Scope Ratings AG has today affirmed the Republic of Bulgaria’s long-term local-currency issuer rating of BBB, following the release of its revised sovereign rating methodology, and has converted its status from subscription to public. The agency has also assigned a long-term foreign-currency issuer rating of BBB, along with a short-term issuer rating of S-2 in both local and foreign currency. The sovereign’s senior unsecured debt in local and foreign currency was also rated at BBB. The Outlooks are Stable.

Rating drivers

Scope’s affirmation of Bulgaria’s long-term sovereign rating at ‘BBB’ reflects the country’s European Union (EU) membership and the resulting wealth and institutional convergence, high growth rates, a reduction in fiscal and external imbalances and stronger reserve levels, backing the stability of the country’s fixed exchange rate regime to the euro. Bulgaria’s ratings are restrained by the country’s low GDP per capita (USD 7,377 in 2016) and small economic size (with nominal GDP of USD 52bn), which in combination with economic openness makes Bulgaria vulnerable to idiosyncratic as well as global shocks. In addition, high levels of non-financial private sector debt, weaknesses in the banking sector and institutional weaknesses are rating constraints. The Outlooks are Stable, reflecting balanced risks to the ratings moving ahead.

Bulgaria’s economy has experienced a sustained recovery, with real GDP growth accelerating to 3.6% and 3.9% in 2015 and 2016, after average growth of 1.1% from 2010-14. In October, the IMF revised its projection for 2017 growth for Bulgaria to 3.6% from 2.9%, and for 2018 growth to 3.2% from 2.7%. The economy continues to benefit from improvements in labour market conditions, with the unemployment rate down to 6.2% as of August (sharply down from peaks of 13.2% in late 2013), higher labour force participation, very strong real wage growth and increases in pension and social benefits. Moreover, domestic demand is also benefitting from a recovery in private sector credit. Scope expects medium-run potential growth to average a more modest 2.25% – implying an easing of growth over time compared with the present, as the labour market nears full employment and elevated real wage growth tempers. Lower potential growth reflects important supply-side bottlenecks due to a rapidly declining and ageing population.

Scope considers Bulgaria’s robust public finances to be an important credit strength. In 2016, Bulgaria recorded a consolidated budget surplus of 1.6% of GDP on a cash basis. This represented a sharp consolidation since 2014, when the cash balance was -3.7% of GDP. The fiscal overperformance in 2016 compared to the government’s projections reflected higher-than-expected growth and revenue collection, and under-implementation of capital expenditures owing to a low absorption of European Union funds. For 2017, the IMF expects the cash balance to revert back to a small deficit of 0.4% of GDP, partly reflecting the unwind of some temporary factors in 2016, before a deficit of 0.7% in 2018, prior to reaching a balanced position in the medium term by 2021 and 2022.

The government’s balance sheet incorporates a low and declining debt level as well as sizeable fiscal reserves. Bulgaria’s gross public debt ratio stood at 27.7% of GDP as of Q2 2017, relatively unchanged since early 2015, but substantially higher than lows of 12.7% of GDP in Q1 2009. The rise from 2009 reflects the earlier economic slowdown, pick-up in the fiscal deficit, crystallisation of contingent liabilities from the failure of Corporate Commercial Bank in 2014 and pre-financing activity. At present, Bulgaria has the third-lowest debt-to-GDP ratio in the EU, after Estonia and Luxembourg. Going forward, the IMF projects the debt ratio to decline gradually to 20% of GDP by 2022. In addition, Bulgaria has sizeable fiscal reserves. As such, government debt net of fiscal reserves stands at 14% of GDP as of Q2 2017. Scope’s forward-looking assessment will include an ongoing concentration on Bulgaria’s budgetary execution and debt trajectory.

Bulgaria’s debt profile is sound. Interest payments as a share of total government revenues were 2.2% in 2016, compared to an EU average of 4.8%. Also, the debt has a long average residual maturity of about 7.8 years, with almost the entire stock on fixed rates. However, about 80% of total government debt is denominated in foreign currency, predominantly in euros. While the Bulgarian lev is fixed to the euro and backed by the nation’s credible currency board regime, it could come under risk in highly adverse environments.

Bulgaria's current account showed a surplus in 2016 of 4.2% of GDP (based on IMF estimates), an improvement on a balance of -0.1% of GDP in 2015. Scope is mindful, however, that Bulgaria’s current account can be volatile, representing a source of vulnerability. In the long term, the IMF expects the current account surplus to revert gradually to a modest deficit of 0.4% of GDP by 2022. Bulgaria holds a net international investment position of -46% of GDP as of Q2 2017, an improvement from -98% of GDP in Q2 2010, driven by deleveraging led by the banking sector alongside current account improvements. Bulgaria’s gross external debt has declined to 68% of GDP as of Q2 2017, from over 100% of GDP in early 2010. Importantly, Bulgaria’s macroeconomic performance is supported by its currency board arrangement and fix of 1.96 levs to the euro. The credibility of the currency board arrangement is bolstered by the central bank’s reserve accumulation, with foreign exchange reserves totalling USD 26.3bn as of September 2017, up from USD 15.1bn in January 2015. In combination with the effect from debt deleveraging, forex reserve coverage of short-term external debt amounted to 3.0x as of July 2017, doubling from 1.4x as of January 2015, and compared with under 1.0x between 2008 and 2011.

Financial stability risks and sources of contingent liabilities are key weaknesses constraining Bulgaria’s sovereign ratings. Following the 2015 banking crisis, Bulgaria has taken steps including conducting an Asset Quality Review and stress test on the financial system, initiating reforms to the supervision of the Bulgarian National Bank (BNB), introducing a new bank resolution authority and requesting a Financial Sector Assessment Program from the IMF. The IMF assessment, however, identified several persistent risks including weaknesses in some banks, high non-performing loans, and limitations in BNB’s ability to provide liquidity support in times of financial stress.

Consolidated private debt remains high in Bulgaria, at 104.9% of GDP at end-2016. While it has declined from 133.8% of GDP as of end-2009, the still-high level of debt – particularly in the corporate sector – represents an important vulnerability. Furthermore, 39% of total lending in Bulgaria is denominated in foreign currency, nearly all in euros, representing a risk in stressed scenarios.

Finally, Bulgaria has middle-range scores on institutional metrics, such as the World Bank’s Worldwide Governance Indicators, and somewhat weaker scores than ‘bbb’ sovereign peers. The country has seen significant political turnover. In the March 2017 snap election, GERB won a plurality, forming a new coalition with the nationalist United Patriots. Boyko Borisov returned as prime minister in May 2017. Bulgaria’s history of unstable governments represents a rating constraint as it restricts continuity in reform drives, raises incentives for populism that weighs on the fiscal balance sheet, reduces the capacity for long-term economic planning, and undermines the business environment and investor confidence.

Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative “BBB” (“bbb”) rating range for the Republic of Bulgaria. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis.

For Bulgaria, the following relative credit strength is identified: i) good resilience to short-term external shocks. Relative credit weaknesses are signalled for: i) current account vulnerabilities; ii) recent events and policy decisions; iii) financial sector oversight and governance; and iv) macro-financial vulnerabilities and fragility. The combined relative credit strengths and weaknesses indicate a sovereign rating of BBB for Bulgaria. A final rating of BBB was assigned to the Republic of Bulgaria.

For further details, please see Appendix 2 of the rating report.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s view that risks to the ratings are balanced.

The ratings/outlooks could be upgraded if: i) Bulgaria achieves stronger than anticipated fiscal results, leading debt ratios on a clear downward trajectory; ii) further significant reforms to banking supervision materialise and/or additional private sector deleveraging takes hold, reducing risks of spill-over onto the sovereign balance sheet; and/or iii) improvements in political stability allow constructive structural reforms and stable fiscal planning, unlocking potential for higher growth and lower public debt.

The ratings/outlooks could be downgraded if: i) a return of financial sector weaknesses or higher private sector debt pose spill-over risks to the sovereign balance sheet; ii) Bulgaria’s balanced budget unwinds significantly, returning to meaningful deficits and pushing debt ratios higher; and/or iii) the current account surplus reverses significantly or Bulgaria’s external balance sheet deteriorates, lowering reserve coverage ratios and undermining the exchange rate regime.

For the detailed research report, please click HERE.

Rating committee

The main points discussed by the rating committee were: i) Bulgaria’s economic performance and outlook; ii) fiscal performance and debt sustainability; iii) Bulgaria’s fiscal framework and exchange rate regime; iv) external position and resilience; v) banking sector performance and oversight; vi) Bulgaria’s business environment; vii) the convergence process with euro area members; and viii) peer considerations.

Methodology

The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com.

The historical default rates used by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default and definitions of rating notations can be found in Scope’s public credit rating methodologies at www.scoperatings.com.

The rating outlook indicates the most likely direction in which a rating may change within the next 12 to 18 months. A rating change is, however, not automatically a certainty.

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings AG.

Rating prepared by Dennis Shen, Lead Analyst

Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director, Public Finance

The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The subscription ratings/outlooks were last updated on 05.05.2017.

The senior unsecured debt ratings as well as the short-term issuer ratings were assigned by Scope for the first time.

As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on the Republic of Bulgaria are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2017" published on 21.07.2017 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the deviation was due to the recent revision of Scope’s Sovereign Rating Methodology and the subsequent placement of the ratings under review, in order to conclude the review and disclose ratings in a timely manner, as required by Article 10(1) of the CRA Regulation.

Solicitation, key sources and quality of information
The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.

The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: IMF, Bulgarian National Bank, Bulgaria’s National Statistical Institute, Ministry of Finance of the Republic of Bulgaria, Eurostat, European Commission, United Nations and Haver Analytics.

Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.

Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Conditions of use / exclusion of liability
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