Between the Euro and the 2025 Budget: First Steps of the New Government

In the first days of the new government, we are getting more clarity on some open questions about the direction of economic policy. A few warning signals are already visible as well. In the Prime Minister’s meetings with the President of the European Commission (EC) and the President of the European Parliament we could glimpse fragments of the new coalition intentions, including on future efforts to catch up in reforms and investment under the Recovery and Sustainability Plan and euro area accession. Moreover, the new finance minister has also had meetings with Eurogroup and European Commission as part of the process towards euro adoption.

The euro area accession turns out to be the focus of a political clash at the very beginning of the new rule. What we know so far and what can we expect? Inflation data to December 2024 show a deviation of 0.1 percentage points from the price stability criterion. Monthly inflation rates in the other Member States and the trend in Bulgaria give reason to believe that this deviation could be wiped out in the next few months. Under these circumstances, the government – at least according to the public statements of the finance minister – seems to go through the following steps: it will wait for the release of inflation data until January (to be published in mid-February), when the criterion is likely to be met, it will submit to the parliament a draft budget for 2025 (by 14 February) and it will send a medium-term fiscal-structural plan to the EC (by 20 February).

Then the government will likely request a convergence report from the EC and the ECB. The report will assess both the fulfilment of the price stability criterion and the criterion for sound and sustainable public finances. In practice, this means that it will need to analyze and assess the final budget deficit data for 2024 (which will be released in April), as well as the immediate outlook for public finances that will become visible from the draft budget for 2025 and the fiscal trajectory and projected macro policies in the coming years.

In other words, there is no getting around the need to formulate a way forward towards a prudent and credible fiscal consolidation. The government and the ruling majority need to agree on revenues and expenditures that achieve a budget deficit of up to 3% of GDP (although the debate on balancing the budget remains open, but this is beyond the scope of this commentary), and not only for the current year, but also in the years to come. In the meantime, this is what already happened:

As expected, the government withdrew the budget draft package. There is a clear political logic in this – let us recall that the newly elected government of Kiril Petkov in December 2021 withdrew the submitted draft budget for 2022 and submitted its own after about a month, which was adopted in parliament in early March. But, more importantly, the framework of the caretaker cabinet has to be changed to a significant extent indeed, or at least this is the claim of the new government.

The government also withdrew the package of tax law amendments. While this seems to be part of the political act of setting some new course for public finances, it is quite needless: unless, of course, the new majority envisages a sharper turn with major tax overhaul. At the moment, the official commitment is that taxes will not be raised. This however is not a sufficient guarantee, especially if we take into account that for some politicians social security contributions are not considered taxes, or if there is no change in tax rates but rather expansion of the tax base, etc.

The prime minister’s hesitant statement on several crucial structural reforms, which are pre-conditions for unlocking further payments under the recovery plan, also seems worrying. At the moment, according to initial statements, they are at the forefront of negotiations within the coalition.

The other path is to try to cut the deficit through limiting the growth of government spending. But here the signals are even more worrying. The finance minister said he will not go through with cuts to the public investment programme – an action that has almost always proved to be a “buffer” in the past and even led to surprise surpluses in some years. Almost as firmly, the finance minister defends the increase in salaries in the Interior Ministry and other security sector services – again, an increase of more than a BGN billion a year, which will weigh on the budget. The defence minister has already issued an order setting the new salary levels in the armed forces at an average increase of around 30%. The government is also without critical overview extending the compensation programme for all non-domestic electricity users – including companies with record profits and those for which energy costs do not affect competitiveness – practically setting a price “ceiling” of BGN 180/MWh with an estimated financial dimension of BGN 440 million, at least BGN 240 million of which will be direct budget expenditure.

All this casts a very serious doubt on the potential of the new government to curb budget populism and to bring the state finances into a sustainable framework. And this is not just a matter of meeting the criteria for joining the euro area, but a fundamental prerequisite for macroeconomic stability, investment and competitiveness, without which there can be no economic growth.