The greatest challenge facing Bulgaria during the transition to
a market economy is the implementation of appropriate policies to
alleviate the debt burden, promote sustainable growth and private
The privatization and the conversion program can promote each
other. Used in combination, they can result in a larger proportion
of retired debt through privatization of some of the enterprises
that contributed to the debt accumulation. That's why the Debt
conversion program should be seen as part of the broader economic
policy of the government, including foreign investment.
The right balance among the trade-offs would depend on the
particular objectives and constraints Bulgaria has. But it is also
important to know how the details of the program are likely to
affect the behavior of potential investors in Bulgaria.
At the beginning, the objectives should be basic - to reduce the
stock of external debt and use foreign investment as catalyst for
faster private sector development
The Bulgarian program should be based on a four-pronged
1. To speed up privatization
Privatization is a special use of swaps for a buy-out.
A state-owned company is sold to a foreign investor, who pays
for it with the local currency generated through a swap
transaction. Since the seller is the government, the transaction is
not inflationary. In this case swaps are increasing the incentives
for the investment and permit the government to retire debt at a
discount. In the case of Bulgaria this is the most valuable aspect
of the DCP.
The sale prices of the state-owned enterprises are often a
controversial issue. The market values are usually below cost.
Swaps are helpful in this respect by making foreign investors
willing to pay a higher local currency price. The government may
enhance the attractiveness of swaps for privatization deals by
reducing the amount of the discount it retains for itself. Mexico
and Chile had swaps for privatization. In the case of Mexico the
debt was redeemed at full face value for investors who applied to
use the proceeds to privatize state-owned enterprises. (Argentina
expressly forbidden this and Brazil did not allow foreigners
gaining control of a Brazilian company).
Argentina's ENTel privatization could serve as important
mechanism to be applied in Bulgaria. It was the amount of debt
being offered, as opposed to the discount from face value, which
was the basis for comparison. Actually, the discount was implicit
(based on whatever total valuation each bidder assigned to the
equity share being sold), and the explicit selection criterion was
the quantity of debt being offered. Since foreign debt is exchanged
directly for the shares of the privatized companies, the
inflationary effect is not a concern. By using this kind of an
auction system, the costly and controversial problem of valuation
of shares and assets is avoided. Two-stage procedure of selection
was applied. In the first round, potential bidders pre-qualified on
the basis of their current operating capacity, efficiency and
financial position. In the second round, pre-qualified consortia
submitted bids which were evaluated solely on the basis of price.
Bids for controlling equity stakes were offered in two parts:
a) a common "base price" in cash US dollars, which all bidders
were required to pay; and
b) an "additional price" in external debt which differed among the
bidders and was used to determine the winners.
The experience gained so far has provided some guidelines for
using debt conversions as an attractive financing tool which
benefits both debtor and creditors. The auction system based on
volume of debt is an effective alternative to the traditional,
costly, controversial and time-consuming valuation of shares. In
the absence of a developed capital market, the use of public
offering markets and ESOPs to complement private auctions of shares
not only contributes to the development of these markets but also
allows for privatizations through equity shares.
2. To reduce the external debt
The agreement with the commercial banks has improved Bulgaria's
prospects for growth. However, the external debt stock remains at a
considerably high level. An active debt management is needed to
reduce the debt burden. The DCP could be an excellent instrument
for this purpose. Combining accelerated structural reforms with
retiring some of the external debt through the program would
strengthen the fiscal situation in the medium term. If drastic
changes in the capacity to pay and the supply of capital do not
take place, Bulgaria's ability to service its debt obligations and
to have access to voluntary lending would require longer period of
3. To increase foreign direct investments
- The level of incentives to the investors should be
kept reasonably high, but a screening procedure should be put in
place to eliminate the most obvious non-additional and
- The continuity of the program should be maintained
over time and the basic thrust of the rules and regulations adopted
at the beginning should be followed without changes (of course, if
needed, minor changes could be introduced).
- Since all investments made by banks are additional,
measures should be adopted to encourage foreign banks'
participation. Investment funds financed by swapped debt could be
an important mechanism.
- Reasonable timing restrictions on repatriation of
dividends and capital are essential.
4. To create favorable business environment
In Bulgaria long term financing for production expansion is not
easily available on reasonable terms. In Argentina and to a lesser
extent in Mexico this was the case. The local company may use its
own foreign exchange to buy the debt because the DCP is acting as
an incentive to capital repatriation, as well as a source of
industrial financing. In Chile the financial markets are
functioning well and a portfolio investment is easier.
A reasonable swap facility can be used not only to transfer
ownership of existing companies but also to create new productive