There is a considerable theoretical and practical knowledge
accumulated during the last decades. Learning from and applying
this experience is imperative for Bulgaria. The main concern is
that as many lessons should be learned as possible. Analyzing the
experience of other countries, three sets of questions have been
considered: those related to the authorization of the investment;
the financial aspects of the conversion itself; controlling the
negative aspects of the process, whilst maximizing the
There is also another important consideration to be kept in
mind: it should be recognized that there is no single policy mix
that can be followed blindly.
First, a significant legislative body with respect to foreign
investments and privatization is already in place in Bulgaria.
Second, the restructuring agreement with the commercial banks
already predetermines the debt instruments eligible to participate
in a future Debt Conversion Program (DCP).
The priorities and preferences elaborated and adopted in the
program are the outcome of a balance stroke between the already
concluded agreement with the private creditors, the existing
legislation and the economic goals pursued by the program.
On the basis of those aspects of the programs of Argentina,
Brazil, Chile, and Mexico that have particular relevance for
Bulgaria, a set of criteria that secures the backbone of the
program was identified.
This set of criteria was discussed with our foreign consultant.
It was the main topic of a special seminar held in Sofia. The
participants represented the executive and legislative branches of
the government, the Bulgarian private sector and the foreign
investors in Bulgaria, as well as the academic circles. This wide
forum allowed the project team to get better ideas and feedback on
the most important aspects of the DCP.
The main objective of the discussion was to clarify those
aspects of the future program that were indisputably appropriate
for Bulgaria. Another important goal was to understand what were
the reasons for the differences in the programs and the background
economic and legal rationale for this. Bearing in mind the legal
and economic framework that prevails in Bulgaria, we focused our
attention on the main criteria that can serve as a backbone for a
1. Eligibility criteria applied to foreign
debt for the participation in the DCP
The debt instruments are determined by the stipulations of the
agreement concluded with the commercial banks. These are the
discount bonds at their face value and the front loaded interest
reduction bonds accepted at a 50 per cent at their face value.
2. Eligible participants in the program
(national, foreign, resident, non-resident)
This is one of the most politicized issue. The Argentine program
allows domestic companies or persons to participate. In Chile,
Chapter 19 is designed to be used only by non-residents. It is
interesting to note that Annex 4 of the Chilean Chapter 18 permits
residents to make investments in existing companies under the
higher incentives of Chapter 19. Mexican-owned foreign companies
could participate in the Mexican swap program. Domestic investors
have no difficulty in circumventing restrictions on their
participation by establishing offshore dummy companies. Chile was
successful in screening the applicants and not allowing
round-tripping. But the restrictions apparently are not effective
and create resentment and political opposition. Moreover, when the
domestic interest rates are high and only short term financing is
available, swaps may give the local companies access to long term
financing at reasonable rate.
3. Exchange rate at which foreign currency debt
is converted into national currency
This issue is covered in the Ordinance on the Terms and
Conditions for Participation in Privatization be the Use of
Bulgaria's State External Debt Bonds, Art 4, Para 2 (SG No.99 of
1994, amended SG No21 of 1995).
Usually, the conversion exchange rate depends on the country's
exchange rate policy and is irrelevant for the Bulgarian program,
because the introduction of any preferential rate would create
additional undesirable distortions. By redeeming at the market rate
but using an auction or a preset discount to regulate the amount of
the incentive for the investor seems to be the most used
4. Fees charged for the right to participate
Countries that have used this provision with the objective of
increasing fiscal revenues have abolished it. There are no fees
charged in Bulgaria as the participation in privatization by the
use of Bulgaria is a part of the market privatization where Brady
bonds serve only as a new payment mechanism.
5. Quotas or ceilings on the amounts to be
This is a very important aspect of the program, if there is
provision for exchanges of debt into local currency. In the case of
Bulgaria it is not recommended. However, the Bulgarian conversion
schemes limit the participation of the Bradies - up to 50% of the
price of the privatization deal can be paid by Bradies, while the
rest could be paid either in cash or by other financial instruments
(privatization bonds to be issued upon the start of mass
privatization, state long-term internal debt bonds).
6. Discounts, if any, at the time of
To capture a larger share of the secondary market discount for the
- Auctions should be used to set the redemption price
of the debt.
- Domestic participants should be allowed.
- Fresh money requirement should be dropped.
7. Investments eligible for financing through
- For high priority areas that are relatively
unattractive to investors, two different levels of incentives (set
in auctions or administratively) could be used.
- For projects with high development potential (for
some border regions, for example) well-defined criteria should be
find out for their selection (employment, agricultural or
industrial restructuring, etc.)
- Only export-oriented investments happen to be
8. Case-by-case negotiations or public auctions
for the right to convert debt
Using auctions to set the redemption value may give the
government a larger share of the discount than applying
administratively set rules or negotiations. Brazil which used
auctions, captured a higher share of the discount than did Chile.
Negotiations or administrative rules giving different redemption
prices for investments of different priority for the government
could be useful. However, if many priorities are included in the
list, then the differences in incentives for investors would be
small and will have no impact on investment decisions. If there
will be one or two high priorities that are unattractive for
investors, than a segmented program that gives a moderate incentive
in the low-priority category and a very high incentive in the high
priority sector, may be effective. Such segmentation could be
achieved either administratively or by separate auctions. Another
point in support of auctions is transparency. Although no
government grants admission to the auction without prior screening
or case-by-case review, auctions may reduce the possibilities for
corruption and add appearance of an honest and fair process.
9. Fresh money, "matching funds" or restrictions
on the proportion of an investment that can be financed through the
Argentina is the only country that has in its program specific
requirement for fresh money. Chile applied the fresh money
requirement on a case-by-case basis.
This requirement may bring fresh money to the country, but it
has no fiscal benefit for the government. Dropping it altogether
may probably increase the price that investors would be willing to
bid in the auction, thus increasing the share of the secondary
market discount that the government can capture.
10. Applicable tax regime
In Argentina the amount of the incentive is subject to the
regular corporate income tax. Mexico is taxing the gain at a rate
of 30 % at the time of the swap. The origin of the investor might
have specific implications (Japan taxes the gain, for an US
investor it might reduce his liability to the Treasury). Any
special treatment should be well determined. Applying the general
provisions for foreign investments does not create distortions.
11. Restrictions on dividends and repatriation
(schedule for capital repatriation and profit remittance)
All existing programs forbid the payment of dividends and/or
repatriation of capital for several years - typically four years
for dividends and 10-12 years for capital. Most non-bank users are
committed to staying in the respective countries for the long term.
The Bulgarian debt-conversion schemes impose some restriction: the
transfer of the income earned from the Brady-bonds investment is
not allowed for no less then four years and the transfer of the
capital (the liquidation guota or the price obtained from the sale
of the enterprise) is not allowed for no less than ten years. . In
general, the limitations do contribute to improving short-term
balance of payments
12. Institutional and operational set of
a) The institutional authority for the program has to be very
clearly defined by the legal instrument governing the DCP -
Ministry of Finance or Central Bank.
b) The legal instrument itself has to be convenient for
operation and matching the legal framework in place.
c) The decision-making process should be well-defined and based
on a permanent flow of information.
d) The operations - applications, screening, agency
coordination, ex-post control of implementation and sanctions -
should be well-structured and transparent to the public.
e) A mechanism for identifying the quality of investors should
be established, including the information network abroad. In Chile
the success of the program is also attributed to the very good
Central Bank of Chile's network of correspondent banks.
f) The system of supervision of the whole process is of utmost
13. Screening of the proposed investments
All governments have special screening procedures for the swap
programs. However, the purpose and criteria of the screening differ
from country to country.
a) for additionality (and preventing round-tripping)
The screening is effective even though it is bound to give less
than perfect results. It should be done on an expeditious
b) for priority sectors, regions or export-oriented
Given the strong positive association of export orientation with
additionality it is recommended that screening, auction or
negotiation restrict swap programs completely to export projects
and screening is more rigorous for non-export projects.
Restrictions to new capacity creation could be counter-productive
because of the strong link between initial swap-financed buy-out
and additional investments. Some of the swaps for financial
restructuring are used to retire debt that has been taken over by
the Central Bank. These swaps are not inflationary and have less
real resource cost to the host economy. (Chile had a good procedure
and mechanism to screen applicants from dummy offshore companies
owned by Chileans).
14. Continuity and stability of the program
A program for debt conversion takes time to mature, to become
well-known and to gain investor's confidence. For this reason
well-designed start and continuity are very important. It is
evident from the outcome of the different programs that a stable
and continuous program after one or two years of implementation
starts to generate significantly more additional investments.