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Moody's Upgrades Bulgaria's Debt Ratings, Praises Sofia's State Finances

Date: 22.07.2011

Moody's Investors Service has upgraded Bulgaria's government debt ratings to Baa2 with a stable outlook from Baa3 in a long-anticipated review.

According to a statement on the website of the international credit rating agency signed by Kristin Lindow, Senior Vice President, Sovereign Risk Group, Moody's Investor Service, the improvement reflects Bulgaria's ongoing fiscal discipline and improving institutional strength as well as the financial system's relative resilience in a volatile regional environment.

This rating action concludes Moody's review for possible upgrade that was announced on 5 April 2011.

Moody's said today's upgrade of Bulgaria's government ratings was motivated by three major factors:

"Еffective fiscal consolidation supplemented by recent structural reforms, which are expected to maintain Bulgaria's very low debt burden by leading to a further reduction in the general government deficit to below the 3 % Maastricht limit in 2011 and roughly balanced budgets in the years to come;

"Strengthened institutional capacity thanks to determined efforts to increase the absorption of EU funds and to reform systems such as the judiciary and the police in order to improve the rule of law; and

"Strong liquidity and capital buffers of both the financial system and the government, which in Moody's opinion are sufficient to absorb shocks deriving from regional volatility.

In related actions, Moody's also upgraded Bulgaria's country ceiling for foreign currency deposits to Baa2/P-2 from Baa3/P-3, and aligned the country ceiling for local currency deposits to the Baa2 level (down from Baa1) because of Bulgaria's currency board arrangement in which the Bulgarian lev is pegged to the euro. In addition, the country ceiling for foreign currency debt was raised from A1 to Aa3, equivalent to the Aa3 country ceiling for local currency debt.

Moody's said the Baa2 rating "takes into account successive Bulgarian governments' strong track record in managing the public finances over more than a decade and policymakers' clear determination to maintain such discipline going forward."

"We expect the general government financial balance to show a deficit below 3 % of GDP in 2011, as evidenced by the results already achieved in the first half of the year," said Moody's. "Moreover, the implementation of the latest pension reforms and the new "Financial Stability Pact" are likely to help keep the government finances close to balanced over the medium- to long-term."

A second factor underlying Bulgaria's upgrade is its improving institutional framework, according to the international credit rating agency, which also notes that Bulgaria's "central bank has been very effective managing its currency board and implementing sound prudential bank supervision, and the Finance Ministry has provided strong guidance on such important milestones as the establishment of the new fiscal rule and tighter procedures for expenditure control."

"Progress has also been noted in improving the judicial and legal enforcement systems, although implementation of newly-strengthened procedures still has some way to go, as noted in a recent EU report. Already there has been a marked increase in the absorption of EU structural and cohesion funds, and further coordination of such programs with needed infrastructural expansion is also underway," the agency said.

Finally, Moody's noted that Bulgaria's government finances and its banking system are expected to weather the impact of the Greek debt crisis thanks to substantial liquidity and capital buffers.replenished the government's fiscal reserves to a comfortable level, it is well-equipped to handle a more adverse than expected environment.

It says Bulgaria's banking system's capital buffers should also be sufficient to absorb additional potential shocks, whether emanating from even-higher nonperforming assets or the regional debt crisis, without needing to raise more capital or government support.

Moody's does not expect any direct financial support to be forthcoming from the central bank or the government to the Bulgarian banks because of the pressure it would exert on the currency board arrangement (CBA). "Still, the central bank does have policy tools that could be used to boost liquidity if required," it points out.

The rating agency also noted that the Bulgarian economy rebalanced itself in the past few years, eliminating very large current account deficits with a remarkably shallow recession compared to those experienced in other currency board countries at similar rating levels. The currency board arrangement has been in place for nearly 14 years and has been successful in establishing and maintaining macroeconomic stability. According to Moody's, the sustainability of the CBA requires the government to keep its debt low and its banking system well-capitalized.

Moody's has further pointed out that economic growth has resumed in Bulgaria, thus far mainly thanks to external demand. Both consumption and credit demand are still very weak, with unemployment much higher than before the recession.

"Although foreign direct investment and other private capital inflows are likely to be permanently lower in the years ahead, substantial new investment projects are being planned that are likely to bring in meaningful capital. Competitive wages and low tax rates should continue to attract private sector investment, while public investment will be at least partially financed by EU funds. Aside from the new Financial Stability Pact, which is a strict but simple fiscal rule, the new Convergence Program outlines a plan to virtually eliminate the budget deficit in the next three years, and the National Reform Program eyes structural reforms intended to reinforce macro- and socio-economic stability over the longer term," the agency stated.

What is more, Moody's has made it clear that an upgrade of Bulgaria's ratings is likely should economic convergence lead to ERM II entry, the so called euro zone waiting room, given that eventual membership in the euro zone will provide a smooth exit strategy from the currency board arrangement and reduce external vulnerabilities.

"However, a serious deterioration in external liquidity and/or a persistent weakening of fiscal policy that causes government debt to rise significantly would put downward pressure on the government's ratings," the agency has warned.

Moody's reminds that its last rating action related to the government of Bulgaria was implemented on 5 April 2011, when the government's Baa3 local and foreign currency ratings were placed on review for possible upgrade, along with the country ceilings for long- and short-term foreign currency debt and deposits. The rating action prior to that was taken on 21 January 2010, when the outlook on the government ratings and the foreign currency ceilings was revised from stable to positive.

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