Fitch affirms Bulgaria at BBB-, outlook stable

The issue ratings on Bulgaria's senior unsecured foreign and local currency bonds have also been affirmed at BBB- and BBB, respectively, while the country ceiling has been affirmed at BBB+ and the short-term foreign currency IDR at F3, the rating agency said in a statement on Friday.

Fitch Ratings also said in the statement:

"KEY RATING DRIVERS
The affirmation and Stable Outlook reflect the following factors:

Public finances have taken a negative hit in 2H14, but on aggregate compare favourably with rating peers. 2014's fiscal deficit is projected to be close to 3.5% of GDP, bringing it above the budget target of 1.8%, and temporarily, the 'BBB' median of 2.7%, but below the 'BB' median of 3.9%. For 2015-2017, Bulgaria's government will target expenditure-driven fiscal consolidation, with the aim of reducing the headline fiscal deficit by 0.5pp annually. Fitch also projects a declining fiscal deficit. However, based on our expectation of weaker economic growth relative to the government's forecasts, we expect an average reduction of 0.3pp annually.

The impact of 2014's wider-than-expected fiscal deficit, on top of additional borrowing to provide liquidity support to Bulgaria's banking sector and replenish the Deposit Guarantee Fund, is projected to increase gross general government debt in 2014 to 28% of GDP from 18.3% of GDP in 2013. Our medium-term projection now sees Bulgaria's debt-to-GDP ratio not peaking until 2019-2020 at around 34.5% of GDP, well above our previous baseline for debt to peak around 23% of GDP by 2017-2018, but still below the median 40% debt ratio of 'BBB' and 'BB' peers. Fitch still views the sovereign's relatively low level of indebtedness, supportive of public finances, as a rating strength relative to peers, although it is diminishing as the debt ratio moves higher. The biggest risks to Bulgaria's debt-to-GDP trajectory include a lack of commitment to fiscal consolidation or further support for the banking sector, neither of which are incorporated into our baseline.

Bulgaria's banking sector has stabilised since being targeted by substantial bank runs in June 2014. Fitch considers both the release of depositors' assets of collapsed Corporate Commercial Bank (CorpBank) on 4 December (unavailable to depositors following the placement of CorpBank under special supervision on 20 June 2014), and the extension of First Investment Bank's (FiBank) BGN900m credit line to the state until May 2016, will support banking sector stability at least in the near term. These events have not proven to be systemic in nature. On the contrary, Bulgarian banks have continued to deleverage (loan-to-deposit; 99.6%), increasing liquidity (liquid assets ratio; 29%) and capital buffers (average Tier 1; 20%).

Bulgaria's economic growth remains subdued compared with 'BBB' peers. Geopolitical risks from Russia and Ukraine and a still fragile eurozone recovery, have led Fitch to significantly revise down Bulgaria's 2015 real GDP growth forecast to 0.7% from July's 2.5%, after growth of 1.5% in 2014. Bulgaria is a highly open economy (trade openness 82% of GDP). Fitch does not expect Bulgaria to enter a prolonged period of deflation, although it is a material risk and could potentially hurt fiscal dynamics. Instead, we expect lower prices to support consumption activity in 2015, which should provide some inflationary stimulus, albeit at a very low level given the impact of weaker imported prices of global commodities.

Bulgaria's external finances are supportive of its ratings. The country's net external debt position has been on a sustained downward trajectory since peaking at 47.7% of GDP in 2009. The net external debtor position of non-financial corporates (NFC) remains high (51% of GDP; 2014), although the majority of it comprises intercompany lending (40% of GDP), is euro-denominated and of long maturities. Meanwhile, the sovereign has a strong net creditor position (26% of GDP; 2014), which lends adequate support to its existing currency board arrangement. Fitch also forecasts Bulgaria to maintain current account surpluses for 2015 and 2016.

Political uncertainty has abated somewhat with the formation of a new government in November 2014 following early elections in October. Bulgaria's new government coalition consists of election winners, centre-right Citizens for European Development, and right-wing Reformist Bloc, but given its minority status, it will rely on outside support from nationalist party Patriotic Front and leftist party Alternative for Bulgarian Revival. Policy mandates between all political parties are quite diversified, which risks creating an uncertain policy environment.

Bulgaria's ratings are constrained by structural bottlenecks, which continue to constrain stronger growth rates, and limits Bulgaria's convergence progress with western European standards of living. Bulgaria is amongst the poorest EU states. GDP per capita is below the 'BBB' median and 47% of the EU average.

RATING SENSITIVITIES
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main risk factors that, individually or collectively, could trigger negative rating action are:
- Significant fiscal slippage that threatens the long-term sustainability of public finances and pushes Bulgaria's public debt ratio above the 'BBB' median.
- Re-emergence of instability in the banking sector, which may increase pressure on government fiscal finances and economic growth.
- A negative economic shock that causes a material downward revision in medium-term GDP and inflation prospects.

The main factors that could, individually, or collectively, trigger positive rating action include:
- Credible fiscal consolidation that supports the long-term sustainability of public debt dynamics.
- Stronger trend GDP growth and progressive convergence towards average EU income levels.
- Sustained improvement in institutional governance and stability of the political environment, which encourages effective policy making.

KEY ASSUMPTIONS
Fitch assumes that Bulgaria's CBA will remain in place and that governments will continue to pursue policies consistent with it.

Fitch assumes that under severe financial stress, support for Bulgarian subsidiary banks would come first and foremost from their foreign parent banks.

Fitch assumes the eurozone will avoid long-lasting deflation, such as that experienced by Japan from the 1990s. Fitch also assumes the gradual progress in deepening fiscal and financial integration at the eurozone level will continue; key macroeconomic imbalances within the currency union will be slowly unwound; and eurozone governments will tighten fiscal policy over the medium term."