History and Theory of World Economy
The Bulgarian Financial Crisis of 1996 – 1997: A Crisis of Transition
Since the fall of communism in the end of 1989 Bulgaria has been experiencing severe economic difficulties. In 1996 the problems of the country’s transition culminated in one of the most severe banking and currency crises in Eastern Europe – the Bulgarian financial crisis of 1996-1997. The main objectives of this paper are to outline the structural vulnerabilities that led to the crisis, to identify the key characteristics of the “twin” crisis and to analyze the rent-seeking nature of Bulgarian transition.
I will argue that the crisis was an outcome of a moral hazard problem in the Bulgarian economic agents’ behavior and the inadequate and unsustainable policies of the government in the period 1990-1997. The legacies of state-controlled economy were too slow to be overthrown and structural reforms were by and large not implemented up until 1997.
Economic and Institutional Background: 1990 – 1996
Bulgaria’s position at the start of the post-communist economic transition was extremely unfavorable. The country had been experiencing severe balance of payments problems since the mid-1980s which led to the accumulation of more than $ 9 billion in foreign debt. Bulgarian economy had been fully integrated into the socialist economic block; therefore, it was hit hard by the collapse of the communist system. Bulgarian industries lost the main markets for their products. Real output declined by more than a third, the debt-service ratio was rising to unsustainable levels (forcing the government to declare moratorium on debt payments in 1990), thus cutting Bulgaria off from Western capital markets and making it impossible for the government to borrow money to cover its budget deficit. The enterprise sector had to be profoundly restructured to respond to trade adjustments resulting from price liberalization and new demand structures. However, throughout most of the early 1990s the reform process proceeded less smoothly and less quickly than in other Central and Eastern European countries. Government subsidies to loss-making state enterprises and lack of fiscal adjustment led to even higher internal and foreign debt. Inflation continued to surge because of inconsistent macroeconomic stabilization policies and monetization of the fiscal debt.
A much more fundamental problem was the fact that economic agents preserved their old patterns of behavior. State enterprise managers took advantage of the loosening controls and extracted resources from the state for their own benefit. In other words, they found it rational to maximize not the profit of the enterprises but their own personal gain. Asset stripping (quasi-managers selling the assets they controlled for their own profit) was widespread and eroded the productivity of the industries. Bulgarian governments were unable (or unwilling) to find an effective solution to the problems of state enterprises. There were accusations that governments in the early years of transition have been manipulated by powerful shadowy interests of enterprise directors, private firms and criminal bosses. This created conditions for rent-seeking (extracting resources from the state) which were extremely difficult to be overcome because the beneficiaries of the partially reformed system “used their financial muscle to stop real structural reform”.
In the banking sector the situation was not much different. The biggest banks were state-owned and their basic use was to provide implicit subsidies in the form of loans to the loss-making state enterprises. Naturally, a large proportion of these loans turned out to be non-performing so the losses were transferred to the state budget and resulted in even higher fiscal deficits. Governments were unwilling to close down the inefficient enterprises because this would create excessive unemployment, so bad loans kept accumulating. Another problem in the banking sector was that, despite its de jure independence, the Bulgarian National Bank (BNB) was de facto totally dependent on the government because it subsidized the government’s strategy. Even if there was no formal promise by BNB to bail out illiquid or insolvent banks, it always provided the necessary financing. Moreover, in some cases BNB gave direct credits to enterprises and to the Ministry if Finance, thus nationalizing losses via monetization. This made BNB lender of first instead of lender of last resort. In addition, banking supervision (which was in its infancy) failed to prevent the gradual deterioration of banks’ balance sheets because the authority of the regulatory institutions was very weak.
 Vesselin Dimitrov, Bulgaria: The Uneven Transition (London: Routledge, 2001), p. 69
 International Monetary Fund, Banking Crises and Bank Resolution: Experiences in Some Transition Economies , by Anne-Marie Gulde et al, IMF Working Paper WP/02/56 (2002)
 Dimitrov, p. 71
 Dimitrov, p. 74
 Ibid., p. 77
 Michael Berlemann and Nikolay Nenovski, “Lending of First Versus Lending of Last Resort: The Bulgarian Financial Crisis of 1996/1997”, Comparative Economic Studies 0 (2003), http://www.palgrave-journals.com/ces/journal/v46/n2/pdf/8100028a.pdf (accessed December 3, 2009)