Following pressures from the IMF and the business community, the government dropped the populist pledges made during the electoral campaign and pursued the reform agenda initiated by the previous government. This volte-face led to a remarkable degree of continuity in the policy course.
The macroeconomic policy framework was maintained, and the currency board ar- rangement remained firmly in place. Fiscal policy was prudent under the medium-term fiscal framework. The 2001 Budget Law reduced the tax burden to support job creation and the development of the private sector. Considerable efforts were made to improve tax collection. In July 2002, the government approved the creation of a National Rev- enue Agency to administer the collection of public receivables. In the following years, fiscal revenues continuously increased and contributed to a surplus in the consolidated fiscal balance. Strong economic growth and active debt management policies reduced the ratio of total public debt to GDP to below 50 percent in 2003.
There was also continuity in institutional reforms, a condition Bulgaria had to meet in order to integrate into the EU. In its 2002 report on Bulgaria’s progress towards accession, the European Commission observed that the country fulfilled the political criteria for accession. It also estimated that Bulgaria was close to being a functioning market economy able to withstand competitive pressure from the EU—provided that it continued to adhere to the reform process. The Commission finally attested that Bulgaria had made good progress in aligning its legislation with the Acquis Communautaire, but that more attention had to be paid to how this was to be implemented and enforced (European Commission, 2002a).
In March 2002, a new Privatization Act was adopted with the objective to increase transparency and compliance with sale contracts, which had been a potential source of corruption in the past. In the following years, significant progress was made in transfer- ring state assets into private hands. By March 2005, the process was complete in large parts of the economy. Significant advances were also registered in the liberalization and restructuring of the energy, transport, and telecommunication sectors. Progress was somewhat slower in areas where EU accession provided weaker reform incentives, such as in improving efficiency of the public sector, enforcing the rule of law, increasing la- bor market flexibility, and simplifying business licensing (European Commission, 2007b; IMF, 2007b).
Despite the efforts undertaken by the previous government to remove administrative barriers, the paradoxical combination of excessive state control and weak enforcement of the legal framework continued to poison Bulgaria’s business climate. In an effort to remove the obstacles faced by investors, the licensing and regulatory regimes were reviewed and simplified. In December 2003, the parliament adopted the Law on the Restriction of Administrative Regulation and Control on Business Activity to facilitate market entry and exit for businesses (EBRD, 2006).
Reforms were also directed towards improving the efficiency of the judicial system. Problems with the judiciary stemmed from the fact that the constitution introduced in 1991 had placed few checks on the judicial branch. The resulting lack of accountabil- ity made the judiciary one of the most corrupt institutions in Bulgaria. In September 2003, the constitution was amended to introduce a higher level of transparency and ac- countability in the judiciary branch. Immunity of magistrates was curtailed. The inner workings of the prosecution process were made more transparent, and accountability mechanisms were improved. A Law on Mediation as an alternative out-of-court pro- cedure for conflict resolution entered into force in December 2004. In April 2005, the parliament adopted a law which unified the registration of businesses and turned it from a legal to a purely administrative procedure (EBRD, 2006).
Despite these efforts, judicial and administrative structures and procedures contin- ued to repel investment because some reforms were delayed while others were not being implemented. Public administration was slow and unresponsive. The judiciary was un- able to deliver a satisfying standard of legal certainty. The burden of administrative regulation was still high: market entry and exit as well as contract enforcement were time-consuming and costly, while tax procedures remained complex and were applied
inconsistently. Evidence also indicated that the declining trend in corruption reported since the late 1990s could not be sustained in spite of the government’s highly promoted anti-corruption strategy. In sum, Bulgaria had come to the point where the adoption of new regulations seemed less urgent than their actual enforcement (European Commis- sion, 2007b; IMF, 2006a).
Limited progress was also made in redressing the health care and education systems, despite the fact that reforms were crucial for the release of scarce public resources needed for high priority spending in these sectors. The education sector was afflicted with severe overstaffing despite a sharp fall in the school-age population. A pool of 110’000 people drew their salaries from educating about 900’000 students. School consolidation and the reduction of staff were urgent reforms needed in order to channel savings toward teacher training, and acquiring materials and equipment. Similarly, health budgets were constrained severely by cost increases and an aging population. Yet the government did very little to improve health financing and implement hard budget constraints at the hospital level. The lack of progress was due primarily to disagreement about the need to consolidate the public service as well as the considerable resistance to change demonstrated by the administrative staff (IMF, 2002b; Dainov, 2005; IMF, 2007b).
While the European Commission acknowledged these deficiencies in its 2004 Progress Report, it nevertheless praised Bulgaria’s reform efforts and endorsed the planned date of 2007 for the country’s EU accession. In June, Bulgaria officially closed all the chapters of the Acquis Communautaire, and the accession treaty was signed in early 2005 (European Commission, 2004a; EBRD, 2006; Crampton, 2008).
During the SNM government’s term in office, Bulgaria enjoyed strong economic per- formance. Real GDP growth averaged about 5.6 percent between 2002 and 2005. In- dustrial gross output recovered and registered double-digit growth rates in 2003 and 2004. Inflation pressures remained limited. Despite these favorable macroeconomic de- velopments, Bulgaria’s vulnerability somewhat increased as the current account deficit widened from 2 percent of GDP in 2002 to 12 percent of GDP in 2005. Much of the increase was due to the buoyancy of domestic investment and consumption. At the request of the IMF, the increase in domestic demand was partially offset by a prudent fiscal policy. While the general government budget was on balance between 2002 and 2003, it slightly increased in the following years (IMF, 2007b).
The favorable economic performance had a positive effect on the living standard of Bulgaria’s population. Per capita GDP increased from 1’988.4 in 2002 to 3’522.7 in 2005. Poverty continued to decrease, although less sharply than between 1997 and 2001. The poverty rate fell by 2.1 percent between 2001 and 2003, to 10.7 percent. Indicators of the depth and severity of poverty also improved. Extreme poverty was at 4.8 percent (Gotcheva, 2007).
The economic environment also had a positive impact on the labor market. Employ- ment grew on average 3 percent per year. The employment rate reached 56 percent in 2005 while unemployment dropped from 16.8 percent in 2002 to 10 percent. Yet both indicators were far from being satisfactory and mirrored the government’s limited suc- cess in removing structural labor market restrictions. While emigration and employment
growth generated increasing constraints in certain segments of the labor market, signifi- cant parts of the labor force were excluded from the formal job market. Bulgaria’s Labor Code was rigid and left little room for implementing more flexible working arrangements. Despite its many positive achievements, the SNM’s time in office disenchanted Bul- garia’s electorate. Public frustration stemmed from the high level of crime and corruption in the administrative sector and the inadequacy of public service provision. The decisive factor, however, was that the improvements in living standards, although important, did not match the inflated expectations set by the 2001 election campaign.
The result was a revival of the BSP’s chances. The latter emerged as the biggest party in the June 2005 elections, but failed to win a majority in the parliament. After almost two months of difficult bargaining, a broad coalition including the BSP, the SNM and the MRF was formed. In spite of being an uneasy alliance, conflicts were suppressed to ensure Bulgaria’s EU accession in 2007.
The new coalition government continued to follow a stability-oriented macroeconomic policy. However, Bulgaria’s strong economic performance was accompanied by growing external imbalances. High FDI inflows coupled with strong domestic demand triggered substantial increases in imports, which led to a widening trade deficit. As a result, the current account deficit further increased and attained 17.9 percent in 2006. In order to reduce the country’s vulnerability to external shocks, gross reserves were increased to above 100 percent of short-term debt. Despite the IMF’s insistence, the government did not keep the fiscal budget in check, and thus the deficit widened to reach 3 percent in 2006 (IMF, 2007b).
Implementing institutional reforms also proved more difficult in the face of fragile party politics and entrenched special interests. European standards were achieved in areas where the EU accession process tended to enforce legal homogeneity. Prices, trade, and the capital account were fully liberalized; so were the financial, telecommunications and energy markets. The long-awaited establishment of the National Revenue Agency centralized the collection of taxes and social security contributions previously spread over several institutions (EBRD, 2006).
Other reforms proved more difficult to carry out. Bulgaria’s Labor Code was amended in May 2006 to allow for greater flexibility in the labor market, but the amendments were not completely implemented. Similarly, the law transforming business registration from a judicial to a purely administrative procedure, while approved in March 2006, was delayed. Reforms aimed at alleviating the regulatory burden and improving the functioning of the judicial and administrative systems remained irresolute and slow. The government introduced a new anti-corruption strategy and performed a number of symbolic actions demonstrating support for it, but it never acted decisively in its implementation. (EBRD, 2006).
The overwhelming structural problems burdening the public sector were acknowl- edged, but no significant action was taken to ameliorate them. Pension contributions were lowered to reduce payroll taxes and create incentives for job creation in the for- mal sector. Further reforms of the pension system were planned, but no details were provided on the timetable. In the health sector, the financing of hospitals was central-
ized at the National Health Insurance Fund, but the measure had no visible effect on financial discipline of hospitals. In the meantime, the accumulation of arrears in the hospital sector continued to burden the central government budget. In the education sector, a comprehensive reform aimed at improving the quality of school education as well as the efficiency of spending was in preparation, and implementation was to start in 2007. Finally, cautious attempts were made to give municipalities greater powers in setting local taxes and fees and managing their own budgets with the adoption of a Law on Fiscal Decentralization in November 2006. But the law was not fully operational and required additional legislation (European Commission, 2007b).
The slow progress of institutional reforms and the unwillingness of successive ad- ministrations to take firm action against corruption raised concerns among EU officials about Bulgaria’s readiness to join the EU. In May 2006, the EU postponed until October its final decision on whether Bulgaria should be given access to the EU in January 2007. In September, the original date was confirmed. However, the European Commission was granted the authority to verify the progress in reforms and to reduce financial support whenever targets were not met (Crampton, 2008).