Rating action

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

Scope affirmed Bulgaria’s ratings and maintained the Positive Outlook due to the expectation of the country’s euro area entry, by 2026 at the latest, acknowledging continued uncertainties on specific timing. The euro accession process has been postponed from an original January 2024 target due to inflationary developments. Political instability in recent years, with six parliamentary elections since 2021 and challenging government formation efforts after the latest elections in June 2024 further complicated the accession process. Another round of elections in H2 2024 is also a distinct possibility. Still, despite these political uncertainties, Bulgaria’s largest political parties and the current caretaker government remain committed to euro area accession as the country’s main medium-term policy goal.

Euro area entry would have multiple credit-positive effects, most notably via adopting a global reserve currency as local currency, eliminating foreign-exchange risk in euroised public- and private-sector balance sheets and greater monetary policy flexibility through the Eurosystem. Scope expects Bulgaria to meet all nominal convergence criteria – price stability (the only criterion not met in the ECB and European Commission June 2024 convergence reports), sound public finances, exchange rate stability and long term interest rates – in the fourth quarter of 2024 or in early 2025. This will ultimately depend on inflationary developments in Bulgaria and other EU member states as achieving the price stability criterion remains the most challenging hurdle at this point. Finally, Bulgaria was already positively assessed on legal compatibility after amending the Law on the Bulgarian National Bank in February 2024.

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Key rating drivers

Prospect of euro area entry by 2026 at the latest

Scope expects Bulgaria to join the euro area and adopt the euro as its local currency by 2026 at the latest, after the initial target of January 2024 and the updated target of January 2025 could not be met, partly due to inflationary developments. To join the euro, candidate countries need to meet four nominal convergence criteria assessed in the ECB’s and European Commission’s convergence reports, published at least every two years or at the request of a European member state (price stability, sound public finances, exchange rate stability and long-term interest rates) and ensure legal compatibility of its national laws with the Treaty and the Statute of the European System of Central Banks/ECB.

Accession to the euro area would improve multiple rating-relevant areas for Bulgaria, including by eliminating foreign-exchange risk in an euroised economy, increasing monetary policy flexibility and strengthening market access. Market access would improve once Bulgaria issues in euro as its domestic currency, reducing foreign-exchange risk in outstanding primarily euro-denominated public debt portfolio. In addition, this would provide domestic banks with access to loan facilities of the ECB, and sovereign access to the European Stability Mechanism (AAA/Stable), bolstering the country’s financial stability.

In the latest convergence reports published in June 2024, Bulgaria was assessed as meeting three out of four nominal convergence criteria. After changes to the Law on the Bulgarian National Bank passed in February 2024, Bulgaria also meets the legal comparability criterion. Scope expects Bulgaria to request another convergence report as soon as its inflation rate is sufficiently low to meet the price stability criterion, paving the way for progression on euro area accession.

Bulgaria met the exchange rate stability criterion, participating in the Exchange Rate Mechanism (ERM II) since July 2020. The external sector is strengthened by robust foreign exchange reserve coverage. Official reserves totalled EUR 37.7bn as of end-June 2024. In combination with declining external debt, official-reserve coverage of short-term external debt (on an original maturity basis) amounted to over 4.9x as of May 2024. Bulgaria’s external position has been strengthening continuously, with its net international investment position improving to -7.1% of GDP as of Q1 2024, from -61.5% in 2015. Gross external debt stood at around 46.7% of GDP in Q1 2024, down substantively from 80.4% in 2015.

Bulgaria fulfilled the criterion on public finances, i.e. not to be subject of an excessive deficit procedure by the European Commission. Scope continues to view public finances as an important credit strength for Bulgaria, even though general government deficits are expected to remain relatively wide in coming years, mainly due to increases of expenditure on personnel and social transfers. Scope expects the deficit to stand at 2.8% of GDP this year, after 1.9% in 2023. For the years from 2025, Scope similarly expects deficits of around 2.8% of GDP.

Bulgaria meets the long-term interest rate convergence criterion. As of early July 2024, Bulgaria’s local-currency ten-year government bond yield stood at around 3.9%, broadly in line with peers and well within the reference range of the EU average plus 2pp.

Finally, Bulgaria did not meet the price stability criterion, but Scope expects that moderating inflation will put the criterion within reach by the end of the year or in early 2025. Bulgaria’s Harmonised Index of Consumer Prices (HICP) inflation rate moderated to a 12-month moving average rate of 4.7% as of June 2024, 1.6pps higher than the reference rate without any “outliers” of 3.1% (the unweighted average of HICP inflation of the three best performing (lowest inflation) Member States plus 1.5pp). In the latest convergence report of the European Commission, three countries with the lowest 12-month average inflation were assessed as outliers and thus excluded from the reference rate calculation, namely Denmark, Finland and Belgium. On that basis, Bulgaria’s HICP inflation rate remained only 1pps above the reference rate as of May 2024.

Robust economic growth and public finance outlooks

First, Bulgaria’s economic growth outlook remains robust. Scope expects real GDP growth at 2.4% in 2024 and 3.0% in 2025, after 1.8% in 2023. This is underpinned by robust private consumption, after real wage growth of an average 13.4% YoY in the first quarter of 2024. Further, co-financed public investment benefitting from EU funds underpins the country’s growth outlook. Bulgaria stands to receive a total of 16.2% of 2023 GDP in transfers from the EU under the Recovery and Resilience Facility (RRF) of the Next Generation EU programme and cohesion funds under the 2021-27 Multiannual Financial Framework. This compares very favourably to the EU average of 5.3% of 2023 GDP. A key risk to the growth outlook is slow absorption of funds under Bulgaria’s RRF. So far, authorities have only requested two tranches of the RRF, and only received payment of the first tranche in December 2022. The country is also currently finalising proposals under the REPowerEU chapter to be added to its Recovery and Resilience Plan (RRP). With a deadline of August 2026 to implement all milestones and request payments, there is an increasing risk to the full and timely implementation of Bulgaria’s RRP.

Second, Bulgaria’s gross general government debt ratio continues to be very low compared to that of sovereign peers. Scope projects the debt ratio to stand at around 24.5% of GDP in 2024, from 23.1% in 2023. Bulgaria retains the lowest government-debt ratio in the EU-27. In the medium-term, Scope expects the debt ratio to trend upward but to remain moderate, reaching around 32% of GDP by 2029, significantly below most A-rated European sovereigns. Bulgaria holds sizeable fiscal reserves, amounting to BGN 11.6bn as of May 2024, or 6% of expected 2024 GDP. Bulgaria’s debt profile is favourable, with a long average maturity of around eight years. The 74% of central government debt denominated in euro as of May 2024 represent a foreign-exchange risk, which is however mitigated by the credible currency board framework.

Rating challenges: political and institutional challenges; longer-term demographic pressures and vulnerability to shocks

Bulgaria’s history of political instability is a rating constraint as it restricts reform continuity, fosters populism, and hinders capacity for long-term economic planning. Political instability has also negatively impacted the euro area accession process. The previous power-sharing arrangement between GERB-SDS and PP-DB broke down in March 2024, leading to snap elections in June 2024. The election, amid record-low turnout, has not resulted in a coalition government yet, with two out of a maximum three attempts at government formation having failed so far. A third failed attempt would lead to another round of elections in 2024, which would be the seventh since 2021. High political turnover and extended periods of caretaker governments significantly impact policy implementation. This is crucial for convergence to other euro area member states in terms of the institutional strength, including reforms on the business environment, the rule of law and anti-corruption measures, as also captured by the World Bank’s governance indicators. Political instability has also led to significant delays in the implementation of the country’s recovery and resilience plan.

Adverse demographics weigh on growth and public finances. A declining working-age population, with an average decline of 0.9% per year in the next five years, weighs on Bulgaria’s potential growth, which Scope estimates at around 2.75% per year. This is still relatively robust compared to euro area and European peers, however, it would need to be improved via productivity gains to enable Bulgaria to converge more rapidly to European and euro area average incomes. Bulgaria’s ageing society also impacts public finances. Transfers from the central government to finance the pension system’s deficit rose by 2.3pps of GDP between 2019 and 2023 due to pension hikes enacted during the Covid-19 pandemic, contributing to wider general government deficits, with further expected increases in coming years.

Finally, Bulgaria’s low wealth levels with GDP per capita at EUR 14,600 in 2023, the lowest level in the EU-27, small economic size with nominal GDP of EUR 94bn in 2023 and high trade openness makes the economy vulnerable to idiosyncratic and global shocks.

Outlook and rating sensitivities

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

Upside scenarios for the ratings are (individually or collectively):

1. Formalisation of euro area accession;
    
2. Sustainable increase in economic growth potential, ensuring continued convergence with EU average per-capita income;
    
3. Progress on addressing institutional challenges, including the rule of law and the fight against corruption.

Downside scenarios for the rating and Outlooks are (individually or collectively):

1. Institutional challenges and/or political instability reoccur, weakening the macroeconomic outlook and/or delaying Bulgaria’s euro area entry significantly;
    
2. Economic prospects deteriorate considerably;
    
3. The fiscal outlook worsens significantly;
    
4. The banking system’s or external-sector resilience weakens.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s SQM, which assesses core sovereign credit fundamentals, signals a first indicative credit rating of ‘a-’ for Bulgaria. Under Scope’s methodology, the indicative rating receives 1) no positive adjustment from the methodological reserve-currency adjustment; and 2) no negative adjustment from the methodological political-risk quantitative adjustment. On this basis, a final SQM quantitative rating of ‘a-’ is reviewed by the Qualitative Scorecard (QS) and can be changed by up to three notches depending on the size of Bulgaria’s qualitative credit strengths or weaknesses compared against a peer group of sovereign states.

Scope identified external debt structure as a relative credit strength for Bulgaria. Conversely, Scope identified the following relative credit weaknesses for Bulgaria: 1) monetary policy framework; 2) social factors; and 3) governance factors. On aggregate, the QS generates a one-notch negative adjustment for Bulgaria’s credit ratings, resulting in final BBB+ long-term ratings. A rating committee has discussed and confirmed these results.

Environment, social and governance (ESG) factors

Scope explicitly factors in ESG issues in its ratings process vis-à-vis the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

Environmental factors are explicitly considered in the ratings process via the environmental sub-category under the ESG sovereign risk pillar. Here, the SQM considers Bulgaria’s comparatively high level of carbon emissions per unit of GDP and greenhouse gas emissions per capita. However, risk to Bulgaria’s sovereign ratings from exposure to natural disasters is moderate as evaluated via the ND-GAIN Index, although climate-change-related weather events such as droughts and floods pose risks. Finally, Bulgaria has strong scores compared with ratings group peers on the ecological footprint of its consumption compared with available biocapacity. Bulgaria’s economy is the EU’s most energy-intensive, and Bulgaria’s energy mix is relatively reliant on fossil fuels (63%), with nuclear (22%) and renewables (15%) as the main other energy sources. Coal is heavily used in electricity generation, with a key deliverable being a plan to phase-put coal, which would support a reduction in CO2 emissions from the energy sector. In addition to risks captured under the SQM, environmental factors are also considered under the QS, under which Scope has assigned an evaluation of ‘neutral’ against Bulgaria’s sovereign peer group.

Socially-related factors are captured under Scope’s sovereign methodology in the SQM via the accounting of Bulgaria’s average labour force participation (74% in Q1 2024, 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. Robust economic 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 factors’.

Under governance-related factors, Bulgaria has relatively low scores on a composite index of five World Bank Worldwide Governance Indicators. Governance considerations include a high turnover of governments in recent years, with six elections between 2021-24. Frequent government turnover has hampered reform momentum crucial for tackling medium- to long-term challenges and in advancing euro area accession. Scope evaluates ‘Governance factors’ in the QS as ‘weak’ compared with Bulgaria’s indicative sovereign peer group.

Rating committee
The main points discussed by the rating committee were: i) euro area accession progress; ii) political developments, iii) economic outlook, iv) fiscal outlook; v) financial sector performance; vi) external sector developments; vii) ESG consideration; and viii) peers.

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and/or Outlooks is (Sovereign Quantitative Model Version 3.0), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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    NO
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.
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 and/or Outlooks 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 are UK-endorsed.
Lead analyst: Julian Zimmermann, Associate Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Ratings/Outlooks were last updated on 21 July 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
© 2024 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis 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.