Bulgaria : from enterprise indiscipline to financial crisis

The first part of the paper highlights the many and often perverse forms taken by the adjustment of State Owned Enterprises in Bulgaria since 1992. The differentiation into four clusters of unevenly performing State firms shows inter alia two important aspects in this process. First, a large number of heavily loss-making public enterprises has been allowed to survive since the beginning of transition at the expense of the rest of the economy, first of all the banks whose insolvency they contributed to while absorbing a large part of newly extended credits. However, as a rule, losses have been much financed more through informal or non-contractual means, mostly by the accumulation of interest and tax arrears, while in principle the impossibility of obtaining new external finance, or issuing equity after having lost all base capital should have made bankruptcy the only remaining solution. The second decisive aspect in the adjustment process is that more competitive, often profitable enterprises have also been accumulating large arrears towards other agents, with the banks again being the main victim. The implication is that arrears have been much larger than the mere financing of losses would have required, and have apparently been considered by a substantial number of enterprises as a current revenue flow rather than as a financing source. Indeed, SOEs as a whole have imposed informal revenue transfers to other agents averaging (on a conservative estimate), 28% of their own value added per year between 1992 and 1995. The second part of the article analyses how the accumulation of enterprise arrears and of budget deficits, since 1992, has been absorbed without major financial disruptions. The evolution of the aggregate accounts for enterprises, government, households and the commercial banking sectors are then presented, so as to highlight three decisive factors in this exercise in crisis deferment. First, households have suffered large inflation taxes on their deposits, which have helped banks to rebalancing their balance sheets; second, despite these heavy wealth losses, private deposits in banks have kept increasing at sustained though declining rates till 1995, a trend which has limited the risk of an immediate liquidity crisis, notwithstanding the increasing insolvency of financial intermediaries; third, the State was able to post a large primary surplus in 1994 and 1995, which has also contributed to containing the financial tensions due to microeconomic indiscipline. However, the banking crisis has been gathering pace since the end of 1995: a series of banks have been closed down and the Central bank has injected increasing amounts of reserve money in the banking sector, so as to reduce the risk of a systemic liquidity crisis and of a large-scale run on deposits. Large withdrawals were observed in April and May 1996, while a sharp foreign exchange crisis developed during the latter month, causing a total fall in the dollar value of the national currency of nearly 50%. Hence, the major risk is that a sharp acceleration in inflation may increase the budget cash deficit (through the Tanzi effect) in the immediate future, leading possibly to high or even hyperinflation. Though such an issue would have very destructive immediate consequences, and would drastically reduce household wealth, it would also inflate away the largest part of the domestic public debt, as well as of the banks huge stock of non-performing loans. In the medium-term, this would provide the basis for re-establishing strong financial discipline on enterprises and banks, so as to set the Bulgarian transition on a more stable, promising course.