site.btaIs Bulgaria Working to Curb Inflation? - IME Analysis

It is now an indisputable fact that inflation dropped considerably in 2023 both in the European economy as a whole and in Bulgaria, compared with the historically menacing peak levels of 2022. As of December 2023, prices grew by 2.9% in the euro area year on year, 3.4% in the whole European Union and 5% in Bulgaria. This compares with 14.3% in Bulgaria as of December 2022, 10.4% in the EU and 9.2% in the euro area, Latchezar Bogdanov, Chief Economist at the Institute for Market Economics (IME), says in an analysis published on the IME website in January.

Bulgaria is visibly narrowing the gap, Bogdanov says. Just as inflation in the country grew more quickly after the energy shock and the Russian invasion of Ukraine, now it is slowing more rapidly here than EU-wide. If we look at food prices only, annual inflation in Bulgaria is even a little lower than the average EU level. Over the last four months there has been practically no difference in price change rates between the EU and Bulgaria.

Let us now look at average annual inflation, that is, the average level of inflation over the last 12 months compared with the previous 12 months. This indicator is at the core of the inflation criterion for a country's preparedness to adopt the single European currency, Bogdanov notes. The gap between average annual inflation in Bulgaria and the euro area reached 5.3 percentage points in March 2023 (14.1% in Bulgaria, 8.8% in the euro area), but by the end of the year it narrowed to 3.2 percentage points (8.6% in Bulgaria, 5.4% in the euro area), the analysis goes.

Can the process unfold faster? Of course, it can, but many public institutions in the country seem uninterested in speeding it up, Bogdanov says. We are witnessing a clear trend of decline in the prices of essential farm products, not just sunflower (which was in the main focus of a politicized debate inevitably tainted by Russian propaganda against supporting Ukraine) but also many cereal crops. In just 12 months, the price of wheat decreased by 31%, and maize by 29%. If we add a 20% fall in the price of electricity and the depreciation of liquid fuels and other energy resources, the result should be a drop, or at least stabilization, of food prices for end-consumers. If nothing like that occurs in the coming months, we should ask ourselves whether market principles are working along the whole farm-to-table chain, or whether competition is violated by such practices as cartels and abuse of dominant position.

In this context it is important to note how the law is interpreted and implemented by the Commission on Protection of Competition, and most importantly, at what pace. Furthermore, the Finance Ministry is actively following up a policy of aggravating business and consumer costs - both through rather cumbersome measures for control over goods of considerable fiscal risk, which hold a large share in the food supply chain, and by raising the fees and other costs associated with the use of electronic food vouchers, although the digitization of the service should have had the opposite effect.

Another example is the Energy and Water Regulatory Commission (EWRC). Instead of taking into account the relevant market landscape in its entirety, EWRC is acting more and more like an invoice verifier endorsing the biddings of the entities it is supposed to control. The price of natural gas on the European exchange has decreased drastically in recent months, but this country's state-owned supplier Bulgargaz is allowed to sell at a higher price on the domestic market to offset the costs of more expensive gas it bought earlier. District heating companies, too, have spiked their selling prices to offset past losses. A major hike for water has somehow gone almost unnoticed. Instead of being encouraged to make reforms to really upgrade their services, water operators are allowed to increase prices to raise money for temporary solutions. Every such decision affects the costs of businesses and households and the prices of all other goods and services, Bogdanov argues.

The much discussed link between fiscal policy and inflation is usually viewed in the context of the state budget balance, the expert goes on to say. Arguments tend to boil down to how much the state budget deficit impacts the general inflation index. Without going into the particulars of the debate, let us mention one detail. A counterinflation approach would involve making staff pay rises in the public sector contingent on reforms leading to staff cuts; service standards would thus be improved while the resources exerting pressure on domestic demand would diminish.

Last but not least, the Bulgarian National Bank seems to pose as an outside observer of what has been the fastest growth of mortgage lending in 15 years. As of November 2023 mortgage loans increased by 20% year on year. Household mortgage balances have gone up by an aggregate of BGN 8.9 billion over the last four years, a considerable amount of resources for funding home purchases, construction, incomes and consumption in all connected activities. Can Bulgaria's central bank do more? Yes, it can. At the systemic level it can set requirements for borrowers and oblige banks to invoke them when lending money to households. In addition to limiting the risk levels for banks, this will cool demand and consumption, and hence, have a counterinflation effect at the macro level, Bogdanov explains.

According to him, all these actions or inactions will impact the budgets of Bulgarian households and will have weight vis-à-vis the inflation requirement in the convergence report on Bulgaria (as a euro area candidate) due in late May or early June. The period which is to be assessed in the report is largely over by now, and we know that we do not comply with the inflation criterion at this point. Leaving the assessment aside, and regardless of whether Bulgaria adopts the euro at the start of 2025, the country should prioritize policies which fuel growth, minimize economic imbalances and do not pump up inflation, the analyst says in conclusion.