Within a week, the Minister of Finance presented medium-term budget forecast with, to say the least, startling parametersmeanwhile, current figures on budget execution through August were released, the government sent its first payment request under the National Recovery and Resilience Plan, and the price of electricity hit an all-time high.
The broader picture includes continued uncertainty in gas supplies across Europe and fresh gas price highs, higher inflation in the eurozone for the month and a growing expectation of further and bigger rate hikes from the ECB. This is how the situation can be summarized and, given the political will, sensible solutions can be taken.
The medium-term forecast presented by the Minister of Finance is under the so-called baseline scenario, or in implementation of current laws and adopted policies. The ministry team tells current and future politicians, businesses and all citizens that if nothing changes next year – and in 2024 and 2025 – Bulgaria will have sustainable deficits of over 6% of GDP. This, quite logically and following simple arithmetic, would lead to an increase in government debt from an expected 25% of GDP at the end of 2022 to 40% of GDP at the end of 2025. In nominal terms, the picture for 2023 is an increase in expenses by BGN 9.7 billion and a deficit of BGN 11.3 billion (6.8% of GDP).
The parties are already in an election campaign and predictably use the occasion for panic-mongering, mutual accusations or hypersensitive defensive reaction. Rather than contemplating an impending collapse in paralyzing fear, however, the debate on public finances should lead to sensible solutions that support growth and reduce the deficit.
Minister Velkova is right, of course, when she says that the current level of the surplus is not in itself an indicator of the state of the fiscal for the whole year, even less – for the next one. In this sense, citing the surplus reported during the week at the end of August of BGN 1.65 billion does not at all predict what will happen until December 31.
However, the data gives an idea of what is happening with the performance of income and expenditure. We see, for example, that total revenues are up 17.2% compared to the same eight months of 2021, only tax revenues are up 14.8%, VAT receipts are up 21.3% up to July, and corporate taxes are up nearly 35%. These and other indicators confirm the relatively budget-friendly picture (at least so far) – growth in the economy, business performance and consumption combined with rising prices. They can be seen, however, and the effects of certain new tax preferences – for example, the weak growth in income tax is a result of the significant tax relief for children. Along with this capital expenditure is less than ¼ of the planned for the year, which once again raises the question of the administration’s capacity to manage investment projects; otherwise, like every year, the unspent is a handy and easy buffer to reduce the deficit.
Speaking of “buffers”, it’s important to mention that the startling forecast of the MoF for the budget balance in 2023. is based on the hypothesis of a recession in Europe, transferred to Bulgaria along the lines of lower external demand, as well as a sharp drop in inflation. This would mean a relative slowdown in budget revenues, while expenditures – at least without political will – will continue to grow at the already planned high rates.
There are grounds for such a scenario – the risk of an energy shock for Europe is still there, prices are shocking, and the ECB could take much bolder steps to raise interest rates, further worsening the situation of heavily indebted sovereigns, businesses and households in the Eurozone with all the resulting consequences for investment , construction, consumption, etc. To begin with, we must note that this is quite a tough scenario and implies a very sharp contraction of the European economy and an immediate strong effect on Bulgaria, leading to deflation already at the end of the year and the beginning of the next – perhaps a repeat of 2008-2009. But the processes must be considered together and in dynamics – for example , if inflation disappears, it removes the grounds for large increases in wages, pensions, welfare payments, etc.
At the same time, with reasonable internal policies, Bulgaria can mitigate the external shock and to avoid a sharp increase in unemployment and a drop in consumption – it is in this direction that management priorities should be directed immediately after the elections. It certainly should, though redefining fiscal objectives, starting with the fact that with economic growth the budget must be balanced.
It continues to ignore the importance of access to EU grant funding and more specifically the additional capabilities of the Recovery and Resilience Mechanism. At the macro level, the effective spending of a significant transfer in value – and next year there are two periods under the operational programs and together with them we have funding under the National Plan for Recovery and Resilience – can at least partially replace a decline in the economic activity of the private sector and to some extent to “smooth out” the inevitable decline in a severe crisis in Europe. But together with this, we must again recall that the funds under the national plans were intended precisely to support the budget balance of the member countries – to be able to afford to implement meaningful investment projects, without increasing their deficits in the difficult period. Bulgaria has available funds equivalent to about 8% of GDP in one year, or nearly 50% of average annual capital expenditure in recent years. This is a significant resource and should be managed in such a way as to reduce the budget deficit – at the very least, by substituting national expenditure on part of the projects.
However, the risk is again political. After the 2021 election cycle caused the advance to be delayed and missed, now the payment request was only sent at the end of August, with one unfulfilled commitment. It is not clear if and when there will be a payment, and the following ones are also at risk – what exactly will January account for the period July-December 2022, and further next summer? As for the first “slip” a lot of reforms and changes (in the main part – legislative, normative and strategic documents) started in previous administrations, now a lot of work will have to be done by the executive power and the national assembly “from scratch”. This puts us in the paradoxical situation that instead of the implementation of the NAP improving the environment for growth, increasing investment and reducing the deficit at the same time, we almost wonder how to cut capital expenditure to compensate for delayed implementation of reforms and missed payments.
In short, avoiding the MoF’s gloomy forecast requires activity and action to use at least the tools at our disposal. In fact, this is also the message woven into the public presentation of the forecast – corrective measures should be considered. The ministry, at least according to stated intentions, appears to be preparing an assessment of the budgetary effect of various possible changes. This includes both cutting spending and raising tax revenue.
Two approaches are traditionally applied to expenses – “liquid”, which is focused on postponing or “carrying” an expense forward, and “structural”, which reduces a given commitment sustainably. However, the situation now will not improve with tricks and tricks to delay the loss – the problem is for the entire period until 2025 anyway. But serious liquidity pressures to cut excess spending are now just beginning to show more serious potential for long-term restructuring and reform. Again, we must recall as an example the significant amount of social spending that is wasted in broad-based programs to a large number of recipients without solving the most serious problems of poverty and inequality.
It would be good if the experts of the MoF would also introduce us an up-to-date “account” of populism, raged during the pandemic and continued in the next three parliaments. Here we are talking both about spending commitments in legal acts – a striking example is the mechanism for personal assistance, for which the Social Assistance Agency itself reports a controversial social effect – and about various tax preferences and discounts. The repeated warnings about the controversial and even the harmful role of reduced VAT rates – for restaurants, bars, now also for bread and flour – must be recalled with specific amounts. The same applies to the 25 cents for fuel, which only poured more revenue into the monopolist.
However, these bills will pale in comparison to the scale achieved by the electricity price compensation scheme for non-household consumers. As we have repeatedly written, market intervention and state aid may be permissible in extreme conditions of shock and sudden and unforeseen changes in the external environment. However, subsidies must be limited in time, targeted at those in real need and not completely isolating those receiving them from market signals. Should all businesses receive a subsidy? or to exclude from it companies that are actually improving their results in this crisis? Should it fully cover costs over BGN 250 per MWh? Should the scheme operate in this form in 2023? Can some of the electricity producers’ profits fund other government spending? To help future managers, it is right to say that according to preliminary data and taking into account average electricity prices in August, for this month alone, the state will have to cover over BGN 900 million expense to business. If we multiply it by 12 – that is keeping the same scheme for a whole year at these high energy prices – this becomes a budgetary task for 11 billion BGN!
A few words about the Eurozone. With such a deficit, at the same time – sustainable for several years – the goal seems unattainable. If the official government, i.e. the president, as well as the main political players, do not want to pursue a policy that will lead to the adoption of the euro in Bulgaria from the beginning of 2024, it is proper to say so honestly and directly to the Bulgarian citizens. For his part, who claims that the Eurozone is an important priority for future management, will have to state what policies to shrink the budget deficit he will pursue in order for the country to receive a positive readiness assessment from the EC and the ECB.