PitchbookUS'pot

1
Bulgaria the CEE platform to growthOpportunities
for US companies, economic outlook Draft for
the Silicon Valley ConferenceSeptember 2004
2
Economic policy challenges

• Maintaining the macroeconomic stability and
  economic growth
• Reducing the trade balance and current account
  deficit
• Keeping a positive primary surplus on the
  consolidated budget in the medium term
• Accelerating the reforms in the real and public
  sector
• Raising the disposable income of the Bulgarian
  citizens
• Accommodating the expected increase in EU-related
  expenditure while at the same time preserving a
  constant debt-to-GDP ratio

3
Consistently strong economic performance

• Bulgaria maintains stable and consistently strong
  growth rates, among the highest in CEE countries,
  and significantly higher than in Eurozone
  countries.
• Slightly lower real GDP growth in 2003 was mainly
  due to a 1.3 drop in agricultural production due
  to bad whether conditions
• Real GDP growth has been consistently robust
  since 1998 despite significant external shocks
  (Russia, Turkey, Eurozone recession)
• GDP per capita has increased gradually, and will
  continue to be supported by the EU convergence
  process. Although on nominal basis, per capita
  GDP is low, on a PPP basis, GDP per capita is
  significantly higher at USD 6,909 (end-2002)

Real GDP growth ( change)
GDP per capita PPP (USD)
Source The World Bank Group
Source IMF, NSI, AEAF
Real GDP growth 2003 ( change)
Source European Commission forecast, National
Statistic InstituteBulgaria
4
Economic growth driven by strong private sector
activity
Private sector ( of gross value added)
Manufacturing sales and output ( change) 2000100
Source NSI
Source AEAF

• Private sector is an increasingly important
  contributor to economic activity
• Economic sources of growth driven by a recovery
  in domestic demand, including investment and
  final consumption, which is supported by stronger
  financial intermediation
• Industrial production increasing rapidly. From
  II2003 to II2004, IP increased 24 YoY in part
  due to higher output of industrial exports, which
  grew by 36. The annual growth of industrial
  output is the highest among the EU-accession
  candidate countries

Stock market performance reflects strong economy
5
Positive inflation dynamics

• During the past year the major pro-inflationary
  factors were poor weather conditions impacting
  food costs, administrative price increases and
  non-tradable services costs growth
• In 2003, average inflation was 2.4, below the
  end-year inflation of 5.7
• The acceleration of the general price dynamics
  over the last months of 2003 is attributed to
  poor weather conditions, which put upward
  pressure on agricultural products and higher
  global prices. Wheat and bread products rose more
  than 30, contributing 2.4 percentage points to
  annual inflation
• In 2004 Bulgarian annual average inflation is
  projected at 3.7. In March 2004, there was
  deflation
• Inflation is low relative to other CEE countries
• Given the liberalization of prices, the impact of
  administrative prices on inflation is expected to
  have a much more limited impact on inflation in
  2004 and forward

CPI movement percent change (August 2000March
2004)
2001
2002
2003
2004
2000
Source NSI, AEAF
CPI yoy annual average (2003)
Source European Commission, Deutsche Bank,
National Statistical Institutes
6
Declining external debt burden
Gross external debt ( bop1 exports)
Gross external debt ( of GDP)
Source BNB, External Debt Indicators 1 bop
exports include credits on merchandise trade
exports, services, and transfers
Source BNB, External Debt Indicators 1 Includes
government and government guaranteed debt, debt
of monetary authorities, municipalities,
state-owned banks and companies
Net public and private external debt ( of GDP)

• External debt has declined dramatically relative
  to exports and GDP due to proactive debt
  management
• Net external debt is very low, and has declined
  by more than 70 over the past 7 years
• Slight increase in external private sector
  indebtedness represents a large hidden
  repatriation of capital (related party lending)

Source BNB, External Debt Indicators Net
external debt gross external debt (public and
private) less gross foreign assets (including
commercial bank foreign assets and BNB
reserves) 1 Based on projected GDP
7
Intermediate debt management objectives

• Continue the policy for steady increase of the
  domestic debt share until average Accession
  countries standards are reached
• Reduce the share of USD-denominated debt by i)
  predominant borrowing in EUR and BGN ii) under
  favorable market conditionsimplementation of
  active debt measures (currency swaps and early
  repayments)
• Maintain interest rate-neutral policy
• Prepay high-cost debt, ineffective instruments
  and loans to IFIs
• Balance debt service schedule in the years prior
  to the expected EU-entry
• Promote domestic government securities market
  through measures aimed at technical upgrade of
  the trading systems and further expansion of
  offered instruments
• Improve the parameters of the domestic market
  bond issues in an effort to increase the nominal
  amount of the issues and achieve greater
  liquidity
• Introduce unified ISMA-yield calculation for all
  securities issued domestically
• Maintain fiscal reserve at a level covering total
  debt payments for a period of at least one year
• Adoption of comprehensive regulations, specifying
  clear targets for the management and the spend of
  the fiscal reserve

8
Bulgaria meets EMU criteria
Bulgaria is ahead of many First Wave Accession
countries in meeting EMU criteria
Shorter maturities Romania, Slovenia, Estonia
and Latvia. Source European Commission, Deutsche
Bank, JP Morgan.

• An inflation rate of no more than 1.5 greater
  than the average of the three countries with the
  lowest inflation rates
• The long-term interest rates not in excess of 2
  above the average of the three countries with the
  lowest inflation rates
• No deviation of the currency from EUR by more
  than /-15 in the two years preceding the
  entrance into the monetary union
• The fiscal deficit of no more than 3 of GDP
• The ratio of general government debt to GDP of
  not more than 60

9
Credit ratings keep up at last with positive
developments
Baa2/BBB
Baa3/BBB-
Ba1/BB
Ba2/BB
Ba3/BB-
B1/B
B2/B
B3/B-

• The dramatic changes in the Bulgarian credit
  story (both qualitative and quantitative) have
  not been fully reflected in the ratings

10
LABOUR MARKET REFORMS
11
Unemployment has declined dramatically
Unemployment dynamics 2000March 2004
Unemployment percent of workforceend of 2003
2004
2000
2003
2001
2002
Source NSI
Q3 2003 Source Reuters

• Unemployment is still somewhat high (13.7 in
  March), but in line with other converging
  economies, and now lower than Croatia, Poland and
  Slovakia
• Unemployment rate on annual basis decreased by
  3.5 percentage points in 2003 compared to the
  highs of 2000
• The unemployment rate stepped down as a result
  mainly of the interplay of the labor market,
  upswing in private sector and the broadened scope
  of the governments active labor market measures
  underway. Hidden employment is widespread in the
  booming construction sector
• The private sector is projected to generate about
  70,000 new jobs during 2004

12
Competitive labor costs and rapidly
increasing productivity
Attractive labor costs in Bulgaria (Level 2003
as of EU-15)
Productivity and real wages growth
Source Eurostat, JPMorgan extrapolation or
estimate
Source AEAF

• Bulgarias labor costs are less than 10 of the
  EU-15 level
• Labor productivity in 2003 rose by 2.5 compared
  to the same period of the previous year, driven
  mainly by growth in the private sector. Bulgarian
  productivity growth is well above that of the
  EU-15 and other EU accession countries
• Rising productivity is also reflected in
  declining unit labor costs
• Real wages are increasing at a healthy pace, and
  not as sharply as might seem from the statistics.
  Improved enforcement of social security payments
  by employers (more effective registration of
  labor contracts) and the establishment of higher
  minimum wage are partly behind the reported
  increase in real wages

13
Most attractive labor market among EU
accession countries
EU candidates GDP per capita At purchasing power
standards, existing EU members 100
Price level catch-upPurchasing power standards,
2003F data, EU-15100
Cyprus
Portugal (2002)
Slovenia
Portugal (EMU1999)
Baltics
Malta
Avg. for Greece, Portugal, and Spain upon EMU
entry
Portugal (EU1986)
Central Europe
Bulgaria
Romania
At market exchange rates, existing EU members
100
Source European Commission for 2003
Source Eurostat
People with at least a bachelor degree in higher
education as a percentage of the population

• At market exchange rates, GDP per capita of
  Bulgaria is about 39 of the richest, and
  provides an attractive incentive for investment
• Non-tradeables prices (the driving force behind
  differences in purchasing power across countries)
  in Bulgaria are much below those of current EU
  countries and below purchasing power levels when
  they entered the EU and EMU
• Low per capita GDP in Bulgaria is an indication
  of significant growth prospects lying ahead as
  real economic convergence takes hold
• Low wage costs attract significant greenfield
  investment

UK
Spain
Bulgaria
Hungary
Germany
France
Greece
Poland
Czech
Italy
Turkey
Portugal
Source OECD, NSI data for Bulgaria (2001)
14
   PRODUCT MARKETS
15
Far reaching reforms in the banking system are
paying-off
Credits to the private sector ( of GDP)
Credits to the private sector ( of deposits)
Source BNB
Source BNB

• Following significant reforms in the banking
  system, including privatization and enhancements
  to the regulatory framework, financial
  intermediation is now playing a more important
  role in economic activity
• The majority of bank balance sheets is being
  directed to the private sector
• Nominal credit growth to the non-government
  sector increased by 50.5 in 2003, with strong
  performance in corporate credit, mortgage lending
  and consumer credits. However, it is expected to
  moderate to 35 in 2004 given government measures
• Credit growth is being largely financed by a
  rapid growth in deposits as well and to a lesser
  extent by continued repatriation of banking
  system foreign assets

16
Banking sector privatization and reforms

• Banking sector privatization is complete
• Banking system is 98 private-owned and 2
  government-owned, and privatization in the
  banking system was successfully completed in H1
  2003
• Banking supervision regulations are now fully
  compliant with the international best practices
  and European criteria
• Effective July 1, 2004, the BNB will enhance
  supervision by expanding the existing credit
  register, including not only records of BGN
  10,000, but also those exceeding BGN 1,000
• The deposit insurance fund grew significantly in
  2004 to EUR 25.7 million from EUR 21.7 million in
  2003 and EUR 17.5 million in 2002

Strategic privatization deals

• UniCredito Italiano acquired an 85.2 in Bulbank
  (2000)
• National Bank of Greece acquired 89.9 and EBRD
  10 in United Bulgarian bank (2000)
• Societe Generale acquired a 98 stake in
  Expressbank (2000)
• Bank Austria Creditanstalt acquired 99.6 in
  Biochim (2002)
• OTP acquired 100 of DSK Bank (2003)

Top ten banks
Source BNB, BCC
17
Credit growth supported by strong banking sector
fundamentals

• Bulgarian banking system is well capitalized,
  liquid and operating under good regulatory
  environment
• Capitalization ratios were above 22 as of
  December 2003, well above Basels committee
  recommended 12 level and the required 8 minimum
• Bulgarian system is fully provisioned for
  non-performing and doubtful credits
  non-performing are low
• Credit growth not a concern since it comes from a
  very low base. Compared to other countries,
  Bulgaria remains under-banked

Credit of GDP 2003
Full provisioning of non-performing and doubtful
credits
Source BNB
18
FDI projected at USD 1.6 billion in 2004
FDI ( GDP/2003?)
Q3 2003 Source IMF IFS, Central Banks

• Bulgarian National bank data show an increase in
  FDI as the end of 2003 by 56.9 YoY or USD
  515 million over the total amount in 2002
• Non-privatization related investment has been
  substantial, and is expected to grow as EU
  accession date draws closer
• The FDI in Bulgaria during the last three years
  exceeded USD 3.1 billion, which equal to half of
  the total amount attracted since 1992
• FDI in 2003 is likely understated due to
  statistical issues. Due to a lag in reporting,
  FDI has historically been underestimated in
  preliminary numbers by 1030. We expect FDI to
  be revised upward

19
Growing FDI in value added sectors
FDI inflow in Bulgaria 1995-2004F, USD m
FDI stock by sector 1998 - 1H 2004 Total USD 6.8
bn
Source BNB, Invest Bulgaria Agency
Source BNB, Invest Bulgaria Agency

• Large portion of FDI is non-privatization
  related. Privatization receipts in 2003 were only
  USD 364 million of FDI and were mainly attributed
  to the acquisition of DSK bank by OTP
• Greenfield investments in 2003 amounted to about
  USD 500 million according to the Bulgarian
  Foreign Investment Agencys estimates
• FDI investments flowing to higher value added
  sectors
• 1st H 2004 marked the record USD 1.2 bn due to
  the largest telecom deal The Bulgarian
  Telecommunications Company sold to Advent

20
Strong incentives for FDI in Bulgaria

• Adoption of Investment Encouragement Law
  establishing equal treatment of foreign and local
  entrepreneurs and relieved administrative
  procedures
• Ambitious economic program stimulating the
  economy
• 0 profit tax in over 1/3 of the territory of the
  country
• Creation of industrial areas with significant
  investment incentives
• VAT-free imports for investment projects over EUR
  5 million
• Almost 100 agreements on the protection of
  investments and avoidance of double taxation
• Institutional support for major foreign
  investment projects
• Simplified licensing, permit and registration
  regimes
• Simplification or abolishment of more than 50 of
  the existing ones
• Clarification of remaining regimes
• New regimes to be imposed solely by Parliament
  vote
• Implementation of International Accounting
  Standards (IAS)

21
   QUALITY AND SUSTAINABILITY OF PUBLIC FINANCES
22

Clear and Transparent Strategy
Net non-interest expenditures - programmed at 35
of GDP by 2006

• Reform of
• - Health-care system
• - Education
• - Legal system
• Budget preparation program budgeting
• - Value for money
• - Expenditure efficiency
• - Stability and predictability of the
  financing
• - Fiscal decentralization

• Ensured funding for
• - Fulfillment of the commitments taken in the
  course of NATO and EU negotiation process
• - Pre-accession aids absorption
• Social spending
• Structural reforms
• - Privatization state monopolies
• - Building modern infrastructure

23
Good fiscal track record with flexibility from
in-built stabilizers
Fiscal balance GDP
Consistently largeprimary surpluses
Source Ministry of Finance and IMF data
Fiscal balance in 2003 ( GDP)
Source European Commission, MoF

• A solid record of conservative fiscal policy,
  with a five-year average deficit of 0.7 of GDP
  compared to a five-year average of -4.2 of GDP
  registered by the first-wave Acceding countries
• In-built stabilizers provide a spending buffer of
  2.5 and include
• Only 90 of current spending is released over
  first three quarters (1.9)
• Budgetary contingency fund of 0.6 of GDP
• Large primary surpluses averaging 2.6 over last
  five years and projected range of 1.32.0 over
  the next three years

24
Fiscal reserve amply buffers debt service
Debt service payments (EUR million)
Fiscal reserve 2003 (BGN million)
Fiscal reserve currently equivalent to over
EUR 2.1 bn covers debt service, even in peak years
Source Ministry of Finance
Source Ministry of Finance
Mar.04 level BGN 4.133 bn

• Source Ministry of Finance
• Based on 2003 year-end level of fiscal reserve
• Based on current level of fiscal reserve

25
Solid fiscal performance and financing
of GDP, gross basis
Source Ministry of Finance ¹ Recalculated with
projected GDP

• In 2003 Bulgaria recorded budget surplus of BGN
  933 200 for the first time since 1998, thus
  outperforming the primarily projected deficit of
  0.7 of GDP. The year-end consolidated budget
  surplus came as a result of the improved tax and
  customs control, which reduced tax evasion and
  raised the revenues
• The Ministry of Finance has pledged to reduce the
  2004 fiscal deficit target to 0.4 of GDP of
  initially projected 0.7 of GDP to
  counter-balance the effect of the growing CA
• Tax incomes increased by 25.4 yoy in Q1 2004

26
Revenue-boosting measures

• Implementation of tax policy fostering business
  environment, initiative and sustainable economic
  growth
• Decrease personal income tax by 2 for all income
  classes, except for the 5 cut of the highest
  ones
• Tax relieves for start-up and already existing
  businesses in regions with high unemployment were
  introduced (0 tax for areas with unemployment
  higher than average)
• To reduce the share of the gray economy, the
  Ministry of Finance will take active measures
  against tax evasion and smuggling
• Further tighten border control
• Introduce better-protected excise labels
• Gradual increase of excise taxes on liquor, oil,
  gas, petrol and tobacco products to reach the
  minimal rates in the EU by 2006
• Corporate income taxrate will be cut from the
  current 19.5 to15 in 2005, bringing it to one
  of the lowest levels in Eastern Europe

Corporate tax rates (19972004)
Source Ministry of Finance