Coalition of the Spending (New Government First Steps)
The constellation after elections
In the previous issue of this bulletin I shared some expectations the proved wrong.
Immediately after elections I expected a tacit coalition led by Socialists (BSP). Now there is an open coalition in place, consisting of BSP, the King's party (National Movement Simeon the Second, NMSS) and the Movement for Rights and Freedoms (MRF) and sealed by a coalition agreement. It took six-seven weeks of tricky talks to reach an agreement to form an executive with MRF mandate after two consecutive failures of BSP and NMSS to recruit sufficient support. (1) The outcome, however, is a legislative majority of 2/3 of the seats, sufficient to amend the constitution if needed. (2)
Also, I expected a slow down in GDP growth. For the time being, however, all data demonstrate a rate of plus 6% y/y in the second quarter. There was a delay in privatization but elections had an impact of Christmas in the summer, stepped up public procurement and increased investment by private sector on projects launched last year and in the first quarter. The take off of the tourist season (May and June) was strong and by end August the number of visitors went up by 18% compared to the same period last year. Central bank restriction on credit (effective since April) and increased oil prices should have a delayed and somewhat insignificant impact this year. Consumption and investment are still strong.
The economic growth and other factors resulted, by the end of the second quarter in a budget surplus of 2.65%.
The composition
There was no such broad ruling coalition in the last fifteen years. In general coalition has been difficult uniting either center-right (1991-1992, 1997-2001, 2001-2005) or center left (1994-1997) like minded political groupings. Only the Movement for Rights and Freedoms (MRF, the party Bulgaria Muslims vote for) had demonstrated inclinations to join either center when necessary. MRF is a member of the so-called Liberal International, the global group of centrist and reformist politicians and parties but its political leaning in Bulgaria context is more to the left. Now the government is built on the MRF mandate. In the period between late June – end August, all other parties had failed to set a workable executive. The coalition members are MRF, the ex-communist Bulgaria Socialist Party (BSP) and the National Movement Simeon the Second (NMSS, the ex-king-PM's party, also a member of the Liberal International).
The only past precedent of a similar left-left coalition was the Fatherland Front of September 1944, which was established with the help of the Soviet army, extinguished the non-cooperative opposition and expelled than the boy-king Simeon. Foreigners would not know and Bulgarians could have already forgotten that the Fatherland Front was the constitutional chirm of the Communist rule until 10 November 1989 and the formal government change after the first multi-party elections of June 1990.
This historic connotation is not suggesting any peculiar treat for the country in the coming years. It simply reveals a reputation shortage of the incumbent government, which could play a creative role: presumably, the coalition member would undertake no policy that could bring about restoration of communist political habits or signs of it. Although, as we will see below, the leftist agenda is already dominating initiatives in the economic area.
The composition of government offices has been agreed under the following scheme of distribution of the seats in the executive: 8 (BSP): 5 (NMSS): 3 (MRF), and the scheme penetrates all layers of government, including appointees on district and central representatives on local level.
The overall division of labor is the following:
- BSP, securing the prime-ministership for its leader, Mr. Stanishev, controls the most spending and key economic ministries, i.e. those of foreign affairs, the interior, economy and energy (united in one), transport, labor, healthcare, culture and housing;
- NMSS, controls most of the bureaucracy via the ministries of state administration, justice, defense, EU integration;
- MRF controls the least accountable spending of EU funds and subsidies via the ministries of agriculture, environment and emergency situations – one of the best funded bodies with loose pockets.
The minister of finance, Mr. Plamen Oresharski, is independent. He is a former deputy minister of finance in the Kostov cabinet of the United Democratic Forces (UDF, 1997-2001) and was responsible for managing the government debt. His only political backing is Mr. Stanishev; the finance minister reports directly to him.
Above the coalition is the Coalition Council, informal Polit-Bureau-like structure, where party leaders deliberate key policies and personnel issues. Taking into account this background, I can name the ruling structure and “Coalition of the Spending”.
What is the government up to?
The PM and the coalition's statement of intent claim this government is one of “European Integration, Economic Growth and Social Responsibility”.
There is little imagination and room to maneuver in the policy area of EU accession. (see the special section on EU Bulgaria relations.) The economic growth is a non-trivial task when a country runs, as it is the case of Bulgaria in 2005, at 5.5-6% annual real GDP rate, has a generous (at 16% of GDP budget expenditures) social welfare, the government spends 42-43% of GDP, the folks are old (the dependency ratio is 1:1), but nobody intends to reduce the fiscal burden.
The first three month of government operation is characteristic with the following:
- The new coalition inherited a luxurious budget surplus of 2.7% of GDP by the third quarter of the year; half of it was agreed with IMF to be saved as surplus by the year end. It is not yet clear (the report on fiscal performance is available at the day of this publication), but it seems that the line ministries have spent more than agreed upon. Last week of October the IMF mission left without approval of the next year fiscal outlook. (3) Part of the spending zeal has been justified by summer floods and other emergency needs but that's not the whole story
- Due to the government composition the number of government employees increased by at least 10%; the exact figure will be known later.
- Privatization, although almost completed with few remaining monopolies (gas, power and tobacco), has been virtually stopped: some privatization deals of the previous government (a power station, ports and airports on the sea coast, harboring the bulk of the charter traffic) have ended up in the courts and there is no clear message how the government intends to handle the entire issue. It is likely that the power station in the Black Sea port of Varna will be sold to Russian RAO Energy.
- Lack of liberalization in the production and international and internal trade of electricity created a conflict with already privatized electricity distribution stations. It has been resolved by increasing the price of industrial consumers by 16% while prices for households remained unchanged. The ancient public heating system, centralized in a Soviet manner in 1950's, has been a joke for years. Lifting its subsidies has been postponed by previous government and had to be implemented by the incumbents.
- Big government deals like granting EURO 740 million highway concession on a non-competitive basis and building a second nuclear power station were nominally put on hold but, in fact, the government relies on the society's ability to forget, in the first case, while it is stubbornly working on the nuclear deal, which will cost EURO 2.1 million.
In this situation it was almost a miracle that the finance minister managed to compile and submit on time, few hours before the deadline, (4) the 2006 budget before the legislature. The fiscal outlook is the following:
- The budget is balanced, although IMF insisted on a planed surplus of about 1.5% of GDP. The envisaged important parameters are: economic growth is 5.5% of GDP, annual inflation – 5.8%, the exchange rate to the dollar is BGN 1.61, and petrol price is 61.4 per barrel.
- There is a plan for less revenue from direct taxation. The lower tax threshold has been lifted from 10% to 20%, while upper threshold is 25%. All excise duties are to be lifted to the minimum EU level from January 1, 2006. The idea is allow the inflation to hit next year and secure the prospect to join the EMU by the end of 2009. The provisional tax burden will be increased by 0.6-0.7% of GDP in absolute terms.
- One of the reasons for this situation is the idea to finance state pensions with tax revenues. Social welfare taxes have been lowered by 6% (from as high as 41.5%), due to decreased employers' pension contributions but the pay-as-you-go system remains unreformed – the system's expenditures will be finances by other tax revenues and quasi-fiscal government income (25% of privatization proceeds and 50% of the money saved through improving administrative efficiency). The expected figures are not named at all but the budget law prohibits line ministers spending excess revenues (thus hinting that currently there is a problem of overspending).
- Eventually, the social welfare (pensions and mandated labor and other benefits) will consume 18.5% of GDP. The next most money wasting sectors – public healthcare and education – remain unreformed and fiscally tolerated against private alternatives.
IMF talks
There is a serious risk that the stand-by agreement would not be reconfirmed. There two key disagreements.
- The first is the spending pace in the recent months. The situation is basically very simple. The first move of the finance minister, Mr. Oresharski, was to push for an amendment of the budget compilation law that requires budget surplus above 1.5% of GDP to be spent upon parliamentary approval. Legislators voted the amendment promptly but the spending ministers acted faster.
- The second issue is more complicated. IMF is worried by the fact that the current account deficit grew unexpectedly from 7.6 to 13.3% of GDP. If investment ceases coming in from abroad there is a probability of an external shock, argued IMF. Given the failure of central bank administrative measures to cool down credit growth (of roughly 30% per annum) (5), IMF did not find any other instrument at hand besides pressing a fiscal break, i.e. keeping taxes high and refrain from spending. The government was not very open what argument they used in the talks, but obviously it insisted on not cutting the expenditures and referred to the common practice of combined current account and (sizable) fiscal deficits in EU, including 2004 members before accession.
The Bulgarian economist community (besides few exceptions) expressed the following arguments against IMF views:
- imports are due to investment and embrace mostly investment goods (a process that is natural given the record high FDI of over EURO 2 billion in 2004); export grows, fiscal reserves have double the amount need, credit expansion, although unexpected, does not signal accumulation of non-performing loans and if there signs of risky behavior the central bank should punish the wrong-doers;
- the fiscal constellation with huge surpluses is more risky for the current account deficit because the spending pattern of the left-minded government is to finance consumption of non-productive populace after taxing productive folks;
- if Bulgaria is to enter EU in 2007, the external balance would become somewhat artificial macroeconomic indicator; there is little provided there is no theory to advice what kind (what amount) of surplus could cure the current account problem but it is likely that taxes could discourage savings and encourage evasion (which is anyway twice the EU average), and, lastly, the hope is that Bulgaria would continue to attract foreign saving as it was the case with new EU entrants.
I think that the current constellation is due to historic factors (delayed consumption and investment, late bank reforms, and generous welfare state) that are hardly manageable by any of the policies discussed. A provisional healthy policy mix could include simultaneous reforms in pensions and healthcare to provide for individual accounts and savings, lowering government expenditures and direct taxes (while keeping the level of indirect ones), accountable public procurement and information sharing between banks. Unfortunately, none of these is entirely in the IMF policy arsenal (of a stand-by agreement) and government is reluctant even to think in this direction. The incapacity is, to extend, due to the long cooperation with IMF; its role in Bulgaria was fairy positive but diminished the ability of Bulgarian establishment to think on its own.
EU prospects
On October 25 the European Commission presented its Bulgaria 2005 Comprehensive Monitoring Report. The key points of the report are relative well-known, I would comment only on the prospect to meet EU requirement in due time, i.e. by early spring next year. The most difficult issues to resolve are the following:
- Organized crime. The issue is really serious one, not so much because of the size of the black economy but because of the uncertainty it nourishes. The roots of Bulgaria problems are in: a) the ineffective prosecution, which plays its own independent game, not reporting to anyone and protected by immunity; b) the immunity itself is broadly defined and widely applied (to all magistrates, top public servant and members of parliament); c) there was little or ineffective (those fired started “businesses”) cleaning up of the ex-communist structures of the ministry of interior, limited or no publicity of their operations, and all attempts to open archives of the Bulgarian analogues of KGB were blocked, including form the previous government; and d) there is little coordination and much competition between different law enforcement bodies, the basic level of skills is very low, and for fifteen years of reforms there was only one minister who fit the task. All these are impossible to resolve in a year or so. The incumbent minister is far from capable of making a difference. On the top of all these – there is no “EU model” to follow. What will be done? The parliament already voted the penal procedure code where most EU requirements are implemented on paper. The government has drafted a constitutional amendment to lift the immunity. Since there is no universal standard, the cabinet is trying to demonstrate successes in fighting crime. Those would be difficult to prove.
- Related to the above point is corruption. It impact on the local economy is most probably bigger than black (organized crime) market. The problem is that for year the lack of accountability has been used to finance political parties, i.e. the very Bulgarian democracy. Political leaders have shown no will and personal example to deal with the issue; the previous government even stated its mandate with a session on how to avoid the requirement of the public procurement law. Foreign governments and EU itself eagerly financed expensive anti-corruption fighting project thus crowding out grass-root efforts to finds answers to simple questions, like: “who got that public procurement auction and why”, “how much the government costs”, “why customs do not function” and the like. Last but not least, small fishes were sometimes persecuted but not the big ones. The government will try to demonstrate resolve and boldness on this front and it is likely that it will manage to improve its accountability and publicity. Otherwise, it will become unmanageable. Part of the problem is linked to the fact that there are two types of inefficiency built one onto another, the EU and Bulgaria one. It seems that it will take time to reconcile those and the country will not use the subsidies that are made available for the pre-and-post-accession period.
- In this regard, there number of technical issues (CAP related filing and statistics, sanitary and environmental controls, copy-right databases and enforcement), which will be fulfilled on time but with a significant delay in the administrative and provisional beneficiaries' capacity to utilize subsidies .
It seems that Bulgaria will join EU in 2007, resembling Greece at the day of accession with less cash available from Brussels.
Instead of conclusion
At the end of October I stroke 50, and a friend from Britain made me a valuable present – a book by Frank Fox title “Bulgaria” and published in London by A. & C. Black Ltd. 90 years ago, on the aftermath of the Balkan wars and the first year of World War One. The last sentence of that book is very epilogue for the end of 2005: “Simple, laborious, religious, frugal, they [Bulgarian peasants] deserve better than to be food for powder”. (6)
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(1) The constitution gives an opportunity to make three attempts to form a cabinet after a change in the government.
(2) It might be the case with reforming judiciary to meet EU accession requirements, particularly in terms of abolishing the immunity of magistrates and prosecutors.
(3) See below the paragraph on the talks with IMF.
(4) By law, the deadline is October 31.
(5) IMF interpreted the widening of the current account deficit as stemming from consumer credit expansion, and these very policies (raising minimum reserve requirement, application of credits ceilings) were inspired by IMF and implemented by central bank in the first quarter of 2005.
(6) Frank Fox, Bulgaria, London, A. & C. Black Ltd, 1915, p.206.
