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1 BLACK SEA TRADE AND DEVELOPMENT BANK BD BULGARIA Countr ry Strategy THESSALONIKI June, 2015

2 BULGARIA COUNTRY STRATEGY TABLE OF CONTENTS TEXT: I. Summary of Recent Developments and Outlook II. III. Overview of Current BSTDB Portfolio Review of Country Strategy : Post Evaluation IV. BSTDB Operational Priorities for TABLES: Table 1: Basic Macroeconomic Indicators at a Glance Table 2: Active BSTDB Portfolio as at end December 2014 Table 3: Post Evaluation of Country Strategy 2

3 Table 1: Basic Macroeconomic Indicators at a Glance for BULGARIA Key Long Term Foreign Currency Sovereign Risk Rating at 1 June, 2015: Moody s: Baa2 S&P: BB+ Fitch: BBB Indicator Proj Proj Population (Million) Avg Exch. Rate (BGL/ USD) Inflation (CPI Avg.) 4.2% 3.0% 0.4% 1.6% 0.5% 1.0% 4 Average monthly wages (US$) n.a. n.a. 5 GDP (BGL billion) current prices 78, , , , , , GDP US$ billion GDP per capita (US$) 7, , , , , , Real GDP growth, % 2.0% 0.5% 1.1% 1.7% 1.0% 1.3% 9 Official Unemployment (ILO, annual average) 11.3% 12.3% 13.0% 11.4% 10.4% 9.8% 10 Industrial Production Growth, % 5.8% 0.4% 0.1% 1.8% 3.5% 4.0% 11 Agricultural Production Growth % 1.1% 3.5% 3.4% 0.5% 1.0% 1.2% 12 Domestic Credit Growth % 7.4% 2.5% 3.6% 8.8% 13 Domestic Credit/ GDP 68.5% 68.8% 71.1% 63.3% 14 Foreign Direct Investment $US million 2, , , , , , FDI/ GDP 3.7% 3.2% 3.4% 3.1% 5.8% 6.7% 16 Consolidated Budget Balance/ GDP, % 2.0% 0.7% 0.9% 2.8% 2.9% 2.9% 17 Total External Debt US$ million 46, , , , , , Total External Debt/ GDP 90.5% 92.2% 90.0% 94.7% 98.3% 94.8% 19 Public External Debt/GDP 10.5% 11.2% 9.9% 15.6%. n.a. n.a. 20 Private External Debt/ GDP 80.0% 81.0% 80.1% 79.1% n.a. n.a. 21 Exports $US million (Goods) 26, , , , , , Imports $US million (Goods) 30, , , , , , Trade Balance $US mn (Goods) , , Trade Balance/ GDP 6.6% 9.6% 7.0% 8.2% 8.7% 9.6% 25 Current Account Balance $US mn , Current Acct. Bal./ GDP 0.9% 0.3% 1.6% 0.9% 1.3% 1.2% 27 Forex Reserves (end period exc gold) US$ m 15, , , , , , Sources: Data for items 1, 5, 8, 10 from National Statistical Institute Data for items 3, 8 from EC Spring Forecast (published May 5) Data for items 2, 12 15, from Bulgarian National Bank Data for item 11 from EIU Country Reports Data for items in USD from IFS, IMF, Feb 2015; same data in EUR from Bulgarian National Bank Data for item 26 from EC Spring Forecast (published May 5) Data for item 14 from the Ministry of Finance Projections from EIU CountryData (Latest update 23 April 2015) 3

4 BULGARIA COUNTRY STRATEGY I. Summary of Recent Developments and Outlook Background Between 2008 and 2012 the economy of Bulgaria suffered from a decline in value added in 2009 and employment throughout the period. Bulgaria s economy registered a growth rate of 1.1% in 2013, following a growth by just 0.5% in 2012, a growth by about 2% in 2011 and a 0.7% positive recovery in 2010; in 2009 the economy contracted by 5.0%. Fixed investment stopped its previous steep decline over the period , but failed to pick up vigorously. On the fiscal side, some consolidation was attempted but with erratic results. Bulgaria recorded in 2013 a cash deficit of 1.8%, following a deficit of 0.4% of GDP in 2012, down from 1.9% in 2011 and 3.9% in In 2013 the current account surplus stood at 1,6% of GDP, reversing a deficit of 0,3% in FDI has fallen significantly to around 3.2% of GDP in 2012 compared to 7% in Although the gross external debt was high, at about 90% of GDP for 2013, it came down slowly from 92.2% in 2012; this factor did not pose any significant threat to public debt sustainability, as the external debt of General Government sector stood at 9.9% of GDP at end Credit growth decelerated to 13.7% in 2009 from 51% in From 2010 to 2013 credit growth remained subdued, although it accelerated slightly in 2011 and Developments 2014 The economy is expected to have expanded by 1.7% in However, downside risks have materialized in The general government gross debt increased from 18.3% in 2013 to 27.6% in , with foreign public debt accounting for half of this amount. Total external debt increased to 94.7% of GDP. Exports remained relatively strong, but imports increased faster widening the trade deficit to 8.2% of GDP. Growth in trade with European partners increased in 2014 compared to Similarly, gross fixed capital formation was mainly driven by buoyant government investment spending on the back of accelerated absorption of EU funds in However, as the current programming period is coming to an end, EU funded investment in the coming years is uncertain. The general government deficit has deteriorated from 1.8% in 2013 to 3.7% of GDP in This is significantly more than planned in the original 2014 budget. Bulgaria has been experiencing deflation since August In 2014, Bulgaria recorded a strong average annual deflation, with prices declining by an average 1.6%. This has been caused by a coincidence of falling global energy prices, significant administrative cuts to electricity and healthcare prices, and declining food prices due to a good harvest. Also, core inflation has turned strongly negative, reflecting overall weak domestic demand, decreasing prices of consumer durables, most of which imported as well as one off factors. In the second half of June a bank run led to the fourth largest bank, Corporate Commercial Bank (CCB), closing. The liquidity pressure in the banking sector was temporary and negative spillovers to the rest of the banks were prevented. The banking system has continued its normal operation since July According preliminary data for deficit and debt data for 2014, published by Eurostat on 21 st April

5 and deposit inflow has recovered since then. The assessment of CCB s assets revealed a serious capital shortfall and following the revocation of the CCB s license for conducting banking activities, the payment of depositors guaranteed amounts began in the beginning of December Almost all deposits paid out remained within the banking system, which is another indicator of restored confidence in the banking system. Prospects for 2015 With the country still feeling the after effects of the economic crisis and experiencing limited investment prospects, the volume of investment loans is quite low, against the background of overall uncertainty in the external environment. However, according to the national official forecast, the growth of private consumption will accelerate in Economic growth Growth is expected to decelerate, with economic activity and investment in Bulgaria likely to suffer from a combination of factors, including limited fiscal space. From the beginning of 2015 survey indicators indicate improvement of economic activity. However, headwinds are expected to continue, with GDP forecasted to remain muted, falling to 1% in 2015 before advancing to 1.3% in With growth expected to be modest, the labor market will likely remain weak. After a deflationary period in 2014, inflation is set to only pick up slowly. The main constraints to the outlook relate to domestic demand, in particular investment and private consumption. Consumption Private consumption was supported in the first half of 2014 by the continuing increase in households real disposable income mainly driven by the deflationary environment. Recent monthly consumer confidence and retail data, however, suggest that from the beginning of 2015 an improvement in consumer confidence and retail data is observed. In addition, the decline in the working age population and planned fiscal tightening are likely to dampen the outlook for consumer spending in the medium to long run. Investment Private investment is seen to contract further in 2015, mirroring the on going deleveraging process in the economy and low profit expectations. With financial conditions remaining tight, firms are expected to freeze or postpone investment plans. Unemployment Slow economic growth is set to result in modest gains in employment over Nevertheless, combined with a continued decline in the labor force, this may bring the unemployment rate from a peak of 13% in 2013 to 11% by end 2015, in spite of the fact that employers favor productivity growth to job creation. Inflation Deflationary pressures are expected to remain high initially, but to become less intensive gradually, with CPI inflation turning moderately positive in the second half of Fiscal policy After a fiscal stimulus in 2013, and following a sizeable fiscal deterioration in 2014, the fiscal policy is forecast to turn broadly neutral in

6 Public debt The general government gross debt is forecast to increase, reflecting not only the financing of the fiscal deficit, but also the need for refinancing the maturing debt and the envisaged possibility to fund the existing liquidity scheme for the stabilization of the financial sector in The debt ratio is forecast to amount to slightly above 30% of GDP by end External accounts Despite a slowdown in the first half of 2014, exports are set to resume growing at a moderate pace in , sustained by the mild recovery in EU and non EU trade partners. On the back of a further slowdown in domestic demand, the contribution of net trade to overall economic growth is projected to turn positive in 2015, while the current account surplus is seen stable at about 2% of GDP by Forecast Potential growth is currently estimated at below 2 % per year. For the period , demand is forecasted to remain subdued, with both consumption and investment weak. The country will escape deflationary pressures, and will record a positive inflation in between 1 and 2%. The trade balance may deteriorate further. In spite of planned fiscal consolidation, it is anticipated that the budget would continue to record deficits. Taking into consideration that global capital markets are volatile and risk averse, additional financing may prove difficult to secure. Consequently, given also the sluggishness of the Eurozone economy, it is expected that economic growth would remain at between 0.5 to 1.0% p.a. throughout the period. Balance of Risks Risks still appear tilted to the downside. A more prolonged economic weakness together with the still fragile labor market could lead to a reduction of domestic demand. However, business and consumers confidence improved since the beginning of An important challenge in the coming years relates to concerns over fiscal sustainability, due to poor tax compliance. Furthermore, reforms in key sectors, including pensions, healthcare and energy are lagging behind schedule. The government is committed to the currency board. However, reduction of fiscal reserves, and overvaluation of the currency may put some pressure on the CBA in the medium term. II. Overview of Current BSTDB Portfolio Table 2: Active BSTDB Portfolio in Bulgaria as at end December 2014 Operation BoD Approval Date Approved Amount Signed Amount Euro Amount Outstanding Maritza East I 1 Oct 05 18,000,000 18,000,000 14,184,000 Balkan Accession Fund 10 Aug 06 1,998,543 1,998,543 1,477,410 Emerging Europe Accession Fund 25 Sep 09 1,173,667 1,166, ,193 Suvorovo Wind Farm 20 Nov 09 11,000,000 11,000,000 9,554,160 BM Leasing SME II 18 Jun 11 3,000,000 3,000,000 1,307,190 Equity to ADM CEECAT Recovery Fund 21 Jul 11 1,635,196 1,635,196 1,208,403 6

7 Bulgarian Development Bank SME II 21 Jul 11 31,000,000 31,000,000 14,466,667 Euphoria 17 Sep 11 7,500,000 7,500,000 4,687,500 Bulgaria Mezzanine Capital I Equity 21 Jun 13 10,000,000 BM Leasing SME III 11 Apr 14 3,000,000 3,000,000 3,000,000 Kastamonu 10 Jul 14 7,560,000 7,560,000 7,560,000 Total 95,867,406 85,860,406 57,852,522 III. Review of Country Strategy : Post Evaluation Independent Evaluation of Country Strategy for Bulgaria The current evaluation was performed by the Bank s Evaluation Office as per the respective Evaluation Policy. It reveals the performance of the Bank s Country Strategy for Bulgaria. Its goal is to provide accountability to the Board of Directors and Board of Governors as well as facilitate the decision making by the Bank s Management and Boards on the eventual update of the country strategies. The evaluation of the respective country strategy compares the stated 2014 targets with actual results as of end of 2014, and provides a country oriented overview and evaluation rating. The Country Strategy was approved by the Board of Directors in early 2011, reflecting an in depth independent evaluation of the implementation of the BSTDB s earlier strategies, conducted by the Evaluation Office. It was aligned with the objectives of the Bank s Business Plan and was therefore evaluated in that context. The implementation of the Country Strategy was not consistent with the Business Plan implementation and came short in reaching the respective objectives. The implementation achieved only 1/3 of both the investment volume objectives, and the intended sector coverage. The performance is in sharp contrast with the Strategic priority of substantial expansion of the Bank s investments in Bulgaria. To this end, the evaluation performance rating assigned to the implementation of the Strategy is the lowest possible: Unsatisfactory. A more comprehensive overview is presented in the table below. Country Strategy Table 3: Post Evaluation of Country Strategy for Bulgaria TARGETS RESULTS Sectors/Priorities Target Actual Evaluation Summary operations: operations: EUR EUR approved/ approved/ EUR signed EUR signed (million) (million) Bulgaria 1. Infrastructure: energy (efficiency and renewable), transport, municipal, telecom, IT, Media; 167/147 64/54 7 Approved volume: 38% Signed volume: 37% 2. Sector coverage: 2.1. BM Leasing SME II (SME)

8 2. Manufacturing: expansion/competitiveness in paper, pharmaceuticals and metals; 3. FI/SME/Trade: export oriented, leasing 4. Tourism related real estate (mountain areas, cultural tourism) 5. Substantial expansion of investments in Bulgaria 2.2. Equity ADM CEECAT Recovery Fund (SME) 2.3.Bulgarian Development Bank SME II and III (SME) 2.4. Euphoria (Real Estate) 2.5. Bulgaria Mezzanine Capital 1 Equity (Financial Sector) 2.6. Kastamonu (manufacturing/materials) The Bank covered its priorities/sectors very marginally. 3. Performance Rating: Unsatisfactory: Targets/sectors covered up to 1/3, Insufficient sector diversity and growth. IV. BSTDB Operational Priorities for Government Priorities The priorities of National Development Program BG2020 are formulated as follows: 1. Improving the access to and enhancing the quality of education and training and the quality characteristics of the workforce. 2. Reducing poverty and promoting social inclusion. 3. Achieving of sustainable integrated regional development and use of local potential. 4. Development of the agricultural sector to ensure food security and production of products with high value added through sustainable management of natural resources. 5. Support of innovation and investment activities to increase the competitiveness of the economy. 6. Strengthening of the institutional environment for higher efficiency of the public services for citizens and businesses. 7. Energy security and increasing resource efficiency. 8. Improving transport connectivity and access to markets. The Government expects that the implementation of the interventions laid down in NDP BG2020 will by 2020: the economy become considerably more competitive (mostly in terms of the quality of human capital, innovation and infrastructure), the country achieves sustainable economic growth, guaranteeing real convergence to the level of income and production in the EU, and 8

9 are ensured conditions for full social, creative and professional realization of the personality of every Bulgarian citizen. BSTDB Priorities The Bank s role and priorities are defined (i) in accordance with the priorities and targets laid out in its Medium term Strategy and Business Plan and (ii) country needs and objectives, as well as (iii) available resources, strategies and policies of BSTDB. In this respect, BSTDB will seek viable opportunities and will continue closely monitoring the developments in the Bulgarian economy in order to stand prepared to support bankable projects. The slow down in the European economies continues to affect Bulgaria negatively. Most of the companies postpone their investments due to the uncertainties in the markets. Under the given circumstances, BSTDB will focus on supporting existing enterprises especially for their modernization and expansion investments that increase their global competitiveness. BSTDB will focus in the next four years on providing support for the implementation of the Government program and priorities, while responding to market demand. In this respect, the Bank will explore new organizational opportunities to facilitate business generation. The Bank will consider undertaking activities and providing services as may advance its purpose, paying special attention to activities promoting export of goods and services, and development of infrastructure, including energy efficiency. In addition, through selected intermediaries, the Bank would attempt to expand its financing programs in favor of SMEs and agribusiness. Financing infrastructure investments will also be among the priorities of the Bank within the next four year period. In addition the Bank shall seek co financing opportunities with IFIs, public sector institutions and private partners. The Bank keeps in regular contact with complementary international financial institutions (IFIs) such as EBRD and IFC to seek ways to coordinate activities and share experiences, given the opportunities which exist for joint involvement. Based on the BSTDB Business Plan, the Bank would expect on average to sign two to three new operation each year, for approximately million. Over the four year period, this connotes eight to eleven new commitments (signed operations) for approximately 126 million (a range of million). These indicative targets are based on the Base Case Scenario of the MTSBP, and given appropriate circumstances and sufficient operational opportunities the Bank would make efforts to exceed this level. In case of higher regional economic growth rates, increased demand for Bank funding, and an improved situation in financial markets, a phased increase in the average number and size of operations would allow the Bank to move towards achieving the targets envisaged under the High Case Scenario. Moreover, at the Mid Term Review, depending upon performance and prospects, the above targets may be revised upwards 2. 2 Under no circumstances would targets be revised downwards unless the lower case scenario of the BSTDB Business Plan were to be followed. 9

10 Areas for BSTDB Financing Financial Sector BSTDB s Trade Finance and Financial Sector Strategy have been created in order to develop a network of financial intermediaries, through whom to deliver its trade finance and SME finance products. The Bank will assess opportunities for participating in FLAC, a government sponsored fund established with support from EBRD aimed at financing municipal projects. Since BSTDB began its operations, the following products have been introduced through selected financial intermediaries in Bulgaria for the purpose of Trade Finance, Micro Finance, and SME development: Pre export finance Facility Combined Trade Finance (export/import) product Medium Term Micro and SME Finance product Leasing Facility for SMEs Besides, BSTDB participated in funds where Bulgaria was one of the recipient countries. The Bank will seek to increase the number of financial intermediaries; while it will seek to change any if their performance is unsatisfactory. The Bank will focus on non bank financial institutions, such as micro finance companies, besides leasing companies, in order to provide medium term funding. BSTDB supports the economic development in Bulgaria, in particular by providing financial assistance in the following areas: Trade finance is necessary to provide financing for increasing exports and expanding regional trade. Financing to exporting companies may help improve competitiveness and content of value added in exports. SME sector is in need of medium term finance, which would promote modernization of equipment and diversification of products and services. In addition, job creation and income generation effects of SME sector development may have positive social impact. BSTDB will continue to offer SME products through eligible Financial Intermediaries in conformity with the Bank s SME Strategy, using Commercial and Development Banks as well as Leasing Companies. Leasing The Bank intends to use the leasing product not only for financing capital expenditure of SMEs but also for other companies as an effective financing tool for the promotion of regional trade. Medium term credit lines opened to leasing companies for trade related purpose will enable them to offer their customers finance for capital expenditures on imports from other countries in the region. Mortgage BSTDB was cautious to provide Mortgage Financing for individuals, while commercial banks were very active in this sector. However, within the framework of SME Financing, BSTDB provides loans for real estate investment of SMEs for commercial purposes. Equity The Bank will also consider the option to take equity participations in selected financial institutions and funds, and will also seek to develop quasi equity products, such as subordinated loans. Co financing The Bank will also keep in regular contact with complementary international financial institutions (IFIs) such as EBRD and IFC to seek ways to coordinate activities and share experiences, given the opportunities which exist for joint involvement. 10

11 Manufacturing and Enterprise Sector Despite some moderate growth in overall Bulgarian economy, manufacturing sector suffers from lack of new investments. BSTDB will support new investments of both local and international companies that bring know how and technology to the country. Also supporting modernization and expansion projects that increase competitiveness of Bulgarian companies in export markets will continue to be a priority for BSTDB. Paper and pulp production, pharmaceuticals, and basic metals (both ferrous and non ferrous) are the areas that Bulgaria has competitive advantage. These sectors are export oriented and have significant contribution to the exports of the country. However, there is still space for further growth and improvement in these sectors. BSTDB will focus on the modernization, expansion, and green field investments in these sectors. Also, investments aiming at improving efficiency and reducing environmental pollution would be given priority to finance. Transportation Transportation investments are important growth drives for the country s economy. Major cross country roads and highways are supported by the EU funding schemes. For BSTDB, the port projects (especially Burgas and Varna), airport investments and road constructions are among the main priorities of the country in transportation sector. The Bank will actively look for opportunities in financing transport projects, jointly with other IFIs and commercial banks. Real Estate and Tourism Construction and real estate and tourism sectors were also negatively affected by the global economic situation in recent years. The new investments are very few. Thus BSTDB will continue to be selective financing projects in these sectors. Priority will be given to those projects that have an impact on tourism revenues of the country and that contribute to the development of less developed areas. Energy and Infrastructure (E&I) Given the E&I development needs, so long as projects are bankable, the Bank will be offering its keen to offer support. This applies to all key infrastructure sectors, including energy and electricity, oil and natural gas upstream, midstream and downstream, transport infrastructure, telecommunications, information technology, and municipal and social infrastructure. In particular, the Bank will be looking forward for more renewable energy opportunities. The existence of an appropriate competitive environment and regulatory framework will be an important consideration in ascertaining bankability alongside development impact. Given the very high investment needs for developing the transportation infrastructure in Bulgaria, and the important development impact of such investments, BSTDB will also consider investment opportunities in this area BSTDB will be willing to explore whether the Bulgarian Government will be able to provide sovereign guarantees for E&I projects. Should a sovereign guarantee be necessary and possible, it shall primarily be sought for an extremely high priority activity in which the guarantee would also serve as a signaling mechanism of the Government s commitment to/ ownership of the operation in order to facilitate greater resource mobilization and broader participation. 11

12 The Bank will continue to ensure that all BSTDB E&I operations in Bulgaria meet sound banking principles and comply with the Bank s Environmental Rules and Procedures and incorporate, where appropriate, Environmental and Social Action Plans. The Bank will work in cooperation with EBRD, IFC, EIB, KWF, DEG, Proparco, other IFIs, commercial banks and ECAs in joint energy and infrastructure sector projects as an important source of the project co financing as well as the institutional knowledge transfer. The Bank will also maintain its contacts with complementary international financial institutions (IFIs) and organizations such as EBRD, IFC, KfW, DEG, OEaB, etc. to seek ways to coordinate activities and share experiences. BSTDB Energy and Infrastructure strategy in terms of banking instruments: Project Finance limited recourse transactions; Corporate recourse financing transactions; Exploration of financing in form of Equity; Co financing of transactions with other IFIs international financial institutions, and commercial banks and ECAs; Participation in the syndicated facilities for the E&I deals in Bulgaria Areas of particular focus in Energy and Infrastructure: Energy (including conventional and renewable) generation, transmission, distribution and storages, Oil and natural gas upstream, midstream and downstream, including transportation and storages Electricity, including rehabilitation and transportation, Transportations of all kinds and transport infrastructure Telecommunications and Information Technology and Services, Municipal and Social infrastructure of all kinds Telecommunications, Information Technology and Media Projects, which support upgrade and extension the telecommunication infrastructure. Projects involving IT, software and hardware assembly, and development of media businesses. The Bank will work in cooperation with other IFIs and commercial banks in joint energy and infrastructure sector projects as an important source of institutional knowledge transfer. 12