VZCZCXRO6632
PP RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHSF #1718/01 3631221
ZNR UUUUU ZZH
P 291221Z DEC 06
FM AMEMBASSY SOFIA
TO RUEHC/SECSTATE WASHDC PRIORITY 3015
INFO RUCPDOC/USDOC WASHDC
RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHINGTON DC

UNCLAS SECTION 01 OF 02 SOFIA 001718 
 
SIPDIS 
 
DEPT FOR EUR/NCE MNORDBERG 
 
SIPDIS 
 
E.O. 12958:  N/A 
TAGS: EFIN ECON PGOV SOCI BU
SUBJECT: BULGARIA'S FIRST EU BUDGET CONTINUES FISCAL DISCIPLINE 
 
Ref Sofia 1495 
 
¶1. (U) SUMMARY: Parliament approved the 2007 state budget on 
December 19 - Bulgaria's first as a full EU member state.  It is a 
fiscally disciplined plan with an expected surplus of 0.8 percent of 
GDP (well above the Maastricht requirement of a 3 percent deficit or 
better for Euro entry.)  This conservative stance - with Bulgaria's 
traditionally understated revenue estimates - is likely to lead to 
budgetary over-performance again as well as a relatively high 
government share of the domestic economy.  Local business has 
praised the reduction of the corporate tax to 10 percent, and after 
intense debate within the ruling coalition, the defense budget will 
be 2.5 percent of GDP in order to meet NATO obligations.  Still a 
concern to the IMF and others is the high current-account deficit - 
projected at 11.8 percent of GDP next year by the government and 
around 15 percent by the IMF.  END SUMMARY 
 
ANOTHER SURPLUS BUDGET/GROWTH OF GOVERNMENT CONTINUES 
 
¶2. (U) The 2007 budget maintains fiscal discipline through a surplus 
of 0.8 percent of GDP, following an expected 3.5 percent surplus at 
end-2006.  The 2007 budget is based on expected real GDP growth of 
5.8 percent due to increases in investment and exports, and expected 
annual inflation of 4.4 percent.  Investment is expected to reach 23 
percent of GDP in 2007.  The Ministry of Finance predicts that 
sustained growth in exports and weaker import growth should narrow 
the current-account deficit to 11.8 percent in 2007 from a 
government estimated 14 percent in 2006 (the IMF claims the gap may 
reach 15 percent both this year and next).  The 2007 budget will 
continue to support a relatively high government share of the 
economy with revenues and expenditures of 41.7 and 40.9 percent of 
GDP, respectively.  Despite the budgeted 0.8 percent surplus, the 
government - after talks with the IMF - agreed to aim for a 2 
percent surplus by year-end using revenues that it hopes will be 
larger than estimated. 
 
REVENUES UNDERSTATED/RECORD LOW CORPORATE TAX RATE 
 
¶3. (U) The government has continued its conservative practice from 
previous years of projecting low revenues, which is likely to lead 
to budgetary over-performance in 2007.  Critics complain this harms 
parliament's ability to give proper budgetary oversight, while 
others claim it is the best way to ensure a sizable surplus (and in 
some years, extra end-of-year funds for the government's pet 
projects).  Planned tax revenues will grow 16.3 percent to reach BGN 
17.5 Billion (USD 11.8 Billion).  Recognizing the need to stimulate 
the private sector for higher investment and employment, the GOB 
reduced the corporate tax rate by 5 percentage points to an EU-low 
10 percent (Ref A).  By lowering the corporate tax rate, the GOB 
hopes to transfer part of the grey sector to the regular economy and 
increase tax collections, as well as give Bulgaria a more effective 
tool in recruiting foreign companies. 
 
EXCISE TAXES RISE 
 
¶4. (U) The government increased excise taxes on tobacco, alcohol, 
coal and fuel, mainly to harmonize with EU tax policies.  The GOB 
argued that this increase is taking place ahead of a pre-agreed time 
schedule because of its efforts to temper inflationary pressures 
before (projected 2010) Eurozone entry.  According to the Finance 
Ministry, the rise in excise taxes will increase the annual 
inflation rate 0.3 percentage points and will not pose a threat to 
financial and macroeconomic stability.  The GOB recognizes possible 
reductions to the budget from lower VAT collection following EU 
entry.  The suspension of customs duties in intra-community trade, 
particularly at the Greek and Romanian borders, has led the 
government to estimate reduced VAT revenues by BGN 450 Million (USD 
300 Million) next year.  Possible VAT fraud due to slower 
integration of EU tax practices may incur additional VAT losses of 
BGN 550 Million (USD 370 Million). 
 
GENEROUS EXPENDITURES IN SOCIAL SECURITY 
 
¶5. (U) Current expenditures will go up 10.7 percent - a significant 
increase of BGN 1.6 Billion (USD 1.1 Billion) - to reach BGN 16.5 
Billion (USD 11.2 Billion) in 2007.  Capital expenditure will grow 
23 percent to reach BGN 2.7 Billion (USD 1.8 Billion).  As in the 
previous year's budget, social security will draw most of the public 
funds - 33 percent out of total expenditures - followed by defense 
and security (13.4 percent), public investment and services (12.3 
percent), health care (10.9 percent), and education (10.5 percent). 
Pensions will be increased by 8.5 percent from July 1 2007.  The 
minimum monthly age pension will go up from BGN 85 (USD 57) to BGN 
92.23 (USD 62.32).  The highest pension will reach BGN 490 (USD 
330).  Public-sector salaries will rise by 10 percent despite the 
IMF recommendation for a lower increase. 
 
MONEY FOR DEFENSE AND HEALTH SPARKED DISAGREEMENT 
 
 
SOFIA 00001718  002 OF 002 
 
 
¶6. (U) Defense spending created disagreements within the ruling 
coalition.  Defense Minister Bliznakov grounded his ministry's call 
for increased spending on obligations to modernize the military 
under NATO.  After protracted negotiations, the 2007 budget will 
allow defense expenditures estimated at 2.55 percent of GDP.  Health 
care expenditures will be BGN 2.22 Billion (USD 1.5 Billion) or 4.33 
percent of GDP.  This has sparked vocal protests inside professional 
groups.  Medical associations contend this is not enough to 
guarantee quality health services and provide a much-needed 
modernization of the sector. 
 
2007 BUDGET - THE FIRST EU BUDGET 
 
¶7. (U) Finance Minister Plamen Oresharski described this first 
EU-era budget as one of Bulgaria's EU integration that will provide 
an effective start in the absorption of EU funds.  Oresharski also 
said the budget will aim at securing greater employment and a higher 
standard of living for all Bulgarian citizens.  The government will 
pay its first annual EU budget contribution, estimated in 2007 at 
BGN 634 million (USD 430 million). 
 
IMF CONCERNS UPON THEIR DEPARTURE 
 
¶8. (U) During their fourth and final visit in December, the Head of 
the IMF mission, Robert Hagemman, commended the 2007 budget as 
adequate and prudent.  The IMF remains concerned with the budgetary 
risks related to the cut in the corporate tax rate and the increase 
in public sector wages.  The IMF will continue to insist on 
conservative implementation of the 2007 budget and at least a two 
percent fiscal surplus to cover against risks of low tax revenue 
collection.  The Fund is also worried about the high current account 
deficit and urges authorities to maintain their restrictive fiscal 
stance even after its departure.  After March 2007, when the 
agreement with the GOB officially expires, the IMF will provide only 
technical assistance upon request. 
 
COMMENT: 
 
¶9. (SBU) Over the past three years, the government has fairly 
closely followed IMF recommendations for tight spending and surplus 
budgets.  Politicians have invoked the specter of the IMF to reduce 
spending, control inflation, promote economic growth, and give 
confidence to international markets.  The government has been 
successful in these efforts, and is further ahead than many other 
countries in qualifying for Euro entry - which will not happen until 
2010 at the earliest.  Upon the IMF's departure from Bulgaria, the 
goal of Euro entry is the next carrot to force politicians to 
continue the virtuous fiscal practices of the past two governments. 
While the current account deficit and an increasing inflation rate 
(the only potential pitfall to early Euro adoption) are notable 
macro problems, the GOB has done a very commendable job of keeping 
its fiscal house in order. 
KARAGIANNIS