High Inflation and a possible recession in Western Europe as the main risks
Several risks are clouding the economic outlook for Bulgaria. Because of the war in Ukraine and the related sanctions between the EU and Russia, energy and food prices increased sharply all over Europe in 2022, which had second-round effects on other goods prices. In autumn 2022, Bulgaria reached its highest price level since 1998. While prices should rise further in 2023, the dynamic of this development will probably slow, which should subsequently lead to a decrease in the inflation rate. Strong price pressure eroded the purchasing power of private households as well as the investment appetite of private corporations in 2022, and should still weigh on both in 2023. However, a lack of energy commodities should not be a major problem for the industry in 2023. Although Russia stopped its gas deliveries to Bulgaria in spring 2022, this can be balanced out via other energy sources as natural gas has only an 11% share in the energy mix in Bulgaria (EU average: 24%). Oil, nuclear and above all coal energy together, however, account for 74% of power consumption. Bulgaria is actually producing more energy than domestically consumed. Production stands at 131% of its own use.
A main risk for 2023 is the looming mild recession in Western Europe over the winter and first quarter of 2023. The Bulgarian economy is specialised in exporting mainly industrial intermediate goods (70% of GDP is total exports of goods and services). Most exports go to the EU (66.3%, with Germany representing 15% of all exports in 2021). While the import-side should remain roughly unchanged in 2023 compared to 2022, the net trade in goods should weigh on the GDP dynamic in 2023. Another brake factor is the interest-rate level. As the Bulgarian Central Bank (BNB) holds the lev in a peg with the euro (BGN 1.96 per Euro (+/-15%)), the BNB mirrors the European central bank policy. Until September 2022, the BNB was able to hold its key interest rate at 0% (its level since 2016), but then had to increase the key interest rate up to 0.6%. As the ECB already proceeded with four rate hikes totalling 250 basis points in 2022 and is expected to increase the interest further towards 3.5-4.0% by the end of 2023, the BNB must slowly follow the same path, with generally a time lag of several months. This will increase borrowing costs sharply and, therefore, weigh on investment and consumption.
However, there are also some positive aspects for the growth outlook 2023 coming from tourism. Already in 2022, tourism was up by 23% in August (the main vacation month) compared to 2021 and remained only 18% below pre-pandemic numbers. This recovery should hold on in 2023 as tourism seems one of the few consumption areas to have remained very resilient in 2022 despite households’ purchasing power losses in Western Europe (the main countries of origin). Other support will also come from the public sector. Already in 2022, the government endorsed measures to cushion the impact of soaring energy prices on households and companies, voting in support packages worth 3.5 billion BGN (2.7% of GDP). These were extended until the end of 2023 and mainly contained an electricity price cap for private households and big companies. Furthermore, the government decided VAT exemptions for small businesses until the end of 2024.
Accession to the EMU is delayed
In 2023, the current account balance should remain in a small surplus, similar to the situation in 2022. The structural trade in goods’ deficit will increase as the import bill will remain very high. The export of goods, however, will be lower because of decreased demand from Western Europe. This effect will be roughly balanced out by higher income due to stronger tourism. The public balance registered a moderate deficit for the third year in a row in 2022, which should persist in 2023, albeit at a reduced level. Public debt will remain very low.
In mid-2020, Bulgaria joined the European Exchange Rate Mechanism 2 (ERM II). During the minimum transition period of two years, the BNB must conserve the peg to the euro and comply with the Maastricht budget and debt criteria, which have been suspended until the end of 2024 due to the pandemic, followed by the energy crisis. Long-term interest rates should remain close to the lowest prevailing in the Eurozone, while the inflation rate may only be 1.5 pp. above those across the three Eurozone member states with the lowest rates. Bulgaria is fulfilling all criteria except for inflation, as, at the end of 2022, the Bulgarian inflation rate was 9.5 percentage points above the Eurozone lower bound. In combination with the domestic political deadlock, Bulgaria is not expected to join the euro in either 2023 or 2024.
No end to politics
After a turbulent 2021, which saw a total of three general elections, politics calmed down only for a short while. In November 2021, the Finance and Economy ministers of the caretaker government formed an alliance (“We continue to change” or PP for short), which won the third election of 2021. They formed a broad government coalition with the left-wing BSP, the populist ITN and the liberal, environmentalist DB.
However, in June 2022, the ITN withdrew from the government after disagreements with other coalition partners over fiscal policy and the lifting of Bulgaria’s veto on starting EU accession talks with North Macedonia. As a result, the coalition lost its parliamentary majority.Two weeks later, the conservative-populist party GERB initiated a successful no-confidence vote against Prime Minister Kiril Petkov. After his resignation, several attempts to build a new government-coalition failed. In August 2022, Galab Donev, an independent politician and former minister of Labour and Social Policy, took over the state’s affairs as a caretaker Prime Minister. In early October 2022, the third consecutive snap election took place. The GERB came first, although the political turmoil started in 2020 with a mass protest originally against the Bulgarian political system, and demonstrations against the former GERB government (2009-2021) and former Prime Minister and GERB chief Bojko Borissow on back of corruption allegations. The new parliament remains split. GERB gained 24.5% of the votes (67 out of 240 seats) followed by the centrist PP (53 seats). Third came the centrist DPS, the party of the Turkish minority (36 seats), followed by the ultra-nationalist Revival party (27 seats), the left-wing BSP (25 seats), the centrist DB (20 seats) and the national conservative BV (12 seats). Technically, the right-wing/conservative block (i.e., all parties, except the PP, the BSP and the DP) has enough seats in the parliament to build a coalition, in which case GERB has to work with the DPS, which is fighting against corruption and therefore cannot lightly form a coalition with GERB, which is still synonymous with corruption. In addition, while GERB is a pro-EU party, other coalition candidates such as the Revival party and the BV are both pro-Russian. Several attempts to form a coalition failed, even after GERB proposed an independent candidate, Nikolay Gabrovski, for the office of Prime Minister. If the third attempt to form a coalition fails, Bulgaria will go to the polls again in early April 2023.