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ACRA assigns long-term credit ratings of A- to Bulgaria under the international scale, outlook Stable

The Republic of Bulgaria (hereinafter, Bulgaria, or the country) has been assigned the following ratings under the international scale:

  • Long-term foreign currency credit rating at A- and local currency credit rating at A-;
  • Short-term foreign currency credit rating at S1 and local currency credit rating at S1.

The outlook on the long-term foreign currency credit rating is Stable and local currency credit rating is Stable.

The Stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18-month horizon.

Credit rating rationale

Bulgaria’s A- sovereign credit rating is supported by the very low government debt burden, high fiscal reserves, a modern fiscal rule framework, consistently low inflation and a sustainable currency board arrangement. However, the country’s GDP growth outlook is a source of concern, as well as inherently volatile components of the balance of payments. ACRA sees moderate risks in the current condition of the financial sector.

The low level of general government debt, which stood at 21% of GDP as of the end of August 2019, gives Bulgaria ample room to apply countercyclical fiscal policy. ACRA expects a gradual reduction in Bulgaria’s government debt over the next three years based on the expectation that at 2–2.5%, potential economic growth will outpace not only base case scenarios with regard to budget deficits, but also pessimistic ones.

Bulgaria’s fiscal rule framework is one of the most prudent among EU members. It has a formal escape clause and special countercyclical options, and covers all the most important fiscal activities, including the scope of government, public expenditures and various budget balances. The current version came into force in 2014 and has not been violated since then. Since 2016, Bulgarian fiscal legislation has incorporated EU laws related to fiscal policy. Historically, compliance with fiscal rules in Bulgaria has been very high and ACRA expects this to continue. Moreover, the considerable size of the country’s fiscal reserve account (9% of GDP) minimizes rollover risk and allows extraordinary expenses to be incurred without a debt buildup. In ACRA’s view, the fiscal space available to Bulgaria is significantly wider than for most other European countries.

At the end of June 2019, Bulgaria’s external debt stood at 60% of GDP and was almost entirely denominated in foreign currency (euros – 85.6%, dollars – 10%). Despite the high share of FX debt, ACRA notes that FX risk is muted due to the sustainable currency board arrangement. Its sustainability is supported by a more than sufficient volume of international reserves held by the Bulgarian National Bank (BNB). In particular, as of the end of June 2019 these reserves covered the country’s monetary base more than 1.5 times, were equal to 74% of external debt, and covered 8.6 months of import. Moreover, the credibility of the policies maintaining Bulgaria’s currency board arrangements is enforced by the government’s strong will to comply with the ERM II process, which paves the way for potential Eurozone accession in 2022. Additionally, there has been a long history of strong commitment to the existing currency board arrangement, which started in 1997.

After four years of strong economic growth (averaging 3.5% from 2015 to 2018), ACRA expects the Bulgarian economy to grow by 3.1% in 2019 and 2.9% in 2020 due to the decelerating growth of the country’s key trade partners, primarily Germany and Turkey, and a high share of cyclical construction activities. In the long-term, we expect the country’s economic potential to be limited by supply-side constraints, which are unlikely to be addressed soon due to the insufficient level of investment so far and the shrinking labor force. Over the last two decades, both the total and working age population have been decreasing annually at 0.8% and 1% on average, respectively. According to the United Nations, by 2035 Bulgaria’s working age population will have shrunk by more than 18%, which is the largest expected decrease among all EU countries. Poor demographics are aggravated by significant migration outflow, at 0.4% a year in 2012–2017, whereas human capital quality growth is restrained by the high rate of school drop-outs, low tertiary education attainment, and high migratory outflow (brain drain). We also note that the small size and high openness of the economy contribute to the volatility of its growth.

In ACRA’s view, the level of the government’s financial sector contingent liabilities is somewhat elevated due to the continuing high level of NPLs in domestic banks, shortfalls in the capital of some banks identified by the ECB’s recent stress test, and the recent incident of the state bailout of a troubled bank. In 2018, the share of gross non-performing loans in the total loans at domestic banking groups and standalone banks was still higher than the EU average (2-3%) and stood at 11.4%, having recorded marginally positive dynamics since 2017. The ECB’s stress test and asset quality review conducted in July 2019 signaled that under the adverse scenario there may be roughly a 0.6% GDP shortfall in tier 1 capital in two Bulgarian banks, which are ranked 4th and 13th largest by assets. In 2014, the bailout of Corporate Commercial Bank (4th by assets at the time) led to a sufficient increase in central government debt.

The overall quality of Bulgaria’s institutional framework is comparable to that of other Central and Eastern European countries, but lags behind the EU average in all of the governance indicators. Nevertheless, positive dynamics exist: in a number of areas, the government is actively trying to comply to EU standards, which is a well-established institutional framework benchmark. Convergence with EU legislation is potentially very beneficial to the long-term creditworthiness of Bulgaria. For example, in the medium-term the BNB may strengthen its supervisory control while implementing the European Banking Authority’s recommendations as it enters the EU’s banking union.

ACRA notes that despite an active opposition — in 2018 Bulgaria’s ruling party faced three votes of no confidence — adherence to key economic policies such as the currency board regime, and fiscal rule framework is common to both the ruling party and the opposition. Therefore, ACRA does not expect these policies to change in the event of a shift in the political climate.

Sovereign model application results

The A+ Indicative credit rating was used to obtain the Final credit rating, even though the core part of the rating model put Bulgaria at AA-. According to the methodology, this conservative correction was made because the indicative score crossed the AA- lower boundary by a marginal amount.

A number of modifiers in the modifiers part of the model allow the Indicative credit rating to be increased. These include the following, which are determined by the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale:

  • Fiscal policy framework and fiscal flexibility;
  • Debt sustainability.

Negative modifiers are the following:

  • Potential economic growth;
  • Sustainability of economic growth;
  • Contingent liabilities and the risk of them materializing on the sovereign balance sheet;
  • Market access and sources of funding;
  • Balance of payment vulnerabilities;
  • External debt sustainability.

In view of the abovementioned modifiers, Bulgaria’s Indicative credit rating has been decreased by 2 notches. A Final credit rating of A- has been assigned. There are no extraordinary factors that could adjust the Final credit rating.

Potential rating upgrade factors

  • Stable economic growth higher than 3% yearly on a 3-4 year horizon.
  • Improvement of the condition of the banking sector.
  • Successful transition to euro as an official currency.
  • Substantial education and healthcare improvements.

Potential rating downgrade factors

  • Broken commitment to maintaining important elements of economic policy: currency board, fiscal rules system.
  • Realization of deflationary risks.
  • Political uncertainty leading to the freeze of eurointegration.

Issue ratings

No outstanding issues were rated.

Regulatory disclosure

The sovereign credit ratings have been assigned to Bulgaria under the international scale based on the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale and the Key Concepts Used by the Analytical Credit Rating Agency Within the Scope of Its Rating Activities.

The sovereign credit ratings have been assigned to Bulgaria for the first time. The sovereign credit ratings and their outlook are expected to be revised within 182 days following the publication date of this press release as per the Calendar of planned sovereign credit rating revisions and publications.

The sovereign credit ratings are based on information from publicly available sources, as well as ACRA’s own databases. The sovereign credit ratings are unsolicited. The Bulgarian government did not participate in the credit rating assignment.

ACRA provided no additional services to the Bulgarian government. No conflicts of interest were discovered in the course of the sovereign credit rating assignment.

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