Economic newsflow has been more positive in early 2010, as clear signs of stabilization have emerged after the sharp output decline last year (GDP growth at -5% in 2009). The balance of payments data underlined what had been already obvious from the improvement in sentiment and activity indicators: recovery has started, led by export and inventories and is proceeding roughly at the same speed as in the rest of Emerging Europe.

But the news is not all positive; data releases for the household sector were pretty downbeat. While low inflation is helping to preserve real incomes, depressed retail sales combined with flagging confidence indicators suggest that households remain reluctant to spend. The latest labor market figures showed that job losses escalated in 4Q09 and even the manufacturing sector, where the recovery process has started, continued to shed jobs. More worryingly, labor market adjustment, which is instrumental for the economy’s rebalancing under the currency board, has predominately taken the form of rising joblessness rather than a sharper slowdown in wages. This is a negative development, as it threatens to make the adjustment socially more painful, thus further eroding the flagging public support for reforms.

The crippled housing market remains at the heart of Bulgaria’s recession, with median home prices falling 30% from their peaks, and even more sharply in heavily affected second-tier regions. The drop has sapped a principal source of wealth for Bulgarian consumers whose spending had largely contributed to growth during the years of the economic boom. On the positive side, the fall in housing prices slackened to just 2% qoq in 4Q09, while 12 out of 28 regions reported positive qoq price changes, suggesting that house prices are stabilizing in a growing number of regions. Surprisingly, house prices on the coast, which was largely viewed as the most “overheated” location during the construction boom, continued to decline at a slower than the average market rate, which seems to highlight that the rebalancing in these particular areas will need more time to fully materialize. Given the above, we are still forecasting negative GDP growth in 2010, as we think that Bulgarian households will need more time to join the recovery process. It would be too optimistic to believe that an upturn in exports and inventory alone would be strong enough to bring the economy out of the woods; hence Bulgaria is likely to remain in recession for the most part of 2010. Moreover, sustainable recovery goes much further than only the rate of growth; it only begins when companies and banks clean up their balance sheets and the economy starts to create new jobs again. In the medium-to-long run Bulgaria needs to press ahead with structural reforms to lay the foundation for sustainable growth, while in the shortrun it needs to boost domestic liquidity and strengthen its reserves position to dampen any potential financial markets concerns on private sector capacity to rollover its external debt.

Opposite to many other emerging markets Bulgaria entered the recession with lower level of government debt and a good state of public finances. However, the unpleasant surprise is that the Bulgarian 2009 budget deficit was revised to 3.7% due to unaccounted procurement deals: this “hidden deficit” is forcing Bulgaria to scrap its bid to apply to join the ERMII mechanism this year. This is not a major threat, but it’s obviously unpleasant and adds to the rather poor fiscal performance registered by Bulgaria in the first three months of the year. The

scale of fiscal consolidation which Bulgaria needs to implement from 2011 onward looks smaller when compared with those due in other peers, but the government cannot rest on its laurels: we may expect VAT increase and more austerity measures being implemented in the moths ahead, as the government will be keen to avoid budget deficit widening again above 3% benchmark.

Силни страни:

• No stimulus phasing out will burden recovery dynamics

• Strong commitment to push structural reforms

• Untapped potential to boost growth by better use of EU aid

Слаби страни:

• Large private sector external debt

• Slower adjustment dynamics due to fixed exchange rate

• Rebalancing of external position is not over