US embassy cable - 05SOFIA1925

UNCLAS SECTION 01 OF 03 SOFIA 001925 
 
SIPDIS 
 
USDOC FOR 4232/ITA/MAC/EUR/OEERIS/SAVICH 
TREASURY FOR ALIKONIS 
 
E.O. 12958:  N/A 
TAGS: ECON, EFIN, ELAB, PGOV, SOCI, BU 
SUBJECT: 2006 BUDGET PROMISED INCREASED SOCIAL SPENDING 
BALKS AT IMF PRIORITIES 
 
 
1. (SBU) SUMMARY:  The Bulgarian government approved on 
October 31 the consolidated draft budget for 2006, which is 
now undergoing Parliamentary committee hearings.  The 
government plans a balanced budget and introduces a package 
of measures aimed at sustaining strong economic growth.  The 
budget proposes a cut in the social security taxes of six 
percent, provides real tax relief for low income citizens 
and increases public wages and pensions.  While balanced, 
the budget will increase social expenditures by 900 million 
Bulgaria leva (about USD 600 million) or 15 percent and 
expand the government's spending to more than 40 percent of 
GDP.  This and other elements of the budget have led to 
concern by the IMF about Bulgaria's external vulnerabilities 
(a widening current account deficit and increased foreign- 
debt-to GDP ratio).  The fund is calling for a budget 
surplus of 3 percent and would like to see the annual credit 
growth rate for 2006 at held to 15 percent.  End Summary. 
 
A BUDGET OF PRO-GROWTH POLICIES AND SOCIAL RESPONSIBILITY 
--------------------------------------------- ------------ 
 
2.  (U) The 2006 draft budget assumes GDP growth will remain 
strong next year at 5.5 percent and inflation low (4.9 
percent).  Included in the budget are measures aimed at 
sustaining strong economic growth such as reducing social 
security insurance by six percent (from 42 percent to 36 
percent); keeping the relatively low corporate profit tax at 
15 percent (but streamlining administration and collection 
procedures); and increasing capital expenditures to foster 
public-private projects.  Finance Minister Plamen Oresharski 
hopes the additional 600 million Bulgarian leva (USD 400 
million) injected into the economy by the social security 
cuts will help stimulate new investments, create new jobs, 
increase salaries and further legitimize labor market 
relations.  Economic growth will further be supported by 
reductions in the personal income taxes of low income 
groups, which will leave an additional 200 million Bulgarian 
leva or USD 133 million in consumers' pockets. 
 
3. (U) Prime Minister Stanishev, who could not realistically 
deliver on many of his party's generous election promises, 
has still placed a special emphasis on social policy with a 
focus on reforms to the personal income taxation, public 
sector salary increases (six percent) and the indexation of 
pensions (leading to an increase of five percent).  The 
thrust of the government's social program is a change in the 
structure of the personal income tax brackets and raising 
the amount of non-taxable income.  It includes simplifying 
the progressive income tax by cutting the four income tax 
brackets to three and raising the non-taxable monthly income 
threshold by almost 40 percent, from 130 Bulgarian leva (USD 
87) to 180 Bulgarian leva (USD 120).  The monthly minimum 
wage will be increased by seven percent to 160 Bulgarian 
leva (USD 107). 
 
BALANCED BUDGET BUT REVENUES AND EXPENDITURES ARE RISING 
--------------------------------------------- ------------ 
 
4. (U) The government's stated policy is to maintain fiscal 
responsibility and macroeconomic discipline through a 
balanced budget.  However, the new budget does little to 
lower the government's overall role in the economy or 
realistically estimate the amount of expected revenues. 
Both revenues and expenditures will increase to 40 percent 
of GDP. 
 
5. (U) The cabinet is continuing the tradition of 
underestimating expected budget revenues.  Past governments 
also have initially planned for less revenues only later to 
"discover" a windfall of state money which they can then 
allocate outside of the budget approval process.  In the 
latest budget, state revenues are expected to reach 18.3 
billion Bulgarian leva (USD 12.2 billion) in 2006.  However, 
given the over-performance of revenues in 2005, the 
projected inflation rate of 4.9 percent and the GDP growth 
rate of 5.5 percent, the state should be projecting at least 
10 percent higher revenues, according to the Institute for 
Market Economics (IME).  Economists calculate that budgetary 
revenues will top 20 billion Bulgaria leva (USD 13.3 
billion) in 2006, which will constitute 43 percent of GDP. 
 
6.  (U) Despite the income tax cuts, the total tax burden is 
still set to rise by 82 million Bulgaria leva (USD 51 
million).  With the increasing of excise taxes toward 
minimum EU levels, indirect tax revenue alone is projected 
to increase by 33 percent next year relative to 2005. 
Excise duties also will rise for gasoline, cigarettes and 
alcohol. 
 
7.  (U) The substantial increase in public spending next 
year guarantees the government an even larger role in the 
economy's direction.  Total spending, including municipal 
budgets, will increase by 1.8 billion Bulgarian leva (USD 
1.2 billion) or 11 percent.  At the same time, however, the 
government has introduced a reform that would limit its 
authority to spend surpluses to 1.5% of GDP without 
Parliamentary consent.  The bulk of next year's public 
expenditure increase is concentrated in the social sphere 
(i.e., social assistance and care).  Indeed, the proposed 
state budget embodies a strong commitment to social 
services.  An extra 900 million Bulgarian leva (an increase 
of 15 percent from 2005) will be devoted to pensions, social 
assistance and compensation, employment programs etc.   This 
surge in social spending has been sharply criticized by 
former Finance Minister Milen Velchev, who claims the budget 
does not adequately address the much needed structural 
reforms in priority sectors such as education, health and 
infrastructure development despite the availability of 
financial resources. 
8.  (U) Key budgeted expenditures for 2006 include: 
-- 6.9 billion Bulgarian leva (USD 4.6 billion or 15 percent 
of GDP) for social security and welfare, an increase of 15 
percent; 
-- 2.3 billion Bulgarian leva (USD 1.5 billion or 5 percent 
of GDP) for defense and security, an increase of 12 percent; 
Defense spending is fixed at 1.1 billion Bulgarian leva (USD 
675 million or 2.38 percent of GDP); 
-- 2.1 billion Bulgaria leva (USD 1.4 billion or 4.6 percent 
of GDP) for economic activities and services, an increase of 
18 percent; 
-- 2 billion Bulgaria leva (USD 1.3 billion or 4.4 percent 
of GDP) for health care, an increase of 12 percent; 
-- 1.9 billion Bulgarian leva (USD 1.3 billion or 4.2 
percent of GDP) for education, an increase of 9.6 percent; 
and 
-- 300 million Bulgarian leva (USD 200 million or 0.7 
percent of GDP) for flood relief. 
 
9.  (U) The budget also aims at better utilization of the EU 
pre-accession assistance and commits to a substantial 
increase in government spending on EU co-financed projects. 
The EU has approved a total of 337 million euro in pre- 
accession assistance for Bulgaria in 2006.  The government's 
commitment is to spend 125 million euro, an increase of 48 
percent relative to 2005, on projects involving EU pre- 
accession aid. 
 
IMF AND BULGARIA AT ODDS OVER TIGHTER TARGETS 
--------------------------------------------- - 
 
10.  (U) The recent IMF Mission to Bulgaria did not succeed 
in completing the second review under the precautionary 
stand-by agreement.  The sides failed to reach an agreement 
on Bulgaria's fiscal policy and additional measures in 
response to the country's external vulnerabilities.  The IMF 
discussions will resume in December, however, the proposed 
2006 budget could turn into a major rift.  While the 
government is planning on balancing the budget for next 
year, the IMF has called for a budget surplus of 3 percent 
of GDP in view of the dramatic widening of the current 
account deficit.  Bulgaria's current account deficit is 
approximately 13 percent of GDP and threatens to reach 14 
percent of GDP by year's end.  This would place Bulgaria's 
current account deficit among the highest in the world on a 
percent of GDP basis.  The budget assumes the current 
account deficit will be reduced to 6.8 percent by 2008. 
 
11.  (U) The IMF's push for more radical fiscal tightening 
in 2006 is part of a twofold strategy to steer Bulgaria away 
from its looming external vulnerabilities: an excessively 
high current account deficit and increasing gross external 
debt ratio (62 percent of GDP).  Also left unresolved is the 
credit growth target rate.  Both sides have agreed on the 
necessity of restraining credit growth in 2006 to curb 
domestic demand, but Bulgarian central bankers would like to 
see credit growth at 16-20 percent while the IMF seeks a 
fixed credit growth rate of 15 percent. 
 
THE REACTION OF EMPLOYERS AND LABOR 
------------------------------------ 
 
12.  (U) Employers praised Stanishev's planned cut in social 
security payments and strongly opposed the IMF request for 
tighter fiscal policy.  A recent survey indicates that most 
employers plan on increasing employees' salaries as a result 
of the social security cuts.  Some employers reportedly will 
use the extra cash for extending production, training and 
modernization. Labor leaders, on the other hand, are less 
happy about the draft budget. The leader of one of the main 
labor unions argued the draft budget gives more concessions 
to business than labor.  According to the Confederation of 
Trade Unions in Bulgaria (CITUB), the changes in the tax 
policy are minor, underlying government's unwillingness to 
undertake more decisive reforms.  The tax changes will 
neither stimulate business activities nor raise the standard 
of living, according to CITUB leadership.  One positive 
step, however, is the zero taxation of transport expenses 
for workers and employees and the reduction of the rate of 
taxation of social expenses for food and recreation to 12 
percent. 
 
COMMENT 
-------- 
 
13. (SBU) Despite lavish electoral promises, Stanishev's 
cabinet has succeeded in balancing the budget while strictly 
following the timeline for year-end approval.  These 
accomplishments are particularly noteworthy given the 
Socialists' poor record in following the budgetary timeline 
and formulating sound budgetary framework. Memories are 
still fresh here of the last Socialist-led cabinet which was 
driven from office in 1997 after bringing the economy to the 
brink of collapse.  Every government since then has 
concentrated on a tight fiscal policy with near-balanced 
budget.  With its stable economy and solid foreign exchange 
reserves, Bulgaria is resisting certain IMF demands in its 
attempt to improve the overall standard of living.  END 
COMMENT. 
 
BEYRLE