S&P Places Bulgaria's Rating on Negative Watch on Heightened External Vulnerabilities

"Bulgaria's economy had been overheating when it entered the current period of credit market turmoil," the agency said in a statement.

"In the eight months through to August, the country's current account deficit reached 14% of [the gross domestic product] GDP. In August, inflation was running 11% year-on-year (yoy), and domestic claims on the non-government sector grew 48.3% yoy, while current account receipts do not match gross external financing needs," it added.

The rating agency warned that the country faces the risk of an abrupt decline in external financing as foreign direct investments, which fully covered the current account shortfall, are decreasing as the property and construction sectors suffer.

"Bulgaria's financial system is dominated by foreign banks, and given the current market conditions, some of the banks may be reluctant to add to their existing cross-border exposure, leading to a slowdown in credit growth," S&P said, adding that although a sudden stop to external financing would lead to a contraction of the current account, the recessionary impact could hurt bank asset quality and test the resilience of the government's fiscal position, which is a credit strength for Bulgaria.

The agency expects the country's general government surplus to exceed 3.5% of GDP in 2008, general government debt to reach 15% of GDP, and liquid fiscal assets to rise to around 17% of GDP.

"A resolution of the CreditWatch action is likely this month pending further information from the sovereign regarding its response to the intensifying pressures resulting from external imbalances," it said.