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Fitch affirms Bulgaria at 'BBB', outlook positive

Fitch affirms Bulgaria at 'BBB', outlook positive Author: Bulgaria's National Palace of Culture / All rights reserved.

SOFIA (Bulgaria), June 20 (SeeNews) - Fitch Ratings said that it has affirmed Bulgaria's long-term foreign-currency issuer default rating (IDR) at 'BBB' with a positive outlook.

The ongoing commitment to euro adoption by 2024 on the part of the Bulgarian government is seen as the main driver for the positive outlook, despite renewed political turmoil in the country, the global ratings agency said in a statement on Friday.

This week, Bulgarian lawmakers are set to debate and vote on a motion of no confidence in the government of prime minister Kiril Petkov, which was filed by the three opposition parties and a former junior partner in the governing coalition.

"At present, we do not expect a delay of more than one year in euro accession if the country fails to meet convergence criteria in 2023, as we consider that there is a clear commitment at EU level to expedite the process," Fitch Ratings added.

The reaffirmed rating is supported by strong external and public balance sheets compared to peers with the same rating as well as "a credible policy framework", which is also upheld by Bulgaria's long-standing currency-board.

Fitch, however, downgraded its forecast for Bulgaria's real economy, in the expectation of gross domestic product (GDP) growth to slow down to 3% in 2022 from 4.2% in 2021, against a current median value of 3.4% amongst countries rated 'BBB'.

Greater investment on the back of upcoming EU funding in 2023 is seen to modestly accelerate GDP growth to 3.8% next year, although the absorption of funds under the national Recovery and Resilience Plan (RRP) risks being delayed if the government loses parliamentary support and the country heads for new elections later this year.

Fitch Ratings also said in the statement:

"Delinking from Russian Energy: The authorities are making concerted efforts to reduce energy reliance from Russia, in particular following the decision in April by Gazprom to halt gas deliveries (Russian gas accounted for around 80% of Bulgaria's 3.2billion cubic metre gas consumption). Gas flows from neighbouring countries have served as stop-gap measure, while a new interconnector with Greece and new supply agreements with other countries will largely help cover the gap by winter 2022 (when gas demand increases sharply). Combined with Bulgaria being exempt from EU oil sanctions against Russia until 2024, this reduces the risks of energy supply disruptions that could significantly affect households and industry, although in such a scenario indirect impacts would still create significant macro challenges.

Inflation Pressures Intensify: Fitch projects that harmonised inflation (HICP) will average 11.8% in 2022 the highest in 15 years, as high energy and food prices feed through all price categories. Although we expect inflation to gradually moderate in 2H22 as base effects kick in, risks are clearly tilted to the upside, given uncertain external developments and rising inflation expectations that will augment wage demands (beyond the close to 10% increase in wages seen in 2021). Government measures to support households could add further demand pressures. In our baseline scenario, inflation will average 6% in 2023, remaining above the Fitch eurozone and 'BBB' median forecast.

Euro Adoption: The implementation of Bulgaria's ERMII post-entry commitments is ongoing and according to the ECB's June Convergence Report, the country fulfils most of the convergence criteria, including interest rate, exchange rate and public finances. However, the country's legal framework is not yet aligned and price convergence was not met. There are rising risks that Bulgaria again fails to meet price stability criterion in May 2023 (the key date for 2024 euro adoption), particularly as Bulgaria HICP inflation is much more sensitive to food and energy costs than most EU member states. Delays to implement a technical changeover plan could also challenge the 2024 goal.

Meeting all other criteria is less challenging, and as long as political commitment remains firm in Bulgaria and the EU we would expect flexibility in the convergence assessment (as shown in Croatia). Overall, we consider euro adoption as supportive of the rating, as underlined by our view that all things being equal, we would upgrade Bulgaria's Long-Term Foreign-Currency IDR by two notches between the inclusion of the Bulgarian lev into ERM II to joining the euro.

Renewed Political Uncertainty: The junior coalition partner TISP announced the withdrawal of its four ministers from the government in mid-June. The three remaining coalition partners intend to continue their mandate with a working minority in order to avoid political instability until end of 2022. A key test would be the approval of the budget revision law before end-June. Fitch notes that current political uncertainty might prove challenging for the government to deliver milestones required for the second tranche of RRP, as 22 reforms including anti-corruption laws need to be passed by the end of the year, requiring political commitment to tackle these issues. The first review of the milestones and targets will take place in 3Q22, with little risk of targets being missed, which would release the first disbursement of EUR 1.4 billion (around 2% of GDP) in 4Q22. Delay in meeting milestones poses risks to completion of the programme and could complicate medium-term fiscal plans.

Budget Revision Amid Inflation Shock: In response to inflation and energy price shock, the government proposed a budget law revision that foresees a set of support measures worth around BGN2.1 billion (2.0% of GDP). Next to VAT rate cuts on some products, increase of tax relief for families and fixed compensation for fuel prices, the plan envisages a two-stage pension hike. If the budget revision is approved in June, pensions will be raised by 10% in July, while the anti-Covid-19 bonus of BGN60 will be permanently included in the pension size. The second increase, due in October, plays a more important role as it aims at reducing inequalities between the pensioners. The total budget cost of pension hikes for this year is expected to be BGN1.4 billion.

Deficit to Widen, Public Debt Below Peers: Fitch forecasts the deficit to widen to 4.9% of GDP in 2022, from 4.1% of GDP in 2021, driven predominantly by support measures. In our view, the government deficit will narrow to 2.9% of GDP in 2023 as expenditure pressures recede. Despite wider deficits expected in the medium term and the post-pandemic increase in debt, Bulgaria's public debt ratio will remain very low compared with EU countries and 'BBB' peers (current 'BBB' median: 55.9%). The government intends to benefit from still low financing costs this year and will aim to pre-finance a large 2023 Eurobond redemption, which will add to increase of public debt level this year. Nevertheless, Fitch expects the public debt/GDP ratio to remain below 30% within the forecast horizon.

External Finances: We expect the current account deficit (CAD) to widen to 2.6% of GDP (from 0.4% of GDP in 2021) owing to the trade and primary income deficits. Although export growth reached a high double-digit dynamic in 1Q22, it was outpaced by import growth. The latter was led by strong domestic demand and soaring international energy prices. The capital and financial accounts will be supported by projected increase in capital transfers from the EU as well as steady FDI inflows, which will keep the net external creditor position at about 30% of GDP in 2022-23 (vs. current 'BBB' median: 4.4%). Despite a foreseen temporary deterioration in current account dynamics, external finances remain Bulgaria's rating strength and a factor that has helped reduce macro vulnerabilities.

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. 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 56th percentile, reflecting a history of unstable coalitions, relatively high perceptions of corruption and moderate institutional capacity versus track record of peaceful transitions and above average regulatory quality.

RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
-External Finances: A significant delay in the timeline of eurozone accession due, for example, to adverse policy developments or a deterioration in macroeconomic conditions.

-Macro: A large adverse macroeconomic shock, for example due to energy rationing in Europe, which would materially lower medium-term growth prospects compared with Fitch's current expectation.


Factors that could, individually or collectively, lead to positive rating action/upgrade:
-External Finances: 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 and/or effective use of EU funds."

Fitch also said it removed the -1 notch in macro to reflect its view that despite long-term structural challenges (mainly an ageing population), the economy has shown resilience to both the pandemic and the war in Ukraine without significant scarring.

In a separate statement earlier last week, the US ratings agency's affiliate Fitch Solutions said it downgraded Bulgaria’s score in its Short-Term Political Risk Index (STPRI) to 62.5 from 64.8 to indicate increased stability risks as the ruling coalition lost its majority in the Bulgarian national assembly.

With the populist There is Such a People (TISP) party leaving the coalition last week, the government led by Petkov's party We Continue the Change (WCC) now holds 109 out of 240 seats in parliament, with 121 votes needed to defeat the motion of no confidence."

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