1. BULGARIA in 2015 Charles Robertson, Chief EMEA economist
Elena Ganeva, Research Analyst
Best EMEA economics team 2004 Institutional Investor (March 2004)
October 2005

2. A presentation in two parts
Part I EU entry, Euro adoption and an exit strategy
Part II Investing in the future

3. New Europe 2005 EU members 2004 EU members 2007
Estonia 2004
Latvia 2004
Lithuania 2004
Poland 2004
Czech Republic
2004
Slovakia
2004
Hungary 2004
Slovenia
2004
Croatia 2010+
Romania 2007
Bulgaria 2007
Turkey 2014+
EU members 2004
EU members 2007
In EU negotiations since 2005
Possible EU candidates
Not EU candidates

4. EU accession, the Euro and exit strategies
EU entry 2007 and
Euro adoption 2010
Exiting the currency board into the euro
Bulgaria has an exit strategy: euro adoption by 2010 – around the same time as Hungary, Poland, Czech Republic and Slovakia.

5. Timing: The EU and the Euro
Entry applicatio ns
Negotiatio ns begun
EU entry
ERM membership
Euro adoption
Currenc y
Regime
Central parity rate
EU MEMBERS (since 1960) and those in negotiations
Denmark
1961/67/71
1973
1979?
Kroner
ERM peg to euro with 2.25% bands
7.46
Ireland
1961/67/72
1979
1999
Euro
N/A UK
(Oct 90-Sep 92)
Pound
Free-float
Greece
1975
1976
1981
Mar-98
2001
Spain
1977
1986
Jun-89
Portugal
1978
Apr-92
Austria
1989
1993
1995
Jan-95
Sweden
1991
Krona
Finland
1992
Oct-96
Cyprus
1990
1998
2004
Apr-05
ERM Peg to euro 15% bands
0.585
Czech Republic
1996
Koruna
Free-float with euro reference
Estonia
Jun-04
Kroon
ERM currency board to euro
15.65
Hungary
1994
Forint
Peg to euro with 15% bands
282.0
Poland
Zloty
Slovenia
2007
Tolar
239.6
Malta
1990/98
2000
2008
Lira
0.429
Latvia
Lat
0.703
Lithuania
Litas
3.45
Slovakia
2006
2009
Managed float with euro reference
Bulgaria
Jan-07
1H 2007
2010
Lev
Currency board to euro
1.96
Romania
2008+
Leu
Managed float to euro
NOT IN NEGOTIATIONS
Croatia
2003
2010+
2013+
Kuna
Managed float vs euro
Turkey
1987
2005
No (2014)
No (2015)
No (2018)
Albania
2011
2015+
2017+
Lek
Macedonia
Denar
Tightly managed float vs euro
Bosnia
2013
Marka
Serbia
Dinar
Montenegro
(Deutschemark adopted as only legal tender in Nov 2000) 1
Ukraine
2020+
Hryvnya
Managed float vs US dollar
Italics = forecasts
Source: EU Commission, ING

6. What is convergence?
Convergence is an over-used term. Initially it referred simply to convergence to the Maastricht criteria, with implications for bond and equity investors resulting from converging interest rates to low German levels.
But, convergence has also been associated with political, regulatory and macro-economic convergence towards west European levels.
We are confident that Bulgaria and Romania are convergence countries; Turkey and Ukraine also offer potential convergence gains if they join both the EU and Euro.

7. External debt compression
In 2002 Bulgaria paid up to 4pps more than Germany to borrow on the international capital markets, now it pays less than 50bp more
Over a two- year time horizon Bulgaria should trade through current new EU members like Poland or Hungary as it is likely to adopt the euro earlier
Today 10Y Eurobonds of the new EU member states trade at some 20bps over Bunds, 10-15bps tighter than a year ago

8. Maastricht criteria Criteria cannot be met before 2008
Timetable - How quickly after EU entry can a country join the Euro
€ minus 2+ years Join ERM - possible only after EU entry (eg, Jan-Feb 2007)
€ minus 12 months Budget/debt criteria (eg, 2008)
€ minus 7-11 months CPI/interest rates criteria (eg, mid-2009)
Enter € (eg. 1 Jan 2010)
Exchange rate mechanism (ERM) membership for two years. Note Estonia joined in June 2004, less than two months after joining EU in May 2004.
The budget deficit must be no more than 3% of GDP.
Long-term (ten-year) interest rates must be within 2% of the average of the three EU countries used in inflation criterion – this will be done by the markets whenever they see EU entry as credible.
Inflation within 1.5% of the best three EU countries record on price stability (ie, around %).
Government debt (internal and external) must be no more than 60% of GDP, or falling towards this level.
Central bank must be independent.

9. Maastricht criteria - public debt Public debt – an easy one
Government debt (internal and external) must be no more than 60% of GDP, or falling towards this level.
Both first and subsequent EU enlargement countries tend to have low debt (public debt, external and internal), decreasing the risks of a financing crisis, with the exception of Turkey.
In , all central/east European applicants had a public debt to GDP ratio below the 60% level, unlike the Eurozone, where the average ratio was 70% of GDP in 2004 (half the Eurozone was below 60%).

10. Maastricht criteria – long bonds
10Y local spreads over bunds – when the market believes it happens
Long-term (ten-year) interest rates must be within 2% of the average of the three EU countries with the lowest inflation - the markets do this when they see euro entry as credible. Italy, Spain and Portugal all met this criterion in early 1997, one full year before it was necessary.
However, we can see volatility in the meantime. In central Europe, spreads were around 200bp in , but have since risen to above 400 in Hungary.
Bond yields in Bulgaria are already close to Eurozone levels because of currency board arrangement

11. Maastricht criteria – budget deficit Budget deficit – more difficult – will governments do it?
The budget deficit must be no more than 3% of GDP. Unlike Italy or Greece, candidate countries do not have very high debt levels and apart from Hungary, they do not pay high interest rates either. So less easy to cut the deficit simply via fall in interest rates. But growth is faster than it was in EU in mid-1990s.

12. Maastricht criteria Inflation – only needs to be met once
Inflation within 1.5% of the three EU countries showing best price stability (this excludes deflation countries) so on past precedent the range could be %

13. Maastricht criteria CPI Part II
Many countries joining the EU have lower inflation than existing Eurozone inflation countries, we urge the EU to only consider the Eurozone countries when setting the inflation and long-bond criteria.

14. 2007-15: EU entry and its effects
While financial markets focus on euro adoption – and falling interest rates/currency stability – as the biggest consequences of EU enlargement, Bulgaria already has low interest rates and a stable currency. Euro adoption will secure these gains, but the boost to Bulgaria may be less than elsewhere.
However, EU enlargement and euro adoption is not just an issue of interest rates. Other gains include:
Free movement of labour – likely to improve from 2007 and be free of restrictions by
Recognition of qualifications.
For the economy, the benefits include:
Huge EU transfers to the Bulgarian economy.
Free trade and cheap wages encouraging investment.
In addition, we can assume continuation of the lending boom.

15. New Europe 2015 EU members 2004 EU members 2007
Serbia 2015+
FYROM
Turkey 2014+
EU members 2004
EU members 2007
In EU negotiations since 2005
Possible EU candidates
Not EU candidates

16. Bulgaria may receive €2bn annually by 2015
One big benefit of joining the EU is the money that comes from EU membership - usually 3-4% of GDP each year for the poorest members. EU GDP was €9,324bn in 2003 and the EU budget was €100bn but EU spending on new countries was only €4bn (Bulgaria received roughly €0.4bn).
But in 10 years time, perhaps €40bn of the €160bn EU budget (1% of 2015 EU GDP), will be spent on new countries.
If Bulgarian GDP in 2010 is €33bn, then 3% of GDP would imply €1.0bn annually. If Bulgarian GDP in 2015 is €47bn, then 4% of GDP would imply €1.9bn in annual flows – just over 1% of the EU budget.
This flow - via the current and capital account - will boost infrastructure and growth.

17. Fitting into the EU How big are these countries’ % of EU27 GDP/population in 2004
Receiving 1% of the budget would be much larger than Bulgaria’s economic weight would suggest - which in 2004 was just 0.2% of EU-27 GDP. However, with 2% of the EU population, 1% of the budget is arguably less than it should receive.
The government can use its population weight in EU voting, to help win EU financial support.

18. Fitting into the EU - Politically Number of votes each country has/will have in the EU Council
In 2007 when Bulgaria enters the EU, new EU members will account for 22% of the population, 32% of the votes (based on the Nice treaty - see left) … and 32% of the EU budget?
Bulgaria will have 2.9% of the EU votes … 2.9% of the EU budget in 2007 could be €2.7bn
Current EU constitution requires 55% of countries with 65% of population to approve. Proposed but not ratified changes suggested majority voting instead. (Bulgaria – 1 of 27 countries means 4% of EU votes, but this is influenced by the 2% weight of population)

19. Investment via the banking sector Increasing indebtedness, Greece from 34%/GDP to 74%/GDP
Until the late 1990s it was not possible for households to be indebted, and lending to corporates was unsafe and sometimes politically motivated.
Lending fell sharply after 1996, but is now growing strongly, up 10% of GDP in just 2004 alone.
The credit boom will be the single biggest factor driving economic growth in the next 5 years, but also a factor widening the current account deficit. The government must aim to compensate for this by reducing its debt level.

20. It is a healthy banking sector
Bulgaria has a healthy financial sector. Privatisation has brought in significant funds for Bulgaria, helping offset the current account deficit. Foreign ownership has also brought in expertise and advanced banking products. Foreign banks are less likely to suffer liquidity squeezes as they have easy and relatively cheap access to funds.

21. Wages data – 2004 and 2005 implied
Wages in Bulgaria are roughly 10% of the level in the EU, and 35-40% of the levels in central Europe. In nominal terms, the difference in wages between the EU and Bulgaria is now 25 Euros per hour, compared to 22 Euros per hour in It has grown wider, making Bulgaria relatively more attractive than previously.
Wages have risen to 2 Euros per hour in Bulgaria, up 45% over four years. While rapid, it is slower than rises in central Europe of up to 85% in Hungary.
With central Europe now in the EU, foreign direct investors start looking farther afield for cheap manufacturing bases for Bulgaria.
However, investors also go to countries with the best infrastructure and this is where EU cash is vital for Bulgaria.

22. Implied PPP currency over/undervaluation
PPP implies stable/stronger currencies
Implied PPP currency over/undervaluation
Lastly it is worth noting that the currency does not appear to be overvalued.
ING’s own purchasing power parity basket of goods (23 imported and local products) shows how much lower prices are in Sofia, Warsaw, etc compared to Madrid in Spain, a relatively cheap EU member state.
With prices in Sofia for these goods 27% cheaper than in Madrid, the currency does not look overvalued.

23. Conclusions
Keeping fiscal policy tight is the best way to support growth
Responsible fiscal policies have allowed Bulgaria to reduce debt levels, both external debt and public debt levels, contributing to falling interest servicing costs.
The EU accession process has also been supportive and remains so.
Prospective euro adoption in 2010 should ensure debt servicing costs will continue to fall, while also providing an “exit strategy” for Bulgaria.
EU accession means big financial transfers to Bulgaria, helping the balance of payments while boosting investment and making Bulgaria more attractive for FDI.
A healthy privatised and foreign owned banking sector should boost consumption and investment, fuelling growth.
Cheap wages and free trade with the EU should see Bulgaria further integrate in the EU economy and attract more foreign direct investment.
But future stability requires governments to stick to the responsible fiscal policies of recent years and try to restrain the current account deficit.

25. EU – less forgiving political climate
The risk of delay is some 20% for Bulgaria and 35% for Romania
Romania and Bulgaria hope to enter EU in 2007
Safety clauses that could delay the entry till 2008 concentrate on
Justice
Environment
Home affairs
October EU report will shed some light on the likely entry dates but the final decision will likely be taken in 2006
From economic point of view the result of delayed EU accession is not necessarily a clear cut – less money from convergence funds but one more year to prepare better.

26. Population 2004
Population can give some idea of potential. The great untapped markets in EMEA appear to be outside the 1st convergence group, like Ukraine and Egypt.
Each square represents 1.5m people.

27. GDP 2004
This map shows EMEA countries in terms of GDP, with each square worth US$4bn.
The disproportionate size (compared to population) of the new EU entrants highlights the positive impact of convergence on GDP.
Note France’s nominal GDP in 2004 was around US$2,050bn, similar to the US$2,111bn total.