Bulgaria and the IMF Again

The unofficial visit of Hans Flikenschild, the head of the International Monetary Fund (IMF) mission to Bulgaria, has ended. During this visit discussions with Bulgarian officials were made about their policies at the end of 2005 and in 2006. According to the public information there had not been an agreement on some crucial issues and further talks are needed.

According to Mr. Flikenschild, the current account deficit (CAD) is a major problem facing the Bulgarian economy and should be offset by a budget surplus of at least 3% of gross domestic product (GDP), which equals around EUR 700 million. (1) The IMF forecasts that the CAD will reach 13.8% of GDP in 2005 and if it exceeds this limit, it should be accompanied by additional budget savings. Along with it measures directed toward restricting the credits by the Bulgarian National Bank (BNB) are taken following the IMF recommendations.

Reducing budget spending is positive and should be welcome. However, the attainment of a budget surplus means that in the current ineffective public spending, which costs too much, the government has taken from the citizens more money than needed. This happened in 2004 when the surplus was around 1.7% of GDP and will happen in 2005 (the provisional surplus at the end of October is around EUR 840 million or above 3.9% of expected GDP and will probably be around 2% of GDP in the year-end). The IMF official insists on the same development for 2006.

This policy of budget surplus is improper as it deprives people and companies of their own incomes produced by themselves and gives the government an opportunity to use the money following its purposes, which could be very different from the people's. On the one hand, additional money taken restricts consumption, which is one the IMF's targets, while on the other it does not allow for some investments that could have a positive effect on the production in the country. It substantially influences not only the demand side, but also the supply side. Temporary lower consumption is on account of restricted chances for longer-run growth in supply.

Let us consider the dynamics of goods import according to latest the BNB data for October 2005. The analysis, made on annual basis, shows that the increase in consumer goods import is around EUR 409 million compared to the previous period. It constitutes about 13 percent of the total increase of imports. Investment goods import grows with about EUR 1 012 million or 32 percent of the total increase, the rest due to raw materials (24 percent), mineral fuels, oils and electricity (30 percent), and other goods (1 percent). As Bulgaria is relatively poor in terms of natural resources, its economy needs to import them to operate. After the importation, the goods are processed and a large share of them is used in the production of exported goods. For example, the increase in energy resources is about EUR 940 million that should be put together with the increase in the energy export with EUR 405 million, and higher oil prices for the period should be taken into consideration.

Therefore, the current account deficit implies that the economy works, attracting capitals and the total balance of payments measured by the change in the foreign currency reserves of the country is well above zero. The IMF officials' concern about this is related to the rise in the private foreign debt. Reasons for this development can be found as a result of the application of their recommendations. On the one hand, BNB has taken restrictive measures against credit growth and on the other hand, the government takes more money from companies and households. Given the higher economic activity at present, demand for credits is directed out of the banking system and out of the country leading to a rise in foreign debt.

However, some of the IMF's advice brings benefits to the economy. Cutting budget spending, reforming some sectors, and buy-backs of foreign government debt are recommendations that should be followed. Reforms in education and the healthcare systems are delayed leading to rising ineffectiveness, worsening quality of the services' and higher costs. In these circumstances, the teachers' demands for higher wages are an example of how one well-organized societal group, knowing its interest, can seek rents by the state to increase its prosperity at the account of the taxpayers. The number of students has decreased due to the lower birth rate and emigration but the result is not a reduction in number of teachers and maintenance costs for education. Higher wages should follow a higher quality of education or the respective service that is provided.

One should note the practice of granting a thirteenth wage to the budget employees. It is completely improper because the source of the funds is not the budget itself, but private sector employees. They have worked more during the year, they have generated more incomes and they deserve to be rewarded for their labor and entrepreneurship. But this reward is taken away coercively through taxes and is given to other people whose contribution is very difficult to measure. A possible resolution of this case is to refund money back to the people by check, a practice which is applied in some countries. However, this enables the government to realize large budget surplus again in the next year, which probably will happen in 2006 when the revenues will exceed the plan by at least EUR 500 million.

A better decision is a reduction of the tax burden via the introduction of a 10 percent flat tax on personal income, a 10 percent tax on the corporate profit and a 10 percent payroll tax. IMF officials would probably disagree but this is the way to create more incentives for people and companies and to boost the supply side. Tax reform should be combined with change in education and healthcare, in the judicial system and with relief in the business environment. Only reforms that expand economic liberty enable faster economic sustainable development, which is necessary for relatively poor countries like Bulgaria.

The precautionary agreement with the IMF expires in the second half of 2006 but this does not mean that the cooperation will be ended. It will be carried out in changed conditions implying weaker influence by the Fund on the government and central bank policies. In such circumstances, the prudent fiscal and monetary policies attain greater importance and the implementation institutions should realize that the justification with the IMF for some inappropriate actions would no longer be applicable.

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(1) According to the forecast in the state budget