This report assesses Bulgaria’s economy in light of the European Commission’s Annual Growth Survey published on 21 November 2018. In the survey, the Commission calls on EU Member States to implement reforms to make the European economy more productive, resilient and inclusive. In so doing, Member States should focus their efforts on the three elements of the virtuous triangle of economic policy — delivering high-quality investment, focusing reforms efforts on productivity growth, inclusiveness and institutional quality and ensuring macroeconomic stability and sound public finance. At the same time, the Commission published the Alert Mechanism Report (AMR) that initiated the eighth round of the macroeconomic imbalance procedure. The AMR found that Bulgaria warranted an in-depth review, which is presented in this report.
Bulgaria’s strong growth momentum and the soundness of government finances offer an opportunity to tackle its remaining structural challenges and raise growth potential. Levels of poverty, social exclusion and income inequality are still among the highest in the EU. As the population ages and skilled workers become progressively scarcer, adequately addressing these challenges and accelerating economic growth will increasingly depend on Bulgaria’s capacity to implement structural reforms. Investment in improving people’s skills, in infrastructure and in research and innovation would support productivity and help Bulgaria catch up with the rest of the EU. This would also help to bolster the resilience and competitiveness of Bulgaria’s open economy, especially given the increasing international risks.
Building on past progress, the authorities have made further efforts to tackle the identified macroeconomic imbalances by strengthening financial supervision and taking steps to address financial sector vulnerabilities. Economic growth remains robust and the labour market continues to perform well. Real Gross Domestic Product (GDP) (adjusted for inflation) grew by an estimated 3.2 % in 2018 and is expected to increase by 3.6 % in 2019 and 2020, driven by domestic demand. Real wage growth will continue to support consumer spending, while investment is increasingly spurred by EU funding. The unemployment rate (5.2 % in Q4-2018) stands below its pre-crisis level. Long-term unemployment has decreased and youth unemployment has fallen below the EU average. Despite its relatively good overall economic performance, Bulgaria has been slow to catch up with the rest of the EU. GDP per head, at 50 % of the EU average in 2017, has grown only slightly faster than the EU average since 2011. Potential GDP growth has strengthened over recent years. This has been driven mainly by improvements in total factor productivity while the contributions of capital and labour have been modest.
The growth potential may be hampered by negative demographic trends and the increasing scarcity of skilled workers, as well as by increasing regional disparities. Labour shortages and planned government wage increases are expected to drive wage growth above productivity growth until 2020, potentially leading to losses in Bulgaria’s cost-competitiveness. Budgetary developments remain positive.
The government achieved a budget surplus equivalent to 1.1 % of GDP in 2017 due to improved tax collection and higher-than-projected nominal (noninflation-adjusted) growth. On the spending side, public investment started to recover and public sector wages increased. The supportive overall economic situation and a generally prudent approach to government finances are expected to lead to sustained budget surpluses until 2020. Investment in skills, social cohesion, infrastructure, and research and innovation is needed to support competitiveness, productivity and the process of catching up with the rest of the EU. Insufficient investment is holding back the modernisation of the economy. Bulgaria’s considerable labour and skills shortages warrant investments in training and reskilling; addressing the lack of digital skills; improving the quality and inclusiveness of education and aligning it to the needs of the labour market; and improving the capacity of public employment services.
Investments in transport, energy and water infrastructure will improve the conditions for attracting foreign direct investment and will strengthen companies’ competitiveness. More investment in research and development (R&D) is needed to boost productivity gains, as well as strengthened links between businesses and research institutions and a better integrated research and innovation system.
Key priorities for support by the European Regional Development Fund, the European Social Fund Plus and the Cohesion Fund over 2021-2027 are identified in Annex D, building on the analysis of investment needs and challenges outlined in this report. Overall, Bulgaria has made some progress in addressing the 2018 country-specific recommendations. There has been substantial progress in: taking measures to follow up on the financial sector reviews; There has been some progress in: improving tax collection and public spending, including by stepping up enforcement of measures to reduce the extent of the informal economy; implementing supervisory action plans in the financial sector and ensuring adequate valuation of assets, including collateral held by banks; making disadvantaged groups more employable by strengthening measures to get them into work or training and improving their skills; providing quality and inclusive mainstream education (however, measures to address the particular situation of Roma and other disadvantaged groups are lagging behind).
There has been limited progress in: upgrading the governance framework for stateowned enterprises in line with international good practices; completing the reform of the insolvency framework and promoting a functioning secondary market for non-performing loans; improving access to health services, reducing ‘out-of-pocket’ payments and addressing shortages of health professionals; introducing a transparent scheme to revise the minimum income and improving its coverage and adequacy.
Regarding progress towards its national targets under the Europe 2020 strategy, Bulgaria is expected to achieve its target for reducing greenhouse gas emissions and increasing the share of renewable energy. It has taken measures to improve energy efficiency but energy consumption remained above the indicative national targets.
Bulgaria has made progress on employment, early school leaving and tertiary education rates, but has yet to meet its targets. The situation has worsened regarding poverty reduction. There was no progress towards the R&D intensity target. Bulgaria faces challenges on a number of indicators of the Social Scoreboard supporting the European Pillar of Social Rights. Bulgaria still has one of the highest shares of people living at risk of poverty or social exclusion, as well as high levels of income inequality. Social transfers have a low impact on poverty reduction. Major challenges for the education and training system remain, including providing quality inclusive education and tackling early school leaving.
The population’s level of digital skills remains very low. Despite improvements in the labour market, the low-skilled, the Roma and people with disabilities still face significant difficulties in finding work.
The main findings of the in-depth review contained in this report and the related policy challenges are as follows: The banking sector has been strengthened overall, but some vulnerabilities remain. Banks have addressed the recommendations arising from the 2016 asset quality review, with one exception. New initiatives in 2018 included new rules for large exposures and the identification of connected clients; improved policies in several banks for making provisions for potential loan losses: an increase in the counter-cyclical capital buffer rate; and macro-prudential tools for borrowerbased measures. Measures to be completed include addressing valuation issues, implementing regulatory initiatives and strengthening the framework for resolving banks in an orderly way. The reform of non-bank supervision has continued. Follow-up measures to the insurance and pension funds reviews are being implemented.
Remaining steps include fully implementing an action plan to establish a proper risk-based, forward-looking supervisory process, and adequately following up on outstanding issues highlighted by the non-bank financial sector reviews, including valuation practices and grouplevel supervision. Concerns that have recently emerged in the car insurance sector also remain to be addressed. These include the rudimentary pricing model and the effectiveness of the National Bureau of Bulgarian Motor Insurers, as well as the lack of a harmonised methodology for compensations set by judges.
The private sector is reducing its debt, but the level remains high. The high debt of non-financial corporations continues to present a challenge, although it has been decreasing over the last few years, partially due to robust nominal GDP growth.
While slowing the reduction in private sector debt, the recent increase in lending activity could support higher investment and growth. Levels of non-performing loans have been falling, in part due to a recovery in credit flows and a more dynamic secondary market, but still remain well above the EU average. Deficiencies in the insolvency framework are slowing the reduction in private sector debt and the work-out of nonperforming loans.
The labour market has improved, supported by economic growth. The employment rate reached 71.3 % in 2017, the highest since Bulgaria joined the EU in 2007. Despite low take-up, bettertargeted policies to help people into work or training are starting to yield results, supported by economic growth. Nonetheless, some groups (the low- skilled, young people, the Roma, people with disabilities) continue to face challenges. A shrinking working-age population as well as skills shortages and skills gaps continue to be of concern.
Other key structural issues analysed in this report, which point to particular challenges for Bulgaria’s economy, are the following: The social protection system is insufficient to tackle the significant social issues. Wide income inequalities and the high number of people at risk of poverty point to the need for ‘active inclusion’ policies designed to enable every citizen to work and participate fully in society. These challenges also point to the need for targeted support to vulnerable groups, as well as better availability and quality of integrated social and healthcare services and housing. The adequacy and coverage of the minimum income remain limited and there is no objective mechanism for regularly updating it. The impact of taxes and benefits on reducing poverty and inequality is significantly lower than the EU average. This reflects the low level of social spending, the uneven availability of social services across the territory and the limited redistributive effects of the taxation system.
The education system is being modernised at all levels but significant challenges remain. Persistently high rates of early school leaving and low educational outcomes highlight the need for significant investment in education. This is particularly relevant for addressing the challenges of quality and equality of opportunity in early childhood education and care, school education and vocational education and training. Despite ongoing efforts, higher education is insufficiently aligned with the needs of the jobs market. The rate of participation in adult learning is one of the lowest in the EU. Inclusion of Roma in education and the high impact of socio-economic status on educational outcomes remain problematic.
Many Bulgarians still face significant obstacles in accessing healthcare. Public expenditure on healthcare remains very low, with formal and informal out-of-pocket payments covering almost half of healthcare costs — one of the highest shares in the EU. The strategy for longterm care is under way, but implementation of the National Health Strategy action plan is considerably delayed.
Public administration reform continues to be slow and is yielding insufficient improvements while the business environment remains weak. Institutional shortcomings, regulatory uncertainty and corruption remain among the main obstacles to investment. There has been little progress in the provision of public services and the perception of their quality remains low.
Notwithstanding the generally good progress in programming and implementing EU funding, administrative capacity remains a challenge. The design and implementation of public policy, as well as capacity-building at all levels of public administration, would benefit from strengthening. The practical benefits of the ongoing reforms to public procurement are limited; aggregated purchases have advanced only at the central level and the uptake of electronic procurement has been delayed. On a positive note, the provision of digital public services for businesses has improved significantly and the introduction of e-government is advancing.
The fight against corruption remains a challenge. In 2018, Bulgaria adopted a comprehensive reform of its anti-corruption legislation and established a new unified anticorruption agency, but results have yet to be seen. Significant progress has been made towards reinforcing the independence of the judiciary. Still, a number of challenges remain, in particular to strengthen the accountability of the prosecution service and public trust in it, and to rebalance the workload among courts. In recent years, Bulgaria has been addressing deficiencies in its anti-money laundering framework, but a number of concerns remain. These include the effective transposition of the European Union’s legal framework and the use of financial information in the investigation and prosecution of financial crime and high-level corruption.
State-owned enterprises suffer from weak corporate governance. The situation of stateowned enterprises reflects to some extent their management and supervision, as well as restructuring challenges. A reform of the corporate governance framework is being prepared, which would help to address current weaknesses.
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