Despite the efforts of supranational institutions, Bulgaria's debt capital market is unlikely to attract much foreign interest before the country adopts the euro, according to analysts. The government's currency board regime has delivered stability and low inflation. But the system has hindered foreign buying of Bulgarian lev-denominated assets as investors' ability to take advantage of arbitrage opportunities is limited.
In October, the European Investment Bank (EIB) took the unprecedented step of issuing a Lev100 million bond in the international market. The transaction, lead-managed by Bank Austria Creditanstalt, matures in 2009 and carries a coupon of 4.875%. "Local and international investors responded favourably in terms of product, timing and diversification," said Barbara Bargagli-Petrucci, EIB's head of funding. The move came as part of the EIB's policy to develop the capital markets of the new and future members of the EU. Despite the EIB's best efforts, financing in the local bond market is minimal.
Instead, corporates and financial institutions, including the EBRD, are using other methods to finance themselves in local currency. In April, the bank received money in leva for the first time when it signed a revolving facility agreement with Raiffeisen Bank Bulgaria.
The treaty provides the EBRD with Lev40 million for on-lending to Bulgarian borrowers. The bank is "now exploring a number of Bulgaria projects that would require funding in the local currency", according to a statement.
Bulgarian corporates also finance themselves through the local bank market or more typically "borrow from [their] foreign-owned parent companies," says Nick Eisinger, director of sovereigns at Fitch ratings agency. 'The IMF likes to talk about capital markets, but I'm not sure how much of a priority it is right now," he adds. "Most financing is channelled through banks and that will remain the case until Bulgaria joins the euro."
The country, which faces parliamentary elections on June 25, has developed a stable economy since the economic crisis of the early 1990s. Privatization receipts have filled government coffers, while the emphasis on fiscal prudence means that the 2005 budget will be in surplus for the second year running.
After a visit from the IMF in March, the government agreed to move its 2005 budget target from a 0.5% of GDP deficit to a 1% surplus. As the surplus now
stands at 2.4% of GDP, this calculation appears to have been too low. "The
government under-estimated revenues," says Berna Bayazitoglu, economist at CSFB. The outcome of the election is uncertain, but whatever the result, orthodox
economic policy is expected to continue.
The Bulgarian government has not issued in the international markets for two years and is instead focusing on reducing the debt-to-GDP ratio. "It is likely that by summer the government will retire the remainder of its Brady bonds," says Eisinger. Bulgaria's debt-to-GDP ratio fell to 38% last year, down from 69% in 2001.
The sovereign has only eight outstanding Eurobonds, which trade at tight levels. "International investors have priced in fully where Bulgaria is in
the EU accession cycle," says Bayazitoglu, "and spreads are pretty tight."
Together with Romania, the Bulgarian government signed the EU accession treaty in April. The agreement contains a safeguard clause, which could delay membership if conditions are not met.
But expectations are that Bulgaria will join the EU in 2007 and could adopt the euro as early as 2009, according to Eisinger, beating some first-wave accession countries to the race.
Unlike Hungary, for example, which became a member of the EU last May, Bulgaria meets most conditions for adopting the single currency. The accession procedure requires that newly joined countries first enter the EU's Exchange Rate Mechanism (ERM 2), under which tight price and exchange rate stability have to be maintained. Only three of the new members have adopted it so far. But Bulgaria is expected to move rapidly towards this goal after joining the EU.
Bulgaria has already pegged its currency to the euro by operating a currency board, which matches one lev to a stable unit of 1.95583 euros. The move successfully stemmed hyperinflation and brought economic stability, but the absence of an independent monetary policy makes the lev unattractive to portfolio investors.
Under a currency board, the government cannot alter interest rates or the exchange rate. The European Central Bank dictates monetary policy instead. This means that investors cannot take advantage of arbitrage opportunities.
"You're not going to get much pick-up from interest rates or currency appreciation in this situation," says Eisinger.
As in all the new-accession countries, worries about poverty, organized crime and corruption remain high. Although Bulgaria's minimum wage has been raised significantly over the past few years, it still only amounts to €75 a month. In April, a survey found that poverty was the greatest worry for Bulgarian citizens, as more than 70% of the interviewees cited it as their central concern. Deputy Prime Minister Nikolay Vassilev has acknowledged that reforms have been "very, very painful".