site.btaBulgarian Economy Bound to Slow Down due to External Factors - Analysis

The state of the world economy has less-than-favourable implications for growth in Bulgaria, the Institute for Market Economics says in an analysis. The war in Ukraine brought short-term benefits for many Bulgarian businesses in 2022, but the last few months have witnessed growing sensitivity to other external factors such as the slowdown in China, rising interest rates in the United States and Europe, and slowing investments, production and consumption in Bulgaria's main trading partners.

The condition of the Bulgarian manufacturing industries clearly depends on external demand. In late 2021 and throughout 2022, the inflation pressure, particularly with regard to some raw materials and products, pushed Bulgarian exports to record-high levels, but since the beginning of 2023 there has been a considerable decline in the export of goods and in industrial activity. Even if we imagine for a while that the huge decline in the energy sector in 2023 can be dismissed as a mere reversal of unusually high growth in prices and exports in 2022, the manufacturing industries reported shrinking production volumes every month between March and August 2023 year on year.

Bulgarian exports between January and August 2023 went down by 7.6% in nominal terms compared with a year earlier. In August alone, they dropped by 22%. This was not surprising, considering that industrial production in August decreased by 4.4% year on year, and retail sales slipped by 2.2%.

To put it in a nutshell, the external environment is deteriorating, and it will have an ever-stronger effect on Bulgaria. The tightening of the monetary policy of the US Federal Reserve and the European Central Bank implies more limited access to loans and higher loan rates. The initial effects in Bulgaria are on investment activity and the markets in financial assets and real estate.

In the second quarter of 2023, housing prices went down by 1.1% in the EU and a startling 9.9% in Germany compared with the second quarter of 2022. In Bulgaria, the housing market does not show such strong signs of cooling yet, but the growth trend is already turning back downwards. In three consecutive quarters from the fourth quarter of 2022 until the second quarter of 2023, both housing construction permits and ongoing housing construction projects in Bulgaria decreased year on year. This came at a time when mortgage rates were record-low (among the lowest in the EU) while lending expanded further, growing by around or over 18% annually. The more restrictive monetary policy in the euro area is yet to be carried over into Bulgaria.

All this will have increasingly stronger fiscal implications. While a sudden inflation spike is always welcome for a minister of finance, as it gives tax revenues an automatic boost, deflation pressure works the other way. Deflation is already visible in relation to producer prices in industry and agriculture, and the costs of energy resources and many raw materials.

Between January and August 2023, revenues from the main tax source, value-added tax, fell by 1.7% compared with January-August 2022. Good public revenue performance, at least for now, is reported for personal income tax (which has been influenced by low unemployment and growing wages) and corporate tax (where short-term profits in 2022 were a major factor).