VZCZCXRO7200
RR RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHSF #1166 2681429
ZNR UUUUU ZZH
R 251429Z SEP 07
FM AMEMBASSY SOFIA
TO RUEHC/SECSTATE WASHDC 4344
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUCPDOC/USDOC WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

UNCLAS SOFIA 001166 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
RETEL: SOFIA 943 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV EINV KCOR BU
SUBJECT:  INFLATION, CURRENT ACCOUNT CAUSE CONCERN 
 
 
¶1. (SBU)  SUMMARY:  IMF officials announced revised statistics on 
Bulgaria September 21, estimating annual inflation of eight percent 
and a current account deficit of 20 percent of GDP in 2007.  Finance 
and banking sector officials remain confident in the Bulgarian 
economy's fundamentals including strong growth (at over 6 percent of 
GDP in 2007), conservative fiscal policy (budget surpluses of at 
least two percent for the past four years) and a well-capitalized 
banking sector.  Still, the persistently-high current account 
deficit, rising inflation, expanding credit growth, and an 
over-heating real estate sector that is dependent on UK-originated 
investments, has Bulgarian finance officials on the lookout for 
potential exogenous shocks.  End Summary. 
¶2.  (U)  IMF officials raised their estimates of annual inflation 
(to 8 percent) and the current account deficit (to 20 percent of 
GDP) for Bulgaria on September 21.  The increased inflation stems 
from rising prices for foodstuffs (partly due to this summer's 
regional drought, reftel) and excise tax increases arising from EU 
membership.  Inflation is expected to decrease in 2008 to four 
percent, still well above the Maastricht criterion for Euro-zone 
membership. 
¶3.  (U)  Optimism related to Bulgaria's EU integration has spurred 
domestic consumption and investment activity and fueled strong 
growth (estimated at over six percent of GDP in 2007) and a large 
current account deficit, which the IMF now predicts will reach 20 
percent of GDP in 2007.  While most observers view the current 
account deficit as a normal -- and temporary -- characteristic of a 
growing transitional economy, IMF Representative in Bulgaria Juan 
Jose Fernandez-Ansola warned September 21 that the GOB must do 
everything it can to assure foreign investors that it intends to 
maintain strict financial discipline (one of the few levers the GOB 
has on the economy given the country's currency board arrangement). 
The current account deficit was more than fully covered by FDI in 
¶2006. 
CENTRAL BANK RAISES RESERVE REQUIREMENTS 
¶4.  (U)  Rapid credit growth is also causing concern.  After 
initially removing administrative barriers to credit growth at the 
beginning of the year, the Central Bank raised reserve requirements 
on deposits from 8 to 12 percent on September 1.  The Bulgarian 
National Bank took this step after the growth rate of bank credit 
reached 47.7 percent in June 2007 compared to 24.6 percent at the 
end of 2006.  The aim of the hike is to withdraw liquidity from the 
banking system and reduce credit demand, thereby relieving the 
country's balance of payments of the pressure of strong domestic 
demand. 
IF UK BANKS COUGH, WILL BULGARIA CATCH COLD? 
¶5.  (SBU)  Even with the growth in consumer credit, according to 
Director of Deutsche Bank Bulgaria Borislav Ivanov, the mortgage 
sector in Bulgaria is still underdeveloped.  Mortgage indebtedness 
amounts to just 5 percent of GDP, well under the European average. 
He noted that Bulgaria has not been touched by the sub-prime 
mortgage threat, as underperforming loans here represent only two to 
three percent of all loans.  Overall, the banking sector is strong 
and well-capitalized. 
¶6.  (SBU)  Still, Ivanov warns that the biggest risk to the 
Bulgarian economy in the near-term is the over-heating real estate 
market.  He noted that over the last two years, Bulgaria's 
impressive growth rates have been driven by real estate, with 35 
percent of FDI coming in this sector.  The real estate boom is 
fueled by foreign investors (individuals, banks and hedge funds) in 
large part from the United Kingdom.  According to James Hyslop, 
Director the EBRD's Sofia office, more than 35,000 UK citizens have 
bought second or retirement homes in Bulgaria, fueling construction 
booms in sea and ski resorts. 
¶7.  (SBU)  With the UK now feeling the effects of the sub-prime 
mortgage crisis, there is increasing concern among Bulgarian bankers 
that UK investments in Bulgaria may experience a slow-down, which 
could cause a correction in housing prices, especially in resort 
areas, of between 20 and 40 percent.  This would take liquidity out 
of the market and affect consumption and growth.  Bulgarian 
financial institutions are watching events in the UK closely given 
Bulgaria's dependence on UK investments in the real estate market. 
¶8.  (SBU)  Comment:  While the fundamentals of the Bulgarian economy 
are strong, the current account deficit, rising inflation and 
overheating housing sector represent potential vulnerabilities.  Key 
for the GOB will be to maintain fiscal discipline, especially in the 
run-up to October 28 local elections, and to continue to attract FDI 
in productive sectors (as opposed to real estate) that will 
eventually lead to increased exports. 
BEYRLE