The new government inherited a bankrupted country. The economy was in a deep recession. Inflation exceeded 1’000 percent in 1997. The general government debt stood at about 320 percent of GDP. More than 50 percent of the goods and services within the consumer price index were administered by the state. Trade was hampered by import tariffs, export taxes, non-tariff barriers, trading licenses, and administrative regimes. Only 24 percent of state assets were privatized. 60 percent of all employees in the country were employed in the public sector. The financial system was in ruins while state companies continued to incur substantial losses.
The crisis gave rise to broad public support for a radical change in the course of economic transition. The UDF advocated a break with the previous previous trend of chronic delays and unfulfilled commitments and promised to rapidly introduce a com- prehensive reform program. The UDF committed fully to implementing multilateral recommendations for stabilizing and restructuring the economy. By the time of the elec- tions the main reform program was ready to be implemented. During its term in office, the government successfully stabilized the economy and privatized much of Bulgarian agriculture and industry (Nikolov et al., 2004).
The centerpiece of the stabilization program was a currency board arrangement im- posed by the IMF as a non-negotiable prerequisite for new funding. The IMF’s intention was to deploy a disciplining mechanism in macroeconomic policy. The nominal exchange rate was fixed against the German mark (and subsequently to the euro) with unlimited convertibility of base money, depriving domestic authorities of a sovereign monetary policy. The currency board arrangement also limited the government’s fiscal sovereignty following the IMF’s insistence on establishing a medium-term fiscal framework which would guarantee long-term fiscal sustainability (Dobrinsky, 2001).
The introduction of the currency board arrangement quickly yielded positive out- comes. The annual average inflation declined dramatically from 1’082 percent in 1997 to 22.2 percent in 1998 and 0.7 percent in 1999. The basic interest rate was reduced from 180 percent in 1996 to 6.7 percent in 1997. The fiscal deficit was brought down to sustainable levels. Despite the inhospitable external environment characterized by the global financial crisis in 1998 and the Kosovo conflict in 1999, the currency board arrangement was effective in maintaining macroeconomic stability. General government debt was brought down to 80 percent of GDP at the end of 1999, with short-term liabilities declining significantly.
A major tax reform was initiated with the twin objective to improve tax collection (by establishing a Unified Revenue Agency), and to lower the tax burden (by simplify- ing the system of income and corporate taxation). Extra-budgetary funds were closed down. These measures significantly increased fiscal revenues and curbed tax evasion and underreporting in the following years (Nikolov et al., 2004; EBRD, 2000).
Prices were gradually, but swiftly liberalized. The Law on Prices, which was intro- duced by the previous government and formed the legal basis for state intervention in price setting, was abolished in July 1999. The prices of coal, electricity, central heating, telephone, postal services, and gas remained administered for some time as a collateral
social policy measure. They were progressively adapted in the following years to ensure cost recovery (EBRD, 2000).
The reform program did not only consist of stabilizing and liberalizing the econ- omy, it also addressed the root causes of the reform failures during the first phase of transition. One of the first priorities was to rehabilitate the banks that survived the crisis. Important institutional safeguards were adopted in order to tighten the pruden- tial banking regulations and increase the efficacy of banking supervision. New criteria regulating risky exposition, capital adequacy conditions, and bank reporting were in- troduced. Another measure designed to stabilize the economy consisted of cutting the flow of bank credit to unviable SOEs. For this purpose, the largest loss-making state companies were placed in financial isolation, forcing them to fundamentally restructure their operations. The implementation of the financial isolation program lasted several years and helped to improve the operational and financial performance of many targeted enterprises. Insolvent companies were liquidated (Nikolov et al., 2004; EBRD, 2000).
Bank privatization was initiated and vigorously pursued. By 2004 all state-owned banks were privatized. By that year, the number of foreign-owned banks had increased to 24, from 7 in 1997. These banks held 81.6 percent of all bank assets in the country. Bank assets in state hands were reduced to 2.3 percent.
Another key element of the reform program was the rapid privatization of SOEs. The government declared that sales to strategic investors would have the highest priority. The period with the most intensive ownership transfer was between 1997 and 1999. By 2000, almost 80 percent of SOE assets available for privatization had been sold, mainly through public sales.
Land restitution was also forcefully implemented, and by the end of 2000 the pro- cess was largely complete. However, some major obstacles impeded the creation of a functioning land market. The process of land titling was delayed by a slow and corrupt local public administration. Only 40 percent of the land subject to restitution had been titled by 2000. The lack of progress in land titling hindered the process of land con- solidation, which was essential to create a viable land market, since agricultural plots were generally small. The land market was further constrained by the lack of access to financial markets, depriving landholders of the possibility to acquire credit. Finally, foreign ownership of land was prohibited, which prevented the transfer of capital and technology from outside. These obstacles significantly curbed the growth of agricultural productivity (EBRD, 2000, 2001; Dudwick et al., 2007).
The year 1998 saw the implementation of a major public service reform program which aimed to improve the financial sustainability of the pension, social welfare, educa- tion, and health care systems. After a decade of economic decline, the financial situation in these areas had become untenable. Following mounting pressure from international donors and the public, the government took decisive steps to reverse the negative trends. Public pensions were provided through a traditional pay-as-you-go system, which was mainly financed via payroll taxes. But the system was increasingly out of line with the demographic and macroeconomic reality. Early retirement schemes had produced over 2.3 million pensioners—which was half of Bulgaria’s working-age population. The
ratio of pensioners to the officially employed was 75.7 percent in 1998. Moreover, high contribution rates encouraged informal working arrangements and under-reporting of income. This situation put the pension system under severe financial stress, and deficits had to be increasingly covered by allocations from the government budget. However, as fiscal constraints ruled out further social security deficits, the authorities had no choice but to allow the real value of pensions to erode. This erosion in turn generated strong social and political pressure for pensions to increase (IMF, 2000b; UN, 2000).
An ambitious reform was launched to improve the financial viability of the public pension scheme. The introduction of a modern three-pillar pension system, including a public pay-as-you-go system, a mandatory privately-managed second pillar, and a voluntary third pillar was prepared. Legislation for the voluntary pillar was passed in 1999, and regulated private pension funds started operating at the end of that year. A reformed pay-as-you-go system, including a higher minimum retirement age and fewer early retirement categories, was implemented in 2000. The efficiency and long-term viability of the pension system greatly improved in the following years (IMF, 2000b, 2004b; UN, 2000).
The government also took measures to improve the provision of social assistance. Until then, social assistance consisted of a large number of poorly-targeted programs which were spread across various institutions. The main poverty alleviation program consisted of a monthly income support. The adoption of a new Social Welfare Law in 1998 improved the eligibility criteria by establishing a single, better-targeted, income guarantee scheme. It also defined the respective roles of central and local authorities in providing social assistance. The effectiveness of social assistance programs subsequently improved, with the cash benefit program having a high incidence among the poor. In 2001 about 68 percent of its resources were channeled to the bottom quintile (IMF, 1999c; World Bank, 2002).
The government also presented a cautiously formulated, yet comprehensive reform plan to modernize the educational system. After a decade of declining expenditures, Bulgarian schools began to show obvious signs of decay. Capital spending had been low during transition so that school buildings were deteriorating and material was missing. Attendance rates were in decline and about 45’000 children dropped out of school each year. Attendance rates of minorities were significantly lower than those of ethnic Bul- garians across educational levels. For instance, secondary enrollments for Roma were in the single digits, while the national level was around 46 percent. Massive failures of children in primary school cast doubt upon the competence of teachers, teacher training, and teaching methods (UN, 2000; Dainov, 2005; EBRD, 2006).
Legislative regulations were adopted to determine the parameters for curriculum standards and student achievements. Secondary educational cycles were elevated to European standards and schools were given greater freedom in defining their plans for implementing the curriculum. Steps were also taken to decentralize the management of the educational system. However, the legislative acts were only partially implemented in the following years as they were met with public suspicion and strong resistance from the administrative staff (Dainov, 2005).
Health care reforms became urgent as the sector suffered from serious institutional deficiencies. During much of the 1990s, priority was given to the costly hospital sec- tor at the expense of primary health care and preventive medicine. Excess capacity, old technologies, poor maintenance, and inefficient utilization of resources were inherent characteristics of the system. In theory, health care was financed by general fiscal rev- enues and access was free. In practice, patients were required to contribute directly to service provision by paying informal fees. As a result, vulnerable groups were excluded from basic health care. In order to remove existing deficiencies, the government adopted the Health Insurance Act and the Law on Health Establishments in 1998 and 1999, re- spectively. The laws were oriented towards increasing efficiency and financial stability of the health system, as well as improving the quality of the services provided (Georgieva et al., 2007).
Similar to the reforms in the education sector, reform implementation was met with resistance by the administration, the staff, the public, and the media. In both cases, part of the problem was that reformers were unable to convince the public of the importance of these reforms. The main problem, however, was the stakeholders’ unwillingness to relinquish existing resources and privileges.
These obstacles notwithstanding, the outpatient care and the primary healthcare provision by family doctors were successfully reorganized. In addition, ownership of health care facilities below the national level was transferred to municipalities. However, problems of coverage, quality and access continued to afflict the health care system. Some municipalities lacked the financial resources and the management capacities to maintain appropriate quality standards. Moreover, in the absence of a functioning health market and given the impossibility to close down insolvent hospitals, incentives for good hospital management remained weak and public funds continued to be channeled to loss-making facilities. Ultimately the reform did not succeed in eradicating informal payments for health services so that vulnerable groups still experienced difficulties in accessing health care (Georgieva et al., 2007; Pashev, 2006).
As a result of the macroeconomic and structural reforms—and in spite of negative external economic and political trends—Bulgaria’s GDP registered an average yearly growth rate of about 4 percent between 1998 and 2001 and thus reversed the negative trend of previous years. The economic upturn was mainly driven by the service sector. The manufacturing industry was negatively affected by the ongoing restructuring, and gross industrial output resumed only in 2000, following an upturn in FDI. The sustained economic recovery contributed to an improvement in living standards, although at a very low level. Between 1997 and 2001 per capita GDP increased from US$ 1 ’257 to US$ 1’723. During the same period, real wages increased by more than a third (IMF, 2002a).
The authorities’ efforts notwithstanding, the reform dividend was relatively slow in coming. A series of adverse shocks kept GDP relatively flat. Exports suffered from an economic slowdown in partner countries as a result of the global financial crisis. In 1999, the Kosovo conflict led to further export losses. Moreover, the intensive privatization and restructuring of large inefficient enterprises produced high levels of unemployment. Having declined to 14.5 percent in 1997, unemployment rose substantially and reached
19.5 percent in 2001. Although headcount rates fell to 12.8 percent in 2001, poverty remained widespread, especially in less developed rural regions (World Bank, 2002).
The decisive political effort to push forward necessary and painful economic reforms triggered a positive response by several important external actors. In 1997, a three-year agreement was concluded with the IMF, and financial support was extended following the government’s determined implementation of macroeconomic and structural reforms. In December 1999, Bulgaria was invited to start EU accession negotiations. The invitation was recognition of the country’s reform achievements thus far. In the follow- ing years, the process of EU accession was to become the impetus of market reforms. While the post-crisis reforms inspired by the IMF and the World Bank mostly sought to establish functioning market institutions, the preparation for EU accession implied a considerable broadening and deepening of the reform process. On the one hand, the EU decision to accept Bulgaria’s candidacy had tangible benefits including greater material and technical support as well as policy stability. On the other hand, Bulgaria had to accept the EU’s active role in designing and monitoring the reform process.
The domestic scene looked quite different from the international one. Although the UDF government stayed popular for over two years, support began to dwindle as the public became concerned about stagnating living standards. The government’s popular- ity was further eroded by ongoing corruption allegations against senior public officials. The latter were suspected of providing unjustified private benefits to their key political friends through favorable privatization deals, public procurements, and business permits. The unexpected appearance of the former king of Bulgaria, Simeon Saxe-Coburg, turned the political scene upside down. His newly-created party—the Simeon II National Movement (SNM)—won half the seats in parliament in the June 2001 elections. The broad electoral base of the SNM—including members of the business elite as well as disappointed former BSP and UDF voters—mirrored the party’s highly eclectic electoral program that combined liberal ideas and populist pledges. A coalition was formed with the MRF, and in July 2001 the new government was inaugurated.