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
ING Bank N.V. – Sofia Branch 3
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
ING Bank N.V. – Sofia Branch 4
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.
ING Bank N.V. – Sofia Branch 5
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
ING Bank N.V. – Sofia Branch 6
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.
ING Bank N.V. – Sofia Branch 7
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
ING Bank N.V. – Sofia Branch 8
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.
ING Bank N.V. – Sofia Branch 9
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
ING Bank N.V. – Sofia Branch 10
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+)
ING Bank N.V. – Sofia Branch 11
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
ING Bank N.V. – Sofia Branch 12
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
ING Bank N.V. – Sofia Branch 14
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.
ING Bank N.V. – Sofia Branch 15
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
ING Bank N.V. – Sofia Branch 16
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.
ING Bank N.V. – Sofia Branch 17
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.
ING Bank N.V. – Sofia Branch 18
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)
ING Bank N.V. – Sofia Branch 19
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)
ING Bank N.V. – Sofia Branch 20
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
ING Bank N.V. – Sofia Branch 21
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
ING Bank N.V. – Sofia Branch 22
• 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
ING Bank N.V. – Sofia Branch 23
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
ING Bank N.V. – Sofia Branch 25
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.
ING Bank N.V. – Sofia Branch 26
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.
ING Bank N.V. – Sofia Branch 27
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