Fitch Ratings - Frankfurt am Main - 21 Aug 2020: Fitch Ratings has affirmed Bulgaria's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook.
A full list of rating actions is at the end of this rating action commentary.
Bulgaria's ratings are supported by its strong external and fiscal balance sheets and credible policy framework, underpinned by EU membership and a long standing currency-board arrangement. The ratings are constrained by slightly lower income levels compared with the current 'BBB' median and unfavourable demographics, which could hinder growth and weigh on government finances over the long term. Governance indicators are in line with peers.
The Stable Outlook reflects a degree of economic resilience to the coronavirus pandemic owing to a long track record of fiscal prudence, large foreign reserve assets and the prospects of very substantial EU transfers over the forecast period. The inclusion of the Bulgarian lev in the Exchange Rate Mechanism (ERM II) and the gradual process towards euro membership will also help anchor macro and fiscal stability in the context of downside risks to growth and rising political uncertainty.
Fitch views the participation of the Bulgarian lev in ERM II and Bulgaria's entry into the Banking Union in July 2020 as an important milestone, as it caps a two-year process of successful implementation of reforms and improved resilience of the banking sector. It also reflects the eurozone authorities' commitment to euro enlargement at a time when macro and policy risks have increased substantially in Europe. The focus will now turn to meeting the convergence criteria for joining the euro area, as well as non-quantitative commitments specific for Bulgaria, including improving the anti-money laundering framework. As part of the ERM II accession process, Bulgaria carried out extensive anti-corruption and judicial reforms and the authorities have also committed to making further improvements in this area. Given the two-year minimum ERM II requirement and the usual 6-12 month assessment period, we think the euro could be adopted in January 2024 at the earliest.
In Fitch's view, euro adoption is net positive for the sovereign's creditworthiness. All else being equal, we would expect to upgrade a sovereign by two notches between joining the ERM II and joining the euro. However, there is uncertainty over when Bulgaria will meet all membership criteria, including the non-quantitative commitments and/or the "price stability" requirement given the growth differential with the eurozone. For positive rating action as Bulgaria moves towards euro adoption, we would need greater confidence in the likely timing of euro adoption, and how far it would offset risks arising from the pandemic and domestic political uncertainty.
Fitch expects Bulgaria's economy to contract by 5.7% in 2020 (a slight downward revision from our 5.1% April forecast) reflecting the adverse impact of the coronavirus pandemic on consumption, investment and exports. The economy contracted by 9.8% qoq in 2Q20 (compared with a 12.1% qoq fall in the eurozone) largely as a result of a sharp fall in external demand and a collapse in output across most sectors due to lockdown measures. A stronger impulse from fiscal spending and improved performance in key sectors such as construction and industry will help drive a rebound in 2H20 but risks to our short-term forecasts are largely on the downside. Service sectors such as tourism (which accounts for 3.4% of total domestic supply according to the EU Commission) remain particularly vulnerable and appear to be recovering at a slower pace than expected, while confidence across the economy could suffer if there is a stronger resurgence of the coronavirus.
We forecast growth to bounce back to 4.4% in 2021 before moderating to 3.2% in 2022 as base effects start to dissipate. GDP per capita should surpass 2019 levels by end 2021 already, but this is partly due to ongoing population loss. The improving outlook is largely premised on a recovery in external demand (trade openness stood at around 124%% of GDP in 2019) and limited hysteresis on the labour market, thanks in part to the authorities' support measures. We expect unemployment to increase from a record low of 4.2% in 2019 to 7.5% in 2020-21 before falling gradually thereafter (and compared with a post global financial crisis high of 13% in 2013).
There is lingering uncertainty around the medium-term impact of the current crisis on Bulgaria's economy, including long-lasting effects on private investment (in particular in service sectors such as tourism) and whether demographic trends will become even more challenging. On the upside, the recent agreement on EU support programmes is likely to provide a positive boost to growth. Bulgaria is set to receive EUR29 billion (42% of 2019 GDP, the highest share in the EU) in 2021-27 from the next multi-annual financial framework (MFF) and Next Generation EU fund. An effective use of funds combined with policies that tackle structural constraints could lead to higher growth potential, offsetting a projected sharp decline in the working age population.
However, the policy outlook has clouded in recent months as the government has come under pressure following a number of protests targeting primarily rule of law and corruption issues in Bulgaria. This has stoked political tensions, with PM Borissov proposing the election of a Grand National Assembly to amend the constitution in part to strengthen the judiciary. It is highly uncertain whether this will take place, or if the ruling GERB party is only seeking to dilute pressure for early elections (the next parliamentary elections are due by March 2021).
Weak support for traditional parties (including GERB) and the emergence of populist figures is likely to fragment the vote at the next elections, complicating coalition building at a time when the authorities need to tackle the social and economic fallout from the pandemic. It also raises questions around the likelihood and effectiveness of reforms to tackle governance issues. However, Fitch believes there are overall currently few risks to economic policy continuity (including euro adoption), owing to the country's long track record of cross-party consensus on maintaining monetary and fiscal stability.
Fitch continues to expect an only moderate deterioration in public finances in 2020, with the deficit reaching 3.6% of GDP (compared with the 'BBB' median of 6.5% and the smallest in the Emerging Europe region). This is due to a strong starting position, fiscal restraint and a relatively weak initial impact of the COVID-19 pandemic on fiscal balances in 1H20. According to preliminary data, the Consolidated Fiscal Programme posted a surplus of BGN1.7 billion (close to 1.5% of projected 2020 GDP) in January-July, with revenue broadly in line with the revised budget. In July the authorities announced a further BGN1.9 billion (1.7% of GDP) fiscal package, focusing largely on wage and social contribution support schemes. Combined with higher capital outlays, this should lift expenditure rapidly in 2H20. Fitch estimates direct fiscal measures to amount to less than 3% of GDP, a relatively modest figure compared with other countries in the region.
The fiscal deficit should narrow over the forecast period (to 1.7% of GDP in 2022) supported by the cyclical recovery in revenues and the gradual phasing out of support measures. There are downside risks attached to macroeconomic performance, the materialisation of contingent liabilities (10% of GDP in 2018 according to EU) and adverse political developments. However, Bulgaria's track record of sound fiscal management, vast EU support and ERM II membership underpin fiscal credibility over the forecast period. Under our baseline scenario, public debt/GDP will rise to 24% in 2020 (less than half the 'BBB' median), before falling by about 1.5pp per year to 2022.
Bulgaria's solid external finances are a rating strength and help mitigate risks from the pandemic on the country's small and open economy. Sharp import compression in 1H20 has offset a rapid fall in trade and services exports, keeping the current account balance at surplus (over 4% of GDP in June on a 12 month rolling basis). We expect the current account surplus to narrow modestly over the short to medium term, in part as a recovery in investment will start driving import growth. Bulgaria has vast FX reserves (46.9% of GDP end June) and one of the strongest net external creditor positions (23% of GDP at end 2019) in the 'BBB' category, which guarantees the smooth functioning of the currency board..
The banking sector remains stable, with high liquidity and capital levels (20.5% in March). Data for 1H20 have yet to show a significant deterioration in credit conditions or asset quality (the ratio of gross non-performing loans and advances stood at 8.1% at end June compared with 8% at end March according to the Central Bank´s new reporting framework), although we expect performance to weaken over the coming quarters. According to data from the Bulgarian National Bank, around 13% of total loans have been placed under the anti-coronavirus moratorium programme. This will put some pressure on profitability next year. Fitch views Bulgaria's entry into the Banking Union (which will formally take place in October) to be supportive of stronger supervision, as well as making the resolution of banks easier in the future.
ESG - Governance: Bulgaria has an ESG Relevance Score (RS) of 5 for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Bulgaria has a medium WBGI ranking in the 60th percentile, reflecting its track record of unstable coalitions, relatively high perceptions of corruption and moderate institutional capacity.
Fitch's proprietary SRM assigns Bulgaria a score equivalent to a rating of 'BBB+' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
-Macroeconomic Performance, Policies and Prospects: -1 notch, to reflect Fitch's view that adverse demographic trends and slow progress on structural reform constrain potential growth over the long term
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main factors that could, individually or collectively, lead to positive rating action/upgrade are:
-Macro/Fiscal: Dissipation of macroeconomic and fiscal risks and increased confidence in a post-coronavirus recovery that is supportive for public finances.
-Structural/External: Progress toward eurozone accession, including greater confidence in Bulgaria meeting membership criteria and the likely timing of euro adoption.
-Macro: An improvement in growth potential, for example via the implementation of structural and governance reforms to improve the business environment, which leads towards faster convergence with income levels of higher rated peers that would cause the removal of the -1 QO notch on Macro.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- Fiscal/Macro: A prolonged rise in public debt driven by persistent fiscal easing, the materialisation of contingent liabilities on the sovereign's balance sheet and/or significant deterioration of growth prospects.
- External: Re-emergence of significant external imbalances and/or deterioration of external competitiveness
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579].
Fitch expects the global economy to perform in line with Fitch's Global Economic Outlook (29 June 2020), which projects the eurozone to contract by 8% in 2020 before growing by 4.5% in 2021 and 2.8% in 2022.
The principal sources of information used in the analysis are described in the Applicable Criteria.
Bulgaria has an ESG Relevance Score of 5 for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are highly relevant to the rating and a key rating driver with a high weight.
Bulgaria has an ESG Relevance Score of 5 for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. Some of these issues have held back implementation of structural reforms and hindered medium-term growth potential.
Bulgaria has an ESG Relevance Score of 4 for Human Rights and Political Freedoms as World Bank Governance Indicators, which have the highest weight in Fitch's Sovereign Rating Model (SRM), are relevant to the rating and a rating driver.
Bulgaria has an ESG Relevance Score of 4 for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Bulgaria, as for all sovereigns.
Bulgaria has an ESG Relevance Score of 4 for Demographic Trends as a falling and ageing population hinder the economy's medium term growth potential. This is relevant to the rating and a rating driver.
Fri 21 Aug, 2020