(C) The Bulgarian economy... May be... May be not

It is often that foreign analysts would treat different economies in a similar, stereotyped way, omitting certain differences and specificities. The recent negative forecasts by Danske bank, should be carefully examined within the context of the issued by the bank fixed income products, that would benefit from weak Bulgarian economy and currency. This is a serious conflict of interest and must be adequately and carefully disclosed in any analysis related to Bulgaria.

Despite all said above, I personally believe that the Bulgarian economy faces severe challenges. The political and the financial skeletons in the central government budget, the retirement system and the national healthcare could easily submerge the economy in a whim of moment.

The educational system’s collapse has been pushing the country to the brink of a national tragedy for the past twenty years. Bulgaria persistently destroys its potential to add value in the economy. The inadequacy of the administration in terms of human resources and organizational structures, causes inability to properly administer and process the EU projects funding. Wide range of programs creates artificial employment, which does not only miss to create value, but manages to destroy one. The strong regulatory protection of the oligopoly companies, the political nepotism among the central government agencies and companies, hand-in-hand with the corruption, the pre-electoral statistical and budget data, are a ticking time-bomb in the backyard of the Bulgarian economy and fully support the forecasts of the foreign analysts.

With the always “absent” R&D sectors,
With the handicapped education in the past 20 years,
Altogether with the thriving oriental habits, the policy of irrational and inefficient capital flow decisions, apropos already dried amid wide spread corruption and the global financial crisis, do not turn me optimist – on the contrary, we are severely missing any of the economic growth generating factors.

(C) Government's G in the GDP! Inefficiencies and perversions!

Often, I have been discussing the role of the Government in the “free” markets. Here is a brief summary of my reflections on the Government role in the Bulgarian economy. It may seem I am taking a political stance … I might be … and there is a purpose … to provoke my dear readers to read and analyze basic macro-data which reads the consequences of the central government's policies.

Government spending of above 40% of the Bulgarian GDP signals significant government intervention in the economy. The appropriate government policy during crisis is a focus on the expenditure optimization, rather than budget revenue hike, which is a huge economy and business development hindrance.

One may easily see that in the consolidated fiscal program, the largest share of expenditures regretfully belongs to the non-interest current expenses, which means that 56% of our taxes go for remuneration, insurance and other current expenses of the central government administrative, regulatory and management inadequate apparatus. The civil servants and their management demonstrate inflated payroll structures, teeming with nepotism, inadequate taxpayers’ service and immoral wealth redistribution schemes.

The appropriate policy is a business management approach governed by radical reduction of the inefficient expenditures and eradication of the central budget and EU funds liquidity drain in certain political parties’ vaults.

(C) CFA exam

To my dear readers:
Hope you'd excuse my 62 days of CFA lethargy.
Promise to back for you after 7 June 2009.
Yours,
Georgi I. Bylgarski

(C) Expansionary Monetary Policy

I have been wondering how some people still think and talk of the expansionary monetary policy as of a printing-press. Kind of alludes some banknotes printing… kind of very misleading allusion for the non-finance backgrounds’.

For those who still think printing banknotes is a solution:
1. Banknotes are just 3-8% of the money supply.
2. A very expensive banknotes printing in order to double the banknotes will result in a mere 5-6% inflation per annum… makes no sense when bearing in mind the high costs.

Let me ask you to think of the expansionary monetary policy in terms of keyboard click made by Marvin King, Ben Bernanke, Jean-Clod Trichet…

Only when the supply of money takes by surprise the economy, the effects might turn positive. Well, this might be the aim of the US, UK, Canadian and Swiss central bankers. However, certain negative consequences might follow such decision; inflationary processes might trigger interest rates, which will hit back the fixed-income instruments, in particular the ones repurchased by the central bank. This dEFFECT might not be easily swallowed by the large creditors of the indebted economies.

What is essential for the economy is the prevalence of the positive effects (lending and confidence) of the stimuli provided through monetary policy. The most difficult task facing the central bankers is the production of the right amount of inflation which will ignite the engine of the economy. Deficit or surplus of money supply could cause more harm than good in periods of crisis.

However, any monetary policy approach, by its own, with no fiscal support, structural changes, regulatory overhaul, introduction of new consumer behavior, would be void, so would be the rebound attempts for the economy.

(C) Inflation of 2-3% … Great … Wait, Wait, Wait

The inflation slowdown and the economic crisis are exogenous to the Bulgarian economy. It is not a result of government or central bank policy, but the financial and the liquidity crisis in the European banking sector, which in turn owns the financial institutions in Bulgaria. Well hypothetically this slowdown seems to help Bulgaria meet the Maastricht criteria…

Wait, Wait, Wait a minute…
Let’s not forget that the inflation criterion is not an absolute one, but relative to the best three inflation performers in the Eurozone. The negative economic developments in the Euroarea have already suppressed the inflation. January 2009 data shows slump to just 1.1 % points, which quickly drives us away from the inflation target.

On the other side, I do expect serious challenges in the 2009 and 2010 budget balance, leave alone any surplus, thus the fiscal stability could easily be derailed. Moreover, in case the crisis deepens further and the business struggles extend to defaults, amid lack of fresh funding … solid government borrowing I see on the horizon. Having pretty low government-debt-to-GDP ratio at this moment, exceeding the 60% barrier (art. 121 (1)) seems unlikely at this stage.

Since the inflationary easing is influenced by financing constraints, one needs to seek direct economic consequences within these factors. The most severely blown will be the labor market, which is dependent on the consumption and investments. In an emerging economy with extremely low labor and capital productivity, lack of any R&D, the drying up of the capital inflow will be crucial for the inefficient productions and services and will cause high levels of unemployment. Shall this coincide with a right-wing political and social policy, there will be an unemployment multiplication by laying off a multitude of hollow, inefficient administrative and social programs employment and will cause havoc on the labor market.

I would be more than happy if the economy seizes all the opportunities the crisis might offer, such as take necessary steps to improve labor force qualification, increase productivity and efficiency, via adequate and modern human capital investments.

(C) Banks' bailouts !?!

Nationalization is an extreme approach to solve any business crisis, which always, always brings the burden of the irrational political influence over the nationalized business. Seeing the banks’ nationalization a counter-measure of the crisis, tough, is a pretty dangerous point of view, contrary to any market principles. On one side, in functioning market economies, only the strongest and the fittest survive. On the other side, the nationalization preserves the infirm businesses, which is in no ones favor.

Have we already forgotten the filthy service at the dusty bank kiosks with max of 15 minutes clients’ service time a day?

We need to admit that there is a multitude of sins of the Bulgarian banking system. However, if a significant problem exists it is the job of the regulator to allocate and eliminate it, thus improve the business environment. This effect would not be achieved by a brutal, nation-wide government intervention, but through thorough, adequate and timely control. It has been the last 3-4 years that the banks managed to evade the recommendations and the restrictions of the central bank, especially in the credit expansion field, through some fancy instruments and by utilizing SPVs designated for balance-sheet clean up of high risk exposures. This has led to a build up of risks in the banking system, in particular the concentration, the operational and the liquidity risks. The symptoms of these problems have shown up recently, due to the diseases of the mother banks of the CEE subsidiaries’ banks. This financial plague will give chance of survival of the healthiest ones.

Besides all said above, we need to answer one more question, before we dare to raise the nationalization question: What resources, if not newly-issued foreign debt, could the government offer to support, leave alone nationalize the banking system?

Currently the Bulgarian government and the Bulgarian national bank can afford to bailout one or two at best, of the largest banks. Shall one dream of nationalizing the banking system, one should issue tens of billions of foreign debt, which will be burden for plenty of generations. Even worse, we will exchange a kind of long-term equity investment into a shorter debt, but for all the Bulgarians. I see no drop of rationality in this hypothesis, even further; I believe that any non-fundamentally-based negative comment or remark is a dangerous flirt with the stability of the banking system and the Bulgarian economy.

(C) Too much noise about CEE economies and banks

This comment comes from the CEE, therefore, please subtract my CEE bias on the issue and focus on the facts, I dare add on the continuous noise about the CEE economies and banks.

1. The region has brought 80% of the returns of the WE banks, just out of 20% of their assets. That is a great return, don't you agree!?, ... and it kept on attracting the greedy WE bankers ... and they kept on pushing their credit expansion in the region, harnessing all their potential to evade the regulatory restrictions on excess lending. Well they "succeeded", kudos... One thing was out of the bankers minds all these 7-8 years - the RISK. They forgot their first finance class - the RETURN goes hand in hand with the RISK.

2. The shock in the financial system in the CEE is 99% exogenous - I mean 99%. It is Europe that pays the toxic losses of the US these days, and it is Europe that holds its imports and restrains its financial expansion, due to the losses suffered from the US fancy investment products. Well it is the same Europe that was importing heavily from the CEE and was investing heavily in the CEE. I guess the link is pretty clear now...

3. Those who orchestrated the housing and the credit bubbles, should have seen the consequences of their efforts to please their consumers, at the expense of a financial Armageddon in the weaker regions of the world...

4. Please do not blame the CEE for what you see on your Bloombergs' and Reuters' ... it is a result of the excessive consumption and gluttonous greed in other parts of the world!!

(C) Fiscal Measures of Last Resort

The financial system is the backbone of every economy. Shall that backbone collapse the whole economy will collapse. Under certain good practice requirements imposed on the banks, the governments should support the banking systems with utmost concern. The banks on their side, however, should resume or continue financing the healthy projects in the real economy.

The major, fundamental questions remain unanswered in the Bulgarian case.

1. With regard to the unsatisfactory credit expansion restriction in 2007 and 2008, which has led to severe imbalances in the real economy and significant current account deficit, can the government and the central bank exert any… any influence on the financial system?

2. With regard to the pre-elections, irrational fiscal expansion, does the government have a financial cushion, to protect the economy against any financial system weaknesses?

(C) The Bulgarian capital market in 2009 – outlook (negative)

It is 08Q4 when the economy has actually started to feel the first symptoms of the economic crisis. Invading through the financial system, the lack of bank financing, coupled with the failing EU programs has cornered the real sector’s investment and production plans.

The positive hypothesis for 2009 states liquidity trap exit and first steps towards global economy recovery. In the context of rising bad loans in our banking system, however, I do not believe that the business lending will make a comeback, leave alone with attractive rates, since it needs to incorporate much higher risk levels in the economy.

Since the markets mirror the economy six to twelve months ahead, it is possible to see green year in 2009, if only 2010 shows symptoms of recovery.

The negative hypothesis for a global economy recession, states unambiguously a negative outlook both for the Bulgarian economy and the Bulgarian capital market.

…

Some under-priced upward corrections though will be more than welcomed.

(C) The Ponzi investor is dead ... long live the Ponzi investor

Ethics … Investment … Investors

The “Madoff” scandal is not a new issue to the financial industry, or the regulators. Though the scale of the damages comes with the large size of the fund (one of the largest ever – USD 50 bill), the ethical image of the regulated markets management, the investment companies management and the regulators’ competence in understanding and regulating sophisticated related deals comes under the attack. The Ponzi investor is dead, long live the Ponzi investor.

Regardless the size of the loss, the financial world should draw conclusions on the degree of trust, the ethical standing of the managers, when taking an investment decision.

Is there a litmus for the investment managers ethics!?

(C) Effects of the minimum reserves change

The central bank reigned by a currency board has one useful, intimidating and powerful tool to control the money supply – the required minimum reserves. For a better analysis of the impacts of the reserves rate change, one needs to know whether this measure is a temporary, anti-crisis one or a long-term, fundamental one.

One potential direct effect of the release of those liquid assets in the banking system would be some downward shift in the short-term interest rates on the inter-bank market. I personally fear that an insignificant part of those BGN 1 bill. will actually enter the economy in terms of business loans and foster the interest income of the banks. Even less probable seems any capital market intervention, having in mind the liquidity thirst the banks suffer from.

The end-effects would most probably sum to stabilization of the inter-bank market and eventually to certain financial account outflow.

(C) Fiscal Combat

Bulgaria does not possess a flexible monetary policy if any. This turns the fiscal policy into a major economy stabilization factor.

The governing parties dilemma is a dramatic one. The first option they have is to pour money into rational business projects, through a rusty administrative machine with strong corruption bias. The second option is to diminish the fiscal burden, thus pouring cash into the irrational consumers – the households, though this might foster the employment.

Ceteris paribus, the better option for the country in the long run is an investment in projects of national importance such as education, qualification, infrastructure and renewable energy.

Could the politicians though, oil the administrative capacity and swallow the pre-election tactics in order to address the strategic development of Bulgaria?

(C) 2009 Shares vs. Inflation

Historically the capital market in Bulgaria exceeds the inflation by some three to five percentage points annually. The history, however, never repeats itself and 2008 is an outstanding example of that, with the inflation rate beating the capital market growth (decline) severely.

Taking into account the increased price of the financing and the credits’ abrupt implosion, the inflation in 2009 will decelerate to a single-digit rate. This credit crunch hand-in-hand with the high interest rates will brutally disrupt the businesses which rely heavily on external financing or have planned leveraged expansion.

The winners in 2009 will be those companies that employ highly qualified personnel, offer non-cyclical or counter-cyclical products and services, and most of all have low leverage, or have already contracted preferable interest rates.

(C) The FDIs in Bulgaria and the influence of the crisis

The FDIs for 2007 and 2008 until now are represented by 27% share capital in the non-banking sector, 30% in real estate and 26% in financial and commercial debts between related companies.

The very first part is inflexible and sensitive to the price and the quality of labor force and the governmental FDI stimulus packages. The critical issue for Bulgaria is the insufficient skills, knowledge and efficiency of the white and blue collars. Until the elections for the next government, the latest should be fully aware that only strong investment in the educational system could meaningfully foster the FDI.

The real estate sector is on its way to hit the economy soon. (decline for the 01-08.2007 versus the 01-08.2008 period by 22.4%)

The most flexible of the three major elements of the FDIs – the loans have already severely stricken the economy. The decline for the first eight months of 2008 compared to the same period for 2007 is some 68.7%, or some 83.9% of the FDI decline.

The solution of the FDI case lies in the fostering of products and services with high added value which require high professional skills and competence.

(C) US Elections and the capital markets

Historically for the last nine US presidential mandates, the republican presidents have brought higher returns on the capital markets in the pre-election day month, that the democrats. During the past twenty years (since George H. Bush’s till nowadays), the democrats hold a unanimous advantage over the republicans in the investors’ trust during their first hundred days and first year in office. If the history repeats itself, we should expect that the current lead of Obama should raise the hopes of the US investors.

In the ongoing campaign the two presidential candidates were a bit late with their update on the economic program regarding the financial crisis. Due to the fact that the crisis is in its climax, I personally believe that the measures of the current George W. Bush’s office will play a much significant role, than the expectations of positive political shifts of the next government.