MONITORING REPORT BULGARIA MAY 2006

Contents
	INTRODUCTION
	POLITICAL CRITERIA
	ECONOMIC CRITERIA
	COMMITMENTS AND REQUIREMENTS ARISING FROM THE ACCESSION NEGOTIATIONS
	GENERAL EVALUATION

In its 2005 Report, the Commission concluded that Bulgaria continues to be a functioning market economy. It concluded that the continuation of the current pace of its reform path should enable Bulgaria to cope with competitive pressure and market forces within the Union. Bulgaria had broadly maintained macroeconomic stability, even if external deficits had further risen. It had continued implementing its structural reform programme, albeit not equally vigorously in all fields.
Following a very strong expansion by 6.2% in the first half of 2005, real GDP growth slowed down in the third quarter mainly as a result of the heavy floods during the summer months and reached 5.5% for the whole year. Gross fixed capital formation grew particularly strongly at a rate of 19.0%; final consumption also continued to expand at a rate of 6.8%. Both the trade deficit and the current account deficit increased further from 15.1% of GDP in 2004 to 20.4% of GDP in 2005 and from 5.8% to 11.8% of GDP. Consumer price inflation (interim HICP) accelerated towards the end of the year due to increases in oil and food prices. While average inflation dropped from 6.1% in 2004 to 5.0% in 2005, end-of-year inflation thus rose from 4.0% to 6.5%.
This section assesses, in each of the outstanding areas, the developments that occurred since the October 2005 Report and Bulgaria’s preparedness for membership.

Macroeconomic stability and current account deficit

The 2005 Report concluded that the continuation of prudent fiscal policy and moderate wage increases remained critical to containing potential risks for the external balance. Since then, there has been progress in the following areas.
Tight fiscal policies and relatively moderate wage increases continued and additional measures to curb credit growth were taken. Still, the current account deficit increased further in the second half of 2005 and reached 11.8% of GDP for 2005. This increase has been mostly triggered by negative exogenous shocks, while macroeconomic policies remained overall very prudent. The general government balance ended with a surplus of 3.1% of GDP (ESA 95) compared to 1.9% in 2004. Minimum wages increased by 25% in January 2005, but average wage increases remained more moderate. Real annual average wages grew by around 4.1%, and thus largely in line with productivity gains.
Additional measures to curb bank credit growth entered into force in April 2005 and were relatively effective in bringing down the annual growth rate from close to 50% in 2004 to below 30% by March 2006. As from January 2006, measures have been tightened further, aiming at bringing down the annual growth rate to below 20% in 2006. Further measures have also been taken to target more specifically household and mortgage lending. Some further fiscal tightening is foreseen in 2006 with a revised fiscal target of a 3% of GDP surplus (cash basis). Public sector wages are scheduled to increase by 6% in June 2006 which together with a more moderate minimum wage increase should help to maintain stability-oriented wage developments.
However, certain outstanding issues remain to be addressed.
The widening of the current account deficit in 2005 was almost exclusively due to a higher trade deficit and a lower surplus in the service balance. Higher oil prices and particularly strong imports of investment goods led to an acceleration of import growth to over 26%. At the same time, export growth slowed down during the year to 18.4% largely because of flood-related disruptions. Consequently, the trade deficit increased to 20.4% of GDP in 2005. High import growth also implied an increase in the transport expenditures, which together with a slowdown of growth in the tourist industry reduced the surplus in the services balance. While the restrictions on credit growth were effective in bringing down credit expansion, their impact on containing the external deficit was more limited, because enterprises are increasingly relying on other sources of financing, including leasing and direct foreign borrowing. In view of the very high trade and current account deficits, the continuation of tight fiscal policies and measures to contain credit growth as well as moderate wage increases remain crucial.
Overall, appropriate steps have been taken to contain the external deficit, but could not prevent a further widening. The continuation of prudent macroeconomic policies together with a further deepening of structural reforms will therefore be critical to achieve a sustained reduction of the current account deficit.

Privatisation and industrial restructuring

The 2005 Report concluded that the momentum in completing the privatisation programme should be maintained. Since then, there has been progress in the following areas.
Out of a total of more than 5800 enterprises with state ownership foreseen for privatisation, the state still holds majority or minority stakes in 520 enterprises. Stakes in 74 enterprises were sold since September 2005, mostly involving minority shareholdings, but the share of privatised assets increased only slightly and remained just below 90% of all assets foreseen for privatisation. Of the larger privatisation deals mentioned in the 2005 report, only three (Boyana film studios, Varna thermal power plant and the river shipping company) were close to finalisation in April 2006. Revised privatisation strategies for the Maritime Fleet and Bulgaria Air were adopted by the Council of Ministers in October 2005 and February 2006. The strategy for Bulgaria Air was approved by Parliament in March 2006. In February 2006, the Bulgartabac Holding adopted a strategy for the restructuring and sale of several individual units.
Some further progress has been made in the liberalisation and restructuring of network industries. The opening up of the gas and electricity markets continued in line with the existing timetable. Plans for the unbundling of the National Electricity Company and Bulgargas have been elaborated. The railways liberalisation is well advanced. Concessions for the operation and upgrading of ports and airports are being granted to private operators, although the granting of the concession for the airports in Varna and Bourgas has been delayed due to court appeals. In the telecommunications sector, the conditions for effective competition have improved, partly due to a third mobile phone operator starting services in November 2005.
However, certain outstanding issues remain to be addressed.
The privatisation process is well advanced, but remains to be completed. Further efforts will be required to successfully conclude the privatisation process in the energy and transport sectors. In the energy sector, the sale of the thermal power plants in Rousse and Bobov Dol has not been completed. The privatisation strategy for the Maritime Shipping Company has not yet been adopted by Parliament and is currently being revised.
The unbundling of the National Electricity Company and Bulgargas as well as the liberalisation of the gas and electricity markets remains to be completed until accession. Regarding rail transport, the rail operator and the infrastructure company continue to make losses and to accumulate arrears. Further progress in the restructuring of the railway sector, including through cost-cutting measures, will be essential to improve the financial situation. Strengthening the capacity of regulatory bodies will be important to further improve the conditions for competition in the network industries.
Overall, while being at an advanced stage, limited further progress was made on privatisation. The liberalisation and restructuring of the gas and electricity sectors remain to be completed. Further efforts are required on the restructuring of the railways sector.

Business environment

The 2005 Report concluded that further reforms were needed to improve the business environment, in particular the functioning of the administrative and judicial systems. Since then, there has been progress in the following areas.
The business registration reform has continued and a new Commercial Register Law was adopted in March 2006. The law foresees that business registration will be taken out of the courts and be turned into a purely administrative procedure. The National Revenue Agency became operational in January 2006 and has the sole responsibility for the collection of central government taxes and social security contributions. Amendments to the insolvency legislation to improve the efficiency, transparency and speed of insolvency procedures were submitted to Parliament in November 2005. The review of regulatory regimes has continued, but with limited progress. The newly established Ministry for State Administration and Administrative Reform is in charge of co-ordinating the review and optimisation of existing regulatory regimes and of giving guidance on improving the methodology for impact assessments. Measures to optimise the size and structure of public administration, to improve training and to promote the provision of e-government services have been proposed. The new Administrative Procedure Code has been adopted in March 2006. Following the adoption of the Law on Arbitration, three arbitration centres have been opened.
However, certain outstanding issues remain to be addressed.
Major challenges remain for improving the conditions for market entry and exit and for contract enforcement, for increasing the efficiency of the administrative and legal system, and for reducing the regulatory burden on business. The new Commercial Register Law still needs to be fully implemented to simplify and speed up business registration. The proposed amendments to the insolvency legislation have not yet been adopted by Parliament. Renewed efforts will be required to achieve further, tangible progress in facilitating the regulatory framework, including through more systematic impact assessments and further simplification. The functioning of the administration needs to be further improved. The Administrative Procedure Code did not introduce the ‘silent consent’ principle more universally. Important challenges remain to increase the efficiency of court procedures. The new draft Civil Procedure Code has not yet been submitted to Parliament. Mediation as an out-of-court settlement procedure is still not widely used. Private bailiffs still need to become operational.
Overall, limited progress has been made in this area. Efforts to improve the functioning of the administrative and in particular the judicial system and to further ease the regulatory burden on businesses should be intensified further.

Labour market flexibility

The 2005 Report concluded that little progress had been made in improving labour market flexibility which, together with a comprehensive reform of the education system, would be crucial for dealing with skills mismatches. Since then, there has been progress in the following areas.
In line with the strong economic growth, employment grew by 2.0% in 2005 and the average unemployment rate fell from 12% in 2004 to 10.1% in 2005. Limited steps were taken to improve the functioning of the labour market. As from January 2006, pension contributions were reduced by 6 percentage points and the share paid by the employer was reduced from 70% to 65%, thus reducing non-wage labour costs and providing incentives for job creation and moving jobs out of the informal sector. The Employment Promotion Law was amended in February 2006, providing for certain financial incentives to regional mobility and for actively searching employment. Preparations for an evaluation of the effectiveness of active labour market programmes have started. A programme for the reform of secondary education was adopted by the Council of Ministers in February 2006. It envisages a re-organisation of the secondary education system, the introduction of short-term vocational training modules, and standardised national examinations.
However, certain outstanding issues remain to be addressed.
Hardly any progress has been made on removing labour market rigidities and modernising the regulatory framework, in particular as regards working time or the use of fixed-term contracts. The integration of seniority bonuses into the regular pay scale has been delayed. A Strategy for Higher Education Development is not yet adopted. The planned reforms of the education system still need to be fully implemented to improve the quality of education and better align educational outcomes with labour market needs.
Overall, only little progress has been made on increasing labour market flexibility. Increased efforts to reform the education system will be important to reduce skills mismatches.

General evaluation

Bulgaria is a functioning market economy. The continuation of the current reforms should enable it to cope with competitive pressure and market forces within the Union in the near term. Bulgaria has broadly maintained macroeconomic stability and advanced structural reforms.
Progress has continued since the October 2005 report. Useful steps were taken to contain the external deficit. The privatisation process and the liberalisation and restructuring of utilities are well advanced. Some additional progress has been made in improving the business environment and in reducing non-wage labour costs.
However, the current account deficit widened and warrants continued prudent fiscal and wage policies. Deepening of structural reforms requires improving the functioning of the judicial system and further easing the regulatory burden on businesses. The regulatory framework for the labour market needs to be made more flexible.