of substantial funding for investment from the EU and a broad commitment to macro and fiscal stability (anchored by the inclusion of the Bulgarian lev into Exchange Rate Mechanism II; ERMII).

Fitch now expects the economy to expand by 4.7% in 2021, compared with 3% previously and in line with the 'BBB' median. The upward revision reflects better-than-expected 1Q21 GDP, largely due to resilient private consumption, despite a more challenging health situation (Bulgaria recorded one of the highest Covid-19-related death rates in Europe in winter). Recent indicators point to further strengthening of domestic demand, while exports (which have struggled in recent quarters) are likely to pick up in 2H21 thanks to cyclical factors. Bulgaria's very low vaccination rate (12.6% fully vaccinated as of 20 July, versus an EU average of 43%) raises some downside pandemic-related risks, although the authorities are unlikely to put in place severe containment measures that would significantly affect economic activity.

Investment will be a key driver of growth over the medium term, as Bulgaria will be one of the main beneficiaries of EU transfers in the coming years, including EUR16.6 billion (27% of 2020 GDP) in the 2021-27 Multi Annual Framework and EUR5.9 billion (10% of 2020 GDP) in grants under the EU's Recovery and Resilience Facility (RRF). Bulgaria has yet to submit its national recovery and resilience plan to access RRF funds (original deadline was end-April), partly due to electoral considerations and challenges around the plan's project and reform priorities. Further delays to the process are possible and could potentially impact disbursement of the first tranches, which could affect growth in 2022. There are also concerns about absorption capacity, given a modest record and weak business environment that could limit effectiveness of investment. However, given the sheer size of funds we still expect the RRF to play a key role in supporting GDP growth of 3.9% in 2022-23.

Fitch has yet to assess the impact of the RRF on longer-term growth potential, as there is little clarity on the timetable and milestones of the reform programme. Key reforms are likely to focus on long-standing structural issues in education, health, social and labour markets, in addition to efforts at improving energy transition. If these reforms successfully increase productivity, they could help offset the negative impact of an ageing population.

The European Commission estimates an average 12% decline in the labour force in each of the next three decades (one of the sharpest falls in the EU), with a significant impact on potential growth from 2025 onwards.

We project a modest widening of the fiscal deficit in 2021, to 5.0% of GDP versus 5.5% for the 'BBB' median, reflecting an increase in pandemic-related expenditure (of around 3pp of GDP according to authorities). Preliminary cash data for January-May point to a solid revenue performance, underpinned by economic recovery and efforts to improve compliance. The authorities plan to make a one-off increase in pensions more permanent, which could cost the budget around 1pp of GDP from this year onwards. This is likely to be partly offset by improved expenditure efficiency elsewhere.

Under our baseline scenario, we expect the fiscal deficit to narrow gradually to 2% of GDP in 2023 thanks to the unwinding of support measures. This will keep public debt/GDP at below 30% over the forecast horizon, broadly in line with the authorities' convergence programme and well below the 'BBB' median of 57%. There is some uncertainty about the fiscal path beyond 2021 given the electoral situation. However, Fitch maintains its view that risks are contained by a long record of fiscal prudence that is well entrenched across the political spectrum.

Bulgaria has held two successive parliamentary elections (April and July) that have resulted in a highly fragmented legislature with limited prospects of a stable government. The country's established parties, centre-right GERB and centre-left BSP, have lost significant support but the other parties have been unable to agree a ruling coalition, in part as they lack a clear majority. At present, the most likely options appear to be a weak minority government (potentially led by now largest party ITN), or new elections that could be held at same time as the presidential poll in 4Q21. Prolonged uncertainty has been a feature of Bulgaria's political scene in the past and can impact confidence and investment. However, at present Fitch does not see major risks to economic policy or to Bulgaria's commitment to the EU/euro area accession, with these issues playing an insignificant role during the campaigns.

The authorities have stated their commitment to adopting the euro by 2024, a timeline that Fitch considers realistic. The county currently meets all convergence criteria except for inflation, which is just above the estimated reference value. Like other countries in the region, headline inflation has accelerated due to supply side and temporary factors (the harmonised index of consumer prices reached 2.4% in June), while core inflation has remained stable. At present, we see limited inflation pressures beyond 2021, but risks could increase if demand-side pressures accelerated. Overall, we consider euro adoption as supportive of the rating, as underlined by our view that all things being equal, we would upgrade Bulgaria's Long-Term Foreign-Currency IDR by two notches between admission to the ERM II to joining the euro.

Bulgaria's solid external finances are a rating strength and a factor that has helped reduce macro vulnerabilities. We expect the current account to remain in deficit, averaging 0.9% of GDP in 2021-23 as service exports continue to struggle and import demand picks up in line with stronger investment growth. The capital account will be boosted by large EU transfers, which combined with ongoing external deleveraging by the private sector, will keep the net external creditor position at close to 28% of GDP in 2021-23 (compared with the 'BBB' median net debtor position of 7%).

The country's banking sector remains liquid and well capitalised (total capital ratio of 22.5% in 1Q21), with the Bulgarian National Bank maintaining a cautious approach to safeguard the sector. Asset quality remains broadly stable, with the ratio of non-performing loans falling to 5.4% in 1Q21 versus 6.4% a year earlier, reflecting the impact of moratoria measures. These measures are expected to be in place until end-2021, after which the NPL ratio is likely to increase modestly. The sector is well positioned to absorb these losses and the authorities are likely to put pressure on banks to promptly address delinquency issues.

ESG - Governance: Bulgaria has an ESG Relevance Score (RS) of '5[+]' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Bulgaria has a medium WBGI ranking in the 61th percentile, reflecting a history of unstable coalitions, relatively high perceptions of corruption and moderate institutional capacity versus track record of peaceful transitions and above average regulatory quality. /BGNES

Categories:

Tags: