Economic Policy Review ISSN 1313 - 0544

Is the Bulgarian Economy Overheating?

Author: Dimitar Chobanov / 29.03.2007
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Recent analyses prepared by experts representing different institutions present their views of the economic situation in Bulgaria and comment on both the positive development and the existence of potential risks. Of such nature are the reports prepared by the World Bank, the International Monetary Fund, the European Commission, and different rating agencies. The main indicators attracting their attention are the increase of the deficit to the current account of the pay-balance, the inflation, the increase in crediting and the GDP. According to common conclusions "overheating" of the economy is possible to occur, in which case there will be negative consequences to the economic agents in the country.

The situation in Latvia is similar, based on symptoms similar to those seen in the Bulgarian economy. A very fresh example is the attack against the fixed rate of the local currency to the euro, which was followed by certain rough moments that triggered the implementation of emergency measures by the Latvian government.

"Overheating of the economy", as referred to in the abovementioned analyses, consists of the following. When the presented production capacity, comprising of capital, work and technologies, is insufficient to answer to the needs of the increasing demand, the consequence is increase in price levels, in salaries, in employment and in the deficit of the current account. There are two possible ways out of this situation. The first is to decrease the inner demand by gradual "cooling" of the economy, and the second way is by sharp "cooling", which could lead to unpleasant consequences. The latter may be combined with decrease in the level of trust of the local economies, outflow of capitals, decrease in the prices of assets and in economic growth. Similarly to the Latvian case, in this way the probability of appearance of a speculative attack against the fixed exchange rate may arise making way for a financial crisis to occur.

The approach is based on comparison between the potential production level that could be achieved with the available resources and technologies and its actual level. This requires availability of data on the economics, which are still insufficient in quantity and quality, to allow the drawing of scientifically based estimates. Notwithstanding the fact that today the institutions use contemporary models, the results, on the basis of which they draw conclusions for the current situation of the economy, depend too much on probabilities, which disorientate them from the reality.

The above-mentioned indicators do not show such development yet. One of the main symptoms for the "overheating" of the economy was the rapid increase in the prices of goods and services. The officially estimated inflation in Bulgaria for 2006 is 7.3% average annually, which is above the average level for the period after the introduction of the monetary fund (5.8%).  A key factor to the increase of inflation in most of the cases is the more rapid increase in the supply of money than the increase in the demand for money. Along with this, though, some other factors apply their forces, changing the relative price levels and affecting their common level. Such are the increased excise taxes on alcohol, petrol and petrol products, and tobacco products, which come as a result of the implemented government policies in relation to Bulgaria's accession to the EU. Moreover, some administratively managed prices were increased in 2006. To sum up, the governmental policy contributes for one half of the increase in prices. Namely, the influence of the "market" factors is visible through smooth increase in the price level, which should not make room for any uneasiness.

The next indicator related directly to the price levels is the increase of salaries. According to the data provided by the National Statistics Institute, they have increased on average by 9.5% for 2006, estimated on the basis of the figures for 2005, which means that they have maintained their moderate rate. The actual increase in the estimation of inflation according to the index of consumer prices equals 2.1%. On the other hand, the increase in labor productivity is expected to be higher, meaning that sufficient pressure on the labour market cannot be exerted. Moreover the labour expenditures for the production of a single unit remain at the levels similar to those from 2005, which shows that the competitiveness of Bulgarian firms has been retained.

The development of the labour market is characterized by an upheaval of economic activity and creation of more jobs, mainly in the private sector. Employment is rising on average 4.4% annually mainly because of the decrease in number of the discouraged people. Nevertheless the coefficient of employment still remains low - 46.7%, indicating the existence of free labour resources. The index of unemployment marks on average a 9 % decrease annually , remaining close to the average values in the EU, but nevertheless still remaining high. On the whole we cannot draw the conclusion that pressure has been exerted on the labour market. The higher, in percents, increase of the salaries of qualified specialists is due to exact estimation of the difference between the labour productivity of the latter compared to the one of the rest of the employees, which shows that the Bulgarian economy is getting closer to the more developed economies in this aspect.

According to official data, the takings of the trade banks from the non-governmental sector have slowed down in 2006 to 24.6% (32.4% in 2005), while at the same time the increase of the takings from households has reached 30.6% (58.4% in 2005). This shows that the Bulgarian National Bank has successfully fulfilled its purposes of limiting the increase of crediting of the trade banks, but this happens on the account of increase in foreign crediting of Bulgarian enterprises. And crediting itself leads to increase in the inner demand; the inner demand leads to increase of the deficit to the current account of the pay-balance.

According to some rough data the latter amounts to 16% of  the GDP, which for the part of most of the experts is a serious ground for concern. Some 13% from the increase of the import is due to the increase of the demand of consumers goods, which is in generally viewed as increase of the demand on the whole, while some 2/3 of it is due to the increase in value of the imported sources and energy resources, the reason for which is the international price level of the latter. On the other hand, the matter of investment goods, which is viewed in the aspect of being positive for the economy,  bringing modern technology able to increase productivity, continues to keep the level of 1/4 of total import, which indicates stable investment activity levels in the Bulgarian economy.

In general, the deficit of the current account displays the increase in the flow of capitals in the country, a result of the positive approach of the foreign investors and their anticipation of realization of profit in Bulgaria. The finance of the deficit happens usually through long-term means, such as direct investments. This results simultaneously in increase of the national debt on one hand and more possibilities for increase of demand in long-term period on the other.

This is the direction that the Bulgarian government should follow into conducting its policies - to encourage the demand. This could be achieved either by taking measures for the increase of the flexibility of the labour market, or by reforming of the judicial system, improvement of the working results in the public sector and in particular - of the state administration, improvement of the quality of education, and reduction of the tax burden. The purpose is that the state functions be limited, while the rest keep functioning properly and effectively in contribution to the activity of the private sector, not in its opposition. Thus, the concentration of physical and human capital will be promoted, which on a long-term scale means greater room for economic growth that doesn't leave room for doubt when it comes to its steadiness.