Moody’s raises outlook on Bulgaria’s ratings

Moody’s Investors Service has raised the outlook on Bulgaria‘s Baa3 long-term foreign and local currency bond ratings to positive from stable prompted by the government’s strong fiscal position, robust economic growth and expected ERM2 membership.

According to preliminary data, the government ran a budget surplus of 3.7% of GDP in 2006. “This is the largest surplus of any European Union member country, and demonstrates the government’s commitment to a prudent fiscal policy,” said Kenneth Orchard, Moody’s lead analyst for Bulgaria.

The ratio of government debt to GDP has declined dramatically from 66% in 2001 to about 24% today. “Risk is further diminished by the improved currency and maturity structure of the government’s debt, combined with a substantial fiscal reserve account that could be tapped in a period of stress,” Orchard added.

Economic growth has been robust and macroeconomic volatility has declined.

The overall economy grew by about 6% last year, driven by investment in plant and equipment and property development. In Moody’s view, high rates of investment should allow the economy to continue to grow at the current trend over the medium term.

Bulgaria is expected to join ERM2 within the next few months. “Bulgaria currently meets the deficit, debt and interest rate Maastricht criteria for euro adoption but does not meet the inflation criterion,” said Orchard. “Although inflation is expected to decline this year from elevated rates, it is unlikely to fall below the Maastricht criterion within the next three to four years,” he continued.

Although EMU accession remains many years in the future, Moody’s believes that the prospect of euro adoption is a deterrent to destabilising capital flows in ERM2 countries. Enhanced exchange rate stability means that any currency mismatches should not prove costly for the government, and the economy and fiscal revenues should not be subject to a meaningful contractionary cycle.

Orchard warned that a number of risks associated with the transition process remain. Most notably, Bulgaria‘s current account deficit is about 16% of GDP and expanding. However, the deficit has been easily financed by foreign direct investment inflows, which are expected to continue for the foreseeable future, and international competitiveness appears adequate.

Gross external debt has also been rising rapidly, fuelled by high rates of investment and the financial deepening process. Banks, corporations and households have all been borrowing abroad to fund consumption and investment, and most of them are in debt for the first time. “It remains to be seen how these borrowers will cope in an economic downturn,” said Orchard.

However, the banking sector appears to be sufficiently resilient to economic shocks. Balance sheets are moderately strong and profitability is high. Moreover, a significant proportion of the banking sector is foreign-owned.