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EconomicReview

EconomicReview

Bulgarian National Bank 2

Bulgarian monetary policy regime seeks national currency stability with a view to price stability. The BNB Economic Re-view presents information and analysis of balance of payments dynamics, monetary and credit aggregates, their link withthe development of the real economy, and their bearing on price stability. External environment is also analyzed since theBulgarian economy is influenced by international economic fluctuations. This publication contains quantitative assess-ments of the development in major macroeconomic indicators in the short run: inflation, economic growth, monetary andcredit aggregate dynamics and interest rates.

The Economic Review, issue 2/2006 was approved for publication by the BNB Governing Council at its 18 May 2006meeting.

This publication should not be regarded as advice or recommendation. Exclusively the information user is liable for anyconsequences thereof.

The Economic Review is available at the BNB website, Periodical Publications submenu. Please address notes, com-ments and suggestions to the BNB Economic Research and Projections Directorate at 1000 Sofia, 1 Alexander Batten-berg Square, or to [email protected].

ISSN 1312 ≠ 420X

© Bulgarian National Bank, 2006

This issue includes materials and data received up to 26 May2006

The contents of the BNB Economic Review may be quoted orreproduced without further permission. Due acknowledgmentis requested.

Elements of the 1999 issue banknote with a nominal value of20 levs are used in cover design.

Economic Review ï 2/20063

Summary .......................................................................................................................................................... 55555

1. External Environment ...................................................................................................................................... 77777

Current Business Situation .................................................................................................................................................................. 7

The USD/EUR Rate ........................................................................................................................................................................... 13

International Prices of Major Raw Materials, Crude Oil and Gold .................................................................................................... 14

Bulgarian External Debt Dynamics ................................................................................................................................................... 18

2. Financial Flows, Money and Credit ............................................................................................................. 2020202020

Financial Flows and External Position Sustainability ........................................................................................................................ 21

Monetary Aggregates ....................................................................................................................................................................... 25

Credit Aggregates ............................................................................................................................................................................. 29

3. Economic Activity .......................................................................................................................................... 3434343434

Household Behaviour ....................................................................................................................................................................... 34

Government Finance and Consumption .......................................................................................................................................... 37

Behaviour of Firms ............................................................................................................................................................................ 38

Exports and Imports of Goods ......................................................................................................................................................... 41

4. Inflation ........................................................................................................................................................... 4747474747

Highlights

ïïïïï Amendments to BNB Ordinance No. 9 and Ordinance No. 21Amendments to BNB Ordinance No. 9 and Ordinance No. 21Amendments to BNB Ordinance No. 9 and Ordinance No. 21Amendments to BNB Ordinance No. 9 and Ordinance No. 21Amendments to BNB Ordinance No. 9 and Ordinance No. 21Adopted in Early 2006Adopted in Early 2006Adopted in Early 2006Adopted in Early 2006Adopted in Early 2006 ................................................................................................................................................................................................................................................................................................................. 30

Contents


Abbreviations

BIR Base interest rateBOP balance of paymentsBTC Bulgarian Telecommunications Companyb. p. basis pointsCEFTA Central European Free Trade AssociationCIF Cost, insurance, freightCIS Commonwealth of Independent StatesEA Employment AgencyEC European CommissionECB European Central BankEIB European Investment BankEMBI Emerging Markets Bond IndexEONIA Euro OverNight Index AverageEU European UnionFDI foreign direct investmentGDP Gross Domestic ProductIEA International Energy AgencyIMF International Monetary FundISM Institute for Supply ManagementLIBOR London Interbank Offered RateÃ1 narrow moneyÃ2 Ã1 and quasi-moneyÃ3 broad moneyMF Ministry of Financemt metric tonsNPISHs Non-profit institutions serving householdsNSI National Statistical InstituteOECD Organization for Economic Cooperation and

DevelopmentOPEC Organization of Petroleum Exporting CountriesPMI Purchasing Managersí IndexPPP Purchasing Power ParityWB World Bank

Economic Review ï 2/20065

Global economic indicators continued to improve over the first quarter of 2006, with world trade growth accel-erating to 11 per cent on an annual basis. The world economy is expected to continue growing in the secondand third quarters, Asian and European economies taking the lead. Growing geopolitical uncertainty posedrisks for growth by increasing volatility in crude oil and energy resource prices.

Over the first quarter of 2006 the US economic activity was higher compared with end-2005. According tomarket expectations, growth will slow down to some 3≠3.3 per cent in the second and third quarters, reflectingmostly slowing private consumption. The US Federal Reserve System has raised the federal funds rate threetimes since early 2006, in increments of 25 basis points, bringing its level to 5 per cent. Expectations are forretaining the current level or a further increase of 25 basis points.

Preliminary euro area GDP data show a 2 per cent increase on an annual basis over the first quarter of2006, investments in fixed capital contributing most significantly to this effect. Thus, forecasts of euro areagrowth were revised upwards, the European Commission projecting a 2.1 per cent growth in 2006. At its meet-ing in early March 2006, the ECB Governing Council raised the repo rate by 25 basis points to 2.5 per cent,reflecting higher inflationary risks. According to current market expectations, the repo rate is expected to rise by25 basis points in early June and at the end of August.

In the first quarter the US dollar depreciated against the euro. Uncertainty associated with US and euro areamonetary policy will affect exchange rate dynamics in the coming two quarters. However, the downward trendfor the US dollar is expected to sustain in a long-term horizon.

Increased concerns about shortages in crude oil supply prompted significant fluctuations in its price. Marketexpectations are for Brent oil average monthly price to range between USD 65 and USD 75 per barrel, reflect-ing primarily geopolitical factors. International raw material prices are expected to retain their upward trends.

Over the first quarter of 2006 BNB international reserves declined by BGN 692.1 million and by March theIssue Department balance sheet figure reached BGN 13,723 million. International reserve dynamics reflectedmostly government operations related to early debt repayments to the World Bank and the IMF and making adeposit to purchase equipment for the Ministry of Defence.

In early 2006 the balance of payments current account deficit almost doubled compared to the first quarter of2005. All major current account components contributed to this growth, with worsening trade balance taking thelead. The current account deficit is expected to rise in the second quarter, whereas projections for the thirdquarter show an improvement.

Significant foreign direct investment inflows on the balance of payments financial account between Januaryand March 2006 are likely to continue in the coming two quarters. Expected positive flows of borrowings cou-pled with high foreign direct investments will contribute to international reserve growth. The financial accountsurplus will exceed the current account deficit and international reserves will rise by approximately EUR 1 billionover the second and third quarters.

Credit limits exceeded by particular banks and deposited additional minimum required reserves were the ma-jor reasons behind accelerating growth in reserve money over the first quarter. Bank reserves by end-March2006 rose by 53.2 per cent on March 2005. Annual growth rates of broad money and credit slowed significantlyin the first quarter due mainly to the high March 2005 base. Excluding credit portfolios from banks' balancesheets contributed considerably to the credit slowdown. Comparatively high levels of banks' net foreign assetsat the end of the first quarter are partially ascribable to transferring a portion of newly extended loans to non-

Summary


residents. The relative share of loans to households in the structure of claims on the non-government sectorcontinued rising to reach 37.5 per cent as of March 2006.

To achieve greater efficiency of BNB restrictive bank credit measures, new statutory amendments wereadopted in February 2006 to discontinue the existing practice of transforming and replacing bank loans withother debt instruments. Ordinance No. 8 was also amended with regard to determining risk weight of mortgageloans. Given the assumption that banks will adhere to imposed restrictions, a 22≠23 per cent annual growth inclaims on the non-government sector may be expected in the second and third quarters of 2006.

Interest rates on time deposits increased in the first quarter as a result of rising international rates, this trendmost likely to sustain in the coming two quarters. Lending interest rates are expected to stay at the currentlevels.

Amid high consumption and investment activity in 2005, gross domestic product rose by 5.5 per cent. House-hold consumption behaviour continued to be driven by increasing employment and incomes. In 2006 consump-tion will progressively rise, with a certain slowdown in the third quarter due to the prior year's high base.

Investments in fixed capital grew by 19 per cent in 2005. The increasing share of investments in GDP under-pinned Bulgarian producers' competitiveness. Currently, a significant reserve has been accumulated in theeconomy to ensure sustainable competitiveness in case of short-term growth in unit labour costs. Availabledata give reason to expect high investment growth with a certain slowdown in the second half of the year.Overall, economic growth will remain high in the second and third quarters.

Export and import growth rates at the end of 2005 matched those in the first quarter of 2006 under thestrong influence of high international prices. Goods exports are expected to grow annually by 23≠25 per cent inthe second quarter and by 25≠29 per cent in the third quarter of the year, consistent with recovering euro areagrowth and the upsurge in key export-oriented sectors of the Bulgarian economy. Retention of energy resourceprices at current high levels and expected moderate growth in domestic demand will maintain nominal growthrates of goods imports at 23≠25 per cent in the second quarter and approximately 15≠19 per cent in the thirdquarter. The trade balance deficit as a share of GDP will reach some 21.9≠22.2 per cent annually in the sec-ond quarter and approximately 21≠21.5 per cent in the third quarter.

Inflation accumulated between January and April came to 4.6 per cent, reflecting mainly increased excise oncigarettes and sugar price rises on international and domestic markets. If cigarettes are excluded, inflation ac-cumulated in the first four months of 2006 is 1.95 per cent, down 1 percentage point on the same period ofthe previous year. Over the second quarter of 2006 inflation is anticipated to stay at approximately 8 per centon an annual basis, reflecting primarily the increased petrol price. In the third quarter consumer price inflation isprojected to slightly fall compared with the second quarter. Risks to the projection may arise from world fuelprice dynamics and its effect on the domestic market.

7 Economic Review ï 2/2006

1. External Environment

Improving economic indicators underpin expectations of accelerating world growth rates in the second andImproving economic indicators underpin expectations of accelerating world growth rates in the second andImproving economic indicators underpin expectations of accelerating world growth rates in the second andImproving economic indicators underpin expectations of accelerating world growth rates in the second andImproving economic indicators underpin expectations of accelerating world growth rates in the second andthird quarters of 2006. Due to crude oil price rises, risks of higher inflation increased. In accordance with marketthird quarters of 2006. Due to crude oil price rises, risks of higher inflation increased. In accordance with marketthird quarters of 2006. Due to crude oil price rises, risks of higher inflation increased. In accordance with marketthird quarters of 2006. Due to crude oil price rises, risks of higher inflation increased. In accordance with marketthird quarters of 2006. Due to crude oil price rises, risks of higher inflation increased. In accordance with marketexpectations, the US federal funds rate may be retained at the current level or may rise by 25 basis points,expectations, the US federal funds rate may be retained at the current level or may rise by 25 basis points,expectations, the US federal funds rate may be retained at the current level or may rise by 25 basis points,expectations, the US federal funds rate may be retained at the current level or may rise by 25 basis points,expectations, the US federal funds rate may be retained at the current level or may rise by 25 basis points,whereas euro area repo rates are likely to increase twice: by 25 basis points in early June and by another 25whereas euro area repo rates are likely to increase twice: by 25 basis points in early June and by another 25whereas euro area repo rates are likely to increase twice: by 25 basis points in early June and by another 25whereas euro area repo rates are likely to increase twice: by 25 basis points in early June and by another 25whereas euro area repo rates are likely to increase twice: by 25 basis points in early June and by another 25basis points at the end of August.basis points at the end of August.basis points at the end of August.basis points at the end of August.basis points at the end of August.

Current Business Situation

Global economic indicators continued im-proving in early 2006, especially in industryand services. World trade growth acceler-ated, its annual rate reaching 11 per centover the first quarter. Asian and Europeaneconomies are expected to occupy leadingpositions in accelerating world economicgrowth in the second and third quarters of2006. Risks may arise from enhanced globaluncertainty associated with Iran's nuclearprogramme. This leads to a stronger volatil-ity in international crude oil and fuel prices.

The USAThe USAThe USAThe USAThe USA

Over the first quarter of 2006 the US eco-nomic activity picked up compared with thelast quarter of 2005: GDP grew by 3.6 percent on an annual basis, with private con-sumption (primarily durables) and invest-ments in business equipment contributingmost significantly to growth. Governmentconsumption also added to growth: in thefirst quarter expenditure went on reconstruc-tion of the regions hit by last summer's hur-ricanes.

Chart 1Global PMI Indices

Source: NTC Research, JP Morgan.

Chart 2World Trade(annual rate of volume growth, %)

Source: CPB Netherlands Bureau for Economic Policy Analysis.

Chart 3Contribution to US Growth by Component(%)

Source: Bureau of Economic Analysis.

External Environment 8

Chart 4US Inflation Rate(change on same period of previous year, %)

Source: Bureau of Labor Statistics, Bureau of Economic Analysis.Note: Note: Note: Note: Note: The US core inflation is measured by personal consumption expenditures indexexcluding energy and food expenditures.

Chart 6US Growth and Labour Market(on an annual basis, %)

Source: Bloomberg.

Chart 5US Unemployment Rate and Change in Payroll Employment

Source: Bureau of Labor Statistics.

Chart 7US Consumer Confidence Indicators(1985 = 100)

Source: The Conference Board.

According to market expectations, in thesecond and third quarters of 2006 growthmay gradually slow to levels of approxi-mately 3≠3.3 per cent which are close tolong-term rates. The main force behind thisprojection may be lower private consump-tion owing to higher interest rates andgradually subduing activity on the US hous-ing market. Government expenditure will alsofall with exhausting the one-off effect of firstquarter's reconstruction expenditure. Theimproving conditions on the labour market(higher incomes and employment) and ex-ports of goods and services are projectedto support economic activity. The upwardtrend in corporate profits over the first quar-ter is likely to boost the investment activity'spositive contribution over the second andthird quarters of 2006.

During the first four months of 2006 infla-tion was driven by fuel price dynamics.Consumer price inflation averaged 3.6 percent on a year-on-year basis, whereas im-port price dynamics (disregarding the effectof petrol prices) showed a certain slowdownto 1.5 per cent annually. The upward pro-ducer price pace also slowed down. In Aprilcore consumer inflation rose to 2.3 per centannually, still remaining stable at 2.1 percent over the first four months. Increasedhousing rents contributed sizably to highercore consumer inflation in March and April.

In the second and third quarters of 2006the US core inflation is likely to stay at ap-proximately 2 per cent on an annual basis.Albeit increasing on a quarterly basis, theUS labour productivity growth in the firstquarter reflected cyclically improving eco-nomic activity. Consequently, dynamics inthis indicator is anticipated to match long-term trends. This supports expectations ofstable core inflation.

Overall inflation will continue to depend onpetrol price movements, with its level in thesecond quarter likely to exceed the firstquarter's level due to high oil prices in Apriland May.

Major risks to the US price level in thefollowing two quarters are associated bothwith fuel price rises and robust consumer


Chart 11Contribution to Euro Area Growth by Component(%)

Source: Eurostat.

Chart 8US PMIs and Growth

Source: Institute for Supply Management.

Chart 9US Federal Funds Rate and Six-month LIBOR in US Dollars(%)

Source: Bloomberg.

Chart 10Expected US Yield Curve(%)

Source: Bloomberg.

demand. As a result, enterprises may bemore inclined to raise prices of productsand services offered.

Over the first quarter unemployment wentdown to 4.7 per cent, with employment rateremaining steady (1.5 per cent on an annualbasis).

In line with market expectations, in early2006 the Federal Reserve System threetimes raised the federal funds rate by 25basis points to 5 per cent as of May. Mar-kets expect retention of the current level ora further rise by 25 basis points at the end-June meeting. Given the assumption thatthe increase to 5 per cent is the last for thecurrent interest rate cycle, the rate on six-month LIBOR deposits in US dollars is likelyto fluctuate between 5 and 5.3 per cent untilend-September.

Euro AreaEuro AreaEuro AreaEuro AreaEuro Area

Moderate expansion of economic activityin the euro area continued in 2006. Accord-ing to preliminary data, over the first quarterof 2006 euro area GDP rose by 2 per centon an annual basis against 1.8 per cent inthe prior quarter. Investments in fixed capital(most of the time stimulated by low interestrates) significantly contributed to economicgrowth in the reporting quarter. Investmentactivity was underpinned by robust externaldemand, reflecting the need to expand andrenew production capacity and boost ex-


Chart 12Euro Area: Incomes, Consumption and Savings(%)

Source: Eurostat.

Chart 13Euro Area Inflation Rate(change on same period of previous year, %)

Source: Eurostat.Note: Note: Note: Note: Note: Euro area core inflation excludes changes in energy, food, alcohol and tobaccoprices.

Chart 14Euro Area Unemployment Rate(%)

Source: Eurostat.

Chart 15Euro Area Consumer Confidence Indicators

Source: Eurostat.

ported production. Simultaneously, low con-sumption activity was observed owing tostagnated employment, slowing real incomegrowth and high propensity to save. Con-sumer budgets were also adversely affectedby high fuel prices.

The expansion of the European economyis evident in the sustainable rise in leadingbusiness climate indicators over the firstquarter. The PMI indices measuring the cur-rent condition of economic activity alsopicked up to reach the highest values regis-tered in the last five years. Expectationsbased on economic indicators show a pro-gressive trend to a moderate upsurge of theeuro area economic growth over the secondand third quarters of 2006.

ECB latest forecasts (March 2006) of GDPgrowth in 2006 and 2007 were revised up-wards to 1.7≠2.5 per cent (the previous fore-cast: 1.4≠2.4 per cent) for 2006 and to1.5≠2.5 per cent (the previous forecast:1.4≠2.4 per cent) for 2007. The EC springforecasts of euro area economic growthwere revised upwards to 2.1 per cent for2006.

In April consumer price inflation in theeuro area came to 2.4 per cent annually(reflecting mainly increased fuel prices) fol-lowing its moderate decline over the firstquarter. The average core inflation was 1.3per cent on an annual basis for the first fourmonths of 2006. Nevertheless, April saw anincrease in core inflation to 1.5 per centannually. Petrol prices, steadily retaining theirhigh nominal levels, gave rise to concernsabout second-round inflationary effects. Mar-ket indicators of inflationary expectationsshowed a similar risk.

Consumer activity is expected to remainlow over the coming quarters which mayresult in a pressure on retail prices. Data onEuropean companies' corporate results forthe first quarter show that businesses havereserves to defray increased productioncosts rather than transfer them on end con-sumer prices. Slightly increased unit labourcosts and the growing labour productivityalso will contribute to retaining core inflationat the current level.


Chart 19Curve of Expected Euro Area Yield(%)

Source: Bloomberg.

Chart 16PMI Indices and Euro Area Growth

Source: Eurostat.

Chart 17Euro Area Base Interest Rates(%)

Source: Bloomberg.

Chart 18BIR on Refinancing Operations and Six-month EURIBOR(%)

Source: Bloomberg.

Risks may arise from euro area inflationdynamics in the future. They are associatedwith further petrol price rises and second-round inflationary effects on end consumerprices and salary negotiation. At the sametime, a counteraction may be expected fromdeclining selling prices of imported goodsowing to the steady appreciation of the euroagainst the US dollar in April and May.

The fall in unemployment to 8.1 per centbetween January and March is a sign ofmoderate improvements in the labour mar-ket. However, EC economic survey data forMarch and April show increasing concernsabout employment in the following 12months which corresponds with modestexpectations of future consumer activity. Incontrast, employment components of thePMI posted growth in services and industry.

At its early March 2006 meeting, the ECBraised the repo rate by 25 basis points to2.5 per cent, explaining the change with theneed to maintain price stability in responseto growing inflationary risks.


Chart 20Euro Area Money Market Yield Curve(%)

Source: Bloomberg.

In the spring the IMF1 and the EC2 publishedtheir latest forecasts of world economic develop-ments between 2006 and 2007. Expectations of2006 world growth were revised upwards, withmost significant revisions to accelerated growth inChina, India and Japan.

Expectations of euro area growth in 2006 showsustainable rates of 2 and 2.1 per cent. 2007 maysee a slowdown due to the 3 percentage pointVAT increase in Germany as from 1 January 2007which will withdraw a portion of household con-sumption and investments from 2007 into 2006.Stable private consumption and comparativelyhigh investment activity in industry will be the mainmotives behind US economic growth.

Economic growth risks for 2006 and 2007 re-flected several factors. High and unstable oilprices pose a serious risk despite the lack of dra-matic fluctuations in growth and inflation. It is quitepossible that fuel price rise effects have not yetbeen manifested since consumers assess it asshort-term. At the same time, free extracting ca-pacities are minimal and each escalation in geo-political uncertainty results in considerable crudeoil price rises. Other risks to world growth stemfrom further US Federal Reserve System, ECB andBank of Japan interest rate increases, as well asgrowing global imbalances, especially in US tradewith Asian countries. A possible avian flue spreadwould have considerable economic and social ef-fects on the world.

The IMF and European Commission Spring Forecasts

1 IMF, World Economic Outlook, April 2006.2 European Commission, Economic Forecasts ≠ Spring 2006, May 2006.

Major Trends in EC and IMF Spring Forecasts(real percentage change)

Spr ingSpr ingSpr ingSpr ingSpr ing Change onChange onChange onChange onChange onforecast,forecast,forecast,forecast,forecast, au tumnau tumnau tumnau tumnau tumn

20062006200620062006 forecast , 2005forecast , 2005forecast , 2005forecast , 2005forecast , 2005

20042004200420042004 20052005200520052005 20062006200620062006 20072007200720072007 20062006200620062006 20072007200720072007

ECECECECEC

EUEUEUEUEUGDP growth 2.4 1.6 2.3 2.2 0.2 -0.2Euro areaEuro areaEuro areaEuro areaEuro areaGDP growth 2.0 1.3 2.1 1.8 0.2 -0.3Unemployment 8.9 8.6 8.4 8.2 0.0 0.1Inflation 2.1 2.2 2.2 2.2 0.0 0.1USAUSAUSAUSAUSAGDP growth 4.2 3.5 3.2 2.7 0.0 0.0Unemployment 5.5 5.1 4.8 5.1 -0.2Inflation 2.7 3.4 2.9 1.6 0.0Japan*Japan*Japan*Japan*Japan* 2.32.32.32.32.3 2.72.72.72.72.7 2.82.82.82.82.8 2.42.42.42.42.4 0.60.60.60.60.6 0.60.60.60.60.6China*China*China*China*China* 10.110.110.110.110.1 9.99.99.99.99.9 9.59.59.59.59.5 9.09.09.09.09.0 1.31.31.31.31.3 1.01.01.01.01.0Latin America*Latin America*Latin America*Latin America*Latin America* 5.55.55.55.55.5 4.34.34.34.34.3 4.34.34.34.34.3 3.73.73.73.73.7 0.70.70.70.70.7 0.10.10.10.10.1Asia (Japan excluded)Asia (Japan excluded)Asia (Japan excluded)Asia (Japan excluded)Asia (Japan excluded)* 8.18.18.18.18.1 7.97.97.97.97.9 7.77.77.77.77.7 7.57.57.57.57.5 0.50.50.50.50.5 0.50.50.50.50.5Africa*Africa*Africa*Africa*Africa* 4.94.94.94.94.9 5.05.05.05.05.0 6.06.06.06.06.0 5.55.55.55.55.5 0.00.00.00.00.0 0.00.00.00.00.0World growthWorld growthWorld growthWorld growthWorld growth 5.15.15.15.15.1 4.64.64.64.64.6 4.64.64.64.64.6 4.34.34.34.34.3 0.30.30.30.30.3 0.30.30.30.30.3

IMFIMFIMFIMFIMF

EUEUEUEUEUGDP growth 2.5 1.8 2.4 2.3 0.2 -0.2Euro areaEuro areaEuro areaEuro areaEuro areaGDP growth 2.1 1.3 2.0 1.9 0.2 -0.3Unemployment 8.9 8.6 8.3 8.4 -0.1Inflation 2.1 2.2 2.1 2.2 0.3USAUSAUSAUSAUSAGDP growth 4.2 3.5 3.4 3.3 0.2 -0.3Unemployment 5.5 5.1 4.9 5.1 -0.3Inflation 2.7 3.4 3.2 2.5 0.4Japan*Japan*Japan*Japan*Japan* 2.32.32.32.32.3 2.72.72.72.72.7 2.82.82.82.82.8 2.12.12.12.12.1 0.80.80.80.80.8 0.50.50.50.50.5China*China*China*China*China* 10.110.110.110.110.1 9.99.99.99.99.9 9.59.59.59.59.5 9.09.09.09.09.0 0.80.80.80.80.8 0.80.80.80.80.8Advanced economies*Advanced economies*Advanced economies*Advanced economies*Advanced economies* 3.33.33.33.33.3 2.72.72.72.72.7 3.03.03.03.03.0 2.82.82.82.82.8 0.20.20.20.20.2 -0.2-0.2-0.2-0.2-0.2Western Hemisphere*Western Hemisphere*Western Hemisphere*Western Hemisphere*Western Hemisphere* 5.65.65.65.65.6 4.34.34.34.34.3 4.34.34.34.34.3 3.63.63.63.63.6 0.50.50.50.50.5 0.10.10.10.10.1Asia*Asia*Asia*Asia*Asia* 8.88.88.88.88.8 8.68.68.68.68.6 8.28.28.28.28.2 8.08.08.08.08.0 1.01.01.01.01.0 0.80.80.80.80.8Africa*Africa*Africa*Africa*Africa* 5.55.55.55.55.5 5.25.25.25.25.2 5.75.75.75.75.7 5.55.55.55.55.5 -0.1-0.1-0.1-0.1-0.1 0.60.60.60.60.6World growthWorld growthWorld growthWorld growthWorld growth 5.35.35.35.35.3 4.84.84.84.84.8 4.94.94.94.94.9 4.74.74.74.74.7 0.60.60.60.60.6 0.30.30.30.30.3

Source: EC and IMF.* GDP growth.

The six-month EURIBOR deposit yield hasrisen since the beginning of 2006 to reachapproximately 3.03 per cent in early May.According to current market expectations ofa 25 basis point rise in repo rates in earlyJune and at the end of August, the six-month EURIBOR deposit yield is expectedto increase ranging between 3 and 3.5 percent over the coming two quarters.


Chart 22USD/EUR Exchange Rate(USD)

Source: Bloomberg.

Chart 21Growth and Inflation in EU-25 and in the New EU Member States(%)

Source: Eurostat, BNB.

EU-25EU-25EU-25EU-25EU-25

Over the last quarter of 2005 EU-25growth accelerated to 2 per cent annually.New member countries' growth increased to5.1 per cent over the reporting period. Po-land (4.1 per cent), the Czech Republic (6.7per cent) and Slovenia (5.1 per cent) con-tributed most significantly to overall growth.

Average monthly inflation in the newly ac-ceded countries fell to 2 per cent over thefirst quarter of 2006, reflecting mainly lowerinflation in Poland.

The USD/EUR Rate

During the review quarter the US dollarfollowed a trend to a gradual depreciationagainst the euro. This trend deepened afterpublication of the G-8 meeting's declarationwhich emphasized on global imbalancesand the policy required for their balancing.The change in expectations toward narrow-ing interest differential between the USA andeuro area also contributed to euro apprecia-tion. This effect intensified in early May whenthe probability of discontinuing US interestrate rises began to dominate market expec-tations. This prompted the mid-May changein the exchange rate of USD 1.28 againstEUR 1.

Over the second and third quarters theUSD/EUR rate volatility is likely to increaseon the first quarter. Uncertainty associatedwith future monetary policy in the USA andthe euro area will further affect investors'attitudes. The long-term trend to the USdollar depreciation will be driven by the lackof policy of reducing external imbalances inseveral countries. To this end, financial flowsof the US government bond market may bereoriented to other monetary areas and re-serve currencies.


International Prices of Major RawMaterials, Crude Oil and Gold

Crude OilCrude OilCrude OilCrude OilCrude Oil

In the first quarter and the beginning ofthe second quarter of 2006 concerns aboutpossible shortages in crude oil supply in-creased, prompting great fluctuations in itsprice. The average monthly Brent price wasUSD 61.9 per barrel in the second quarter(against USD 56.9 per barrel in the previousquarter).

Geopolitical factors dominated market in-centives and expectations. Over the first fourmonths of 2006 terrorist attacks in Nigeriadamaged oil facilities (those ensured 15 percent of the country's output) which have notbeen restored as of May. Growing threats ofterrorist attacks against Middle East's refin-eries (following the attempt to blow up oneof the largest Saudi Arabia's and world'srefineries) aroused serious concerns.

Chart 23Crude Oil(USD per barrel)

Source: World Bank.

Chart 24World Crude Oil Demand and Supply(million barrels per day)

Source: I≈¿.

The Balkan RegionOver the fourth quarter of 2005 Balkan countries posted comparatively high economic growth. Overall growth rates in

2005 were lower than in 2004 due to subdued external demand. Romania's low growth was mostly ascribable to reducedagricultural produce as a result of summer floods.

In the first quarter of 2006 inflation in this region increased, reflecting food and fuel price rises and increased adminis-tratively set prices in some countries (Romania, Turkey, Macedonia, and Bulgaria).

The favourable business climate is expected to sustain and even improve underpinned by enhanced external demanddue to global growth acceleration in 2006.

Real Growth and Inflation in Balkan Countries

2004 2004 2004 2004 2004 2005 2005 2005 2005 2005 20062006200620062006

I quarterI quarterI quarterI quarterI quarter II quarterII quarterII quarterII quarterII quarter III quarterIII quarterIII quarterIII quarterIII quarter IV quarterIV quarterIV quarterIV quarterIV quarter TotalTotalTotalTotalTotal I quarterI quarterI quarterI quarterI quarter II quarterII quarterII quarterII quarterII quarter III quarterIII quarterIII quarterIII quarterIII quarter IV quarterIV quarterIV quarterIV quarterIV quarter TotalTotalTotalTotalTotal I quarterI quarterI quarterI quarterI quarter

Growth Growth Growth Growth Growth (on the previous year, %)Bulgaria 4.6 5.5 6.2 6.3 5.7 5.9 6.5 4.6 5.5 5.5Greece 4.3 4.1 4.0 4.2 4.2 3.5 3.7 3.8 3.7 3.7Macedonia 3.4 4.8 4.6 3.4 4.1 2.9 5.0 4.1 3.8 4.0Romania 6.1 7.1 11.1 8.9 8.3 5.9 4.1 1.8 4.6 4.1Turkey 11.8 14.4 5.3 6.3 8.9 6.6 5.5 7.7 9.5 7.4Croatia 4.2 3.8 3.6 3.6 3.8 1.8 5.1 5.2 4.8 4.3Serbia and Montenegro 7.5 5.5 9.5 14.2 9.3 5.3 6.8 5.6 5.9 6.3

Inflation Inflation Inflation Inflation Inflation (averaged for the period, %)Bulgaria 6.4 6.7 6.8 4.8 6.2 3.8 4.9 4.8 6.6 5.0 8.0Greece 2.9 3.1 3.0 3.2 3.0 3.4 3.2 3.8 3.5 3.5 3.2Macedonia 1.6 -0.5 -1.5 -1.1 -0.4 -0.4 0.9 0.8 0.8 0.5 2.7Romania 13.6 12.3 11.9 10.0 11.9 8.9 9.9 8.9 8.5 9.0 8.6Turkey 14.1 9.3 9.5 9.7 10.7 8.6 8.6 7.9 7.6 8.2 8.1Croatia 1.8 2.3 1.8 2.3 2.1 3.1 3.0 3.4 3.8 3.3 3.5Serbia and Montenegro 8.5 10.2 12.3 13.0 11.0 16.0 16.5 15.6 16.8 16.2 15.2

Source: Statistical institutes and central banks of respective countries.


Chart 25World Production of Crude Oil in 2005(share, %)

Source: I≈¿.

3 In May the US National Hurricane Centre published its fore-casts for 2006. It predicted a very active hurricane season. Fourto six high-category hurricanes (like Rita and Katrina in Augustand September 2005) are likely to occur.

The Iran's nuclear programme and intensi-fied confrontation with the USA predeter-mined market's ascending dynamics at theclose of February. A possible military conflictresumed fears that the United Nations Secu-rity Council would impose trade sanctionsagainst Iran. This country produces 3.9 mil-lion barrels daily, or 4.7 per cent of theworld output. At the same time, the OPECmaintains high volumes of oil production,retaining a reserve capacity which would notbe enough to offset a possible Iran's with-drawal from the market. In April and Maythe Brent price exceeded USD 70 per barrel(reaching the absolute maximum of USD 75per barrel on 2 May).

Market expectations put average Brentmonthly price at USD 65≠75 per barrel.Geopolitical factors, such as oil supplies,UN Security Council sanctions and fears ofa military conflict, will mainly influence Brentprices. High volumes of OECD petrol prod-uct inventories will contribute to price falls.The US petrol inventories jumped to theseven-year high in May.

Risks to this forecast stem from a signifi-cant crude oil price rise under unfavourablegeopolitical circumstances and poor weatherconditions in the Gulf of Mexico over thethird quarter (the height of the hurricaneseason).3

The price of the crude oil OPEC basket,calculated in euro, increased during the firstquarter of 2005 up to EUR 47.9 per barrel(a 7.7 per cent rise compared with theprevious quarter and a 43.9 per cent in-crease compared with the first quarter of2005). Based on market expectations of theUSD/EUR exchange rate, the price is pro-jected to vary between EUR 49 and EUR 55per barrel over the second and third quar-ters of 2006.

Chart 26OPEC Crude Oil Basket Price in Euro

Source: World Bank, ECB, BNB, OPEC.


The Sugar PriceOver the first quarter of 2006 the sugar price

in US dollars increased by 91 per cent on anannual basis. Intentions declared by Brazil(world's largest sugar exporter and producer) touse more sugar cane for ethanol production re-sulting in reduced sugar exports and decliningEU sugar exports due to the restriction intro-duced by the World Trade Organization (partiallyremoving quotas and admitting 49 sugar-pro-ducing countries to the EU market as from2009) were the reasons behind the price hike.As a result of crude oil appreciation, the ethanolproduction has been rising in recent years witha view to its use as an alternative energysource. Major sugar producers are Brazil, theEU, India, China, and the USA, and major sugarexporters Brazil, the EU, Australia, Thailand, andGuatemala. Brazil's increasing output and itsdominating position in sugar trade contributed tofalls in international prices at the end of 90iesand their retention until 2005.

No deficits of sugar cane and sugar beetwere reported worldwide. Restrictions were im-posed on most producer countries by introduc-ing high tariffs and limited import quotas in theUSA, the EU, and India. Notwithstanding, con-tinuing high oil prices stimulate the growing in-terest in alternative fuels in the long run. Brazil isan example of a country introducing new alter-native fuel technologies. Ethanol produced in2004 came to 14 billion litres which was enoughto replace 40 per cent of petrol consumption,and 60 per cent of the new automobiles havehybrid petrol and ethanol engines.

Expectations of sugar price dynamics showretaining the appreciation to the level matchingthe first 2006 quarter's level. Motives behind thisforecast are seen in increasing output and ex-ports of smaller exporters as a result of theopening European market. This will compensategreater internal consumption of sugar cane forethanol production in Brazil.

World Production and Consumption of Sugar(thousand mt)

Source: United States Department of Agriculture.

Sugar Producers and Exporters(million t)

Source: Illovo Sugar.

Sugar Price(price/kg)

Source: World Bank.

Major Raw Material and Commodity PricesMajor Raw Material and Commodity PricesMajor Raw Material and Commodity PricesMajor Raw Material and Commodity PricesMajor Raw Material and Commodity Prices

Over the first quarter of 2006 non-ferrousmetal prices rose significantly. In the firstfour months zinc, copper and aluminiumprices increased most significantly: by 69.3per cent, 39.6 per cent and 16.6 per centrespectively. Low world inventories and en-hanced industrial demand, especially inChina and India, as well as speculativehedge fund demand gave grounds to con-cerns about longer-than-expected non-fer-rous metal deficits. Steel prices did not


Source: World Bank, BNB.

Chart 27Price Indices of Major Commodities and Commodity Groups(2000 = 100)

Steel Copper

Food Wheat

change considerably over the first quarterthanks to the high world production growth(6 per cent in the first quarter).

Expectations of metal prices remain un-changed: non-ferrous metals will continue toappreciate over the second and third quarters,and the steel price will retain its current level.

Food prices increased by 7.6 per centannually over the first quarter. Wheat andsugar prices also grew. Drought in particularregions of the USA pushed wheat prices.The 2006≠2007 yields are expected to de-cline by 11 per cent on the previous period.In contrast to poor crops in the USA, Russiaand Ukraine, high yields are forecasted forArgentina, Canada, Australia and the EU.According to the US Department of Agricul-ture, the wheat price is most likely to rise bysome 19 per cent in the case of poorweather conditions.

Sugar and corn prices posted growth asa result of increased demand for sugarcane used for ethanol production. In thesecond and third quarters of 2006 a slightappreciation is expected due to enhanceddemand and growing probability of low-qual-ity yields in several large grain exporters.


Chart 29Spread of JP Morgan Index for Emerging Markets(basis points)

Source: Bloomberg.

GoldGoldGoldGoldGold

During the first quarter of 2006 investmentdemand for gold increased, the gold pricereaching record high levels. Gold's stronglink with the US dollar, crude oil and non-ferrous metals was sustained, with the cor-relation between gold and the dollar remain-ing negative. The enhanced demand coun-teracted with increased inflationary expecta-tions owing to oil price rises. The Iran's nu-clear programme was the geopolitical factorexerting a permanent pressure on the goldprice. Simultaneously, the downward trend ingold demand by Asia's jewelry industry wasretained due to the high price pressure onthis market segment.

Over the second and third quarters of2006 market expectations show sustainedinternational tension over Iran's nuclear pro-gramme which will increase demand forgold as a secure investment haven. Thegold's link with the US dollar will probablypersist, affecting the exchange rate behav-iour. US short-term interest rates reached5 per cent in tandem with increasing financ-ing costs of gold positions. This will notstimulate some market participants. Theannouncement of the Bank of Japan that itwill stop using monetary stimuli may alsoimpact demand for future contracts. TheGFMS (Gold Fields Mineral Services) analy-sis shows a possible increase in investmentdemand for gold in China and in physicaldemand in India, Iran, and Thailand. Despitethe high gold price, no significant rise inproduction is expected. Moreover, the larg-est South Africa's gold mine announced anexpected 50 per cent contraction in produc-tion.

Bulgarian External Debt Dynamics

The prior year's trend towards a progres-sively increasing interest in governmentdebts of emerging markets was sustained inthe first four months of 2006. Between Janu-ary and May the spread on these countries'government debt securities, measured bythe JP Morgan EMBI+ index, fell by 67 ba-sis points, fluctuating around 180 basispoints in early May. Despite the prospectsfor global interest rate rises, market partici-

Chart 28Spot Price of Gold(USD per troy ounce)

Source: Bloomberg.


pants continued to assume greater risk,underpinning the enhanced demand forhigh-yield financial instruments. Improvedmacroeconomic conditions in most emerg-ing countries and favourable fiscal resultspushed up their debt securities' ratings.

The Bulgarian government securitiesspread, measured by the JP MorganEMBI+ index, stayed stable, moving withinthe 70 to 90 basis point range. It was un-derpinned by the sustainable investor inter-est. Stable macroeconomic conditions, re-duction in public sector's external debt andprospects for the pending Bulgaria's mem-bership in the EU contributed most to this.In response to the sound fiscal position andfavourable macroeconomic environment, inearly March Moody's (after two other ratingagencies) upgraded Bulgaria's foreign cur-rency long-term debt rating to an investmentgrade.

The outlooks are for sustaining the stableinvestors' interest in Bulgaria's governmentdebt over the second and third quarters of2006. Factors which will progressively sup-port the interest are the prudent fiscal policyof the government and stable macroeco-nomic environment boosting economicgrowth.

Financial Flows, Money and Credit 20

Over the recent years Bulgaria's economicdevelopment was determined by capitalinflows. The increase in international interestrates in 2005 and the beginning of 2006caused no changes in the direction andvolume of financial inflows due to relativelyhigh investment returns in the country. Theworsened trade conditions and slowergrowth rates of the EU countries contributedto the increase of the trade balance deficit,but the notable inflow of financial resourcesduring 2005 was in excess of the currentaccount deficit. The positive capital inflowscontinued in 2006 and contributed to theprivate sector investment growth. The influ-ence of capital inflows is additionally shownin the change in international reserves whichthrough the currency board arrangementsleads to a change in monetary base, andthrough the process of money multiplicationit affects broad money and credit dynamics.

In the first quarter of 2006 BNB interna-tional reserves decreased by BGN 692.1million and in March 2006 the Issue Depart-ment balance sheet figure reachedBGN 13,723 million (EUR 7016.5 million).International reserves dynamics to a greatextent reflected the government operations:the early repayment of debt to the WorldBank and the IMF, and the deposit madefor purchasing equipment for the Ministry ofDefence. These outflows prompted a de-crease in international reserves during thequarter.

2. Financial Flows, Money and Credit


On an annual basis, in the second quarter of 2006 current account deficit is expected to vary within the rangeOn an annual basis, in the second quarter of 2006 current account deficit is expected to vary within the rangeOn an annual basis, in the second quarter of 2006 current account deficit is expected to vary within the rangeOn an annual basis, in the second quarter of 2006 current account deficit is expected to vary within the rangeOn an annual basis, in the second quarter of 2006 current account deficit is expected to vary within the rangeof 14.3 and 14.6 per cent of GDP and in the third quarter within 13.2 and 13.4 per cent. The inflow of FDI intoof 14.3 and 14.6 per cent of GDP and in the third quarter within 13.2 and 13.4 per cent. The inflow of FDI intoof 14.3 and 14.6 per cent of GDP and in the third quarter within 13.2 and 13.4 per cent. The inflow of FDI intoof 14.3 and 14.6 per cent of GDP and in the third quarter within 13.2 and 13.4 per cent. The inflow of FDI intoof 14.3 and 14.6 per cent of GDP and in the third quarter within 13.2 and 13.4 per cent. The inflow of FDI intothe economy will stay high and the private sector will continue borrowing. Private debt is expected to be a bitthe economy will stay high and the private sector will continue borrowing. Private debt is expected to be a bitthe economy will stay high and the private sector will continue borrowing. Private debt is expected to be a bitthe economy will stay high and the private sector will continue borrowing. Private debt is expected to be a bitthe economy will stay high and the private sector will continue borrowing. Private debt is expected to be a bitover 48 per cent of GDP in the second and third quarters of 2006.over 48 per cent of GDP in the second and third quarters of 2006.over 48 per cent of GDP in the second and third quarters of 2006.over 48 per cent of GDP in the second and third quarters of 2006.over 48 per cent of GDP in the second and third quarters of 2006.

International reserves will rise in the second and third quarters of 2006.International reserves will rise in the second and third quarters of 2006.International reserves will rise in the second and third quarters of 2006.International reserves will rise in the second and third quarters of 2006.International reserves will rise in the second and third quarters of 2006.

The inflow of financial resources, mainly inthe form of net currency purchases andchanges in commercial banks' minimumrequired reserve accounts, only partially off-set the decrease in international reservescaused by the government operations ef-fected over the first quarter.

Financial Flows and ExternalPosition Sustainability

Table 1Cash Flows Which Prompted Significant Changes in Gross International Reserves

First quarter, 2006First quarter, 2006First quarter, 2006First quarter, 2006First quarter, 2006 2005, total2005, total2005, total2005, total2005, total

¿) Purchases and sales of reserve currency¿) Purchases and sales of reserve currency¿) Purchases and sales of reserve currency¿) Purchases and sales of reserve currency¿) Purchases and sales of reserve currency- Net purchases from commercial banks

- Revenue (outflows) related to net purchases(sales) at tills

B) Changes due to revenue (outflows) onB) Changes due to revenue (outflows) onB) Changes due to revenue (outflows) onB) Changes due to revenue (outflows) onB) Changes due to revenue (outflows) oncommercial banksí minimum required reservecommercial banksí minimum required reservecommercial banksí minimum required reservecommercial banksí minimum required reservecommercial banksí minimum required reserveaccounts in foreign currencyaccounts in foreign currencyaccounts in foreign currencyaccounts in foreign currencyaccounts in foreign currency

C) Changes due to flows on governmentC) Changes due to flows on governmentC) Changes due to flows on governmentC) Changes due to flows on governmentC) Changes due to flows on governmentaccounts (only the largest cash flows:accounts (only the largest cash flows:accounts (only the largest cash flows:accounts (only the largest cash flows:accounts (only the largest cash flows:revenue and payments)revenue and payments)revenue and payments)revenue and payments)revenue and payments)

EUR +199 million

EUR +205 million

EUR - 6 million

EUR +231 million

RevenueRevenueRevenueRevenueRevenue: total EUR +67 million,incl. 1) transfer for participation in the tenderfor Trakia highway: EUR +20 million, and2) an external credit received from SofiaAirport: EUR +4 million

Payments on external debt:Payments on external debt:Payments on external debt:Payments on external debt:Payments on external debt:total: EUR -785 million; USD -131 million;JPY -647 million; SDR -6 million, incl. on earlyrepayment of debt to:1) World Bank: EUR -147 million andUSD -57 million; 2) IMF: EUR -151 million,and a payment to the Ministry of Defence fordelivery of equipment for the Bulgarian army:EUR -240 million

EUR +1408 millionEUR +1419 million

EUR - 11 million

EUR + 394 millionUSD - 99 millionCHF - 52 million*

RevenueRevenueRevenueRevenueRevenue:1) EUR 602 million from privatisation;2) EUR 175 million from external loans;3) EUR 17 million from domestic debt issues

Payments on external debtPayments on external debtPayments on external debtPayments on external debtPayments on external debt**:USD 1777 million;EUR 728 million;JPY 2.1 billion; SDR 26 million

Payments on domestic debtPayments on domestic debtPayments on domestic debtPayments on domestic debtPayments on domestic debt:EUR 14 million

* Outflows in US dollars and Swiss franks for 2005 resulted from amendments to Ordinance No. 21, under which banks may no longer maintain minimumrequired reserves in currencies other than levs and euro.

** External debt payments for 2005 include an early repayment of EUR 1.3 billion.

Source: BNB.

The current account deficit picked upreaching EUR 1052.4 million in the first quar-ter of 2006 against EUR 550.6 million duringthe same period of 2005. All major currentaccount components contributed to the in-crease in the deficit during the first quarterof 2006: the trade balance deficit growthaccounted for two thirds of the deficitgrowth, while the remaining 25 per cent re-flected the larger deficit reported by theservices sector.


Despite the trade deficit nominal growth,export and import dynamics did not poseany problems to foreign trade. In the firstquarter export growth amounted to 28.2 percent on the corresponding period of 2005and it was relatively evenly distributed bymonth, while the increase in imports cameto 33 per cent. The bulk of it can be ex-plained by the higher import prices (see theEconomic Activity Section). The latter werethe factor behind export growth, albeit to alesser extent. Early 2006 data confirm theexpectations expressed in the EconomicReview, issue 1/2006 that strong domesticdemand, growing employment, higher realincome and rising international prices willretain their significance for foreign trade dy-namics in the first half of 2006 as well. Theimpact of these factors is most likely to sus-tain in the second half of 2006.

In the first quarter of 2006 the balance ofservices totaled EUR -198.5 million, the defi-cit exceeding by EUR 121 million that for thefirst quarter of 2005. The rise resulted mainlyfrom the great increase in imports on theOther services item (50.9 per cent for thequarter) and from the slower export growthrates on the Travel and Other services items(by 2.2 per cent and 1.2 per cent respec-tively). Although the former can be partiallyexplained by the growing need for variousservices (legal and consulting, related to theenhanced investment activity in Bulgaria),such high growth rates could not be main-tained over a longer-term horizon. Concur-rently, the growth of the items on the liabili-ties side was lower than the usual valuesobserved in previous periods. Acceleratingservices growth on the liabilities side ac-companied by a certain slowdown in theOther services: debit is possible in the nextquarters. However, the dynamics of Otherservices: debit is exposed to the risk of sus-tained high growth rates reported in recentfew quarters.

Surpluses on the balances of income andcurrent transfers declined in the first quarterof 2006 compared with the correspondingquarter of 2005 but the effect was negligiblesince the total worsening of the two itemswas less than EUR 50 million. In the second

Chart 30Dynamics of Current Account, Financial Accountand International Reserves (on an Annual Basis)(million BGN)

Source: BNB.


and third quarters the income balance isexpected to remain practically unchangedon the corresponding periods of 2005, whilenet current transfers may show a certainimprovement stemming from the recoveredgrowth rates on the liabilities side followingthe slowdown in 2005.

The trade balance deficit is expected torise nominally in the second quarter and toresult in a greater nominal deficit on thecurrent account compared with the secondquarter of 2005. The influence of the bal-ances of services, income and currenttransfers will practically be neutral; hence, inthe second quarter the current account defi-cit is anticipated to be between 14.3 and14.6 per cent of GDP on an annual basis.In the third quarter a minimum effect of thetrade deficit on the current account is ex-pected due to the high deficit reported inthe third quarter of 2005. An improvement inthe current account is anticipated in thethird quarter owing to the predicted nominalimprovement in the balances of servicesand current transfers. On an annual basis,the current account in the third quarter willprobably move between 13.2 and 13.4 percent of GDP.

The start of 2006 saw a sizable inflow offoreign direct investment into the balance ofpayment financial account. In the first quar-ter foreign direct investment in Bulgariatotaled EUR 755.4 million against EUR 392million for the first quarter of 2005. Since noprivatisation transactions were concluded inthe comparison periods, it can be assumedthat the increase in direct investment re-flected the enhanced investor interest in theBulgarian economy. The foreign direct in-vestment inflow into Bulgaria is expected tocontinue rising in the next quarters.

Debt flows are an important financing re-source of Bulgaria's economic growth. Apart of them is used to directly finance com-panies, and the other part is distributed onthe domestic market through the bankingsystem. Debt resources for the non-govern-ment sector amounting to EUR 1071.7 mil-lion entered the Bulgarian economy in thefirst quarter of the current year.

Chart 32Gross External Debt(million EUR)

Source: BNB.

Chart 31Current Account Deficit to GDP and Foreign Direct Investment to GDP(on an Annual Basis)(%)

Source: BNB, NSI.


Chart 33Long- and Short-term Gross External Debt Dynamics(million EUR)

Source: BNB.

Between January and March 2006 grossexternal debt picked up by EUR 645.6 mil-lion on the end of 2005. Short-term externaldebt grew by EUR 871.2 million mainly dueto the increased short-term obligations ofcommercial banks. The long-term externaldebt went down by EUR 225.6 million in thefirst quarter of 2006. The decline resultedentirely from operations of the General gov-ernment sector whose external debt fell byEUR 461.6 million (see Table 1 about repay-ments on the debt to the IMF and the WorldBank).

In the second and third quarters of 2006positive flows of borrowed funds are ex-pected which coupled with foreign directinvestment will boost international reserves'growth. Unlike the first quarter, governmentoperations will affect insignificantly debt dy-namics. The financial account surplus isexpected to exceed the current accountdeficit and international reserves to rise bysome EUR 1 billion over the two quarters.

Following the early repayment of obliga-tions to the IMF and the World Bank by theclose of 2005 and the start of 2006, publicand publicly guaranteed external debt willretain its nominal amount in the second andthird quarters of 2006. Forecasts put it atsome 21 per cent of GDP on an annualbasis by the end of the second quarter. Inthe third quarter of 2006 public debt is ex-pected to be a little under 21 per cent ofGDP on an annual basis.

First quarter data on external debt confirmthe hypothesis proposed in the EconomicReview previous issues that commercialbanks' debt will grow more moderately in2006. Indebtedness of the private non-banksector is likely to continue going up. There-fore, in the second and third quarters privatedebt is expected to come to a little over48 per cent of GDP on an annual basis.


Given the projected dynamics of international reserves and the government deposit, reserve money are ex-Given the projected dynamics of international reserves and the government deposit, reserve money are ex-Given the projected dynamics of international reserves and the government deposit, reserve money are ex-Given the projected dynamics of international reserves and the government deposit, reserve money are ex-Given the projected dynamics of international reserves and the government deposit, reserve money are ex-pected to slow down its growth to 23≠24 per cent in the second quarter and to 17≠18 per cent in the third quar-pected to slow down its growth to 23≠24 per cent in the second quarter and to 17≠18 per cent in the third quar-pected to slow down its growth to 23≠24 per cent in the second quarter and to 17≠18 per cent in the third quar-pected to slow down its growth to 23≠24 per cent in the second quarter and to 17≠18 per cent in the third quar-pected to slow down its growth to 23≠24 per cent in the second quarter and to 17≠18 per cent in the third quar-ter of 2006. In the second quarter of 2006 banks' reserves will nominally surpass those in the first quarter, butter of 2006. In the second quarter of 2006 banks' reserves will nominally surpass those in the first quarter, butter of 2006. In the second quarter of 2006 banks' reserves will nominally surpass those in the first quarter, butter of 2006. In the second quarter of 2006 banks' reserves will nominally surpass those in the first quarter, butter of 2006. In the second quarter of 2006 banks' reserves will nominally surpass those in the first quarter, butgrowth rates will gradually slow down. The slowdown will be more significant in the third quarter. Growth rates ofgrowth rates will gradually slow down. The slowdown will be more significant in the third quarter. Growth rates ofgrowth rates will gradually slow down. The slowdown will be more significant in the third quarter. Growth rates ofgrowth rates will gradually slow down. The slowdown will be more significant in the third quarter. Growth rates ofgrowth rates will gradually slow down. The slowdown will be more significant in the third quarter. Growth rates ofcurrency in circulation are expected to decline slightly to about 13 per cent by the close of the third quarter.currency in circulation are expected to decline slightly to about 13 per cent by the close of the third quarter.currency in circulation are expected to decline slightly to about 13 per cent by the close of the third quarter.currency in circulation are expected to decline slightly to about 13 per cent by the close of the third quarter.currency in circulation are expected to decline slightly to about 13 per cent by the close of the third quarter.

In the second and third quarters of 2006 broad money growth is projected at some 18 to 20 per cent on anIn the second and third quarters of 2006 broad money growth is projected at some 18 to 20 per cent on anIn the second and third quarters of 2006 broad money growth is projected at some 18 to 20 per cent on anIn the second and third quarters of 2006 broad money growth is projected at some 18 to 20 per cent on anIn the second and third quarters of 2006 broad money growth is projected at some 18 to 20 per cent on anannual basis.annual basis.annual basis.annual basis.annual basis.

The upward trend in the interest rates on deposits is likely to sustain in the next two quarters.The upward trend in the interest rates on deposits is likely to sustain in the next two quarters.The upward trend in the interest rates on deposits is likely to sustain in the next two quarters.The upward trend in the interest rates on deposits is likely to sustain in the next two quarters.The upward trend in the interest rates on deposits is likely to sustain in the next two quarters.

Chart 35Commercial Bank Deposits(million BGN)

Source: BNB.

Chart 34Reserve Money(volume and annual growth rate, %)

Source: BNB.

Monetary Aggregates

In the first quarter of 2006 reserve moneypicked up by 25.3 per cent on an annualbasis, their growth accelerating by some 7percentage points on the end of 2005. Thedriving factor of this acceleration was thedramatic rise in banks' reserves: by end-March they came to BGN 2817 million, upby BGN 979 million (53.2 per cent) com-pared with the same period of the previousyear. In March 2006 the average commer-cial banks' reserves with the central bankcomprised BGN 2738 million of whichBGN 2054 million in minimum required re-serves and BGN 683.9 million in additionalreserves associated with exceeded creditlimits set in BNB Ordinance No. 21. Theaverage monthly minimum required reservesgrew by BGN 225 million and additionalreserves by some BGN 300 million on De-cember 2005. Despite the fact that some ofthe banks exceeded the set credit growthrates, as a whole the measures taken bythe BNB proved effective and the bankingsystem total credit stayed within the regula-tion limits. A trend towards maintaining agreater part of reserves in foreign currency(euro) was observed ensuing from the previ-ous year's amendments to BNB OrdinanceNo. 21 according to which commercialbanks may also maintain reserves in euroon funds attracted in levs.

Growth rates of currency in circulationsubsided in line with expectations; in the firstquarter of 2006 banknotes and coins grewby 14.6 per cent against 16.9 per cent inDecember 2005. In the next two quarters theincrease in currency in circulation is mostlikely to continue slowing down mainly dueto the large base, although it will stay higherthan the nominal GDP growth.

Chart 36Currency in Circulation(volume and annual growth rate, %)

Source: MF, BNB.


Chart 37Influence of Consolidated Budget on Other Sectors Liquidity(Quarterly)(share of GDP)

Source: MF, BNB.

Deposits of the government and budgetorganisations with the central bank limit thefiscal policy effect on liquidity of individualeconomic sectors and correspondingly onthe BNB balance sheet. Curtailed non-inter-est expenditure and the considerably lowerprimary deficit on the consolidated statebudget in the last quarter of 2005 led to alower-than-usual level of liquidity flow to thenon-government non-banking sector.

Since early 2006 flows from the budget tothe external sector have increased owing tothe early government debt payments; as aresult, government deposits with the BNBdecreased. In the second and third quartersno significant changes are expected in thefinancial flows related to government opera-tions. This will prompt an increase in gov-ernment deposits with the central bankwhich is typical of this period of the yearand these deposits will again exceed BGN4 billion.

In the first quarter of 2006 broad moneymeasured by the M3 monetary aggregate,went up by 10.1 per cent on the samequarter of the previous year. The major rea-son behind the considerable slowdown inannual growth rates was the high March2005 base when enhanced commercialbank lending caused a sharp rise in depositbase and particularly in deposits of non-financial corporations. Broad money in-creased by 1.2 per cent in the first quartercompared with the end of 2005. Quasi-money played a key role for this, while thecontribution of M1 was negative owing tothe seasonal decline in money outsidebanks. Between December 2005 and March2006 overnight deposits posted a 3 per centrise, with households reporting a fastergrowth in lev deposits and non-financial cor-porations in foreign currency deposits.March 2006 saw a significant rise in compa-nies' overnight foreign currency deposits:within a month they went up by BGN 212million or 21 per cent.


Chart 39Ã3 Money Multiplier

Source: BNB.

Chart 38Contribution of Quasi-money and Their Componentsto Ã3 Growth (Quarterly)(percentage points)

Source: BNB.

Households reported the greatest increasein lev deposits with agreed maturity of up totwo years (5.7 per cent for the first quarterof 2006 and 30.9 per cent on an annualbasis), while non-financial corporations regis-tered a decline (4.8 per cent on December2005 and 16 per cent on March 2005). Timeforeign currency deposits of non-financialcorporations picked up by 6.2 per cent overthe quarter and those of households by 3.9per cent. The faster rise in euro depositscompared with those in other currenciessustained; thus, as of March 2006 the rela-tive share of euro deposits in total time de-posits came to 62.6 per cent against 57.4per cent by the close of the previous year.

Broad money annual growth rates areexpected to increase to some 18≠20 percent in the second and third quarters of2006 due to the exhaustion of the high baseeffect and provided the nominal depositinflow is stronger than in 2005. This assump-tion is based on the favourable prospects ofeconomic activity and mostly on the positivetrends in employment and salaries, on theone hand, and the continuing capital inflowfrom abroad, on the other one.

Subdued lending as a result of the meas-ures taken by the BNB to limit credit expan-sion affected the dynamics of money multi-plier which declined in the previous year.

The money circulation velocity continuedto subside, retaining its clearly pronouncedseasonal profile. This downward trend isanticipated to sustain although at lowerrates.

In the first quarter of 2006 banksí rates ontime deposits picked up again, especiallythose on one-month deposits. Overnightdeposits and deposits with maturities longerthan one month did not show an increase.The average interest rate on time lev depos-its grew from 3.37 per cent in December2005 to 3.61 per cent in March 2006. Timedeposits in euro rose from 2.35 per cent to2.42 per cent and in US dollars from 2.24per cent to 2.31 per cent. The upward trendin interest rates in recent months most prob-ably stemmed from the change in interna-tional interest rates. As it is seen from

Chart 40Currency Circulation Velocity(Quarterly)

Source: BNB.

Note: Note: Note: Note: Note: The velocity of circulation for the first quarter of 2006 is based on GDP projec-tions.


Chart 43Interest Rate Distribution on Household One-month Lev Deposits

.

Source: BNB.

as of March 2006

as of December 2005

Chart 42Interest Rates on USD-denominated Time Depositsand Three-month LIBOR(%)

Source: BNB.

Chart 41Interest Rates on BGN- and EUR-denominated Time Depositsand Three-month EURIBOR(%)

Source: BNB.

Charts 41 and 42, internal interest rates ondeposits followed quite closely the dynamicsof international reference interest rates in therespective currency. There was a strongdependence between interest rates on USDtime deposits and the USD LIBOR: the cal-culated correlation coefficient of the two se-ries in the January 2000 to March 2006 pe-riod came to 0.91. However, this correlationhas been weakening in the last few years(in the January 2003 to March 2006 periodthe correlation coefficient was 0.74).

Vice versa: the correlation between interestrates on time deposits in levs and EURIBORstrengthened considerably: from 0.03 to 0.68for the whole sample and for the periodafter 2003 respectively. The dependenceremained strong throughout the period after2000 (the correlation coefficient was 0.87) ininternal interest rates on euro deposits, onthe one hand, and EURIBOR, on the otherone. These indicators display a relativelystrong and increasing financial integration ofthe Bulgarian economy into the euro areaeconomy and a weaker influence of interna-tional USD interest rates on internal USDinterest rate levels.

The distribution of interest rates on one-month lev deposits by bank did not displayany substantial changes on December 2005.


Under BNB-imposed lending constraints, growth rates of claims on the non-government sector will slow downUnder BNB-imposed lending constraints, growth rates of claims on the non-government sector will slow downUnder BNB-imposed lending constraints, growth rates of claims on the non-government sector will slow downUnder BNB-imposed lending constraints, growth rates of claims on the non-government sector will slow downUnder BNB-imposed lending constraints, growth rates of claims on the non-government sector will slow downto 22≠24 per cent in the second and third quarters of 2006. No significant changes in lending interest rates areto 22≠24 per cent in the second and third quarters of 2006. No significant changes in lending interest rates areto 22≠24 per cent in the second and third quarters of 2006. No significant changes in lending interest rates areto 22≠24 per cent in the second and third quarters of 2006. No significant changes in lending interest rates areto 22≠24 per cent in the second and third quarters of 2006. No significant changes in lending interest rates areexpected.expected.expected.expected.expected.

Credit Aggregates

In the first quarter of 2006 the BNB meas-ures continued to curb lending growth paral-lel to the retained sizable credit demand.The nominal increase in claims on the non-government sector between January andMarch 2006 was BGN 327.9 million, far lessthan that reported in the prior quarter(BGN 1454.5 million). The annual creditgrowth rate came to 5.6 per cent by end-March 2006, the reasons behind the sharpdrop at the close of 2005 (32 per cent) be-ing the base effect of the brisk lending inMarch 2005 and the process of excludingcredit portfolios from banks' balance sheets.Assuming that banks will adhere to the im-posed restrictions, in the second and thirdquarters of 2006 a 22 to 23 per cent annualgrowth in claims on the non-governmentsector could be expected.

Moderate credit growth at the start of 2006should be considered a signal of a changein the structure of financing the non-govern-ment sector rather than of curbing creditflows into the economy. The change re-sulted in the decreased relative share ofbank credits at the expense of increasedleasing and financing from abroad.

In February 2006 new amendments broad-ening the scope of BNB Ordinance No. 21were adopted, consistent with improving theefficiency of measures taken by the BNB tolimit lending growth. The amendments areaimed at discontinuing the practice of trans-forming bank loans into, or replacing themwith, other debt instruments, thus avoidingthe restrictions imposed by the Ordinance.Amendments to BNB Ordinance No. 8 werealso adopted providing for changes in deter-mining the risk weights of mortgage loans.Hence, banks are encouraged to be moreconservative in determining the level ofcollateralization on extended credits.

Chart 44Claims on Non-government Sector

Source: BNB.


Chart 46Foreign Assets and Liabilities of Commercial Banks(million BGN)

Source: BNB.

Chart 45Domestic Credit(share of GDP, %)

Source: BNB.

In the first quarter of 2006 financial inter-mediation measured by the internal credit toGDP ratio slowed down partially due to tak-ing credit portfolios out of banks' balancesheets. The moderate growth of credit ag-gregates over this period could explain theslight decrease in the claims on the non-government sector to GDP ratio from 44.6per cent by end-2005 to 44.1 per cent as ofMarch 2006.

The BNB-imposed measures and thechanging structure of credit flows into theeconomy affected the dynamics of banks'net foreign assets as well. Adherence to amore moderate credit portfolio growth ratecould account for the slower growth of for-eign liabilities on a quarterly basis: up 5.8per cent at the close of 2005 (against a20.7 per cent growth in the prior quarter).On the other hand, transferring a part of thenewly extended credits to non-residentscould partially be responsible for the factthat by end-March 2006 net foreign assetsindicated the highest levels since theenforcement of the measures (BGN 333.3million).

Amendments to Ordinance No. 8 and Ordinance No. 21 Adopted in Early 2006New amendments to Ordinance No. 8 and Ordinance No. 21 in line with the BNB policy of stimulating commercial

banks to maintain moderate growth rates of claims on non-financial institutions and to apply a more conservative ap-proach to credit risk evaluation were adopted in March 2006.

Ordinance No. 21 on the Minimum Required Reserves Maintained with the Bulgarian National Bank by BanksOrdinance No. 21 on the Minimum Required Reserves Maintained with the Bulgarian National Bank by BanksOrdinance No. 21 on the Minimum Required Reserves Maintained with the Bulgarian National Bank by BanksOrdinance No. 21 on the Minimum Required Reserves Maintained with the Bulgarian National Bank by BanksOrdinance No. 21 on the Minimum Required Reserves Maintained with the Bulgarian National Bank by Banks

In order to prevent avoidance of the restrictions provided for in the Ordinance through transferring some of the existingand newly extended loans into other debt instruments, as of March 2006 new amendments came into force under whichfor the purposes of determining additional minimum required reserves all bonds and other debt securities acquired by thebanks after 31 December 2005 were included in the concept 'loan'. Securities issued by other state-owned, central or lo-cal banks and other debt instruments with an investment rating are exceptions to this.

Ordinance No. 8 on the Capital Adequacy of BanksOrdinance No. 8 on the Capital Adequacy of BanksOrdinance No. 8 on the Capital Adequacy of BanksOrdinance No. 8 on the Capital Adequacy of BanksOrdinance No. 8 on the Capital Adequacy of Banks

The amendments to this Ordinance aim to apply a more conservative approach in extending mortgage loans and tosupplement the amendments on provisioning these loans. Claims secured with real estate and especially housing loansare among the credit aggregates growing at fastest rates and the increasing competitiveness of banks in this marketsegment presupposes applying lower standards to credit risk assessment. Therefore, the BNB approved changes in de-termining the risk weights of mortgage loans. In calculating the banksí capital adequacy ratio, only mortgage loanswhose amount does not exceed 50 per cent of the mortgaged real estate will be included with a half of their weights inthe asset risk component. Until now this method of weighting was applied to all mortgage loans whose amount was upto 70 per cent of the mortgage. A tighter approach applied to determining the risk weights of mortgage loans will be astrong stimulus for banks to extend fewer mortgage loans with a lower degree of collateralizing the claims.


Table 2Changes in Major Balance Sheet Items of Commercial Banks(Quarterly)(million BGN)

20052005200520052005 20062006200620062006

IIIIIIIIII IIIIIIIIIIIIIII IVIVIVIVIV IIIII

Claims on non-financial corporations -1922.6 334.6 784.9 76.8Deposits of non-financial corporations -1258.6 292.5 710.3 140.8

Claims on households 590.6 537.5 704.2 188.2Deposits of households 633.0 575.6 813.0 453.9

Foreign assets 23.1 251.2 670.0 775.0Foreign liabilities -752.7 155.6 951.4 319.7

Claims on government sector 209.8 135.4 137.1 14.2Deposits of government sector 105.4 110.6 -112.7 73.7

Claims on central government 203.5 113.9 133.8 -5.7Liabilities to central government 94.7 129.9 11.8 -54.9

Source: BNB.

Chart 47Net Financial Flows to Commercial Banks (Quarterly)(million BGN)

Source: BNB.

The first three months of 2006 saw a mini-mum change in all segments of the creditmarket; on a quarterly basis the growthrates were considerably lower than thoseregistered in the previous period. Since theyear start claims on non-financial corpora-tions have picked up by BGN 76.8 million(against BGN 784.9 million for the fourthquarter of 2005). The slowdown in the cor-porate loan growth reflected to a certainextent the transfer of portfolios abroad as faras similar practices are realized predomi-nantly in the corporate segment of lending.

In the first quarter of 2006 credits ex-tended to individuals also exhibited moder-ate growth rates with a relatively low in-crease in volumes since the beginning ofthe year: BGN 188.2 million againstBGN 704.2 million for the prior quarter of2005. Nevertheless, claims on householdswas the credit market segment which grewat the fastest pace contributing to more thana half of the rise in the claims on the non-government sector on a quarterly basis. Theannual growth rate of claims on households(39.7 per cent) exceeded several times thaton total loans since the base effect of the2005 dramatic credit growth was significantlyweaker.

The most rapidly rising component of cred-its extended to individuals were housingloans reporting a 7.9 per cent increase on aquarterly basis with their relative share inclaims on households picking up from 28.4per cent to 30.6 per cent. Annual growthrates of housing loans continued to slowdown in January and February 2006 reaching95 per cent and 91 per cent respectively andfalling to 81 per cent in March due to thehigh base of March 2005. The slowdown inhousing loans is expected to sustain particu-larly under the influence of the recent statu-tory changes associated with provisioningand risk weights of these loans.

Chart 48Claims on Non-financial Corporations

Source: BNB.

Chart 49Claims on Households

Source: BNB.


Chart 52Yield on Assets and Interest Expenditure on Commercial BankLiabilities(%)

Source: BNB.

Table 3Claims on Non-government Sector (Quarterly)

Annual growth rate Annual growth rate Annual growth rate Annual growth rate Annual growth rate, %, %, %, %, % StructureSt ructureSt ructureSt ructureSt ructure

20052005200520052005 2 0 0 62 0 0 62 0 0 62 0 0 62 0 0 6 as o fas o fas o fas o fas o f

I II II II II I I I I I I I I I I I I I I I I I VI VI VI VI V I I I I I 333331. I I I1. I I I1 . I I I1 . I I I1 . I I I.200.200.200.200.20066666

Claims on non-government sector, incl.: 41.8 35.9 32.4 5.6

on non-financial corporations 32.2 25.7 23.1 -5.9 60.6 on households and NPISHs 72.2 63.5 58.4 39.7 37.5 on financial corporations -27.6 -12.4 -32.4 -44.6 1.9

Source: BNB.

Chart 50Housing Loans(%)

Source: BNB.

Chart 51Structure of Claims on Non-government Sector(%)

Source: BNB.

The upward trend in the relative share ofloans extended to households in the struc-ture of claims on the non-government sectorsustained, their share coming to 37.5 percent by March 2006. It is normal to observesuch a trend at this stage of the bankingsector development in Bulgaria since theretail banking potential has not been ex-hausted yet. In addition, households haveno more favourable borrowing alternatives,unlike companies, some of which havingaccess to international financial markets. Itcould be suggested that measures aimed atlimiting lending will affect asymmetrically thecredit market segments with various yield,the effect of consraints on retail lending be-ing comparatively weaker than on corporatelending.

The first quarter of 2006 saw a drop ininterest rates on credits to companies andhouseholds. Data on households creditsindicate significant interest rate falls in thelast two years. Some of these falls reflectedthe rising competitiveness on the market ofbank services to households which led tocredit product structuring in a way that cutinterest expenditure in the first few years ofthe credit. This resulted in an underesti-mated price of credits to households in thedata on interest rate statistics. The interest


Chart 53Interest Rates on Household Loans(%)

Source: BNB.

Note: Note: Note: Note: Note: Interest rates include promotional interest rates offered by banks.

Chart 54Interest Rates on Long-term Loans in Levs and Euro(%)

Source: BNB.

rate downward trend is likely to reverseupon exhaustion of banksí price strategiespotential and the ECB continued policy ofincreasing reference interest rate in the euroarea. These developments would limitbanks' opportunities of gaining a marketshare through decreasing interest rates.Therefore, no sizable changes in lendingrates are anticipated in the following months.

Economic Activity 34

The gross domestic product exhibited a5.5 per cent increase in 2005. Growth ratesin private consumption and investment ac-celerated significantly. Household consumerexpenditure growth reached 7.7 per centand investments in fixed capital 19 per cent.Total economic growth slowed down by 0.2percentage points on the previous year,consistent with the low growth in exports ofgoods and non-factor services in the thirdquarter.

Economic growth is expected to stay high in the second and third quarters. Household consumption and fixedEconomic growth is expected to stay high in the second and third quarters. Household consumption and fixedEconomic growth is expected to stay high in the second and third quarters. Household consumption and fixedEconomic growth is expected to stay high in the second and third quarters. Household consumption and fixedEconomic growth is expected to stay high in the second and third quarters. Household consumption and fixedcapital investments will contribute most significantly to this growth despite the anticipated slowdown in growthcapital investments will contribute most significantly to this growth despite the anticipated slowdown in growthcapital investments will contribute most significantly to this growth despite the anticipated slowdown in growthcapital investments will contribute most significantly to this growth despite the anticipated slowdown in growthcapital investments will contribute most significantly to this growth despite the anticipated slowdown in growthrates attributable to the base effect in the third quarter. Foreign trade balance contribution is expected to berates attributable to the base effect in the third quarter. Foreign trade balance contribution is expected to berates attributable to the base effect in the third quarter. Foreign trade balance contribution is expected to berates attributable to the base effect in the third quarter. Foreign trade balance contribution is expected to berates attributable to the base effect in the third quarter. Foreign trade balance contribution is expected to benegative in the second quarter and positive in the third quarter. Government consumption contribution will notnegative in the second quarter and positive in the third quarter. Government consumption contribution will notnegative in the second quarter and positive in the third quarter. Government consumption contribution will notnegative in the second quarter and positive in the third quarter. Government consumption contribution will notnegative in the second quarter and positive in the third quarter. Government consumption contribution will notexceed 0.5 percentage points.exceed 0.5 percentage points.exceed 0.5 percentage points.exceed 0.5 percentage points.exceed 0.5 percentage points.

Developments in consumption will depend on income and employment growth. The investment activity will beDevelopments in consumption will depend on income and employment growth. The investment activity will beDevelopments in consumption will depend on income and employment growth. The investment activity will beDevelopments in consumption will depend on income and employment growth. The investment activity will beDevelopments in consumption will depend on income and employment growth. The investment activity will bedetermined by the improvement of business climate assessments and capacity workload, as well as by sustain-determined by the improvement of business climate assessments and capacity workload, as well as by sustain-determined by the improvement of business climate assessments and capacity workload, as well as by sustain-determined by the improvement of business climate assessments and capacity workload, as well as by sustain-determined by the improvement of business climate assessments and capacity workload, as well as by sustain-able financial inflows on the balance of payments financial account associated with high investment returns inable financial inflows on the balance of payments financial account associated with high investment returns inable financial inflows on the balance of payments financial account associated with high investment returns inable financial inflows on the balance of payments financial account associated with high investment returns inable financial inflows on the balance of payments financial account associated with high investment returns inBulgaria and pending membership in the EU.Bulgaria and pending membership in the EU.Bulgaria and pending membership in the EU.Bulgaria and pending membership in the EU.Bulgaria and pending membership in the EU.

Table 4Dynamics of GDP Components According to Final Consumption Method(on corresponding period of previous year, %)

2004 2004 2004 2004 2004 2005 2005 2005 2005 2005

I quarterI quarterI quarterI quarterI quarter II quarterII quarterII quarterII quarterII quarter III quarterIII quarterIII quarterIII quarterIII quarter IV quarterIV quarterIV quarterIV quarterIV quarter I quarterI quarterI quarterI quarterI quarter II quarterII quarterII quarterII quarterII quarter III quarterIII quarterIII quarterIII quarterIII quarter IV quarterIV quarterIV quarterIV quarterIV quarter

Consumption, 5.2 4.4 3.8 6.7 7.1 5.9 8.6 5.6incl.

Household consumption 5.7 5.3 4.0 6.8 7.6 5.5 10.4 7.1Government final consumption expenditure -3.2 -4.5 3.0 4.5 4.5 10.3 0.2 7.2Collective consumption 9.8 6.5 2.9 7.8 6.4 6.5 4.3 -4.7Gross fixed capital formation 23.7 8.4 14.1 11.4 11.2 16.9 24.0 21.5Exports of goods and non-factor services 7.0 10.5 14.0 19.8 9.2 12.0 1.1 8.9Imports of goods and non-factor services 16.7 11.1 12.0 16.9 10.8 15.3 18.8 12.9GDP, real growth 4.6 5.5 6.2 6.3 5.9 6.5 4.6 5.5

Source: NSI, BNB.

Household Behaviour

Household consumer behaviour continuedto reflect the clearly pronounced upwardtrend in employment and income. Incomefrom salary contributed most significantly tothe total household income and resourcesused to finance consumer spending. Thesignificance of income from property and

Chart 55Contribution to GDP Growth by Component of Final Consumption(percentage points)

Source: NSI.

3. Economic Activity


Table 5Employment and Income Dynamics (Quarterly)(%)

2004 2004 2004 2004 2004 2005 2005 2005 2005 2005 2006 2006 2006 2006 2006

IIIII I II II II II I I I II I II I II I II I I IVIVIVIVIV IIIII I II II II II I I I II I II I II I II I I IVIVIVIVIV I I I I I Apr i lApr i lApr i lApr i lApr i l

Unemployment at the end of the periodUnemployment at the end of the periodUnemployment at the end of the periodUnemployment at the end of the periodUnemployment at the end of the period(Employment Agency data) 13.7 12.2 11.7 12.2 12.7 11.1 10.5 10.7 10.8 10.2Employed under labour contractEmployed under labour contractEmployed under labour contractEmployed under labour contractEmployed under labour contract share on corresponding quarter of previous year 5.8 5.7 5.7 3.4 4.3 3.5 1.5 1.6 0.8 share on the previous quarter -1.5 3.0 3.2 -1.2 -0.7 2.2 1.2 -1.1 -1.5Employees Employees Employees Employees Employees (Labour Force Survey data) share on corresponding quarter of previous year 2.9 3.3 3.1 3.1 2.0 1.3 2.4 2.4 3.6 share on the previous quarter -1.5 6.7 1.8 -3.7 -2.5 6.0 3.0 -3.7 -1.4Real salaryReal salaryReal salaryReal salaryReal salary share on corresponding quarter of previous year -0.7 -1.8 -0.2 2.2 3.3 3.9 3.3 0.8 1.7 share on the previous quarter -4.8 3.5 1.7 2.1 -3.8 4.1 1.1 -0.4 -2.9Wages and salariesWages and salariesWages and salariesWages and salariesWages and salaries, deflated by CPI, an increase on the corresponding quarter of prior year (System of National Accounts data) 1.3 -0.5 1.9 4.3 2.6 6.0 7.3 9.6

Source: NSI, Employment Agency ≠ Ministry of Labour and Social Policy.

Chart 56Sources of Financing Households(share of consumer expenditure, %)

Source: NSI, MF, BNB.

Chart 57Status of Economically Active Population(Quarterly)

Source: NSI, Employment Agency ≠ Ministry of Labour and Social Policy.

entrepreneurship was sustained. Labourincome and transfers from abroad com-prised a significant portion of householdfinancial resources. Data on household con-sumption and household assets in the bank-ing system on the one hand, and data onfinance sources on the other one, were stillimbalanced. Provision of a comprehensivescope of various types of income cause anumber of difficulties. To ensure a moreeffective use of available data, the BNB Sta-tistics Directorate introduced a new method-ology for assessment of residents' incomefrom employment abroad,5 an item of thebalance of payments current account. As aresult, the statistical data on household in-come provide a more reliable informationabout household behaviour.

5 http://www.bnb.bg/bnb/home.nsf/vPages/S_BP_MNotes_Employment/$FILE/CoE%20Meth_bg_rev.pdf


Chart 58Net Household Credits Extended (+)/Received (-) to/from theBanking System (Quarterly)(share of annual GDP, %)

Source: BNB, NSI.

Chart 59Structure of Household Consumer Expenditure(%)

Source: NSI.

Table 6Consumer Demand Dynamics (Quarterly)(share on the corresponding period of prior year)

2004 2004 2004 2004 2004 2005 2005 2005 2005 2005 2006 2006 2006 2006 2006

IIIII I II II II II I I I II I II I II I II I I IVIVIVIVIV IIIII I II II II II I I I II I II I II I II I I IVIVIVIVIV I I I I I

Retail sales 13.3 15.3 14.0 15.2 13.9 15.7 11.5 9.8 10.8Income from retail trade 19.5 19.1 20.3 22.6 12.0 13.2 12.9 12.8 8.6Food, drinks, tobacco 13.4 7.8 7.8 10.9 9.5 10.1 8.3 4.0 6.1Pharmaceutical and medical goods,cosmetics and toiletries 19.8 22.8 18.7 16.8 3.3 7.3 12.3 10.9 6.2Textiles, clothing, footwear and leather 26.0 27.6 19.9 22.8 10.0 17.5 24.7 25.9 7.5Household goods and home appliances 32.9 31.4 39.3 39.6 20.7 18.7 18.9 24.8 12.9

Source: NSI.

Chart 60Household Confidence Indicator

Source: NSI, consumer survey.

Growing household income was the majorfactor behind the increased household sol-vency and extended access to additionalfinancial resources. Over the recent yearsthe share of consumer expenditure fundedby consumer credits went up thoughsmoothly. Based on monetary statistics thenet amount of newly extended consumercredits did not exceed 7 per cent of con-sumer spending. Concurrently, householdscontinued to be a net creditor of the bank-ing system.

Progressively improving household welfareled to a sustainable change in the structureof expenditure, prompting a growth in theshare of expenses related to enhanced con-sumer and economic activity (non-foods,non-production services, catering, communi-cations, transport) at the expense of foodspending and current home maintenanceexpenses.

The 2006 first quarter current data evi-dence a reviving household confidence.Consumer surveys conducted by the NSIreported a decline in the expectations aboutunemployment, improved expectations aboutthe financial state of consumers and theiropportunities for saving. The upward trend inincome and consumption sustained. Con-sumption continued to grow over the fore-cast period. A slowdown is expected in thethird quarter given the high growth reportedin the 2005 corresponding period.


Chart 63Contribution of Major Tax Groups Growth to Tax Revenue Growthunder the Consolidated Fiscal Programme (Quarterly)(percentage points)

Source: MF, BNB.

Chart 61Contribution of Government Final Consumer Expenditure andCollective Consumption to Economic Growth (Quarterly)(percentage points)

Source: NSI, BNB.

Chart 62Primary Balance (Quarterly)(share of GDP for the quarter, %)

Source: MF.

Government Finance andConsumption

The major elements of the forecast aboutgovernment finance and consumption re-mained unchanged. Nominally, cumulativecash balance will probably vary around pre-vious year's levels and total expenditure isanticipated to rise at a rate close to theannual inflation rate, with government con-sumption contributing insignificantly to theGDP real growth.

Total revenue and aid over the first quartermatched the indicative target of BGN 4251million set out in the agreement with theIMF, reflecting mostly the good tax revenueperformance. Earnings from indirect taxesremained the major factor behind the totalrevenue growth. Following the insignificantslowdown in total revenue growth ratessince early 2006, consistent with the slowerincrease in excise revenue, in the secondand third quarters it is expected to boost toapproximately 10 per cent. Social securityinstitutes' revenue will nominally match theprevious year's levels, and growth in em-ployment and social security income will bealmost entirely offset by decreased socialsecurity contributions.

Accomplishment of the quarterly objectivesset in the agreement with the IMF in respectof the consolidated budget cash balanceand total revenue implicitly presupposes areduction in expenditure. The first quarterpreliminary data indicate that the surplusover projections was due to the lower ex-penditure irrespective of their higher growthrate compared with total revenue. Over thefollowing two quarters annual growth rates ofexpenditure are expected to fall under thoseof revenue and to stay relatively stable: from6 per cent to 8 per cent. Salary, operationaland subsidy expenditures are anticipated tocontribute insignificantly to total expendituregrowth. Moreover, some types of expendi-ture may have a negative contribution tototal spending growth in the second quarter.The reasons behind these expectations re-flect the high prior year's base due to theextra expenditure made on the 2005 parlia-mentary elections. This quarterly expenditureprofile will lead to government consumption


Chart 64Contribution of Major Groups of Current Non-interest Expenditureto Total Growth (Quarterly)(%)

Source: MF, BNB.

Table 7Gross Value Added Growth by Sector(corresponding quarter of previous year = 100)

2004 2004 2004 2004 2004 20052005200520052005

Quarte rs Quarte rs Quarte rs Quarte rs Quarte rs

IIIII IIIIIIIIII IIIIIIIIIIIIIII IVIVIVIVIV IIIII IIIIIIIIII IIIIIIIIIIIIIII IVIVIVIVIV

Agriculture and forestry -0.3 0.7 4.5 3.8 -1.9 -5.8 -6.9 -17.1Industry 6.7 6.7 5.3 4.7 11.0 9.2 3.8 5.9Services 5.0 4.9 7.1 5.8 5.9 7.0 6.2 7.0At base prices, totalAt base prices, totalAt base prices, totalAt base prices, totalAt base prices, total 5.2 5.0 6.1 5.3 7.1 6.5 3.3 4.4

Contribution, percentage pointsContribution, percentage pointsContribution, percentage pointsContribution, percentage pointsContribution, percentage pointsAgriculture and forestry 0.0 0.1 0.8 0.4 -0.1 -0.5 -1.2 -1.6Industry 2.1 2.0 1.5 1.3 3.6 2.8 1.1 1.7Services 3.1 2.9 3.7 3.6 3.6 4.2 3.3 4.4

Source: NSI.

growth rates close to null without affectingsignificantly households' disposable income.

Behaviour of Firms

In 2005 production activity slowed downcompared with the previous year. The majorreason behind this was the negative per-formance of agriculture due to unfavourableweather conditions and the slowdown in theenergy industry, a result of lower industrialconsumption. In other sectors high valueadded growth rates sustained and acceler-ated.

Trade and manufacturing industry contrib-uted most significantly to this growth.

Buoyant consumption helped sustain thevalue added growth rate in trade at 15 percent matching the prior year's level. Withinthe manufacturing industry sales in oil refin-ing, food and drinks, machines and equip-ment, non-ferrous metallurgy and chemicalsincreased most significantly. Constructioncontinued to grow dramatically. The valueadded in this sector rose by 14.1 per centin 2005 matching the growth reported in2004. This dynamics evidences the sus-tained high investment activity in Bulgaria.

Fixed capital investments went up by 19per cent in 2005 and by approximately 23per cent in the 2005 second half-year com-pared with the corresponding periods of theprior year. Similar acceleration in investmentdemand growth was reported at the initialstage of the Bulgarian economyís recoverybetween 1998 and 2001. The increasingshare of investment in the GDP is the majorfactor behind the improved technologicallevel and enhanced economic efficiency, animportant condition for real salary growthwithout threatening the competitiveness ofBulgarian producers.

The real unit labour cost index is a keyindicator of the corporate competitiveness. Itshows the dynamics of the compensationfor employees (the entire labour costs) andvalue added ratio. This indicator may beused to check whether the real salarygrowth corresponds to the labour efficiencygrowth.


Chart 65Unit Labour Cost (Quarterly)(1998 = 100%)

Total for the Economy Manufacturing

Agricultural Sector

Source: NSI, BNB.

Mining and Quarrying

Construction Electricity, Gas and Water Supply

Trade Transport and Communications

Financial Intermediation Other Sectors


Table 8Index of Value Added per Employee(2000 = 100)

20012001200120012001 20022002200220022002 20032003200320032003 20042004200420042004 20052005200520052005

TotalTotalTotalTotalTotal 107.4 111.1 111.8 114.3 117.8Agriculture 115.8 117.6 105.3 110.1 105.5Mining and quarrying 100.1 117.5 107.2 122.2 129.8Manufacturing 108.3 113.7 123.4 124.5 131.3Energy and water supply 104.7 101.9 97.3 99.3 89.4Construction 128.0 123.1 118.0 120.8 123.0Trade 108.5 112.5 111.7 124.9 139.7Transport and communications 115.4 124.3 132.0 140.1 148.3Financial mediation 91.5 103.1 145.5 147.2 153.4Other sectors 100.3 102.3 101.6 100.6 103.7

Source: NSI, Eurostat.

As a result of restructuring of the eco-nomy after the 1996≠1997 crisis the real unitlabour cost index fell quickly to approxi-mately 90 per cent of the 1998 average leveland around 91 per cent on average in thelast five years. In particular sectors (themanufacturing industry, construction, trans-port and communications) this index fellunder 70 per cent, consistent with enhancedlabour efficiency, improved human and ma-terials management and moderate real sal-ary growth. Labour efficiency for the entireeconomy went up by 18 per cent between2000 and 2005. In most sectors efficiencygrowth over the period mentioned aboveexceeded the average growth rate.

Sizable inventories have been accumu-lated in the economy as a whole and par-ticularly in the manufacturing industry, trans-port and communications, and constructionwhich are instrumental in preserving com-petitiveness in case of a short-term rise inunit labour costs. To this end, the increasein this indicator, started in mid-2005, shouldnot be cosidered as a threat for the com-petitive position of the economy as a wholeand the manufacturing industry, the majorexporting industry.

Over the first quarter of 2006 productionactivity in industry was high. Industrial salesgrowth rate matched that of the correspond-ing quarter of the previous year. Oil refiningindustry benefited from favourable conditionsand maintained the rate of export growthhigh. Metal products output and productsfrom non-metal mineral raw materials wereamong the leading industries. Domesticmarket sales played a key role in the re-ported results, indicating a buoyant activityin construction. Industries manufacturinginvestment goods, that is production of ma-chines and equipment, including electricalmachines, exhibited a substantial growth inexport sales.

Information on investments in the firstquarter is insufficient. In addition to salesgrowth in manufacturing industries servicingconstruction, imports of investment goods,posting a 19 per cent nominal growth, is anindicator of a significant investment activity.The high degree of workload of industrial


Table 9Industrial Sales in the First Quarter of 2006(change on the corresponding period of 2005)

Industries with Industries with Industries with Industries with Industries with rate, % contribution, p.p.rate, % contribution, p.p.rate, % contribution, p.p.rate, % contribution, p.p.rate, % contribution, p.p.

largest contributions largest contributions largest contributions largest contributions largest contributions total total total total total domestic domesticdomestic domesticdomestic domesticdomestic domesticdomestic domestic

market market market market market exports exports exports exports exports market market market market market exportsexportsexportsexportsexports

TOTAL 8.2 3.2 13.5 1.7 6.5Metal goods 31.9 35.8 26.4 20.9 11.0Electrical machines and equipment 33.3 29.1 36.3 12.3 21.0Energy and water supply 3.9 0.9 16.7 0.7 3.2Food and drinks 3.4 5.2 -1.8 3.8 -0.5Goods of non-metalmineral raw materials 10.3 22.6 -11.7 14.5 -4.2Machines, equipment andhome appliances 5.8 -4.1 12.6 -1.7 7.5Vehicles (car excluded) 35.2 69.3 19.2 22.2 13.1

Source: NSI.

capacities is also an indirect indicator of theneed to expand the production capacity.Available data give ground to expect a two-digit growth rate in investments in the firstquarter, with the buoyant investment activityanticipated to retain over the whole yearthough at a slower rate in the second halfof the year.

Based on the surveys conducted in indus-try, construction, trade and services expec-tations about production activity in the sec-ond and third quarter are optimistic. Thefavorable upward trend in business climateassessments retains, with services and in-dustry contributing most significantly to im-provement. Confidence in construction stayshigh and conservative assessments of retailtrade are probably attributable to the in-creasing competitiveness within the sector.Notwithstanding, the prospects for the tradesector are favorable, since consumer confi-dence is tending to strengthen.

Exports and Imports of Goods

Exports in euro reached EUR 2666.7 mil-lion in the first quarter of 2006, a nominalincrease by EUR 586.1 million or by 28.2per cent on the corresponding quarter of2005. Imports (FOB) came to EUR 3705.2million over the review period, up EUR 919.8million on the first quarter of 2005, or 33 percent.

Forecasts about retaining export and im-port growth rates in the second quarter re-flect the expected stabilization of interna-tional prices of raw materials of decisiveimportance for the Bulgarian economy attheir currently high levels and a moderateincrease in domestic demand. The adverseeffect of some factors which occurred in2005, such as a decline in agriculture

Nominal exports of goods in euro is expected to grow on an annual basis by about 23≠25 per cent over theNominal exports of goods in euro is expected to grow on an annual basis by about 23≠25 per cent over theNominal exports of goods in euro is expected to grow on an annual basis by about 23≠25 per cent over theNominal exports of goods in euro is expected to grow on an annual basis by about 23≠25 per cent over theNominal exports of goods in euro is expected to grow on an annual basis by about 23≠25 per cent over thesecond quarter on the corresponding period of 2005, and by approximately 25≠29 per cent over the third quartersecond quarter on the corresponding period of 2005, and by approximately 25≠29 per cent over the third quartersecond quarter on the corresponding period of 2005, and by approximately 25≠29 per cent over the third quartersecond quarter on the corresponding period of 2005, and by approximately 25≠29 per cent over the third quartersecond quarter on the corresponding period of 2005, and by approximately 25≠29 per cent over the third quarterunderpinned by the reviving growth in the euro area and the recovery in production of key export-oriented sec-underpinned by the reviving growth in the euro area and the recovery in production of key export-oriented sec-underpinned by the reviving growth in the euro area and the recovery in production of key export-oriented sec-underpinned by the reviving growth in the euro area and the recovery in production of key export-oriented sec-underpinned by the reviving growth in the euro area and the recovery in production of key export-oriented sec-tors of the Bulgarian economy. Retained high current prices of energy resources and expected moderate growthtors of the Bulgarian economy. Retained high current prices of energy resources and expected moderate growthtors of the Bulgarian economy. Retained high current prices of energy resources and expected moderate growthtors of the Bulgarian economy. Retained high current prices of energy resources and expected moderate growthtors of the Bulgarian economy. Retained high current prices of energy resources and expected moderate growthof domestic demand will help keep the nominal growth rates of imported goods within 23≠25 per cent in theof domestic demand will help keep the nominal growth rates of imported goods within 23≠25 per cent in theof domestic demand will help keep the nominal growth rates of imported goods within 23≠25 per cent in theof domestic demand will help keep the nominal growth rates of imported goods within 23≠25 per cent in theof domestic demand will help keep the nominal growth rates of imported goods within 23≠25 per cent in thesecond quarter and about 15≠19 per cent in the third quarter.second quarter and about 15≠19 per cent in the third quarter.second quarter and about 15≠19 per cent in the third quarter.second quarter and about 15≠19 per cent in the third quarter.second quarter and about 15≠19 per cent in the third quarter.

Based on the forecasts about export and import dynamics, the trade balance deficit in the second quarter ofBased on the forecasts about export and import dynamics, the trade balance deficit in the second quarter ofBased on the forecasts about export and import dynamics, the trade balance deficit in the second quarter ofBased on the forecasts about export and import dynamics, the trade balance deficit in the second quarter ofBased on the forecasts about export and import dynamics, the trade balance deficit in the second quarter of2006 is anticipated to reach approximately 21.9≠22.5 per cent of the GDP on an annual basis and about 21≠21.52006 is anticipated to reach approximately 21.9≠22.5 per cent of the GDP on an annual basis and about 21≠21.52006 is anticipated to reach approximately 21.9≠22.5 per cent of the GDP on an annual basis and about 21≠21.52006 is anticipated to reach approximately 21.9≠22.5 per cent of the GDP on an annual basis and about 21≠21.52006 is anticipated to reach approximately 21.9≠22.5 per cent of the GDP on an annual basis and about 21≠21.5per cent in the third quarter.per cent in the third quarter.per cent in the third quarter.per cent in the third quarter.per cent in the third quarter.

Chart 66Dynamics of Exports and Imports (Quarterly)(million EUR)

Source: BNB.


6 Average Brent price (in US dollars) on international marketsrose by 30 per cent over the January to March 2006 periodagainst the prior year.

Chart 67Exports of Mineral Products and Fuels(million EUR)

Source: BNB.

(caused by the floods in Bulgaria) and on-going post-privatisation renewal of enter-prises from metallurgical industry, impededadditionally the acceleration of Bulgarianexports over the second quarter of 2006.

Based on the assumptions about interna-tional price dynamics of major raw materialsand the base effect of the correspondingquarter of 2005, over the third quarter ex-ports are expected to accelerate and im-ports to slow down. The forecast is under-pinned by the expected expansion of pro-duction and export activity in ferrous andnon-ferrous metallurgy in the second half ofthe year and higher agricultural output in2006. Over the third quarter of 2006 foreigntrade dynamics will be also impacted by theanticipated improvement of trade conditionsin Bulgaria and the slowdown in total do-mestic demand.

In terms of developments in exports andimports by commodity group and the re-spective contribution to total foreign tradeflows, high growth rates in the group of en-ergy resources is expected to sustain in thesecond and third quarters, prompting a risein their weights in foreign trade. No qualitychanges in the developments of other com-modity groups are expected.

Exports of mineral products and fuelsposted the largest growth in the first quarterof 2006 (115.1 per cent), followed by ma-chines, vehicles and appliances (48.7 percent) and base metals (18.9 per cent). Inaccordance with the expectations exposedin the Economic Review, issue 1/2006, theincreased physical volume of importedcrude oil in the second half of 2005 led to arise in exported volume of petroleum prod-ucts in early 2006. The physical volume ofexported petroleum products over the firstquarter grew by 111 per cent on an annualbasis and the increase in the average price(in euro) was 31 per cent. The high crudeoil prices are expected to retain in the sec-ond and third quarter of 20066, with theprice effect on an annual basis anticipatedto be stronger than in the second quarter.


Chart 68Exports of Machines, Vehicles, Appliances, Tools and Weapons(million EUR)

Source: BNB.

The increasing imports of crude oil andmore effective workload of production ca-pacities of the local refinery will help sustainthe high nominal growth rates of exports inthis group.

Between January and March 2006 exportsof machines and vehicles rose by EUR150.8 million on the corresponding period of2005 and their value reached EUR 460.7million. Following the exports of mineralproducts these goods posted the highestgrowth rates, prompting a 15 per cent in-crease of these goods in the structure ofexports in the first quarter of 2005 and a 17per cent increase in the first quarter of 2006.The dynamic developments in this groupalso match the expectations: the trend isanticipated to sustain in the second andthird quarters of 2006.

The total increase in exports of base met-als was EUR 92 million in the first quarter of2006 compared with the correspondingquarter of 2005, and to a great extent re-flects the upward price dynamics of non-ferrous metals on the international markets.Exports of copper and copper products,which increased by 49 per cent over thereview period, contributed most significantlyto the total growth, by 4 percentage points.The downward trend in the volume of ex-ported cast-iron, iron and steel which oc-curred in the second half of 2005, contin-ued. The change in this group over the firstthree months of 2006 was -12 per cent onan annual basis and its contribution to totalcommodity exports of Bulgaria is -1.1 per-centage point. This trend is expected tosustain in the second quarter and to reversein the third quarter of 2006 when productionand export activity in metallurgy is antici-pated to expand.

Only exports of animal and plant products,food, drinks and tobacco exhibited a 4 percent decline between January and March2006 compared with the first quarter of2005, with the export volume amounting toEUR 212 million. Floods in 2005 and loweragricultural output were probably the majorreasons behind the lower exports ofunprocessed food and tobacco since early2006. This trend is expected also to sustain

Chart 69Exports of Base Metals and Base Metal Products(million EUR)

Source: BNB.

Chart 70Exports of Animal and Plant Products, Food, Drinks and Tobacco(million EUR)

Source: BNB.


Chart 72Imports of Consumer Goods(million EUR)

Source: BNB.

Table 10Contribution of Commodity Groups to Trade Growth betweenJanuary and March 2006

Exports Exports Exports Exports Exports Imports Imports Imports Imports Imports

growth,%growth,%growth,%growth,%growth,% contribu-contribu-contribu-contribu-contribu- growth,%growth,%growth,%growth,%growth,% contribu-contribu-contribu-contribu-contribu-tion, p.p.tion, p.p.tion, p.p.tion, p.p.tion, p.p. tion, p.p.tion, p.p.tion, p.p.tion, p.p.tion, p.p.

Consumer goods 8.8 2.7 26.6 4.0Raw materials 14.0 6.3 18.1 6.9Investment goods 46.2 6.6 18.7 5.2Energy resources 126.6 12.5 95.4 17.0Other -30.2 -0.3

Source: BNB.

Chart 71Imports of Energy Resources(million EUR)

Source: BNB.

in the second quarter of 2006, while in thethird quarter exports of food are anticipatedto recover after gathering the new crop.

Between January and March 2006 importsreached EUR 3933.2 million, a nominal in-crease by EUR 971.5 million or 32.8 percent on 2005. Energy resources and con-sumer goods contributing by 17 and 4 per-centage points correspondingly to the totalimport growth, increased most significantlyin the structure of imports by use: 95.4 percent and 26.6 per cent respectively. Acceler-ated growth of imported energy resources interms of value reflected both the largerphysical volumes and higher internationalprices of crude oil and petroleum products.Between January and March 2006 importedcrude oil increased by 62.7 per cent com-pared with the corresponding period of2005, with the average price (in euro) risingby 43 per cent. Total expenditure on im-ported crude oil (on an annual basis) roseby EUR 357.3 million over the review period,with EUR 145.4 million attributable to theprice factor. High growth rates reported inthis group are expected to retain in the sec-ond and third quarters, consistent both withthe sustained international crude oil pricesand increasing physical volumes. Interna-tional price developments are anticipated tocontribute significantly to the value growth(on an annual basis) in the second quarterand to help gradually subdue the price ef-fect in the third quarter.

In contrast to the expectations importedconsumer goods in the first quarter of 2006grew at a faster pace (on an annual basis)compared with the second half of 2005,exhibiting a 27 per cent increase. Notwith-standing, the first quarter growth remainedlower than total import growth as its wasforecast, and this trend is expected to retainin the following two quarters.

The slowdown of imported investmentgoods, which started at the end of 2005,continued in January and February 2006,posting a 19 per cent growth in the firstquarter. In terms of value, between Januaryand March 2006 imports of investmentgoods went up by EUR 153.4 million com-pared with the corresponding period of 2005


when it was EUR 972.5 million. On adisaggregated basis imports of vehicles andimports of machines and appliances contrib-uted most essentially to the total importgrowth: by 2 percentage points and 1.1 per-centage points respectively. In spite of thefact that accelerated imports of investmentgoods were reported only in March (32 percent on an annual basis), the expectationsare about comparatively high growth rates inthe second and third quarters.

Imports of raw materials posted the lowestgrowth rate in the first quarter, 18.1 per centon an annual basis, consistent with the pre-vious forecasts. The volume reported be-tween January and June 2006 wasEUR 1345.8 million, up EUR 205.8 million onthe corresponding period of 2005. Imports ofores and non-ferrous metals, increasing by1.8 percentage points and 1.6 percentagepoints respectively, contributed most sub-stantially to total growth, while raw materialsfor food production exhibited a decline andhad a negative contribution of 0.7 percent-age points. In the second and third quartersforecasts about imported raw materials arefor positive growth rates, though lower thantotal import growth, tending to moderatelyaccelerate in the third quarter.

No significant changes are anticipated inthe geographical structure of Bulgaria's ex-ports and imports in the second and thirdquarters of 2006. Improved economic rela-tions between Balkan countries and intensi-fied integration with the ten new EU memberstates (EU-10) will lead to an increase in theshares of these regions in the Bulgarianexports. Exports to Balkan countries over thefirst quarter of 2006 accounted for 21.2 percent (an increase of 0.9 percentage pointson the corresponding period of 2005) andexports to EU-10 comprised 7.7 per cent(an increase of 1.7 percentage points). Siz-able imports of energy resources from Rus-sia in the first quarter of 2006 was the majorreason behind the 7.4 per cent increase (to25.4 per cent) in the share of Europeancountries outside the EU in Bulgarian ex-ports under the conditions of a progressiveprice rise.

Chart 73Imports of Investment Goods(million EUR)

Source: BNB.

Chart 74Imports of Raw Materials(million EUR)

Source: BNB.


Based on the reported data under theSystem of National Accounts, imports ofgoods and non-factor services grew fasterthan in 2005 when the growth of physicalvolumes was 14.6 per cent and 7.2 percent. This trend is expected to sustain in thefirst half of 2006 and to change radically inthe third quarter. Based on the forecasts thevolume of exported goods and non-factorservices is expected to increase from 10 to14 per cent in the following two quarters,with the exports accelerating in the thirdquarter due to increased euro area demandand the recovery of key industries in theBulgarian economy. The forecast dynamicsof exports is additionally underpinned by theanticipated weaker effect of transitional ad-verse factors which occurred in the secondhalf of 2005.

The real growth in exported goods andnon-factor services is expected to graduallyslow down in the first three quarters of 2006and to post a single-digit growth by the endof the forecast period. These expectationsare based on the domestic demand dynam-ics, where growth rates are expected todecline under the average rates for 2005.The dynamics of the EUR/USD exchangerate is not expected to have a significanteffect on Bulgaria's foreign trade balance inthe following two quarters.


Accumulated inflation between Januaryand April 2006 reached 4.6 per cent, per-taining mostly to the increased excise oncigarettes and higher sugar prices on inter-national and domestic markets. Tobaccoproducts contributed most significantly (by2.72 percentage points) to the inflation rate,reflecting the adjustments in cigarette ex-cise under the program for harmonizingindirect taxes and fees in order to complywith the EC minimum rates. With the ex-ception of the group of cigarettes, thechange in prices of consumer goods andservices between January and April 2006was 1.95 per cent, down 1 percentagepoint on the corresponding period of 2005due to lower contribution of food, servicesand fuels. Food prices rose by 3.83 percent from early 2006, consistent with thesugar price rise on international markets.Despite the increased excise fuels posteda mere 0.8 per cent growth on domesticmarket and did not reflect higher interna-tional prices of energy resources.

Since early 2006 prices of controlledgoods and services rose by 12 per cent. Inaddition to tobacco products price riseswere reported by postal services (23.6 percent), fees related to personal vehicles (7.6per cent), hospital services (6.7 per cent),passenger railway transport (2.2 per cent),while the prices of pharmaceuticals exhib-ited a decline of 0.54 per cent. BetweenJanuary and April 2006 accumulated pricerise of tobacco reached 74.8 per cent, withthe excess over the initial assessmentssignaling a depleted excise effect. Giventhe significant increase in the excise oncigarettes, by April 2006 prices of control-led goods posted a 17 per cent growth on

Table 11Inflation Accumulated since Yearís Start

January ≠ AprilJanuary ≠ AprilJanuary ≠ AprilJanuary ≠ AprilJanuary ≠ April

20052005200520052005 20062006200620062006

Inflation, % 3.04 4.60 Contribution, percentage pointsFoods 1.50 1.43Non-foods 0.63 2.82 Fuels 0.39 0.02Catering 0.10 0.14Services 0.82 0.26

Goods and services with administratively set prices 0.45 2.70 Controlled-price goods 0.31 2.69 Tobacco 0.18 2.72 Controlled-price services 0.14 0.01 Electricity and heating 0.08 0.00

Source: NSI.

Chart 75Consumer Price Index(on an annual basis)

Source: NSI.

In the second quarter of 2006 inflation is expected to stay at about 8 per cent on an annual basis due mostlyIn the second quarter of 2006 inflation is expected to stay at about 8 per cent on an annual basis due mostlyIn the second quarter of 2006 inflation is expected to stay at about 8 per cent on an annual basis due mostlyIn the second quarter of 2006 inflation is expected to stay at about 8 per cent on an annual basis due mostlyIn the second quarter of 2006 inflation is expected to stay at about 8 per cent on an annual basis due mostlyto the April hike in petroleum prices on international markets. By the end of the review period a slight decreaseto the April hike in petroleum prices on international markets. By the end of the review period a slight decreaseto the April hike in petroleum prices on international markets. By the end of the review period a slight decreaseto the April hike in petroleum prices on international markets. By the end of the review period a slight decreaseto the April hike in petroleum prices on international markets. By the end of the review period a slight decreaseis anticipated which will also sustain in the third quarter.is anticipated which will also sustain in the third quarter.is anticipated which will also sustain in the third quarter.is anticipated which will also sustain in the third quarter.is anticipated which will also sustain in the third quarter.

4. Inflation

Inflation 48

Chart 77Price Indices(on an annual basis)

Source: NSI, BNB.


Source: NSI, BNB.

7 Defined as inflation of goods and services excluding control-led-price ones.

an annual basis. In the following two quar-ters the growth rate is expected to fall in-significantly to 16 per cent in accordancewith the announced adjustments in admin-istratively set prices.

In the first quarter core inflation7 sloweddown to 6.4 per cent on an annual basis,down 0.2 percentage points on the lastquarter of 2005, consistent with the lowerinflationary contribution of food and serv-ices. The annual rate of core inflation willcontinue falling in the following two quartersuntil the effects of the 2005 fuel price risehave been exhausted. In the second quar-ter of 2006 core inflation rate is expected tovary between 5.2 and 5.7 per cent due toa typical summer recovery in deflationarytrend of unprocessed food. Given the lackof inflationary pressure from the prices ofenergy products and services in the do-mestic market, core inflation rate may sub-due ito 3.5 per cent in the third quarter.

Sustained high growth rates of foodprices reflect both the low base in the firstquarter of 2005 and a number of other fac-tors having a divergent effect on price dy-namics of processed and unprocessedfood. Increased international prices ofsugar and sugar products (3 percentagepoints) contributed most significantly to theprice hike of processed food to 6.2 percent on an annual basis. As a result ofenhanced market competition the contribu-tion of bread and cereals went down to 1.2percentage points, while alcohol drinkscontributed by 0.73 percentage points dueto the increased excise. Unprocessed fooddeclined on an annual basis from 13 percent in the fourth quarter of 2005 to 9 percent on average in the first quarter of 2006,partly attributable to the restored normalfruit and vegetable seasonal price dynam-ics. Decreased consumption of chickenmeat as a result of the information aboutAvian flu spread in early year had a strongeffect for the 2 percentage point lower infla-tionary contribution by the Meat groupcompared with the fourth quarter of 2005.



Source: NSI, BNB.

Food prices will continue falling under fa-vourable weather conditions in the summerand with the depletion of adverse effects ofthe 2005 fuel price rises.

The annual price rise of fuels for trans-port and household heating subsided to11.9 per cent on average in the first fourmonths of 2006. Similar trend occurred ininternational prices of energy raw materialsin US dollars on an annual basis (32 percent for crude oil Brent type). The signifi-cant slowdown in the annual retail fuelprices on the domestic market could hardlybe explained by the international situationwhere crude oil prices rose by 43 per centin levs on an annual basis, taking into ac-count the effect of the BGN/USD exchangerate. Between January and March 2006 fuelprices went down by 0.97 per cent on thedomestic market despite the increased ex-cise by 7.11 per cent on average. The im-pact of international prices on the domesticmarket subsided and fuel prices has de-creased since early 2006 reflecting prob-ably the high domestic market prices at-tained in 2005 and the higher excise rate.The dynamic market developments of en-ergy raw materials over the recent monthsand occurrence of specific internal factorswhich have a divergent effect, make fore-casts about fuel price dynamics in Bulgariauncertain. In the following two quarters theannual inflation of this commodity group isexpected to decline progressively.

The annual growth rate of services prices(controlled prices excluded) in the firstquarter averaged 6.5 per cent, exhibiting afall to 5 per cent in April owing to the baseeffect of the 2005 price rise in fixed tel-ephone services. As a result of the plannedrestructuring of fixed telephone servicesprices in the second quarter, prices ofthese services will increase by approxi-mately 8 per cent. This coupled with early2006 effects of raised minimum salary,which directly affects medical services, pre-determines the expected annual inflationrate of market services to vary between 5and 5.5 per cent in the following two quar-ters.

Inflation 50

The annual price rise in non-food (fuelsand controlled-price goods) went up to 1.5per cent on average in the first quarter, aresult of the indirect effect of sustainedhigh growth rates of transportation expendi-ture and stable domestic demand. In thefollowing two quarters inflation of non-foodsis expected to stay at about 2.5 per cent.

Given the expected changes in the exter-nal environment and the velocity at whichthey impact the domestic market, the annualinflation rate in the second quarter is likelyto stay at 8 per cent and may start subsid-ing to approximately 7.8 per cent. The lackof inflationary pressure from energy goodsand services coupled with the typical sum-mer recovery in deflationary trend ofunprocessed food may prompt an inflationdecline to about 6 per cent in the thirdquarter. Forecasts are challenged by themovements in international fuel prices andtheir effects on the domestic market whichmay indirectly push domestic prices up.


Source: NSI, BNB.

Published by the Bulgarian National Bank1000 Sofia, 1, Alexander Battenberg Sq.Tel.: (+359 2) 9145 1351, 9145 1906, 9145 1978Fax: (+359 2) 980 2425, 980 6493Website: www.bnb.bg

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