Bulgaria: Budget 2024: no fiscal consolidation, focus on capital, wage, pension spending
Metodi Tzanov
Helping finance professionals understand what is going on in Emerging and Frontier Markets
The finance ministry has presented a very controversial draft 2024 budget bill, in which the focus has been set on generous capital spending, pension and wage increases, while fiscal consolidation efforts have been abandoned for the entire 2024-2026 period. The ministry set the cash-based budget deficit for 2024 at BGN 6.2bn (3% of GDP) and the deficit under the ESA 2010 methodology, which will be used for assessing Bulgaria's readiness to join the eurozone, at 2.9% of GDP. The disappointing news was that the planned 2.5% of GDP deficit for 2023 will increase to 3.0% of GDP, due to the state institutions' failure to collect all of the due revenues in the annual plan. The finance ministry also set 3.0% of GDP deficits for 2025 and 2026, which will lead to an increase in the new government debt to be issued in the next years in order to cover the deficits and will boost the interest rate payments significantly in the next years. We recall that Bulgaria had a solid track record of budget surpluses or close to balance budgets in the years before the pandemic, but the trend has reversed since then. While the deficits incurred in the pandemic and the few post-pandemic years were comprehensible, we see the government's decision to continue preparing for budget deficits in the upcoming years as risky and unjustifiable, especially taking into account the optimistic forecast for a speeding 3.2% GDP growth in 2024. We think that the lack of commitment to returning to fiscal prudency may send negative signals to the international investors and partners about Bulgaria's public debt trajectory and fiscal soundness in the upcoming years, although Bulgaria's debt-to-GDP ratio will remain one of the lowest in the EU in the short- and medium-term.
Overall, the defining theme of the budget bill is related to boosting incomes and public investments, which has superseded the priority of bringing the public finances back to sustainability or adopting structural reforms, in line with finance minister Asen Vasilev's widely known convictions against austerity budgets. Vasilev has been arguing that fiscal austerity policy is preventing the modernisation of the country's economy and recently reiterated his stance that the state could not become richer under the premise of low incomes and weak public investments. The budget deficit target, along with the overly optimistic revenue projections for 2024, triggered a strongly negative reaction from the other ruling party GERB. We recall that under the agreement for a rotational cabinet between the two ruling parties WCC-DB and GERB, GERB's candidate for PM, Mariya Gabriel, will become head of the government as of Mar 2024. She will have to abide by the adopted budget bill during her nine-month tenure, i.e. till the end of 2024, so we think that GERB's willingness for changes to the budget framework has been understandable. GERB even threatened to sabotage the budget adoption in the parliament and eventually the finance minister agreed to reduce the planned revenues by BGN 2.4bn compared to the already published bill. The minister also pledged to cut the planned capital expenditure from BGN 12bn to BGN 10bn, in line with the amended revenue plan. The compromise secured GERB's support for the budget in the parliament, but we think that the budget parameters remain controversial even after the reduction of the revenue and expenditure plan.
We see several downside risks to the current 3.0% of GDP deficit target in 2024, taking into account the still excessively optimistic projections about revenue growth and the overall GDP growth. The risks stem from the constant increases in expenditure, especially on pension and wage hikes, the persistent delays in the absorption of EU funds under the Recovery and Resilience Facility (RRF), the economic slowdown in the main trading partners from the EU that may affect revenues, as well as the frictions between the ruling parties that could easily undermine the government, parliamentary and institutional work at any moment. Vasilev already failed to secure the meeting of the revenue and expenditure targets in 2023, so we do not rule out the possibility of a new miscalculation of the budget parameters and policies that could compromise the budget execution in 2024 as well.
Financing needs to keep rising
The government planned a record high ceiling on the new debt to be withdrawn in 2024, set at BGN 11.9bn, up from the BGN 7.5bn of new debt issued in 2023. Later, on Nov 17, after the meeting with GERB, the finance minister announced that he agreed to update the new debt ceiling by BGN 1bn, in a downward direction. The increase of the new debt was motivated with Bulgaria's obligation to cover expiring bonds and loans totalling BGN 3.5bn in 2023, as well as to cover the budget deficit and guarantee the fiscal reserve liquidity.
The government will tap both the domestic and international markets, as well as may take structural programme loans worth up to BGN 500mn with the EIB and the Council of Europe Development Bank (CEB) to co-fund EU projects in 2024. Government debt-to-GDP ratio is expected to stay unchanged from 2023, at 23.8% of GDP, and will rise in the next few years, reaching BGN 57.2bn or 26.3% of GDP in 2025 and BGN 66.5bn or 28.8% of GDP in 2026, according to the mid-term budgetary framework. The nominal increase in the government debt and the global increase in the interest rates will raise Bulgaria's interest expenses to BGN 1.0bn as of 2024 and BGN 2.3bn in 2026, which will reduce the room for public investments and will raise systemic risks to the budget in the medium term, in our view.
Finance ministry comes up with optimistic macroeconomic outlook
The finance ministry projected a 3.2% GDP growth in 2024, accelerating from the expected 1.8% GDP growth in 2023. The forecast was in line with the latest IMF's autumn forecast for Bulgaria, but exceeded significantly the latest EC's projection for a 1.8% GDP growth and the WB's forecast for a 2.7% GDP growth in 2024. The finance ministry based its economic growth forecast on the assumption about a partial improvement in the external demand, especially from the EU, as well as about a strong increase in public and private investments next year. We think that the finance ministry's baseline scenario tends to be overly optimistic, considering the ongoing recession in some of the most important EU trading partners such as Germany, as well as the high risks to the realisation of the public investments from the already big delay in the implementation of the national recovery plan. The outlook for the private investments is also questionable, in our view, given the deteriorating performance of the domestic industry since the beginning of 2023, with no signals for some improvement for the time being. The other risks to the finance ministry's economic forecast are related to the high uncertainty of global geopolitical environment, stemming from the military situation in Ukraine and Israel, as well as the volatile dynamics of the global energy prices, in our opinion. Furthermore, the Bulgarian National Bank (BNB) expects that the transmission of eurozone's higher interest rates to the domestic market will finally speed up as of 2024, which would also weaken Bulgaria's economic growth prospects.
The finance ministry expected investments to be the main engine for the economy in 2024 and to rise by 9.6% y/y, boosted by both the public and private sectors. It added that the inventories' contribution to the economy should be neutral. We note that investments were projected again to be the main economic driver in 2023, however, instead of rising by the expected 6.3% y/y, their growth in 2023 will be only 0.6% y/y, according to the ministry's revised forecast. The finance ministry raised the planned capital expenditure to a record BGN 12.0bn and then announced that it will cut them to BGN 10bn, which is still up from the BGN 8.1bn in the 2023 budget bill that were not realised. Worsening financing conditions and the traditional lagging behind of the EU fund utilisation put a big question mark to the growth projections for both public and private investments, in our view. We think that the stronger capital spending should be seen as an implicit buffer on the expenditure side rather than a realistic target.
Domestic private consumption growth was expected to slow down to 3.5% y/y in 2024, down from 4.1% y/y in 2023, according to the forecast. The finance ministry explained that weaker growth of employment and retail loans will be the main factor to subdue household consumption. Nevertheless, we think that slowing inflation, along with the expected further wage increases (the government expected the nominal wage growth to stay solid at 11.2% y/y on average in 2024), should act in the opposite direction, providing some support to the private consumption. We do not expect these factors to suffice to offset the trend of slowing household consumption in 2024.
Export growth was projected to accelerate to 4.0% y/y, on the back of some expected recovery in the external demand, but import growth will be even stronger of 6.0% y/y, which means that the negative contribution from net exports to GDP growth will strengthen in 2023, according to the forecast.
HICP inflation should continue its gradual deceleration, reflecting the international price dynamics. The average HICP inflation should ease to 4.8% in 2024, on the back of a negative contribution from energy prices, the finance ministry commented. Food and services will continue to contribute the most to the headline inflation, although the contribution was projected to narrow down compared to 2023. Nevertheless, the ministry acknowledged that there are risks to the inflationary outlook related to the unstable geopolitical situation in Ukraine and the Middle East, the potential restriction in supplies of some commodities or in the case of a new disruption in the global supply chains. The risks are predominantly tilted to the upside and if they materialise, the higher inflation may weigh on consumption growth and reduce households' disposable income, the ministry said. We also see a risk to the inflation forecast related to the uncertainty of the energy price dynamics, which remains very susceptible to sudden geopolitical shocks.
Revenues are overestimated compared to their lower-than-expected collection in 2023
One of the most controversial part of the submitted draft budget bill has been the 15.5% y/y increase in planned revenues in 2024. After the meeting with the other ruling party GERB last week, the finance minister cut the targeted revenues by BGN 2.4bn, which will result in setting the total revenues at BGN 75.2bn in 2024, according to our calculations. Vasilev admitted that the BGN 2.4bn correction was on the back of the recently imposed new fee on Russian gas passing in transit through Bulgaria, but that its collection was very questionable, which is why he reconsidered the revenue calculations. Even after the revision of the plan, the new target of BGN 75.2bn of revenues remains exaggeratedly optimistic, in our view, rising by strong 11.9% y/y from the preliminary estimates for the collected revenues in 2023. To compare, the nominal GDP growth is forecast to reach 7.7% y/y in 2024, at a quite slower pace, which poses significant questions about the feasibility of the revenue target. Total revenues are expected to rise on the back of tax revenues and grants, while non-tax revenues are expected to decline by 4.0% y/y. Tax revenue growth should be 9.4% y/y, according to our calculations, after the removal of the previously projected BGN 2.4bn of revenues from the fee on the Russian transiting gas.
Against the background of the already disappointing figures for the 2023 revenue collection, the finance ministry has failed to provide convincing arguments on how tax collection will significantly improve in 2024, which leaves room to serious doubts about the plan, in our opinion. We think that the revenue plan had to be more conservative, considering the negative macroeconomic trend in the country and its main trading partners, the easing inflation and the lack of proper policies to boost tax collection and to improve EU fund absorption. Even in case the finance ministry's positive scenario for Bulgaria's economic growth takes place, the increase in the budget revenues is unlikely to be driven by a real recovery in the economic sectors' performance, but will rely on administrative hikes of the minimum and public sector wages, the minimum and the maximum insurance income (which will raise the insurance revenues), as well as on the receiving of the delayed due second BGN 1.4bn tranche under the Recovery and Resilience Fund (RRF), which was previously expected to arrive at end-2023.
领英推荐
The revenue-side policies are limited to hikes of wages, an increase of the corporate tax for multinational corporations to 15% and some amendments to the VAT rate for several goods. The minimum wage will be raised by 19.6% to BGN 933 in 2024, in line with the new rule setting the minimum wage at 50% of the average wage for the previous year. The government will increase the maximum insurance income, by BGN 350 to BGN 3,750 as well. The reduced VAT rate for sport facilities will be returned to the standard 20% rate as of the beginning of 2024, while the 0% VAT rate for flour and bread will stay in force until mid-2024, after which it will be raised back to the standard level. On the other hand, the reduced 9% VAT rate for restaurants and hotels will stay in place till the end of 2024, which has provoked many criticisms against GERB, as it defended the restaurants' interests and blackmailed the finance ministry to extend the application of the reduced VAT for the sector.
The finance ministry expected that additional BGN 740mn compared to 2023 should be generated by measures for tax collection improvement, another BGN 140.1mn - from an increase in the excises on tobacco and cigarettes, BGN 302.5mn - from the increased maximum insurance ceiling and BGN 220mn - from the newly raised tax for big multinational corporations to 15%. We note that the government's decision to raise the corporate tax for multinational big companies to 15% compared to the current 10%, is in line with the EU's directives. However, it was questioned by local business associations, insisting that Bulgaria could have asked the EC for a postponement of the rate increase. Still, the number of such companies in Bulgaria, which have to generate at least EUR 750mn of annual revenues in at least two of the four preceding years in order to be taxed by the higher rate, is very small and we think that the expected additional BGN 220mn of revenues out of this tax may be questionable.
The biggest risk to the tax collection is related to the VAT revenues, which the government expects to rise by a solid BGN 2.4bn y/y, in our opinion. In 2023, the collected VAT revenues will be BGN 935mn lower than the annual plan, as a result of lower imports and easing prices of imported commodities. Inflation is projected to continue slowing next year and will exert an unfavourable impact on the VAT revenues. We think that this strong increase in VAT revenues is not realistic, taking into account the prospects for slowing domestic consumption and easing inflation, as well as the uncertainty regarding the plausibility of the economic growth forecast. We view pessimistically the ministry's conviction that it will collect an additional BGN 740mn from VAT and corporate tax only by means of a few minor measures aimed at raising the fiscal control and preventing tax evasion.
The state will demand the payment of 100% of the dividends of the state-owned companies for a second consecutive year, which should lead to a new BGN 324.3mn of revenues, according to the forecast. We note that the collection of the entire amount of the dividends of the public companies by the state is another controversial decision of Vasilev, as it is poses risks to the liquidity of the companies themselves.
The grants to be received in 2024 are expected to double y/y compared to the downward revised estimates for 2023 and should reach BGN 7.1bn in total. The finance ministry said that the second instalment under the Recovery and Resilience Fund (RRF), worth BGN 1.4bn, will rather arrive in the first months of 2024 instead at end-2023, which explains the stronger y/y increase in the planned grants. However, the continuous delays of the tranches so far perpetuate the doubts about the state's ability to implement timely the necessary projects and reforms, which can lead to postponement of the next tranches under the RRF and other EU programmes in the next years.
Expenditure soars, no vision about securing sustainability of pension system
Government expenditure was planned to rise by 14.8% y/y (compared to the estimated spending in 2023) to BGN 83.8bn in 2024. Vasilev said that the spending will be cut by BGN 2bn compared to the initial plan, which means the expenditure should amount to BGN 81.8bn, or 12.1% higher than in 2023. We note that compared to 2021, the 2024 expenditure is going to rise almost twice, by 45.5%, which we see as an alarming signal for the sustainability of pension and wage payments, in particular.
The larger part of the y/y spending growth will be on account of higher capital expenditure, the upcoming new increase in pensions as of mid-2024 and hikes in some public wages. Capital expenditure was supposed to reach 12.0bn in the draft budget, but will be reduced to BGN 10bn, according to the minister's statement. There is no detailed information about what the funds will be spent on, except for the plans to allocate BGN 1bn for municipality infrastructure projects, but we think that the other funds will be allocated to the construction of several highways, which is what the ruling partner GERB insisted about, and possibly on investments under the recovery plan. GERB in particular requested the inclusion of the motorways Hemus and Struma, as well as the speedy roads between Ruse and Veliko Turnovo and Pleven in a list of priority projects, but the list will be finally prepared and presented only after the first reading of the draft budget in the parliament. We view the government's announced prioritisation of capital spending as very questionable, given the lack of sufficient number of ready for implementation projects on both state and municipality level, which almost certainly means that the planned capital expenditure target will not be met.
The main discretionary measures on the expenditure side are related to the 11% pension hike as of Jul 1, the increase in the widows' pensions (which will cost the budget BGN 104.8mn), the minimum wage hike to BGN 933 (worth additional BGN 230.3mn), the teacher wage hike to 125% of the average wage (estimated to cost BGN 289.9mn), as well as increases in public wages in some institutions (worth BGN 375mn). The wages in the judicial system will be also indexed, which will cost BGN 120.0mn. The increase of the maximum insurance income to BGN 3,750 can be seen as both revenue- and expenditure-side policy and their cost is assessed at BGN 35.9mn in 2024. The hike in the poverty line to BGN 526 in 2024 will boost social payments by BGN 104.3mn, as well. The government expenditure will rise by BGN 77.0mn due to its decision to start paying the sick leaves of employees as of the third day of their leave instead of the fourth day, which was the case until present. There will be no changes in the unemployment benefits and the maternity leave payments for the second year.
Pensions will be upped by 11% as of Jul 1, 2024, in line with the Swiss formula and pension costs will rise by 12.9% y/y to record high BGN 21.7bn. We think that the issue with high spending on pensions will pose significant challenges for the public finances over the medium- and longer term, taking into account the demographic crisis and population aging, as well as the lack of government initiative in the direction of reforms to stabilise and optimise the pension system.
The main gainers from the government's generous spending in 2018 will be the public works and environment protection, defence and security, education, healthcare, and social insurance sectors. In the defence sector, the government plans to allocate BGN 161.0mn for the purchase of a military shop, BGN 546.0mn for the purchase of military technology for the set-up of battalion combat groups, as well as BGN 156.3mn expenditure on activities required for the upcoming arrival of new F-16 military aircraft in Bulgaria. The larger part of the increased allocations to the above-mentioned sectors will mostly aim to cover increased wages of public employees, while no structural reforms have been included. Accordingly, besides the increased payments for higher wages, pensions and capital spending, the budget expenditure does not differ in any visible way compared to the 2023 budget.
Mid-term outlook is unfavourable
Return to fiscal consolidation is not planned in the 2024-2026 period, according to the mid-term three-year programme, as the government prefers to raise wages and pensions without initiating reforms to re-organise state administration and to make spending more sustainable. We think the lack of an effort for returning the budget in the balanced or surplus territory bodes ill for the fiscal health and debt trajectory in the mid-term, taking into account the further increases in government debt in the next years.
The pro-cyclical policies of the government eventually can be considered as a populist effort to please large groups of people and sectors, while postponing more painful reforms that could undermine support for the ruling parties, in our view. Realistically, any attempts for cuts in expenditure and keeping wages unchanged will topple down the the ruling coalition, given the unstable domestic political environment in the past three years, in our view. However, we think that any unexpected external shocks that could result in slowing GDP growth, may pose a strong risk for the budget and could endanger Bulgaria's aspirations to enter the eurozone in the beginning of 2025.