Statement of К. Pavlov at a BalREx conference – 11 May 2011

Contents:

• Structure of the Bulgarian economy in the post-crisis period;

• Challenges which will be faced by the economy as a result of the changed external and internal conditions;

• Necessary measures to avoid repetition of the up-and-down cycle in GDP growth.

Main conclusions:

• Policies for boosting tradable products competitive power are needed;

• Important is to strengthen the link between labour productivity increase and income increase;

• Pre-crisis risk underestimation will not happen any time soon. Meaning that post-crisis access to capital will remain tighter;

• In the post-crisis period we will witness a higher saving rate for households;

• Unfavourable demographic tendencies will remain a main long-term challenge for post-crisis Bulgarian economy.

According to the economists of UniCredit, in the post-crisis period the Bulgarian economy will have a more balanced structure in which all components of the end–user demand, including net export, will contribute positively to growth.

The individual consumption is expected to increase with 3 - 3.5% p.a. in real terms compared to 6 - 7% p.a. during the boom. Again investments will be the fastest growing GDP component from the perspective of end-user demand, the expectations being for levels between 5 - 7% p.a. compared to 15 - 20% during the years of the boom. Anyhow, returning to pre-crisis peak levels for individual consumption and investments, will take time. Considering that in the last quarter of 2010 individual consumption was on the average with 9% lower compared to the beginning of the crisis, pre-crisis levels are expected to be reached in 2014. The full recovery of the gross capital formation will take more time as the last quarter of 2010 saw investments of around one third lower than the pre-crisis high. According to UniCredit’s economists, full recovery of the gross capital formation can be expected at the end of 2017 or the beginning of 2018.

In order for this new, more balanced growth structure not leading to new external imbalances, to happen, several important actions in the business policy will be needed:

Firstly, policies will be needed which aim to boost the competitive power of the tradable goods sector. Thus we will have an economy of sufficiently diversified structure which will make it resistant to new shocks.

This new structure largely and almost automatically follows the end of the foreign savings inflow boom of 2005-2008. Thus, with or without policies especially aiming to change the economy growth structure, the change will be a fact, as far as the next decade will probably not see the preconditions for the boom in investments and consumption of 2006-2008. However, this will not be enough, because given the scales of the tradable goods sector at the moment (with share in the gross produced GDP and the unemployment of less than one third), probably it will turn out that a considerable period of time will be needed to reach the desired structure of the economy.

“This is why I think that we need policies directed at creating sufficiently big and diversified sector for production of tradable goods. To achieve this goal the full range of measures related to the human capital, technologies, industrial and regional policy must be used”, Kristofor Pavlov thinks. These policies must lay the ground so that when West European companies again start moving productions eastward, Bulgaria to be ready and to be among the most attractive destinations for investments in the tradable goods sector, and not to repeat the situation from the beginning of the transition, when Bulgaria missed the chance to benefit from the first wave of such investments and they went to the former socialist countries from Central Europe.

Secondly, in order to avoid imbalances leading to a new up-and-down cycle in the economy, it is important to strengthen the link between labour productivity increase and income increase. This may require improvement of the labour market regulation especially regarding collective bargaining of salaries.

Thirdly, the crisis revealed pre-crisis risk assessment mistakes on a global level. We witnessed the euphoria of the markets and the risk assessment considerable deviations from the values determined by the fundamental factors. One conclusion we can draw with a degree of certainty is that underestimating risk from the pre-crisis period will not happen again anytime soon. This means that access to capital in the post-crisis period will remain tighter. To a considerable degree this is due to the crisis as such which undermined the net profit of the households and companys’ capital positions due to the price drop of many asset categories. Consequently, one challenge for the economy will be for the companies and for the households to adapt to the tighter access to capital both from abroad and from domestic sources. “According to our estimates, while during the boom FDI accounted for some 20% from the GDP p.a. on the average, in the post-crisis period we expect them to stabilize at around 4 - 6% from the GDP, and that under the condition that the pace at which the business environment continues to improve speeds up”, Kristofor Pavlov thinks. Thus the reduced inflow of foreign savings will call for policies aiming at higher national savings.

The improved EU funds utilization will also be a major mechanism to counteract the drop in foreign savings inflow. Despite the considerable progress in the EU funds utilization there is a considerable potential which remains unused.

Fourthly, the households also underwent deterioration of their finances and their potential to service new loans also decreased due to the crisis. Thus the households must rely more on own sources to finance purchases of durable use products, including homes. Other will have to undergo a voluntary process of reducing their financial indebtedness because their future income now seem lower than before the crisis, when the impression was created that salaries could growth at a two digit pace over the mid-term. All this points to the fact that in the post-crisis period we will face an increase in the savings rate by households. This process must be welcomed as it will serve as counter balance to the drop in foreign savings inflow. Its negative effect regarding growth and mostly domestic demand can be compesated for with bigger fiscal incentives in the course of the recovery and with more efforts in support of the export-oriented productions.

Finally, the unfavourable demographic tendencies will remain among the main long-term challenges before the Bulgarian economy in the post-crisis period. This is a general challenge for most EU countries. According to UniCredit, in order to meet the challenge, Bulgaria will have to learn the art of attracting successfully emigrants from other countries whose skills fulfill the needs of the Bulgarian economy.

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