Minor Budget Expenditure Reduction in 2009 despite the Crisis

The budget implementation data for 2009 published at the end of last week shows consolidated program annual deficit of 529.5 million leva or 0.8% of the GDP forecast. On the one hand the deficit coincides with the recent government budget statement of no more than 500 million leva deficit for the year. On the other hand, the forecast used for the 2010 budget adopted in December 2009 was for a balanced 2009 budget. This means that the government failed to meet its zero-deficit forecast which it made only two months ago. Not to mention that the final balance significantly differed from the official yearly budget forecasting 3% surplus based on unrealistic assumptions for the revenue during a crisis.

As we have mentioned before, the more we popularize positive stance towards a small deficit, the more likely it is that we loosen our budget discipline. Reasonable budget policy was part of the main reasons of two out of the three big credit rating agencies, Moody's and S&P, to improve our credit rating perspective from stable to positive and from negative to stable respectively. Stable budget finances would also serve as Bulgaria's main "trump" in its ambition for a quick admission to the Exchange Rate Mechanism II, the so called Euro zone waiting room.

The 2009 budget data discloses not so much a year of economic downturn, but one of elections. While the budget revenue for the consolidated program shrank by 11% in real terms (i.e. isolating the inflationary effect) the expenditure shows disproportionately small reduction of about 2 percent in comparison to 2008. The situation with the central budget revenues and expenditures is the same – substantial drop in revenue and symbolic drop in expenditure. The reasons behind the serious revenue reduction are due to the lower tax revenue caused by reduced internal consumption and as a consequence – decrease in imports, lower fuel and main raw materials prices on the international markets (which reflects the import's VAT revenue) and reduced corporate sector profits due to the economic downturn. Despite the official 2009 pay freeze, a real 3% wage and remuneration increase took place in the public sector both in the national and in the consolidated budget.

2009 Budget completion

Source: Ministry of Finance, IME calculations

*Inapplicable

As a result of the symbolic drop in state expenditure, the state intervention in the economy [1] remains high despite the budget revenue drop from 40,9% of 2008 GDP to 38,7% for 2009. As seen from the chart below, budget expenditures increased from 37.9 percent of GDP in 2008 to 39,5% in 2009. According to the famous Rahn Curve there is an inverse relation between government spending and a country's economic growth – i.e. the higher the budget expenditures, the lower economic growth [2]. In this sense the increased 2009 budget expenditures could slow the country's exit from the crisis.

Source: Ministry of Finance, calculation and GDP 2009 forecast – IME

Still it has to be acknowledged that the latest data confirms the fiscal discipline strengthening for the second half of the year. This can be clearly seen through the monthly consolidated budget balances which can be implicitly derived from the official balance accumulation statistics over the year. After reaching a record deficit in the last month of the triple coalition mandate, monthly deficits significantly decreased since August 2009 and in some months we even had a small surplus. It is a different issue how exactly this was achieved and whether it is not happening at the expense of a contract non-compliance between the state and the private sector.

Source: Ministry of Finance, IME calculations

The 2010 budget forecasts 0,7% budget deficit for the consolidated program. It has to be taken into account that the budget is based on a more optimistic 2009 budget completion assumptions than the final data shows. In this sense achieving the targeted budget balance for 2010 could be more difficult than expected and it requires more caution and conservatism in the new year. The same thing is illustrated by the January budget data showing a significant 495 mln leva deficit caused by project expenditures financed by euro funds (240 mln leva), external debt expenditure (214 mln leva), and public errands arrears paid (40 mln leva). According to the finance minister the budget is expected to continue deficit accumulation in February and March (besides everything else, due to 160 mln leva more firm arrears which has to be paid during the first quarter), before the tendency reverses and the state starts to achieve positive monthly balances .

Conclusions:

• The Bulgarian government still has high expenditure which in times of crisis can only hinder a more rapid recovery of the economy;
• Efforts are underway to reduce expenditure, but the partial approach cannot be a long term strategy;
• The real wage growth in the public sector in times of crisis when not accompanied by serious staff cuts is scandalous. It illustrates the pressing need of an administrative reform (staff cuts and functional optimization) which should ultimately lead to lower maintenance expenditure.

[1] Measured through budget expenditure to GDP ratio

[2] This dependence of course is a subject of wide debate in the academic community