June 6, 06

NEWS / Business progress in Central and Eastern Europe examined

The countries of Central and Eastern Europe have made surprisingly good progress in the past few years in expanding their position as a location for business, according to the latest report by Bank Austria Creditanstalt (BA-CA).

The report examined the progress and prospects of the Central and Eastern European region, as well as countries within it, including Bulgaria.

According to the report, it was ???not so long ago??? that there was heated debate as to whether the then candidate countries to join the European Union would, besides nominal convergence (adjustment of inflation and interest rates), succeed in achieving real convergence with the EU within the required time frame.

With per capita gross domestic product (GDP) growth of four per cent a year, the level of prosperity in the new member states has risen twice as fast as that of the EU 15, the report said.

The new member states also had succeeded in completely reorienting their export flows. Sixty per cent of their exports now go to the EU 15 and they have increased their market share of EU imports by three percentage points from 6.3 per cent to 9.3 per cent.

???This represents an almost 50 per cent increase in market share,??? BA-CA said. ???The quality of exports has improved markedly, and this is crucial for the convergence process.???

The new member states had won additional market share and the structure of goods had changed dramatically, from relatively low-priced mass-produced articles to products in the middle and high-tech segments.

The most recent data showed that the new member states had won the largest market share in this area, and showed that the prices of exports relating to this category of goods from the new member states had increased, with a disproportionately strong improvement in the quality of exports in this category.

The data indicated that the export achievements of new member states were to be found in low-cost production and in a significant improvement in quality, meaning, in real convergence.

Two factors are also responsible for the improved quality. The new member states, for the most part, have a well-qualified workforce, especially in the technical occupational groups, and the EU??™s industry has been looking for ???lower cost??? production sites for relatively work intensive, technically demanding manufacturing segments.

In relative terms, the new member states are the region with the highest level of FDI. Cumulated FDIs in the new member states amounted to about 40 per cent of GDP, more than those of China (25 per cent of GDP).

???The reality of the situation has refuted all those who, during the accession negotiations, maintained that real convergence would be insufficient,??? BA-CA said.

In regard to real convergence (level of prosperity, economic structures), the pace of the catching-up process in the new member states had also been quite astounding.

???Even if the convergence process is not yet over, a great deal has been accomplished in the past few years,??? the report said.

With regard to Bulgaria, the report said that the current political agenda was dominated by Bulgaria??™s forthcoming accession to the EU.

???Top priority is being given to the reform of the economic and political areas criticised by the (European) Commission, such as public administration and the judiciary, as well as the need to fight corruption.???

At the end of March, Parliament adopted a resolution for an amendment to the constitution that would promote co-operation among state-run institutions, more precisely define the separation of powers and strengthen the independence of the judiciary. The question of EU accession had eclipsed the unsuccessful no-confidence motion brought by the opposition against the Government based on the crisis management after the floods. There would probably be more activity in Bulgaria??™s political landscape in the autumn in the light of the upcoming presidential elections.

The report said that the Bulgarian economy had maintained its strong performance in 2005 with GDP growth of 5.5 per cent, despite negative one-off factors and structural deficits, and it only just failed to match the record growth of +5.7 per cent achieved in 2004.

On the production side, the Bulgarian economy was driven by industrial output of +7.3 per cent (including construction), which generated 30.4 per cent in gross value added.

???With a growth rate of +6.6 per cent and 60.3 per cent share of gross value added, the services sector also expanded at a disproportionately strong rate.???

The dynamic performance of these two sectors was reflected in the labour market, the BA-CA report said. Unemployment declined from an average 12.7 per cent in 2004 to 11.5 per cent in 2005, the lowest level in nine years.

Agriculture fell well behind these booming sectors, contracting by 8.6 per cent in 2005 because of adverse weather conditions. The agricultural sector, consequently, contributed less than 10 per cent to the gross value added for the first time since the beginning of the transition process.

On the demand side, growth continued to be driven by robust domestic demand.

Although private consumption slowed towards the end of the year in the light of stronger inflationary pressure, slower growth in real wages and efforts by the central bank to curtail the credit boom, it expanded by as much as 7.4 per cent in 2005 as a whole.

Investments grew even faster at 19 per cent, driven by reconstruction work required after the floods and strong inflows of foreign direct investment.

Because of the Government??™s strict fiscal policy, public consumption grew by a moderate 2.2 per cent. Export activity (+7.2 per cent) slowed markedly because of weaker exports of agricultural and textile products, and following restructuring within the steel sector, while imports continued to record strong double-digit growth (+14.6 per cent).

The gap between exports and imports was reflected in a further deterioration of Bulgaria??™s net exports.

???The trend will be similar in 2006, although the central bank??™s efforts to curb credit growth and the current rise in inflation are likely to slightly dampen private consumption.???

However, buoyant investment activity and stronger inventory investments in the run-up to EU accession would ensure that domestic demand remained the key growth component.

???The imbalance in foreign trade will persist in 2006 due to the stronger import pull in the run-up to EU accession, despite an expected revival of export activity.???

The year 2005 saw a marked deterioration of Bulgaria??™s current account, the report said. Notwithstanding a sharp downward correction of the current account data for 2004 and 2005 as a result of methodological changes, the current account deficit more than doubled in 2005 in both absolute terms and as a percentage of GDP, reaching a record level of 2.5 billion euro, or 11.8 per cent of GDP.

The deterioration was mainly because of a significant widening of the trade deficit. Merchandise exports grew by 18.4 per cent, while merchandise imports expanded by 26.4 per cent from a much higher base level in the light of strong demand for capital goods and price effects of energy imports.

???The trend will be similar in 2006, despite signs that exports are beginning to accelerate.??? The gap between imports and exports would probably widen further towards the end of the year due to the accelerated purchases of imports in the run-up to EU accession.
This, the bank said, was likely to prompt a further rise in the current account deficit in 2006.

In 2005, net inflows of direct investment amounted to almost 1.9 billion euro, which corresponded to about 70 per cent of the current account deficit.

On the financing side, the marked widening of the current account deficit was in 2005 consequently accompanied by a rise in foreign debt, which climbed to 14.5 billion euro or 67.7 per cent of GDP, notwithstanding a significant reduction of public debt.

The share of private foreign debt as a percentage of total foreign debt rose from 47.6 per cent in 2004 to 62.9 per cent at the end of 2005, and short-term foreign debt from 19.3 per cent to 24.5 per cent.

Although foreign exchange reserves climbed from 6.8 billion euro in 2004 to 7.4 billion euro in 2005, the import cover ratio contracted from six to 5.3 months as a result of the strong growth of imports.

The BA-CA report said that Bulgaria??™s rate of inflation had accelerated discernibly at the beginning of 2006 to an average of eight per cent year-on-year for the first quarter, the highest level in four years.

The rise in prices was prompted by the sharp increase in excise taxes on alcohol and tobacco that was brought forward to January 1 2006 with a view to preventing inflationary problems prior to the adoption of the euro.

???Although the gradual weakening of these one-off effects will be accompanied by an easing of the inflationary pressures in the second half of the year, the inflation rate is expected to average 7.3 per cent in 2006, which is above the five per cent recorded in 2005. The rise is, however, temporary.???

Bulgaria??™s inflation rate will start moving downward again as from 2007 despite further price and tax adjustments on entry into the EU.
The downward trend should also be supported by the more restrictive credit policy, the BA-CA report said.

The report noted that the central bank had announced that it intended to limit credit growth to 17.5 per cent in 2006.

???With a view to improving the efficiency of its minimum reserve policy, the central bank moreover expanded the definition of loans to include bonds and other debt instruments, imposed restrictions on mortgage loans, and made recommendations regarding the financial circumstances of private households for the loan-granting process.???

The general Government budget ended 2005 with a record surplus of 682 million euro or 3.2 per cent of GDP (2004: 1.7 per cent of GDP). This was attributable to the positive development of budget revenues.

In this context, revenue from value-added tax, excise taxes and customs tariffs were above target on account of the robust growth of the domestic economy.

Expenditure was below the level envisaged for the year.

A balanced budget is planned for 2006. In light of the need to continue the rigorous austerity programme ??“ against a background of a high current account deficit and stronger inflationary pressure ??“ the Government, in consultation with the IMF, announced that it would target a budget surplus of three per cent of GDP for 2006.

???Depending on the progress made in lowering the current account deficit, the Government may subsequently ease its fiscal policy.???

The high budget surpluses enabled the Government to substantially reduce the public sector??™s foreign debt in 2005. Early repayments brought the level of public sector foreign debt down from 6.6 billion euro (33.6 per cent of GDP) in 2004 to 5.4 billion euro (25.1 per cent of GDP) by the end of 2005. This was the lowest level since the beginning of the transition process.

Fiscal reserves remained at high levels in 2005 despite massive repayments of foreign debt. This enabled Bulgaria again to make early debt repayments to the World Bank (191.7 million euro) and the IMF (151.4 million euro) in the first two months of 2006. ???The current year may see further debt repayments, so that public sector foreign debt could fall to below 20 per cent of GDP in 2006.???

In the light of Bulgaria??™s fiscal discipline, prudent debt management and imminent EU accession, the country was awarded Investment Grade status by Moody??™s at the beginning of March.

The BA-CA report said that it was likely that the European Commission would make a positive recommendation for Bulgaria??™s accession to the EU in 2007, and this was expected to give fresh impetus to the reform process.

???The presidential elections scheduled for the autumn could however put the ruling three-party coalition to the test.???

The economy was running smoothly despite adverse one-off factors and structural shortcomings in foreign trade.

A rigorous fiscal policy and ongoing debt repayments were helping to improve Bulgaria??™s risk rating.

Negative developments included the acceleration in the rate of inflation, which was, however, mostly a result of administrative measures and therefore only a temporary phenomenon.

The imbalance in foreign trade had deteriorated significantly.

???After rising to record levels in 2005, the current account deficit will remain in the high two-digit region in the current year before falling in 2007 due to stronger, investment-driven export capacities.

???Strong inflows of capital, substantial foreign exchange reserves and easier access to international financial markets at the same time facilitate the financing of the deficit,??? the BA-CA report said.



Tags: foreign trade,