Charles Robertson, Chief EMEA economist [email protected] +44 20 7767 5310 Elena Ganeva,...

Charles Robertson, Chief EMEA [email protected]

+44 20 7767 5310

Elena Ganeva, Research [email protected]

+359 2 917 6720

Best EMEA economics team 2004 Institutional Investor (March 2004)

October 2005

BULGARIA in 2015

ING Bank N.V. – Sofia Branch 2

A presentation in two parts

Part I EU entry, Euro adoption and an exit strategy

Part II 2005-2015 - Investing in the future


New Europe 2005

Estonia 2004

Latvia 2004

Lithuania 2004

Poland 2004

Czech Republic 2004 Slovakia

2004

Hungary 2004

Slovenia 2004

Turkey 2014+

Romania 2007

Bulgaria 2007

Croatia 2010+

EU members 2004

EU members 2007

In EU negotiations since 2005

Possible EU candidates

Not EU candidates


EU accession, the Euro and exit strategies

EU entry 2007 and

Euro adoption 2010

Exiting the currency board into the euro

Bulgaria has an exit strategy: euro adoption by 2010 – around the same time as Hungary, Poland, Czech Republic and Slovakia.


Timing: The EU and the Euro

Entry

applications

Negotiations begun

EU entry

ERM membership

Euro adoption

Currency Regime

Central

parity rate

EU MEMBERS (since 1960) and those in negotiationsDenmark 1961/67/71 1973 1979? Kroner ERM peg to euro with 2.25% bands 7.46Ireland 1961/67/72 1973 1979 1999 Euro N/AUK 1961/67/71 1973 (Oct 90-Sep 92) Pound Free-floatGreece 1975 1976 1981 Mar-98 2001 Euro N/ASpain 1977 1979 1986 Jun-89 1999 Euro N/APortugal 1977 1978 1986 Apr-92 1999 Euro N/AAustria 1989 1993 1995 Jan-95 1999 Euro N/ASweden 1991 1993 1995 Krona Free-floatFinland 1992 1993 1995 Oct-96 1999 Euro N/ACyprus 1990 1998 2004 Apr-05 2008-09 Pound ERM Peg to euro 15% bands 0.585Czech Republic 1996 1998 2004 2007-11 2010-14 Koruna Free-float with euro reference

Estonia 1995 1998 2004 Jun-04 2007-08 Kroon ERM currency board to euro 15.65Hungary 1994 1998 2004 2007-2011 2010-14 Forint Peg to euro with 15% bands 282.0Poland 1994 1998 2004 2006-2010 2009-13 Zloty Free-floatSlovenia 1996 1998 2004 Jun-04 2007 Tolar ERM Peg to euro 15% bands 239.6Malta 1990/98 2000 2004 Apr-05 2008 Lira ERM Peg to euro 15% bands 0.429Latvia 1995 2000 2004 Apr-05 2008 Lat ERM Peg to euro 15% bands 0.703Lithuania 1995 2000 2004 Jun-04 2007 Litas ERM Peg to euro 15% bands 3.45Slovakia 1995 2000 2004 2006 2009 Koruna Managed float with euro reference Bulgaria 1995 2000 Jan-07 1H 2007 2010 Lev Currency board to euro 1.96Romania 1995 2000 2007-08 2008+ 2012-13 Leu Managed float to euro NOT IN NEGOTIATIONSCroatia 2003 2006 2010-11 2010+ 2013+ Kuna Managed float vs euroTurkey 1987 2005 No (2014) No (2015) No (2018) Lira Free-floatAlbania 2007 2011 2014-2018 2015+ 2017+ Lek Managed float vs euro Macedonia 2004 2006-07 2011-15 2015+ 2017+ Denar Tightly managed float vs euro Bosnia 2010-11 2013 2015-2018 2015+ 2017+ Marka Currency board to euro 1.96Serbia 2008 2010 2014-18 2015+ 2017+ Dinar Free-float with euro reference

Montenegro 2008 2010 2014-2018 2015+ 2000 Euro (Deutschemark adopted as only legal tender in Nov 2000) 1

Ukraine 2009 2010 2017-2020 2017+ 2020+ Hryvnya Managed float vs US dollarItalics = forecasts Source: EU Commission, ING


What is convergence?

Convergence is an over-used term. Initially it referred simply to convergence to the Maastricht criteria, with implications for bond and equity investors resulting from converging interest rates to low German levels.

But, convergence has also been associated with political, regulatory and macro-economic convergence towards west European levels.

We are confident that Bulgaria and Romania are convergence countries; Turkey and Ukraine also offer potential convergence gains if they join both the EU and Euro.


External debt compression

In 2002 Bulgaria paid up to 4pps more than

Germany to borrow on the international

capital markets, now it pays less than 50bp

more

Over a two- year time horizon Bulgaria

should trade through current new EU

members like Poland or Hungary as it is

likely to adopt the euro earlier

Today 10Y Eurobonds of the new EU

member states trade at some 20bps over

Bunds, 10-15bps tighter than a year ago

Eurobond spreads over Bunds (bps)

0

50

100

150

200

250

300

350

400

450

500

Ma

r/0

2

Se

p/0

2

Ma

r/0

3

Se

p/0

3

Ma

r/0

4

Se

p/0

4

Ma

r/0

5

Se

p/0

5

Ma

r/0

6

Se

p/0

6

Ma

r/0

7

Bulgaria'13 Romania'12 Lithuania'08

Slovakia'10 Poland'10

Lithuania, Slovakia and Poland lagged by 2 years and 8 months


Maastricht criteriaCriteria cannot be met before 2008

Timetable - How quickly after EU entry can a country join the Euro

€ minus 2+ years Join ERM - possible only after EU entry(eg, Jan-Feb 2007)

€ minus 12 months Budget/debt criteria (eg, 2008)

€ minus 7-11 months CPI/interest rates criteria (eg, mid-2009)

Enter €

(eg. 1 Jan 2010)

•Exchange rate mechanism (ERM) membership for two years. Note Estonia joined in June 2004, less than two months after joining EU in May 2004.

•The budget deficit must be no more than 3% of GDP.

•Long-term (ten-year) interest rates must be within 2% of the average of the three EU countries used in inflation criterion – this will be done by the markets whenever they see EU entry as credible.

•Inflation within 1.5% of the best three EU countries record on price stability (ie, around 2.0-2.5%).

•Government debt (internal and external) must be no more than 60% of GDP, or falling towards this level. •Central bank must be independent.


Maastricht criteria - public debt

Public debt – an easy one• Government debt (internal and external) must be no more than 60% of GDP, or falling towards this level.

• Both first and subsequent EU enlargement countries tend to have low debt (public debt, external and internal), decreasing the risks of a financing crisis, with the exception of Turkey.

• In 2002-04, all central/east European applicants had a public debt to GDP ratio below the 60% level, unlike the Eurozone, where the average ratio was 70% of GDP in 2004 (half the Eurozone was below 60%).

2004 Public debt (% of GDP)

0

20

40

60

80

100

Russia

Romania

Ukrai

ne

Czech

Bulgaria

Poland

Croat

ia

Serbia

Netherla

nds

Hungary

Maa

stric

ht lim

it

Eurozo

ne

Turkey

Gre

ece


Maastricht criteria – long bonds

10Y local spreads over bunds – when the market believes it happens

• Long-term (ten-year) interest rates must be within 2% of the average of the three EU countries with the lowest inflation - the markets do this when they see euro entry as credible. Italy, Spain and Portugal all met this criterion in early 1997, one full year before it was necessary.

• However, we can see volatility in the meantime. In central Europe, spreads were around 200bp in 2002-03, but have since risen to above 400 in Hungary.

• Bond yields in Bulgaria are already close to Eurozone levels because of currency board arrangement

-100

0

100

200

300

400

500

600

700

800

900

Italy Greece

Czech (2001 +) Poland (2001+)

Bulgaria (2004+)


Maastricht criteria – budget deficit

Budget deficit – more difficult – will governments do it?

•The budget deficit must be no more than 3% of GDP. Unlike Italy or Greece, candidate countries do not have very high debt levels and apart from Hungary, they do not pay high interest rates either. So less easy to cut the deficit simply via fall in interest rates. But growth is faster than it was in EU in mid-1990s.

-10-8-6-4-20

Italy (1999) Spain (1999) Portugal(1999)

Greece(2001)

Euro - 5 Euro - 4Euro - 3 Euro - 2 (Maastricht)Euro - 1 Year of Euro adoption

Budget deficit (% of GDP)

2004 Budget balance

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3

Russia

Bulgaria

Romania

Serbia

Ukraine

Maastricht

Czech

Croatia

Hungary

Poland

Turkey


Maastricht criteria

Inflation – only needs to be met once

• Inflation within 1.5% of the three EU countries showing best price stability (this excludes deflation countries) so on past precedent the range could be 2.0-4.2%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Inflation rate of low est three EU members Maastricht upper limit

Lowest average CPI and EU and Maastricht limit

ING Bank N.V. – Sofia Branch

Maastricht criteria CPI Part II

Many countries joining the EU have lower inflation than existing Eurozone inflation countries, we urge the EU to only consider the Eurozone countries when setting the inflation and long-bond criteria.

2004 average inflation

-10123456789

1011121314


2007-15: EU entry and its effects

While financial markets focus on euro adoption – and falling interest rates/currency stability – as the biggest consequences of EU enlargement, Bulgaria already has low interest rates and a stable currency. Euro adoption will secure these gains, but the boost to Bulgaria may be less than elsewhere.

However, EU enlargement and euro adoption is not just an issue of interest rates. Other gains include:

Free movement of labour – likely to improve from 2007 and be free of restrictions by 2014.

Recognition of qualifications.

For the economy, the benefits include:

Huge EU transfers to the Bulgarian economy.

Free trade and cheap wages encouraging investment.

In addition, we can assume continuation of the lending boom.


New Europe 2015

Turkey 2014+

Serbia 2015+

FYROM 2015++

EU members 2004

EU members 2007

In EU negotiations since 2005

Possible EU candidates

Not EU candidates


France 12.2

Spain 10.9

Italy 10.8

Germany 10.2

UK7.8

Greece5.6

Portugal3.2

Sweden, Finland,

Denmark 4.2

Benelux 4.3

Austria and Ireland 4.0

10 new entrants 3.3

EU budget spending by country in 2000 (EURbn)

Bulgaria may receive €2bn annually by 2015

• One big benefit of joining the EU is the money that comes from EU membership - usually 3-4% of GDP each year for the poorest members. EU GDP was €9,324bn in 2003 and the EU budget was €100bn but EU spending on new countries was only €4bn (Bulgaria received roughly €0.4bn).

• But in 10 years time, perhaps €40bn of the €160bn EU budget (1% of 2015 EU GDP), will be spent on new countries.

• If Bulgarian GDP in 2010 is €33bn, then 3% of GDP would imply €1.0bn annually. If Bulgarian GDP in 2015 is €47bn, then 4% of GDP would imply €1.9bn in annual flows – just over 1% of the EU budget.

• This flow - via the current and capital account - will boost infrastructure and growth.


EU27 GDP

Germany21%

UK15%

France16%

Italy13%

Spain8%

Netherlands5%

Denmark 2%

Poland 2%

Romania 1% Bulgaria0%

Greece/Port 3%

Finl/Irel/Lux 3%

Austria 2%9 entrants 3%

Sweden 3%

Belgium 3%

EU27 Population

Germany17%

UK12%

France12%

Italy 12%

Spain 8%

Poland8%

Romania5%

Netherlands 3%

Greece 2%Czech 2%

Belgium 2%Hungary 2%

Portugal 2%

Slovakia/Denmark 2%

Bulgaria 2%Sweden 2%

Cyp/Lux/Mal0%

Latv/Slove/Est1%Finl/Ire/Lith

3%

Austria 2%

Fitting into the EU

How big are these countries’ % of EU27 GDP/population in 2004

Receiving 1% of the budget would be much larger than Bulgaria’s economic weight would suggest - which in 2004 was just 0.2% of EU-27 GDP. However, with 2% of the EU population, 1% of the budget is arguably less than it should receive.

The government can use its population weight in EU voting, to help win EU financial support.


Fitting into the EU - Politically

Number of votes each country has/will have in the EU Council

France, Germany, UK, Italy 29

Spain, Poland 27

Romania 15

Netherlands 13

Belgium, Czech Republic , Greece, Hungary , Portugal 12

Austria, Bulgaria , Sweden 10

Denmark, Finland, Ireland, Lithuania , Slovakia 7

Cyprus , Estonia , Latvia , Luxembourg, Slovenia 4

Malta 3

NB : We assume Turkey would have 29 votes and Croatia 7 votes

In 2007 when Bulgaria enters the EU, new EU

members will account for 22% of the population,

32% of the votes (based on the Nice treaty - see

left) … and 32% of the EU budget?

Bulgaria will have 2.9% of the EU votes … 2.9%

of the EU budget in 2007 could be €2.7bn

Current EU constitution requires 55% of countries

with 65% of population to approve. Proposed but

not ratified changes suggested majority voting

instead. (Bulgaria – 1 of 27 countries means 4%

of EU votes, but this is influenced by the 2%

weight of population)


Investment via the banking sector

Increasing indebtedness, Greece from 34%/GDP to 74%/GDP

Until the late 1990s it was

not possible for

households to be indebted,

and lending to corporates

was unsafe and sometimes

politically motivated.

Lending fell sharply after

1996, but is now growing

strongly, up 10% of GDP in

just 2004 alone.

The credit boom will be the

single biggest factor

driving economic growth in

the next 5 years, but also a

factor widening the current

account deficit. The

government must aim to

compensate for this by

reducing its debt level.

020406080

100120140

UK

Euroz

one

(98) US

Czech

Rep

Greec

e

Croat

ia

Sloven

ia

Slovak

ia

Hunga

ry

Bulgar

ia

Turke

y

Lithu

ania

Estonia

Poland

Roman

ia (9

6)

Russia

Latv

ia

Lending to private sector as % of GDP (1995)

020406080

100120140160180

UK

Euroz

one

Greec

e

Sloven

ia US

Croat

ia

Hunga

ry

Latvi

a

Estonia

Czech

Rep

Slovak

ia

Poland

Bulgar

ia

Russia

Lithu

ania

Turke

y

Roman

ia

Lending to private sector as % of GDP (2004)


It is a healthy banking sector

• Bulgaria has a healthy financial sector. Privatisation has brought in

significant funds for Bulgaria, helping offset the current account deficit.

Foreign ownership has also brought in expertise and advanced banking

products. Foreign banks are less likely to suffer liquidity squeezes as they

have easy and relatively cheap access to funds.

Bank Main foreign shareholder Initial amount paid Milestones Asset value as of 1Q04

DSK OTP (100%) €311m Est 1951, priv 1 Oct 03

€2,028m

Bulbank AD UniCredito Italiano (85.2%) US$ 325m Est 1964, purch 2000

€1,689m

United Bulgarian Bank (UBB)

NBG (99.9%) US$ 207m / 21m Est 1992, purch 2000/02, priv 1997

€1,383m

Raiffeisenbank Bulgaria

Raiffeisen International Bank Holding - 100%

- €1,144m

First Investment Bank

EPIC (20%), EBRD (20%), 2 Bulgarian businessmen

- €1,140m

Biochim Bank Bank Austria CA (99.6%) €83m Est 1987, purch 2002

€1,120m


Wages data – 2004 and 2005 implied

Wages in Bulgaria are roughly 10% of the level in the EU, and 35-40% of the levels in central Europe. In nominal terms, the difference in wages between the EU and Bulgaria is now 25 Euros per hour, compared to 22 Euros per hour in 2000. It has grown wider, making Bulgaria relatively more attractive than previously.

Wages have risen to 2 Euros per hour in Bulgaria, up 45% over four years. While rapid, it is slower than rises in central Europe of up to 85% in Hungary.

With central Europe now in the EU, foreign direct investors start looking farther afield for cheap manufacturing bases for Bulgaria.

However, investors also go to countries with the best infrastructure and this is where EU cash is vital for Bulgaria.

2004 2005F 2004 2005F 2004 2005F

EU 25.7 27.0 13.3 18 3.0 4.3

Czech Republic 5.7 5.8 45.5 47.5 1.8 1.9

Hungary 6.7 7.3 75.5 84.0 2.9 3.5

Poland 4.7 4.9 4.6 8.6 0.2 0.4

Slovakia 4.4 4.7 45.0 52.0 1.4 1.7

Bulgaria 1.9 2.0 40.8 43.8 0.6 0.7

Romania 1.3 1.8 29.7 62.2 0.5 0.9

WAGES IN EUROS SINCE 2000 (%ch) WAGES SINCE 2000


• Lastly it is worth noting that the currency does not appear to be overvalued.

• ING’s own purchasing power parity basket of goods (23 imported and local products) shows how much lower prices are in Sofia, Warsaw, etc compared to Madrid in Spain, a relatively cheap EU member state.

• With prices in Sofia for these goods 27% cheaper than in Madrid, the currency does not look overvalued.

PPP implies stable/stronger currencies

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8(b

ask

ets

)Cheap Expensive

Implied PPP currency over/undervaluation


Responsible fiscal policies have allowed Bulgaria to reduce debt levels, both external debt and public debt levels, contributing to falling interest servicing costs.

The EU accession process has also been supportive and remains so.

Prospective euro adoption in 2010 should ensure debt servicing costs will continue to fall, while also providing an “exit strategy” for Bulgaria.

EU accession means big financial transfers to Bulgaria, helping the balance of payments while boosting investment and making Bulgaria more attractive for FDI.

A healthy privatised and foreign owned banking sector should boost consumption and investment, fuelling growth.

Cheap wages and free trade with the EU should see Bulgaria further integrate in the EU economy and attract more foreign direct investment.

But future stability requires governments to stick to the responsible fiscal policies of recent years and try to restrain the current account deficit.

Keeping fiscal policy tight is the best way to support growth

Conclusions


EU – less forgiving political climate

The risk of delay is some 20% for Bulgaria and 35% for Romania

Romania and Bulgaria hope to enter EU in 2007

Safety clauses that could delay the entry till 2008 concentrate on

Justice

Environment

Home affairs

October EU report will shed some light on the likely entry dates but the final decision will likely be taken in 2006

From economic point of view the result of delayed EU accession is not necessarily a clear cut – less money from convergence funds but one more year to prepare better.


Population 2004

EU m em bers 2004

EU m em bers 2007

In EU negotiations from 2005

Poss ible EU candidate

Not EU candidates

Russia143m

Turkey70m

South Africa44m

Israel6m

Bulgaria8m

Kazakhstan15m

Romania22m

Hungary10m

Czech Rep10m

Slovakia5m

Ukraine47m

Poland39m

Lithuan4m

Latv 2m

Est 1m

Egypt78m

Slov2m

Croatia5m

Population can give

some idea of potential.

The great untapped

markets in EMEA

appear to be outside

the 1st convergence

group, like Ukraine

and Egypt.

Each square

represents 1.5m

people.


GDP 2004

This map shows

EMEA countries in

terms of GDP, with

each square worth

US$4bn.

The disproportionate

size (compared to

population) of the new

EU entrants highlights

the positive impact of

convergence on GDP.

Note France’s

nominal GDP in 2004

was around

US$2,050bn, similar

to the US$2,111bn

total.

EU members 2004

EU members 2007

In EU negotiations from 2005

Possible EU candidate

Not EU candidates

Bulgaria$24bn

Hungary$101bn

Est $11b

Czech Republic$108bn

Romania$74bn

Slovakia$42bn

South Africa$215bn

Turkey$302bn

Israel$118bn

Poland$246bn

Ukraine$65bn

Russia$583bn

Latv $14bn

Lithuania$22bn

Kazakhstan$41bn

Egypt$78bn

Slovenia$32bn

Croatia$35bn

Charles Robertson, Chief EMEA economist [email protected] +44 20 7767 5310 Elena Ganeva,...

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Transcript of Charles Robertson, Chief EMEA economist [email protected] +44 20 7767 5310 Elena Ganeva,...