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Rating action

Scope Ratings GmbH (Scope) has today affirmed the Republic of Bulgaria’s BBB+ long-term local- and foreign-currency issuer and senior unsecured debt ratings and maintained the Outlook at Stable. The short-term issuer ratings have been affirmed at S-2 in both local- and foreign-currency with the Outlooks Stable.

Rating drivers

The affirmation of Bulgaria’s BBB+ investment-grade credit ratings is supported by the inclusion of the Bulgarian lev into the Exchange Rate Mechanism II (ERM II) in July 2020. The inclusion of the Bulgarian lev into ERM II reinforces a roadmap to adoption of the euro over a medium-run horizon, which, if or once achieved, is expected to significantly enhance Bulgaria’s level of institutional strength. In addition, the ratings affirmation reflects reduction of financial-system risk and significant reforms made in the area of banking-system governance, underscored by successful entry to the Banking Union in October 2020. Driven by euro convergence requirements, Scope expects continued reform commitment, including those impacting financial-system governance, under the next Bulgarian government following forthcoming snap elections to be held in July after no party was able to form a government after elections in April. Finally, Bulgaria’s BBB+ ratings are supported by low government debt levels and a record of prudence in fiscal policy making.

These credit strengths are balanced by challenges related to the economy’s vulnerability to shocks as a small, open economy. Moderate economic and fiscal deterioration has been observed during the Covid-19 shock, although the government deficit in 2020 was, nevertheless, the most modest of 14 central and eastern European economies rated by Scope. In addition, above-EU-average ratios of non-performing loans (NPLs) and the limited lender of last resort function of the Bulgarian National Bank (BNB), as well as institutional and demographic weaknesses represent credit constraints. Finally, forthcoming parliamentary re-run elections and presidential elections later in the year present uncertainties at this stage with respect to the post-election policy framework although, importantly, EU membership and euro-area accession hold consensus across the political spectrum.

The Stable Outlook reflects Scope’s view that risks to the ratings are balanced over the coming 12 to 18 months.

The ratings/Outlooks could be upgraded if: i) Bulgaria sustainably raises its economic growth potential, ensuring continued convergence with EU average incomes; ii) progress is made in addressing institutional challenges, such as the rule of law and the fight against corruption; and/or iii) additional reforms support resilience of the non-banking financial system and/or progress is made under other euro-area convergence priorities, in aggregate supporting steps towards euro accession.

Alternatively, the ratings/outlooks could be downgraded if: i) reform momentum as well as institutional convergence with the euro area weakens after coming elections, delaying the timetable for euro-area accession and weakening economic growth potential; ii) institutional challenges and/or political instability escalate(s); iii) fiscal discipline deteriorates and Bulgaria’s debt ratio continues to increase above expectations; and/or iv) there is stress in the banking system or measures of external-sector resilience weaken.

Rating rationale

First, the affirmation of Bulgaria’s sovereign credit ratings at BBB+ is anchored by the inclusion of the Bulgarian lev into the Exchange Rate Mechanism II in July 2020¹. Achievement of ERM-II participation represents a milestone in reduction of external-sector risk and has reinforced a clear roadmap to medium-run accession to the euro area, which Scope assesses as credit positive. Accession to Economic and Monetary Union would improve multiple rating-relevant areas, including monetary policy flexibility as well as strength of market access. The latter is due to Bulgaria issuing in euro as domestic currency after accession and associated reduction of foreign-exchange risk in Bulgaria’s outstanding primarily euro-denominated public debt portfolio in addition to providing access to domestic banks to loan facilities of the European Central Bank and Bulgarian sovereign- and corporate issuers eligibility in ECB purchases programmes. In Scope’s opinion, attainment of ERM-II entrance represents an incremental credit-positive step in achieving the credit-relevant implications of euro accession.

The process to entering the euro area requires a minimum two years under the Exchange Rate Mechanism, making 1 January 2023 the earliest feasible date for accession. Under the European Commission (EC)’s latest Convergence Report (of June 2020)², the EC referenced Bulgaria’s fulfilment of the criterion on public finances (at time of reporting) – concluding constructively Bulgaria as, moreover, the only EU nation fulfilling the Stability and Growth Pact’s deficit criterion in 2020 (although Bulgaria’s 2021 potential spending requirements present a challenge here). In addition, fulfilment of the criterion for the convergence of long-term interest rates was observed. The exchange-rate criterion is expected to be fulfilled after the minimum two-year phase under ERM II. The last of the four convergence criteria³ – relating to price stability – is not fulfilled as of May 2021. Bulgaria’s inflation rate, while having moderated substantively to a 12-month moving average rate of 0.7% as of May 2021, nonetheless diverged substantively (more than 1.5pps) compared with that of the average of the three best performing (lowest inflation) EU Member States (-1.1% average YoY in the 12 months to May 2021). In addition, assurance of compatibility of Bulgarian laws and addressing challenges in the business environment and institutional bottlenecks relating to corruption, organised crime and government efficiency remain priorities. Achievement of specific euro-entrance requirements – especially on the institutional side – may prove challenging especially recognising observed postponements in areas of reform due to the Covid-19 crisis as well as amid current political uncertainty. Here, accession could see delays past 2023.

The anchor of Bulgaria’s macroeconomic stability has been the nation’s credible currency board since July 1997, which has been given further strong institutional support with entrance to ERM II. The external sector is, moreover, anchored by enhancements to foreign-exchange reserve coverage. Currently, official reserves total EUR 27.7bn as of end-May 2021, off peaks of EUR 31.1bn of September 2020 but still nearly double the EUR 15.6bn as of January 2015. In combination with external-debt deleveraging, official-reserve coverage of short-term external debt amounted to over 3.2x as of March 2021, double the coverage multiplier of 1.6x in January 2015, and compared with under 1.0x between end-2008 and September 2009. Bulgaria’s adequate reserves back the credibility of the exchange rate during the current period of participation of the lev in ERM II. Bulgaria has observed improvements in its net international investment position to -28% of GDP as of end-2020, from -98% in Q2 2010. Gross external debt stood at 61% of GDP in Q1 2021 (up slightly since the crisis from lows of 57% of GDP in Q1 2020), but nonetheless down substantively from above 100% of GDP as of 1H-2010. These improvements strengthen resilience to potential external shocks.

Second, the affirmation of the ratings reflects significant reforms made to banking-sector governance, underscored by successful entry to the Banking Union on 10 July 2020. Starting 1 October 2020, the ECB assumed direct supervisory responsibilities over five “significant” Bulgarian banks.⁴

The advancement of reforms improving banking-system resilience was anchored by Eurogroup approval in July 2018 of a series of procedural steps for Bulgaria to enter ERM II and Banking Union. In this respect, Bulgaria became the first non-euro area country to apply to enter into close cooperation with the European Central Bank relating to Banking Union entrance, and fully completed actions under seven commitments between 2018 to 2020⁵: i) entering the Banking Union by establishing a close cooperation with the ECB and conducting amendments in the legislative framework, including with regard to the powers of the ECB during the close cooperation period; ii) adopting legislative amendments in the Law on Credit Institutions in order to introduce borrower-based macro-prudential tools; iii) enhancing the supervision of the non-banking financial sector; iv) addressing gaps in the insolvency framework; v) strengthening the anti-money laundering framework; vi) improving the governance of state-owned enterprises; and vii) ratifying the agreement on the transfer and mutualisation of contributions to the Single Resolution Fund. Scope views constructively banking-system reforms that have been undertaken, in convergence with euro-area standards. Via entrance to Banking Union, Bulgaria has, furthermore, joined the Single Resolution Mechanism (and Single Resolution Fund) in 2020 – supporting institutional capacity to more effectively respond to banking failures in the future and sever the sovereign-bank nexus.

Maintenance of a commitment to reform in financial-system governance is crucial over the period ahead. Per example, Bulgaria's legal framework is expected to be adapted to fully comply with EU treaties and statutes in fields of central bank independence, the prohibition of monetary financing and central bank integration in the Eurosystem.

In advance of Banking Union, two Bulgarian banks raised additional capital on the basis of results of the stress test adverse scenario conducted as part of the ECB comprehensive assessment. In June 2020, the state-owned bank, Bulgarian Development Bank, acquired a minority stake in one of the banks: First Investment Bank. System-wide tier 1 capital ratios have been enhanced, reaching 22.1% of risk-weighted assets as of end-2020, compared with 18.3% as of Q1 2019. In addition, banking-system deposits and loans in foreign currency have been reduced (to 40% of bank deposits, from 65% at end-2009, and to 43% of bank loans, from a 2012 peak of 67%). As foreign-currency bank deposits and loans are mainly denominated in euro, FX risks will be mainly eliminated upon event of euro adoption; however, the recent reduction in foreign currency in the banking system is nonetheless credit positive during the transitory phase in ERM II. In addition, domestic non-financial private-sector debt stood at 107.1% of GDP as of end-2020, slightly above Q1-2020 pre-crisis lows but below peaks of 136.6% of GDP in 2010.

Third, the affirmation of Bulgaria’s ratings reflects low government debt, despite the public debt ratio rising moderately since the Covid-19 crisis, plus a track record of prudent fiscal policy setting. Over 2020-21, the government expects to expend BGN 2.4bn (1.9% of GDP) from state coffers in support of households, BGN 1.8bn (1.5% of GDP) helping businesses while making available BGN 1.7bn (1.4% of GDP) to government bodies involved in combating the pandemic and its consequences.⁶ In the Convergence Programme (2021-23), the Finance Ministry expects a wider deficit (on accrual basis) of 5.6% of GDP in 2021.⁷ While Bulgaria’s deficit of 3.4% in 2020 was comparatively modest and Bulgaria does have fiscal space given low levels of public debt and moderate debt service payments, counter-cyclical fiscal consolidation will be needed as the economic recovery continues gathering a foothold.

Bulgaria’s gross public-debt ratio is projected to increase to 26.1% of GDP in 2021, from 18.4% pre-crisis – returning the debt ratio to 2016-17 levels. Nevertheless, the increase in the government debt ratio is estimated to be the most modest of 14 CEE countries covered by Scope and Bulgaria retains the lowest government-debt ratio in the EU-27 with the exception of Estonia and Luxembourg. Medium term, Scope expects the debt ratio to resume a declining trajectory, reaching around 24.5% of GDP by 2026. Accounting for sizeable fiscal reserves, government debt net of liquid reserves, moreover, stood at (only) 18% of GDP at the end of 2020. Bulgaria’s debt has a long average residual maturity. A risk, however, is the 80% of general government debt denominated in euro as of 2020. The credible currency board framework mitigates this risk, but exchange-rate risk remains a current ratings constraint.

Despite these credit strengths, Bulgaria’s BBB+ rating faces several challenges:

First, Bulgaria’s economy has been impacted by the public-health crisis in line with peers, with renewed lockdowns in Q4 2020 and Q1 2021 as the country experienced severe second and third virus waves. In addition, significant downside economic risk exists due to languishing rates of fully vaccinated persons, of only 10% versus an EU average of 24% as of 13 June 2021. Scope estimates 5.4% economic growth in 2021 and 4.7% in 2022 after a 4.2% contraction recorded in 2020. Medium term, Scope foresees potential growth averaging around 2.75% – higher than that of peers but held back by supply-side bottlenecks due to a working-age population projected to decline 0.9% per year between 2021 and 2025.

Bulgaria’s ratings are, in addition, constrained by low GDP per capita (of an estimated USD 11,321 in 2021) and small economic size (nominal GDP of USD 78bn), which, in combination with economic openness, make the economy vulnerable to idiosyncratic as well as global shocks. Looking at banking sector risks, non-performing loans remain above an EU average – although the gross NPL ratio (broad scope) declined to 5.6% of total loans as of end-2020 from 6.5% at end-2019, risks for higher NPLs will increase as loan moratoria and extraordinary liquidity support measures are slowly tapered. Furthermore, the currency board restricts the BNB’s capacity to act as lender of last resort to banks as support can occur only under strictly specified conditions and over short periods, against highly liquid collateral, and only to the extent that the central bank foreign-exchange reserves exceed its monetary liabilities.

Bulgaria has middle-range performance on several institutional metrics, such as the World Bank’s Worldwide Governance Indicators. In the latest Cooperation and Verification Mechanism report⁸, the EC considered Bulgaria's efforts since EU accession sufficient to meet commitments made on accession in 2007. Institutional deficits remain, however, evidenced, for example, by persistent protests since 2020 that demanded the government’s resignation amid corruption allegations. In June 2021, the US Department of the Treasury sanctioned three Bulgarian individuals for roles in corruption as well as their networks encompassing 64 entities.⁹

The re-run of parliamentary elections is programmed for 11 July 2021 (with presidential elections later in 2021). Since April’s inconclusive National Assembly elections, anti-status-quo parties have gained further ground in opinion polling at expense of GERB – the latter which has dominated Bulgarian politics since 2009. At this stage, it remains unclear whether a stable majority government will be able to be formed after July elections and scenarios of a weak government being formed, intensification of political instability and/or adverse changes to the pre-elections reform programme present risks to the credit outlook. Bulgaria’s history of political instability is a rating constraint as it restricts continuity in reform drives, encourages populism (which weighs on the government balance sheet), and reduces capacity for long-term economic planning.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides a first indicative rating of ‘a’ for the Republic of Bulgaria. Bulgaria receives no positive adjustment under the methodology’s reserve currency adjustment. As such, a ‘a’ indicative rating can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses against a peer group of countries.

For Bulgaria, no relative credit strengths are signalled compared with the ‘a’ peer group. The following relative credit weaknesses are signalled: i) monetary policy framework; ii) macro-economic stability and sustainability; iii) debt profile and market access; iv) current account resilience; v) environmental risks; vi) social risks; and vii) institutional and political risks.

The combined relative credit strengths and weaknesses generate an aggregate two-notch downside adjustment and indicate BBB+ long-term ratings for Bulgaria.

A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope explicitly factors in ESG sustainability issues during the ratings process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 20% weighting in the quantitative model (CVS) and qualitative analyst judgment (QS). Bulgaria’s performance on ESG-relevant factors is average but has improved. Under governance-related factors, Bulgaria has average scores on a composite index of six World Bank Worldwide Governance Indicators. Bulgaria’s Worldwide Governance Indicators scores on government effectiveness and political stability & absence of violence/terrorism have improved. Nonetheless, the qualitative governance-related assessment reflects Scope’s evaluation of the ‘institutional and political risk’ QS category as ‘weak’ compared with Bulgaria’s ‘a’ indicative sovereign peer group.

Socially-related factors are captured under Scope’s sovereign methodology in the CVS via accounting of Bulgaria’s average level of labour force participation (72.7% in Q4 2020, recovering from Q1 2020 lows of 71.4%), but comparatively high level of income inequality. Bulgaria’s old-age dependency ratio compares weakly against that of sovereign peers. High growth since Bulgaria’s 2007 accession to the EU (2.5% over 2007-19, compared with an EU average of 1.0% during the same period) has advanced income convergence and reduced levels of unemployment. However, faster convergence towards EU average incomes requires acceleration in areas of reform given significant demographic bottlenecks – this could include action in priorities such as infrastructure, education and health care as well as addressing labour-market shortages. Social factors are also considered in the QS evaluation with an assessment of ‘weak’ on ‘social risks’.

Environmental factors are explicitly considered in the ratings process via the environment sub-category under the ESG sovereign risk pillar. Here, the CVS considers Bulgaria’s comparatively high level of carbon emissions per unit of GDP. However, risk to Bulgaria’s sovereign ratings from exposure to natural disasters is low as evaluated via the United Nations University’s World Risk Index, although climate-change-related weather events such as droughts and floods do pose risks. Finally, Bulgaria has strong scores compared with ratings group peers on the ecological footprint of its consumption compared with available biocapacity. Bulgaria has pursued a relatively rapid increase in the share of renewables in overall energy supply and the elimination of high carbon-emitting fuel sources. In addition to risks captured under the CVS, environmental risks are also considered under the QS, under which Scope has assigned an evaluation of ‘weak’ against Bulgaria’s sovereign peer group.

Rating Committee
The main points discussed by the rating committee were: i) ERM II and euro accession; ii) governance risks; iii) banking sector reforms; iv) growth potential and economic structure; v) inflation and wage growth; vi) forthcoming elections and the next government’s priorities; and vii) sovereign peers considerations.

Rating driver references
1. European Commission, announcement of Bulgaria and Croatia’s entry to ERM II
2. European Commission, Convergence Report 2020 
3. European Commission, convergence criteria for joining the euro area
4. European Central Bank, Bulgarian/Croatian banks directly supervised by the ECB
5. Letter from the Eurogroup President, prospects for Bulgaria participating in ERM II
6. Republic of Bulgaria Ministry of Finance, The Bulgarian Economy (May 2021) (Confidential)
7. Republic of Bulgaria Ministry of Finance, Convergence Programme (2021-23)
8. European Commission, Progress in Bulgaria under the Cooperation and Verification Mechanism
9. US Department of the Treasury

Methodology
The methodology used for these Credit Ratings and/or Outlooks, ‘Rating Methodology: Sovereign Ratings’ 9 October 2020, is available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation    YES
With Access to Internal Documents                                  NO
With Access to Management                                            NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain and the Rated Entity.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks is/are UK-endorsed.
Lead analyst Dennis Shen, Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 22 February 2019.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
© 2021 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions 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. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5, D-10785 Berlin.