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DEBT-EQUITY SWAPS IN THE CONTEXT OF PRIVATIZATION: THE CASE OF BULGARIA

Sophia Kassidova

I. THE ECONOMY AND ECONOMIC POLICY ON THE WAY TO
STABILITY


 

Macroeconomic improvements

The few years that have passed since the beginning of the reform in 1989 have brought about evidence for positive changes. The reduction of monetary overhang after the price liberalization in 1991, curbing the inflation and bringing the BLV to its market value are sensitive indicators for the reached financial stability (see Table 1 and Table 1a).

The GDP figures evidence the changes in the real structure of the economy as a result of the new set of market prices and private ownership establishment. The process of restructuring has resulted in a decrease of the share of industry and agriculture at the expense of growing services and chemical production.

Table 1

Economic Indicators 1990-1994 (percentage change over the corresponding period preceding year unless otherwise noted)

1990 1991 1992 1993 1994 prog (1)
GNP per capita(USD) (2) 1,840 1,330
Private Sector
- share in % of GDP 12 16 18.5
- share in % of employment (3) 5.9 9.4 16.5
Real GDP growth % -9.1 -11.7 -7.7 -4.2 -2.5
Consumer price inflation % 21.6 474 80 64.0 40-60


Table 1a

1990 1991 1992 1993 1994
Exchange Rate (BLV/USD end period) 2.150 21.7 24.8 32.7 53.60(end of June)
Balance of Payments(4)
- Exports (bn USD) 2.5 3.7 5.1 4.6
- Imports (bn USD) 3.3 3.8 4.6 4.8
- Trade balance (bn USD) -0.8 -0.1 0.5 -0.2
- Current account balance(bn USD)(5) -1.2 -0.08 0.45 -1.0
    • 1 SIEEE forecasts

      2 Estimated by the World Bank, published in The World Bank Atlas 1994

      3 Source: Ministry of Labour

      4 Data on payments basis

      5 Current account balance, excluding transactions in convertible currencies with the former CMEA countries, ended with a deficit of 887 mn USD and 250 mn USD in 1991 and 1992 respectively

Source: Bulgarian National Statistical Institute; Bulgarian National Bank

The framework of the economic policy of transformation has been set by agreements with the IMF. It involves enhanced macroeconomic stabilization, industrial restructuring and privatization programme. Austerity budget and tighter financial discipline and restrictive monetary policy are the elements of the 1994 economic policy agreed upon.

The IMF's condition for imposing hard budget constraints in front of the inefficient state enterprises resulted in the Parliament approval of law on bad debts. The state has taken over bad loans held by the commercial banks and these loans have been exchanged for long-term government securities, to be denominated in convertible currency and redeemed in lev. The bonds will be freely negotiable by the banks. The affected enterprises will make arrangements with the Ministry of Finance on the repayments of write-off debts. An Ordinance of Council of Ministers provides for the participation in privatization of the holders of these long-term government bonds using them as payment notes in all privatization deals, including buying of stocks, separate parts of or the whole enterprise. The combination of privatization efforts with debt conversion schemes may promote foreign capital participation in this process . The recent purchase of a 70% stake in the Chocolate and Sugar Confectionery LTD. of Nestle S.A. together with taking over the company's debt is an encouraging indication of foreign investors' interest in privatization. The buyer will also make extra investment for marketing and distribution network. It is on this basis that the state Agency for Economic Coordination and Development has urged the state to sell off its holdings in indebted enterprises as soon as possible in order to induce enterprises' restructuring, halt their subsidy-seeking behaviour and speed up privatization.

Undoubtedly, the growth of the private sector and its increasing share in the GDP is one of the most positive process of the reform. A mention has to be made for the unsatisfactory evaluation of the GDP figures. It has been difficult to compile information on much of the private sector which leads to its underestimation. Even controlling for this, the slow progress of privatization is an impediment to fast private sector expansion. Recently, the Government has undertaken an ambitious program for speeding up privatization efforts putting up for mass privatization under rather vague schemes about 500 state companies (around 36% of the state assets). The priority arrears include tourism, processing industry, agriculture and trade. A long-term privatization plan recently approved by the Privatization Agency envisages that two-thirds of the economy will be in the private sector by 1997 (see Table 2 and Table 3).

Table 2

Privatization of State Enterprises by April 30, 1994

1. Decision to open the procedure 443
- on whole enterprises 365
- on separated parts of enterprises 78
2. Transactions concluded - total 97
- auctions 29
- tenders 50
- direct negotiations 18
    • Source: National Statistical Institute

Table 3

Municipal Privatization by April 30, 1994

1. Decision to open the procedure 775
- on whole enterprises 26
- on separated parts of enterprises 749
2. Transactions concluded - total 101
- auctions 77
- tenders 23
- direct negotiations 1
    • Source: National Statistical Institute

Stronger signs of recovery emerged in October 1993 which made the decline of production less steeper than in 1992. Nevertheless, there still has been little restructuring, as indicated by the fact that branches which have increased their output include energy production, coal mining, chemical industry, whereas production fell in the branches in which Bulgaria is believed to have a comparative advantage. Trade liberalization following opening up of the economy together with the changes in the real stricture of the economy introduced new trade patterns.

The recent changes in the supply side of the economy are parallel to developments on the demand side. Retail volume in the end of 1993 in the private sector rose by 16.1% while in the state and cooperative sector the decline was still considerable. Another component of the aggregate demand which underwent developments is private consumption. The decrease in household consumption as a proportion of their disposable income is reflected in an increase in the flow of households savings. During the 80s the savings-GDP ratio was about 5.1% while in 1991-1992 this ratio reached 21%-22% (see Bank Review, January 1994). The dynamics of the saving-investment ratio show the share of the former in financing capital formation. The period of financial stabilization is marked by low investment activity of the population - throughout 1991-1992 the net share of investment expenditure in population savings reached its minimum - under 3%, against 31% in the 80s (see Bank Review, 1994).

In the monetary sphere the dynamics in money aggregates is influenced by the current restrictive monetary policy. The increase in quasi-money (transfer of money assets into time deposits) of the population turned to be a net source of financing the other economic agents. On the one side, the depreciating effect of the inflation accompanied with the high nominal interest rate crowded-out private investment outlays rather than accommodating them; on the other side the underdeveloped financial markets limit the scope for diversification of households assets. Thus, it is rather unlikely to expect mass privatization schemes initially to accumulate vast quantities of assets required for large-scale privatization. The pace of the urgent restructuring of inefficient SOEs can be promoted by attracting foreign capital for privatization. Debt-equity transactions as a mode for financing foreign privatization can immediately contribute to the recipient economy's efficiency through introducing "responsible" ownership and efficient management.

Foreign trade and payments

The Interim Agreement with the EU (pending the ratification of the Association Agreement) was approved by the EU Council of Ministers in December 1993. By the terms of the agreement, about 70% of Bulgaria's industrial exports are to enter the EU duty-free. About 50% of Bulgaria's total exports to the EU are in "sensitive sectors", where the concessions are far less generous and thus requiring market standard quality for Bulgarian goods. It is the effect of foreign capital for setting up profit-maximizing ventures that will raise country's export competitiveness. If promoted in import-substituting sectors in the medium-term inward investment will exert positive effect on current account balance. In the 80s excessive state involvement in the economy through government spending mostly financed from external borrowing has led to the external debt expansion and budget deficits. The situation was further aggravated during the past years of the reform when a moratorium imposed on its servicing in 1991 has put Bulgaria in financial isolation and discouraged investment in it. Said to be not a creditworthy country economic reforms have been carried out in an unfavourable environment. According to World Bank's classifications Bulgaria is a severely indebted, lower middle-income country: its GDP per capita is bellow $ 2,695 and either one of the two key ratios for 1989-1992 is above the critical level (see Table 4).

Table 4

                • (US$ million)

1990 1991 1992

1. SUMMARY DEBT DATA

TOTAL DEBT STOCKS (EDT) 10,867 11,970 12,146
Long-term debt (LDOD) 9,813 9,987 9,951
Public and publicly guaranteed 9,813 9,987 9,951
Private nonguaranteed 0 0 0
Use of IMF credit Short-term debt 0 414 590
Short-term debt 1,055 1,569

1,605

2. DEBT INDICATORS

EDT/export of goods and services (%) 153.7 285.5 203.2
EDT/GNP (%) 57. 106.6 110.7
      • Memo: debt indicators' critical level:

        • EDT/export= 200%

          EDT/ GDP = 80%

    Source: World Debt Tables, World Bank 1992

It is for this reason, that the deal signed with the London Club creditor banks which could lead to a total reduction of 47,1% of BulgariaŠ²s debts to the commercial banks is an unique opportunity for improving Bulgaria's financial image . There were some recent policy discussion concerning Bulgaria's potential for meeting its obligations on the deal and the short-run effect on the balance of payments to be effected by the initial payments on the deal. The debt reduction which corresponds to the ratio among the debt instruments and creditors' choice to exchange their debt holdings into equity investment will soften the pressure on the balance of payments. Another aspect of debt-equity-swap (DES) schemes will be their positive effect on the budget. At present, the tough fiscal policy is an indispensable tool for the economy management and regulation of budget deficit. Thus, debt-equity programs will relieve budget expenditures for debt servicing and could raise tax revenues from the return on equity investment in the country. Further and more detail analysis of Bulgaria's costs and benefits from DES schemes will be given in the third part of the paper.

 
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