Rising interest rates are holding budgetary illusions down

Тhe finance minister’s recent words of caution on the topic of the worrisome upward trajectory of budget deficits in the period 2023-2024 have sparked many ideological debates. Yet, the last issue of government debt shifted the discussion and gave signals that politicians must comprehend well, especially given that they are once again pleading for the support of the citizens, and more specifically – the private sector and households.

Taking on more debt in the past months was expected – hopefully everyone understands that a budget deficit would have to be covered by borrowing, given that no privatization of major state-owned assets has been set in motion. The interesting part was whether the caretaker cabinet would pass this challenging task onto the next regular government, or it would issue debt, as is the plan according to the 2022 budget. In this case, the Finance Ministry decided to do the work and issued two tranches of government debt on international capital markets, more specifically 7-year bonds with a yearly return of 4,35% amounting to 1.5 billion euro and 12-year bonds with a return of 4,82% amounting to 750 million euro. A few days later the government raised funds on the internal market, issuing two hundred million leva worth of 4-year bonds with a return of 3,01%.

The new debt is within the limits of the annual budget, so at this stage, there is no point in worrying too much. Even with it, the overall debt level of the country remains around 23% of the forecasted GDP, which makes Bulgaria one of the countries with the lowest debt in the EU still. Nevertheless, one should not expect things remain just as they were before.

Central banks have already started raising interest rates and will continue for some time. We must accept that the free lunch is over and that financing government budgets through loans with interest rates close to zero is in the past. During the pandemic, Bulgaria issued 10-year bonds with a return of 0,4% and 30-years bonds with a return of 1,48%. Even amidst all the uncertainty caused by the war in Ukraine the return on 7,5-year bonds on the internal market was just 1,33%. However, in the middle of September, the situation was already different and international investors demanded interest rates of more than 4%, while local financial institutions with high liquidity expect rates of over 3% for mid-term loans.

Every new tranche of debt would come with annual interest expenses that each new finance minister would have to deal with before allocating funds for pensions, salaries, and hospitals. In the fairy-tale world of debates around the dangers of large deficits and debt levels seemed distant and discipline was seen as dogmatism more than anything else. Indeed, why not spend and borrow generously, if it costs nothing, many said.

The worryingly high interest rates on recent borrowing are only the beginning though. Just a few days after Bulgaria issued new bonds the Fed raised rates by another 0,75 percentage points; the ECB is expected to announce a raise in October and then increase rates at least twice more by springtime. This means that the next government, be it elected or appointed, should not think that it can spend unlimitedly. The markets would quickly crush any attempt to increase the deficit with interest rates above 4%, especially given the political instability and the absent clarity on pushing reform, initiating growth, and the management of the state’s finances.

The situation is further complicated by the ever-larger delay in the implementation of the National Resilience and Recovery plan. Last year Bulgaria missed a payment in advance, but back then the price of financing a deficit was close to zero. The idea of the Recovery and Resilience mechanism is to cover some of the deficits of member states so that they do not need to cut expenses or borrow further. Paradoxically, Bulgaria has still not utilized this instrument and we are yet to receive the first payment of 2,4 billion leva. Moreover, one of the needed requirements is still unfulfilled and the European Commission needs time to evaluate our progress and formalize the results from its assessment in the official payment recommendation. It is possible that this payment is not finalized even by the end of 2022.

At the same time, another issue concerning the next stage of the mechanism is already looming – Bulgaria has promised to fulfill sixty-six requirements between June and December, the majority of which require a properly functioning parliament and government. As of now, according to the information portal UMIS, 63 stages and goals are uncompleted, while the remaining time for this is just 83 days. This is how a little over 1,4 billion leva, expected to be received around March 2023, could be delayed for a long time. Furthermore, Bulgaria has promised to complete another forty-seven measures and reforms; the progress on these is non-existent, yet it is what will determine whether the country would receive 1,48 billion leva for the autumn of 2023.

It will be interesting to see how politicians would justify their lack of effort for ensuring the recovery funds, while the budget is being financed through loans with interest rates of 4-6% or even higher. Last year being late was inconsequential, but now every month of delay means millions of additional interest expenses. We may also have to think seriously about using financing via debt according to the Mechanism, given that up until now the Bulgarian NRRP has not intended any borrowing. This might change if the conditions on a specific loan are better than those at the capital markets. Provided that there is a clear capital program for the next three years, one must consider the option of covering some of these expenses through the Recovery and Resilience Plan, instead of taking on more debt with market rates. The Bulgarian government must conclusively declare its intentions in front of the EC by August 2023, which requires this topic to be part of the debate on the new budget at the end of this year.

The high returns on newly issued government debt should also signal caution for banks, businesses, and households. Rates on consumer loans and mortgages will soon adapt to the new reality. The simplest guide for the future price of money is the rate, paid by the sovereign, plus a risk premium on top. In other words, financial institutions could always opt for the alternative of financing the state instead of the private sector. Therefore, we advise that the reader follows the news on the page of the finance ministry so that they may see what kind of rates to expect on their loans.


*This document is funded by Active Citizens Fund Bulgaria through the Financial Mechanism of the European Economic Area and Norwegian Financial Mechanism. All its contents are the sole responsibility of Institute for Market Economics and do not represent in any way the views of the Financial Mechanism of the European Economic Area and Norwegian Financial Mechanism and Active Citizens Fund Bulgaria. (www.activecitizensfund.bg

Related publications.