Bulgaria Needs Stricter Fiscal Rules

photo: Klearchos Kapoutsis
photo: Klearchos Kapoutsis

There have been talks, for a few months now, about introducing new and stricter fiscal rules in European Union (EU) member-states, which would help reduce the fast piling up of public debt. During the last week of January there was, at last, a public debate about the position of Bulgaria on this issue. The debate was in the form of a round table organized by the Institute for Market Economics called “Fiscal Rules – Alternatives for Bulgaria”. One can say that among the participants including academia, economist from different NGOs, banks and employer organizations, MPs, representatives of the Ministry of Finance and the Bulgarian National Bank, a principle consensus was reached on two issues – we need rules but we also need mechanisms to ensure their implementation.

The current proposal for new fiscal rules in the EU imposes a limit for the structural budget deficit, which is defined as “the balance, adjusted for the economic cycle that excludes one-off and temporary measures”.  This limit is set at 0.5% of GDP with the option to be raised up to 1%, if the public debt of the country is “significantly below 60 % [of GDP] and where risks in terms of long-term sustainability of public finances are low”. However, this exception sounds too general and it is not entirely clear if it applies to Bulgaria. The ceiling of 60% for government debt is kept, and if a potential breach of this limit triggers an automatic correction mechanism that foresees gradual reduction of the debt stock at an average annual rate of 5% of the difference between the actual level and the 60% ceiling. There are, again, certain exceptions to this rule – states will have the right not to imply these restrictions temporarily in the case of “unusual events”, which have a negative effect on the fiscal position, or during “serious economic downturn”. In the absence of such extraordinary events and “significant deviations from fiscal targets” “a correction mechanism will be triggered automatically”. The design of the said correction mechanism shall be in line with principles agreed upon by the European Commission, which fully respect the responsibilities of national Parliaments.

photo: Klearchos Kapoutsis

Effective from the beginning of this year, Bulgaria introduced two fiscal rules into national law – a maximum budget deficit of 2% of the expected GDP and a limit on public spending at 40% of GDP. Despite the fact these rules do not comply with the newest measures discussed in the EU, their implementation has two advantages. First, they show the government’s commitment to lowering the deficit. This commitment can be traced back to 2010, but introducing it into national law would make it more binding. Second, after the first step they made on the way to improving the trust in the conduct of fiscal policy, the administration prepared the ground to make the regulations tougher. A day after the round table took place Parliament gave the administration a mandate to join the discussed fiscal rules in the EU, the so-called Fiscal Compact.

In contrast to most states in the EU, Bulgaria actually needs tougher rules than the discussed ones.  For objective reasons (i.e. the structure of the national tax system), Bulgaria’s budget revenues are to a large extent dependent on VAT and excise duties. This makes the whole budget highly vulnerable to the fluctuations in the economic activity in the country.  Simply put – when the economy grows, government revenues expand.  This was the case in 2007 and 2008, when revenues reached 40% of GDP and the budget was in surplus. In the last couple of years, however, revenues shrunk to 36% and 35% of GDP respectively, and the budget was in deficit.

For that exact reason Bulgaria needs fiscal rules which target a balanced structural budget. This means that after adjusting the budget for the effects of the economic cycle, spending would equal revenues. And so the actual budget balance could be in deficit or in surplus, depending on the phase of the economic cycle the economy is in, but over the entire cycle – in the medium to long term, these effects will net out. In other words this will help the government pile up reserves due to budget surpluses in good years that can be spent in bad years.

When talking about the Fiscal Compact, one should keep in mind that apart from it, the draft treaty that is about to be signed by 25 EU member states includes also another proposal – namely a title on “Economic Policy Coordination and Convergence”. The mandate of the Bulgarian government is one that allows joining the Fiscal Compact right away, and postponing application of the title on economic policy coordination for the time the country joins the Eurozone.

According to the latest changes in the proposed treaty “all major economic policy reforms that [countries] plan to undertake will be discussed ex-ante and, where appropriate, coordinated among [member-states]”. However are there objective criteria according to which reforms are to be labeled “major” or non-major? And if there are none, could all reforms be considered major, leading to the bulk of economic policies being dictated from abroad, turning a blind eye to the specific needs of the Bulgarian economy?

The details around the formulation of the fiscal rules in Bulgaria are yet to be discussed and specified. But two things are already clear. First, the country needs fiscal restrictions, which address the cyclically-adjusted fiscal balance and enable the government to focus on the structure of the budget. A reasonable proposal to that end is for the cyclically-adjusted budget to be in balance. Second, Bulgaria cannot afford to forego its exclusive powers to choose the country’s own economic policy, because the latter is a key instrument that helps or hinders the economic development of the country.

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