VZCZCXRO3491
RR RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHSF #1495/01 3030651
ZNR UUUUU ZZH
R 300651Z OCT 06
FM AMEMBASSY SOFIA
TO RUEHC/SECSTATE WASHDC 2743
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUCPDOC/USDOC WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

UNCLAS SECTION 01 OF 02 SOFIA 001495 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV EINV BU
SUBJECT: BULGARIA WOOS INVESTORS WITH 10 PERCENT CORPORATE 
TAX; CONTINUED STRONG GROWTH 
 
¶1.  SUMMARY:  The Bulgarian government's recent decision to 
lower the corporate tax rate to 10 percent was a bold act to 
put the country in the lowest bracket in Europe, attract 
foreign investors and encourage domestic growth.  During its 
recent mission visit, the IMF commended continued strong 
economic growth and the government's prudent fiscal 
policies.  The widening current account gap of 14.2 percent, 
however, remains a point of concern for the Fund.  Inflation 
of 5.6 percent, well above the Maastricht criteria for 
eventual eurozone entry, is also a potential problem.  The 
IMF argued against a corporate tax reduction because of its 
affect on next year's budget, which currently enjoys a more 
than three percent surplus.  END SUMMARY 
 
BUSINESS PRAISES CORPORATE TAX CUT, WHILE IMF OPPOSES 
 
¶2.  In proposing to cut the tax rate, Bulgaria seeks to win 
"the race to the bottom" and establish itself in Europe as a 
tax champion.  Through the lower rates, officials hope to 
attract more investments, encourage further business 
development and reduce the level of the gray economy. 
However, the IMF sees potential risks to the budget due to 
the expected 10 percent growth in public sector wages and 
the payment of 624 million BGN (USD 405 M) in EU membership 
fees in 2007, and called on authorities to abolish as 
"groundless" the introduction of the new rate.  The decision 
for the tax abatement was agreed to by the three-party 
coalition, and must now go to parliament where it is likely 
to pass without significant opposition.  Parliamentary 
budget committee chairman Petar Dimitrov said the decision 
is final and is part of the draft budget for 2007. 
 
IMF PRAISES GOOD MACROECONOMIC INDICATORS 
 
¶3.  During its October 18-25 mission, part of the fourth and 
final performance review under the precautionary standby 
agreement expiring in March 2007, the IMF commended 
Bulgaria's strong economic performance so far in 2006.  The 
Fund projected 6 percent growth for this year, higher than 
the previous estimate of 5.5-5.6 percent.  The Fund pointed 
to buoyant domestic demand, especially in the investment 
sector, and praised the government's tight fiscal policies, 
with an expected budget surplus for 2006 at around 3.3 
percent of GDP. 
 
CURRENT ACCOUNT DEFICIT GROWS EVER LARGER 
 
¶4.  Despite tight fiscal policies, the risk from the rising 
current account deficit remains high, according to the IMF 
and others.  The Fund estimates that the current account 
deficit is likely to grow to over 14 percent of GDP this 
year, versus 11.8 percent in 2005, and this expansion is 
expected to continue in 2007.  The Fund attributes the 
current account deficit to strong private domestic demand -- 
particularly in the import sector -- fueled by a substantial 
resurgence of bank credit growth.  Foreign Direct Investment 
(FDI) covers around 90 percent of the current account 
deficit, which when combined with strict bank regulation 
gives most observers confidence that this will not become a 
serious problem in the short term.  After a complete 
standstill of privatization in 2005, this year the process 
has regained momentum, which should bring more FDI to 
Bulgaria.  The IMF remained critical of progress in 
implementing structural reforms, calling it "uneven." 
 
INFLATION TO FALL FROM LAST YEAR, BUT STILL HIGH 
 
¶5.  Conservative fiscal policies will help bring the 
expected end-year inflation down to 4.8 percent from last 
year's 6.5 percent, according to the Fund.  Although this 
projection seems rather optimistic, especially compared to 
official estimates of 6.6 percent for 2006, it follows the 
recent deflationary trend.  Inflation remains the only 
macroeconomic parameter under the Maastricht criteria for 
eurozone entry that the GOB has failed to achieve at this 
point.  EU membership may provoke some upside pushes on 
domestic prices in early 2007, but the GOB argues that there 
are no economic reasons for a price boom after 2007.  The 
Finance Ministry is optimistic that Bulgaria will be fit to 
enter the eurozone in 2010.  Prime Minister Stanishev called 
on business to be cautious about raising prices. 
 
IMF DRAFTS THREE POLICY RECOMMENDATIONS 
 
¶6.  The IMF encouraged authorities to maintain the 
deflationary trend of the past quarter while sustaining 
strong growth and containing the current account risks.  To 
this end, the IMF drafted three policy recommendations: 
--Maintain a minimum budget surplus of two percent of GDP in 
2007 based on realistic budget projections and without 
 
SOFIA 00001495  002 OF 002 
 
 
relying on within-year conditional caps on discretionary 
spending; 
--Moderate wage increases in the public sector to secure an 
affordable wage bill; 
--Intensified efforts in the implementation of structural 
measures in the remainder of this year. 
 
¶7.  COMMENT:  Bulgaria faces tough decisions over the next 
few months on its fiscal outlook.  Budget hawks will push to 
maintain a substantial surplus in order to reduce inflation, 
cut the current account deficit, and qualify for early 
eurozone entry.  Threats to the strong fiscal picture will 
come chiefly from the new tax cut, political pressure to 
raise social spending, additional payments to the EU for 
membership and to finance Bulgaria's share of EU-sponsored 
projects, and increased price expectations due to EU entry. 
In our view, the coalition government understands the 
competing needs and will do what is needed to keep it all in 
balance.  As Finance Minister Oresharski told the Ambassador 
recently, "we've worked too long to rebuild our fiscal 
reputation internationally" to allow populist or political 
pressures to weaken macro discipline."  END COMMENT 
 
BEYRLE