Risk and state finances

Fake and real problems before the fiscal program of Bulgaria for 2023

09:00 | 16 юни 2023
Обновен: 11:00 | 20 юни 2023
Снимка: Bloomberg L.P.
Снимка: Bloomberg L.P.

By prof. Dr. Gancho Todorov Ganchev

The public discussions about Bulgaria’s budget for 2023 are focused mostly on two problems – the relation between the budget deficit and the high inflation from the end of 2022 and the beginning of 2023 and the possibility of the country to fit in the notorious 3% budget deficit, included in the Maastricht Convergent Criteria. The latter acquire strategic importance because of the plans of the political elite for the country to join the Eurozone in the shortest possible time.

Regarding the first question, it should be noted that in our country there is no and cannot be a connection between the budget deficit and, more broadly, between the government debt and the price level. The country is in a currency board. This excludes dependence between the government debt and the budget deficit, on the one hand, and inflation, on the other, since government securities are not part of the BNB's assets and do not affect the money supply, and therefore the price level. Inflation is still, as Milton Friedman points out, a monetary phenomenon.

When the country issues bonds on the domestic finance market, it seizes a certain amount of money from circulation, which it returns when it uses up the corresponding resources. In cases where the government draws financial resources from international markets, the relationship is more complex, but the free movement of capital at a fixed exchange rate precludes any independent impact of the fiscal and monetary sectors on domestic inflation. The acceleration of the inflation processes in recent months, reflects almost entirely the influence of such external factors as energy prices, EU’s inflation, as well as specific market imperfections related to the country's domestic market. The fiscal position plays a marginal role. Re-exposing the budget deficit problem in the context of inflation has a purely political genesis within the framework of mutual accusations between political parties for high inflation.

However, the budget deficit problem is more complicated. The deficit is important both from the point of view of fiscal sustainability and through the prism of the requirements for joining the eurozone. It is well known that deficit is the difference between the income and expenditure of the state budget. The bill on the state budget proposed by the interim government on April 28, 2023 foresees a negative budget balance of over BGN 11 billion or over 6% of the estimated GDP. The budget deficit as a share of GDP depends both on the quality of estimates of the state's revenues and expenditures, and on the realism of assumptions about the dynamics of the economy and inflation.

Here I would like specifically to point out that the caretaker government’s attitude towards the draft budget for 2023 is quite odd. On the one hand, a budget program with an unacceptably high deficit is proposed, which practically erases the country's prospects for joining the Eurozone in the foreseeable future. On the other hand, a system of measures in the revenue and expenditure parts of the budget is proposed to overcome the shortcomings of the draft law on the state budget prepared by this same government. This schizophrenic attitude towards public finances can also be traced in greater detail.

We will analyse only the vaguest hypothesis laid down in the draft budget offered by the caretaker government. The main problem stems from the expected insignificant increase in the tax income. According to the calculations of the Ministry of Finance, under the so-called unchanged policies, tax revenues would increase by about BGN 4 billion. The explanation for this phenomenon is extremely unclear. It is tied to the financing of programs to overcome the consequences of rising electricity and natural gas prices, raising the VAT registration threshold, restrictive measures regarding Russia, etc. A large part of these measures could be dropped, as advised by the European Commission, and their impact in the noted volume is doubtful.

The impact of the EU’s budget funds is unclear. The receipts of European funds are expected to decrease from approximately BGN 6 to approximately BGN 4 billion in 2023, compared to the previous year. At the same time, the costs of financing European projects should increase from BGN 3.2 to BGN 6.5 billion. This leads to a worsening of the received-spent funds balance of the order of BGN 5.3 billion. These estimates are conditional, since Bulgaria uses resources not only under the Recovery and Resilience Plan, but also within the medium-term fiscal program of the EU.

The insufficiently justified cuts in tax revenues and the deterioration of the financial balance in relations with the EU already represent a total of about BGN 9 billion, with a total deficit of BGN 11 billion. BGN. The fiscal program allows additional savings from subsidies, administrative costs, etc. In other words, a deficit of the order of 3% of GDP is entirely feasible.

It should also be noted that not only the expected in the draft budget balance seems inflated, but also the whole midterm budget forecast regarding the financing needs of the public sector and the growth of the state debt seems unreasonably high.

The fiscal program, like any budget, is associated with significant additional risks. Assumptions, related to the exchange rate of euro, oil and gas prices, interest rates on international credit markets, growth rates of the world, European and Bulgarian economy allow for deviations from the base scenario both up and down. An uncertain factor remains inflation, which is probably underestimated in the budget forecast, even though there is also some risk of deflation in the end of 2023.

The war in Ukraine is a major factor creating uncertainty in terms of the movement of the financial and commercial flows in the European region and on world markets. Bulgaria is particularly vulnerable in terms of energy supplies, trade in wheat, sunflower and other important crops for our country. European sanctions against Russia may also have adverse impact on supplies and trade of oil, petroleum products and gas. This necessitates placing larger buffers in the budget.

But in fact the noted inaccuracies, problems and risks are the least of our worries. First, we still don't have a budget passed for 2023, which in itself is a serious problem. Second, drawing up a consistent budget meeting the Maastricht convergence criteria, while possible, will face the conflicting preferences of the parties represented in the parliament. It is possible that pre-election considerations will lead to a budget with an even bigger deficit than the one proposed by Galab Donev's caretaker government.

The proposed rotation scheme for a future government is also associated with serious risks. The party that heads the Ministry of Finance will simultaneously assume all risks in the preparation, approval and execution of the budget. Whatever the future fiscal program adopted by the parliament, it will be attacked and discredited from the opposition. The absence of stable parliamentary majority and the lack of consensus in society regarding the strategic economic priorities of the country is the main risk before any future fiscal program.

THE BOTTOM LINE The fiscal program, as any other budget, is associated with significant additional risks