III. ECONOMIC TRENDS AND OUTLOOK A. Major Trends and Outlook Bulgaria's difficult and painful transition from a Soviet-model command economy to a Western-style free market continues. The domestic economy is characterized by continuing stagflation. Officially, gross domestic product (GDP) has fallen approximately 44.5 percent since 1989. Unofficial forecasts predict a further drop in 1994 of two percent. Industrial production has fallen precipitously due to the government's tight monetary policy, the collapse of Bulgaria's export market in the former COMECON countries, United Nations sanctions against Iraq and Serbia, and by the cutoff of foreign trade credits (see below), which deprives many enterprises of raw materials and semi-finished goods imported from abroad. Falling output is concentrated in the state-owned manufacturing sector. The private sector, mostly consisting of small retail and service establishments, continues to grow and even prosper. Although reliable statistics do not exist, by some estimates, the private sector contributes as much as 40 percent of GDP, 50 percent of retail sales, 30 percent of trade, and 20 percent of personal incomes. With the support of IMF, the World Bank, and G-24 nations, Bulgaria embarked on a rigorous macroeconomic stabilization program in 1991. Until the first half of 1994, the inflation rate was high, but gradually fell (from 420 percent in 1991 when prices and interest rates were decontrolled to 63.8 percent in 1993). However, the consumer price index jumped to 59.4 percent for January-June 1994, although much of this increase was due to a sudden 21.7 percent jump in April as the Lev rapidly depreciated. Monthly inflation seems likely to remain stuck in the four to five percent range for the rest of 1994. Trade with the COMECON nations once accounted for 80 percent of Bulgaria's total trade (60 percent with the former Soviet Union alone). The collapse of this market has led to both a shrinkage of trade overall and a relative increase in trade levels with the OECD countries and with Bulgaria's Balkan neighbors. In 1993, only 25 percent of Bulgaria's exports went to former COMECON countries. 28.1 percent went to the EU and a further 14.9 percent to the other OECD countries. While Russia remained Bulgaria's largest single trading partner, Germany is second and Italy third. With the collapse of COMECON trade has come a restructuring of imports and exports as well. The old pattern of trading manufactures for Soviet raw materials (mostly energy) is being replaced by exports of agricultural products and light manufactures in exchange for consumer goods. Indicative of these new patterns are Bulgaria's changing relations with the United States and the European Union (EU). Bulgaria has a Bilateral Trade Agreement with the United States, which provides for MFN treatment for Bulgarian exports to the United States. On January 1, 1994 an interim association agreement with the EU took effect, which grants preferrential trade status to Bulgarian imports, but does impose quotas in sensitive trade sectors such as agriculture, steel, and textiles and apparel. The final agreement will take effect when it is ratified by all EU member states. Bulgaria has a similar association agreement with EFTA and has reactivated its accession negotiations with the GATT, in which it already has observer status. B. Principal Growth Sectors Of the three main sectors of the economy (agriculture, industry, and services), the principal growth sector is expected to be services, followed by agriculture and industry. An average of over 3% annual growth of GDP is expected from the service sector over the next five years. According to reliable analysts, Bulgarian industry will continue to decline during its major transition phase and privatization, not gaining any substantial growth until approximately 1996-7. Services contributed over half of Bulgaria's GDP in 1993 compared to less than one-third in 1990. The strength of the service sector is also a reflection of the dynamism of the private sector in that more than half the private sector is involved with services. Tourism, which has been a strong growth center, will likely continue to be a key area of future growth. Agriculture, while declining 9% in output in 1993 due primarily to a severe drought affecting key crops such as wheat, maize, and sunflowers, is expected to rebound in 1994 given anticipated bumper crops and strong production in vegetables and wines. Expected momentum in land restitution should provide a further impetus for agriculture, resulting in approx. 3% of GDP growth for the next several years. Agriculture has the potential to make Bulgaria basically self-sufficient in basic grains, (wheat, corn, and barley) but the country will need animal protein feeds such as soybean meal for the foreseeable future. When the livestock sector recovers, energy animal feed ration components, such as corn will also need to be imported. Fresh fruits and vegetables could become important foreign exchange earners if the Bulgarians complete privatization and establish a market which can respond to West European demands for quality and packaging. There are excellent prospects to further increase sales and hard currency earnings from wine, cheese, and tobacco. Industry remains the most volatile portion of the economy, having dropped from 51% of GDP in 1990 to 35% in 1993. Since 1989, Bulgarian industry has shrunk almost 50%, more than all other sectors in the economy. Not surprisingly, industry is also the sector with the poorest record of privatization. Not all is gloom, as several sectors experienced significant growth namely, ferrous metallurgy (+19.3%); non-ferrous metallurgy (+14%); the chemical industry and oil processing (+10%); and electricity generation and heat production (+3%). Major losers were: machine building and metals processing (-28.1%); food processing (-26.5%); and, the textile industry (-23.3%). It should be noted that these figures reflect only state activity. Though relatively small, significant growth with the small-medium sized private firms in such sectors as textiles, woodworking, food processing, and machine tooling should be taken into account. C. Government's Role in the Economy: Since February 1991, interest rates and most prices moved to market-clearing levels, most state subsidies have been eliminated, and the Lev has been allowed to float under a system of internal convertibility. Restitution of urban property to the original owners or their heirs has given a significant boost to small-scale private retail and service business. Private agriculture on restituted land is developing fare more slowly, in part because private agriculture is still largely dependent on monopoly/monopsony state agribusiness enterprises, and there is a resistance to full restitution to individual farmers by the Socialist Party (BSP). Privatization of larger state enterprises is only beginning and may take many years to advance. Parliament has passed new market-oriented laws governing foreign investment, intellectual-property protection, labor relations, land reform, corporations, bankruptcy, and banking reform. Initially, Bulgaria relied on a policy of "market" privatization, in which individual enterprises are put on the market on the basis of their own privatization plans. This program has been plagued by political sniping, extreme caution on the part of the Privatization Agency, obstruction by the Industry Ministry and other agencies, questions of ownership stemming from the government's restitution program, and by the poor financial health of many of the enterprises themselves. Of note is the fact that U.S. investors have played a role in several major privatization that have taken place so far. To accelerate the privatization process, the Bulgarian government adopted a "mass" privatization program in 1994 based on the Czech voucher model. Plans are to auction off the first wave of 500 enterprises. In February 1994, parliament passed a severely constrained budget which provides for a deficit of 6.5 percent of GDP. To the surprise of many observers, by mid-year, Bulgaria was on target. In itself, this achievement provides an important anchor of stability in Bulgaria's otherwise troubled macroeconomic situation. In addition, this success allowed Bulgaria to secure important external financing support from the International Monetary Fund, the World Bank, and the G-24 countries. Another high government priority, tax reform, has moved slowly through parliament. Tax administration and tax laws passed in July 1993 and a unified rate 18 percent value added tax (VAT) followed in October 1993. The VAT took effect on April 1, 1994, and within only two months garnered 38 percent of its projected 1994 revenues and was the primary reason the state deficit was kept to the target 6.5 percent. Revised income and profits tax bills are expected to pass parliament in late 1994, at the earliest. Many observers fear the marginal rates are too high to stimulate the economy. In 1993, most of the tax burden fell on corporate profits, creating a significant drag on companies' ability to import capital goods and inputs. Bulgaria is revising its old communist era Commercial Code to Western, and specifically European Union , standards. Parliament passed the new Corporation Law in 1991 and the Bankruptcy Law in 1994, however the Commercial Law itself -- has not been revised and currently is not considered adequate by Western observers. The government is currently restructuring the state-owned commercial banks into eleven competing banks. D. Balance of Payments Situation Bulgaria suffered current account deficits of 794.6 million dollars in 1991 and 71.8 million dollars in 1993, while achieving a current account surplus of 451.4. million dollars in 1992, based on bank settlement data. During this period, Bulgarian exports suffered due to a combination of factors noted previously: collapse of its former COMECON market, UN sanctions imposed on Iraq and Serbia, and depressed domestic output. In March 1990, with more than $10 billion of external debt outstanding, the then-Socialist government declared a unilateral debt-service moratorium. Bulgaria continued to service three small convertible currency bond issues. In late 1992, it resumed partial servicing of its commercial agreement with its commercial (London Club) creditors. A deal was concluded and later ratified by parliament in July. The agreement will reduce Bulgaria's 8.1 billion dollar commercial debt by 47 percent. Bulgaria has rescheduled its official (Paris Club) debt maturities annually since 1992. Servicing its debt in coming years will prove challenging for Bulgaria, especially in 1997, when an estimated 917 million dollars must be paid, and 1998, when 1.313 billion is due. Annual debt service payments decline thereafter. After protracted negotiations, the IMF approved a one-year standby agreement/structural transformation facility of approximately 410 million dollars for Bulgaria in February 1994. To support the IMF stabilization program, the G-24 countries pledged 330 million dollars in balance of payments support for 1994. Bulgaria also complied with the final conditions of its World Bank Structural Adjustment Loan, permitting the release of the 100 million second tranche and 100 million dollars in Japanese matching funds. An additional 255 million dollars will be loaned jointly by the IMF and World Bank to help finance the initial payment of Bulgaria's London Club rescheduling. E. Trade and Investment Barriers With virtually no Western banks operating in Bulgaria as a result of the Bulgarian moratorium on servicing foreign debt, trade with the U.S. and elsewhere has suffered. With the June 1994 signing of an agreement, some trade credits should now become available. The U.S. EximBank has not extended a line of credit, however a new category of lending has just opened as of August 1, 1994. Bulgaria's Association Agreement with the EU provides for an average annual reduction in duties of 10 to 20 percent over ten years on EU products. These reductions would put similar U.S exports at a price disadvantage, however reductions in Bulgarian duties on imports from the U.S. currently are being negotiated bilaterally within the framework of Bulgaria's accession to GATT. Bulgaria's foreign investment law stipulates equal treatment for foreign and Bulgarian investors. The law permits repatriation of all profits. One hundred percent foreign ownership is permitted in all sectors of the economy with the significant exception that foreigners are not permitted to own land zoned for agricultural use. Foreigners and foreign-owned companies are, however, permitted to lease such land for up to 70 years and foreigners may have up to 49 percent equity in a land-owning enterprise. Foreign investors are required to obtain a license to own or have controlling interest in firms producing arms, ammunition, or military equipment; in banking and insurance; and in research, development, and the extraction of natural resources. Licenses are issued by the Council of Ministers' Foreign Investment Commission or (in the case of banking) the Bulgarian National Bank. These institutions have published conditions for licenses, which Bulgarian officials state are nominal and routine. F. Labor Force A skilled, well educated work force is perhaps Bulgaria's chief economic resource, although productivity in some sectors is low and management skills are weak. Western businesses in Bulgaria agree that, properly managed, Bulgarian employees generally are hard-working, honest, and eager to learn. With the restructuring of the economy, shortages of skilled labor should not pose a problem. Bulgaria has two large trade union confederations, the confederation of Independent Unions of Bulgaria (CITUB) and Podkrepa. CITUB is the successor to trade union integrated with the former Communist Party. G. Major Local & Third Country Competitors As noted (section I), Bulgaria has traditional strengths in the agricultural sector especially in fruits and vegetables. Due to the recent drought, animal feed stocks have been low and as a consequence early slaughter of animals has created some meat shortages. Similar shortages have also appeared in the poultry sector. Bulgarian wines are now being marketed internationally and gaining greater recognition and stature. In starch and syrup production, Western investors have created one of the more modern and efficient maize processing plants in Europe in the North East part of the country. Bulgarian textile production is growing with special strengths in traditional weaves, rugs, and carpets. Confectionery manufacturing has also gained recent prominence with the purchase of a major facility by Kraft Jacobs Suchard. In the electronics field, few facilities are operating, and the remainder are only in partial production given that their former markets have dried-up and product lines are obsolete. In a few instances, Western firms have utilized clean room facilities and local skills and/or specialized equipment to manufacture products such as disc drives and magnetic tape readers. In the traditional industries, Bulgaria still claims to have the world's largest forklift truck facility - BalkanCar. Bulgaria also produces significant amounts of steel and related steel products at its major plant -- Kremikovski. In the chemical and petrochemical sectors, Bulgaria produces significant amounts of urea and other fertilizers while its Neftochim refinery on the Black Sea is a major petroleum center in this part of the world, with refining capabilities of over 14 million tons of crude oil per annum. Finally, Bulgaria has a developed pharmaceutical industry, specializing in antibiotics. Bulgaria's former major trading partner, Russia, is still a major supplier of raw materials and energy. The Ukraine supplies coal, among other resources. Greece is a supplier of many consumer products and high value foods, many of which are U.S. brands. Germany, Italy, France, and Austria have a diversified export product profile in Bulgaria but as with the U.S., lack of major financing and the absence of European banks have inhibited their penetration. Germany, The Netherlands, France have all been active through their major multi-national companies in conducting infrastructure projects under international funding. Companies present in Bulgaria are Siemens, Alcatel, Erickson, Brown-Boveri, British Telecom, Philips to mention a few. H. Infrastructure Situation: Bulgaria has only a limited number of land border crossings. This problem is severely aggravated by the UN sanctions imposed on Serbia, which block the most direct and heavily used land route between Bulgaria and Western Europe and increase the strain on the few crossing points along Bulgaria's other borders. There currently is only one bridge across the Danube which serves as Bulgaria's border with Romania to the North, at Russe. A ferry has been established at Vidin. The wait at both these crossing points can last up to several days. There are only two crossing points along the Southern border with Greece, and one of these is open only in the summer. Bulgaria has two crossing points into Turkey and three into the former Yugoslav republic of Macedonia. Bulgaria has two significant ocean ports, Varna and Burgas. Port facilities are generally adequate for bulk commodities, but lack facilities for special handling. Railroads are also poorly maintained. Most cargo hauling remains in the hands of the state-owned Bulgarian State Railroad and Somat trucking Company. Both enterprises lack specialized equipment, such as reefers. Bulgaria has more telephones per capita than any other central or East European country, but it also has the lowest call completion rate. Circuit quality is poor with an aging infrastructure and equipment which suffers frequent breakdowns. The limited number of international circuits result in long delays for overseas calls. U.S. must be placed through an operator. Financial services are rudimentary. Bulgaria has only begun to develop the capital markets that are commonplace in the West. Business is regularly conducted on a cash only basis due to the inflexibility of the banking system. There are no personal or corporate checking accounts. Fund transfers, even within Bulgaria, take an inordinate amount of time and are not always successful on the first try. I. Major Infrastructure Projects Underway: (see section VIII, F, 1-3)