For the detailed rating report, click here.

Scope Ratings has today affirmed the Republic of Bulgaria’s long-term local-currency and foreign-currency issuer ratings at BBB and revised the Outlook to Positive. The sovereign’s ratings of BBB for senior unsecured debt in local and foreign currency are also affirmed, with the Outlook revised to Positive. The short-term issuer ratings have been affirmed at S-2 in both local and foreign currency with a Stable Outlook.

Rating drivers

The drivers for the Positive Outlook on Bulgaria’s long-term ratings reflect: i) the sovereign’s low and declining general government debt ratio, and favourable debt profile; ii) a commitment to reform, including the addressing of banking system vulnerabilities; iii) the significant boost to reserve coverage ratios, critically supporting the nation’s currency board exchange rate regime; and iv) declines in the external debt ratio and improvements in the net international investment position. In Scope’s assessment, these collective credit strengths outweigh the still meaningful challenges stemming from the economy’s vulnerability to shocks as a small, open economy, high (though decreasing) levels of private sector debt, financial system risks, the restrictions on the Bulgarian National Bank (BNB) in serving as the lender of last resort, and institutional concerns.

The first driver underpinning Scope’s decision to raise Bulgaria’s Outlook is the strength of the country’s public finances. In 2017, Bulgaria recorded a budget surplus of 0.9% of GDP on a cash basis, exceeding expectations. This represented a sharp consolidation since 2014, when the cash balance was -3.7% of GDP. While the 2018 budget envisions the cash balance reverting back to a deficit of 1% of GDP (0% of GDP on an accrual basis), reflecting increased public investment, the revised medium-term budget framework sees this easing back to a balanced position by 2020.

The government’s balance sheet incorporates a low and declining debt ratio, sizeable fiscal reserves and a favourable debt structure. Bulgaria’s gross public debt ratio stood at 25.4% of GDP as of Q4 2017, slightly under 2016 peaks. Going forward, the IMF projects that the debt ratio will decline slowly to 19% of GDP by 2023. Accounting for Bulgaria’s sizeable fiscal reserves, government debt net of fiscal reserves stood at 15% of GDP as of Q4 2017. In addition, Bulgaria’s debt has a long average residual maturity of about 7.8 years, with almost the entire stock on fixed rates.

The second driver of the outlook change is a commitment to reform. Following the 2014 banking scandal, Bulgaria has taken steps including an Asset Quality Review and stress test on the financial system, the initiation of reforms to the supervision of the Bulgarian National Bank, the introduction of a new bank resolution authority and the proactive request and implementation of recommendations from an IMF Financial Sector Assessment Program. Moreover, cross-party support for Europe and for entry to the pre-euro Exchange Rate Mechanism II (ERM II) instils a level of prudence into pro-growth policymaking, facilitating income convergence alongside fiscal discipline, institutional improvements and the maintenance of external stability.

The third driver supporting the Positive Outlook is the boost to reserve coverage, which bolsters the stability of the nation’s currency board exchange rate regime. Bulgaria’s currency board fix of 1.96 levs to the euro was introduced after a 1996-97 banking crisis, and has brought policy discipline, lowered inflation and interest rates, and prevented further bouts with the hyperinflation experienced in the 1990s. At the same time, it places significant constraints on the central bank. The credibility of the fixed exchange rate is supported by the central bank’s reserve accumulation, with foreign exchange reserves totalling USD 25.1bn as of March 2018, up from USD 15.1bn in January 2015. In combination with the effects of debt deleveraging, forex reserve coverage of short-term external debt amounted to 2.6x as of February 2018, almost doubling from 1.4x as of January 2015, and compared to under 1.0x between 2008 and 2011.

The final reason for the outlook change are improvements in Bulgaria’s external position. Bulgaria's current account balance showed a 2017 surplus of 4.5% of GDP – an enhancement on a balance of -0.0% of GDP as of 2015. Scope is mindful that Bulgaria’s current account is volatile, however, and in the long run, the IMF expects the current account surplus to revert back towards a balanced position. Bulgaria has a net international investment position of -40% of GDP as of Q4 2017, up from -98% of GDP in Q2 2010. Here, gross external debt has declined to 66% of GDP as of Q4 2017, from over 100% of GDP in early 2010. These developments strengthen resilience to balance of payment shocks.

Bulgaria’s economy has experienced a recovery, with real GDP growth accelerating to 3.9% and 3.6% in 2016 and 2017. This month, the IMF revised its projection for Bulgaria’s growth in 2018 to 3.8%, up from 3.2% in the October forecast, and for 2019 growth to 3.1% from 2.9%. However, Scope expects medium-run potential growth to average a more modest 2.25% – implying an easing of growth over time compared with the present, as the labour market nears full employment and elevated real wage growth tempers. Lower potential growth reflects supply-side bottlenecks due to a rapidly declining and ageing population.

In contrast to these factors, Bulgaria’s ratings are restrained by the country’s low GDP per capita (USD 8,064 in 2017) and small economic size (with nominal GDP of USD 57bn), which, in combination with its economic openness, make Bulgaria vulnerable to idiosyncratic as well as global shocks. In addition, domestic non-financial private debt remains high, at 217% of GDP as of Q4 2017. This partially reflects high inter-company lending. Financial stability risks and sources of contingent liabilities are key weaknesses constraining Bulgaria’s sovereign ratings. While the banking system’s profitability, capital levels and liquidity have improved, two banks identified in the 2016 Asset Quality Review and stress test still require additional capital and new investment. Moreover, measures are also necessary to improve bank supervision and regulation, and reduce non-performing loans.

According to the currency board, the BNB’s ability to act as a true lender of last resort is restricted. This is a rating constraint, although amendments to the Public Finance Act attempt to remedy this to an extent. The BNB can provide liquidity support to the banking system only to the degree that reserves exceed monetary liabilities. In addition, Bulgaria has middle-range scores on institutional measures, such as the World Bank’s Worldwide Governance Indicators, and somewhat weaker scores than ‘bbb’ sovereign peers. Bulgaria’s history of unstable governments represents a rating constraint as this restricts continuity in reform drives, raises incentives for populism which weighs on the fiscal balance sheet, reduces the capacity for long-term economic planning, and undermines the business environment and investor confidence.

Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative “BBB” (“bbb”) rating range for the Republic of Bulgaria. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis.

For Bulgaria, the following relative credit strengths are identified: i) economic policy framework; and ii) good resilience to short-term external shocks. Relative credit weaknesses are signalled for: i) current account vulnerabilities; ii) recent events and policy decisions; and iii) macro-financial vulnerabilities and fragility. The combined relative credit strengths and weaknesses indicate a sovereign rating of BBB for Bulgaria. A final rating of BBB was assigned to the Republic of Bulgaria.

For further details, please see Appendix 2 of the rating report.

Outlook and rating-change drivers

The Positive Outlook reflects Scope’s view that risks to the ratings are skewed to the upside over the next 12 to 18 months.

The ratings could be upgraded if: i) Bulgaria maintains a prudent fiscal policy, leading debt ratios on a clear downward trajectory; ii) significant reforms to banking supervision continue in line with the IMF’s Financial Sector Assessment Program; iii) improvements in reserve coverage ratios are preserved and/or further built upon; and/or iv) private sector deleveraging continues and a robust current account surplus is sustained, reducing external and private sector imbalances.

Alternatively, the outlooks could be returned to Stable if: i) there is renewed stress in the banking system or private sector debt risks re-arise; ii) Bulgaria’s fiscal balance deteriorates significantly, compromising anticipated improvements in the public debt ratio; iii) the current account surplus moderates significantly or measures of external resilience worsen; and/or iv) institutional challenges re-arise.

Rating committee

The main points discussed by the rating committee were: (1) Bulgaria’s economic performance and outlook; (2) fiscal performance and debt sustainability; (3) Bulgaria’s exchange rate regime and reserve coverage; (4) external debt and net international investment position; (5) banking system reforms and fragilities; (6) institutional weaknesses; and (7) peer considerations.

Methodology

The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com.

The historical default rates used by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default and definitions of rating notations can be found in Scope’s public credit rating methodologies at www.scoperatings.com.

The rating outlook indicates the most likely direction in which a rating may change within the next 12 to 18 months. A rating change is, however, not automatically a certainty.

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Rating prepared by Dennis Shen, Lead Analyst
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director, Public Finance
The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The ratings/outlooks were last updated on 03.11.2017.
The senior unsecured debt ratings as well as the short-term issuer ratings were last updated by Scope on 03.11.2017.

Solicitation, key sources and quality of information
The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.
The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: IMF, Bulgarian National Bank, Bulgaria’s National Statistical Institute, Ministry of Finance of the Republic of Bulgaria, Eurostat, European Commission, United Nations and Haver Analytics.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Conditions of use / exclusion of liability
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