By Kristofor Pavlov, chief economist of UniCredit Bulbank
In the short term the economic consequences of the decision of the UK to leave the EU are clear. This decision will make the UK poorer. It is hardly likely to cause a new trade war, but in any event it will harm the trade between the UK and the EU, with all ensuing consequences for the productivity and the income. All public institutions and private companies in the forecast business are now busy with revision of their forecasts and the general opinion is that the economic growth in the UK will slow down to nearly 0% next year in comparison with the expected value of 2% from before Brexit. As the UK is the fifth largest economy in the world, this will have its impact on the global economy too, Bulgaria included.
The negative effects on the Bulgarian economy will be felt via three main channels, the most significant of which will be that of the foreign trade. The effect to be felt via the foreign trade channel will be mostly indirect, as the share of the UK in Bulgaria’s total commodity export is only 2.5%. The indirect effect will be more significant because the Bulgarian economy is small and open and because most of the export-oriented companies in Bulgaria are part of West European production chains, which have more trade contacts with the UK. The slowdown of foreign trade will start materializing in the last months of this year, when the signs of slowdown of the UK economy will become more apparent, and will keep materializing even more in the course of next year, when, according to our main scenario, the growth in our main foreign trade partner – the Eurozone – will slow down to around 1% in comparison with a forecast growth by 1.6% from before Brexit.
The effect to be felt via the expectations channel will be smaller. In any case the decision of the UK to exit the EU will lead to further uncertainty, which will increase the obstacles to the recovery of private investments. This will affect negatively the global investment demand and hence the investment demand in the CEE developing markets, Bulgaria included. As a result we can expect a certain slowdown of the capital flows to Bulgaria, including also of FDI during the current and next year, especially when having in mind that FDI in the base year 2015 were supported by some one-off factors, such as the completion of the project for in-depth processing of crude oil, used by the refinery in Burgas. In a similar way, the money transfers by Bulgarian emigrants to their relatives in Bulgaria will grow at a mode modest pace in comparison with the initial expectations from before Brexit.
The effect to be felt via the financial channel will be the least noticeable one, in our opinion. The reason for this is that the Bulgarian economy remains resistant to external shocks due to the lack of new or exacerbation of existing macroeconomic disbalances. The country has a very favourable combination of strong fiscal parameters, a moderate current account surplus, abundant international reserves and decreasing needs of external financing – both for the state and for the economy as a whole. Therefore we do not expect the higher anxiety on the financial markets to lead to any noticeable change of the conditions under which the state and the Bulgarian private companies receive financing from abroad.
What does all this mean in the language of figures? Our estimates show that if the current policy is preserved, the negative shock from the decision of the UK to leave the EU will lead to slowdown of the economic growth in Bulgaria by nearly 0.2 percentage points this year and 1.1 percentage points in the coming year. As already mentioned, most of the slowdown of the GDP growth will result from slowdown of the export, whereas the negative effect on the private investments and consumer spending (through weaker income growth due to weaker increase of the money transfers from emigrants and slower recovery of the labour market due to reduced growth of export) will be less strong.
Can the government afford compensatory measures aimed at mitigation of the unfavourable effects? We think that it can, as the Bulgarian economy is in a very strong position – competitive, without any significant macroeconomic disbalances and with considerable progress achieved with regard to the fiscal consolidation. In our opinion, the compensatory measures will consist in increase of the public investment costs, at the expense of increase of the budget deficit from the forecast level of 1.8% of the GDP this year to 2.5% next year. This is supposed to mean increase of the public investment costs next year by around 0.7-0.8% of the GDP, in comparison with our forecast from before Brexit. Thus the Bulgarian government will be able to benefit from the progress already achieved with regard to deficit reduction in the past year (from 3.6% of GDP in 2014 to 2.9% at the end of 2015) and this year (from 2.5% of GDP in 2015 to an expected level of 1.8% at the end of 2016). Upon activation of compensatory measures, in proportions close to those specified above, the GDP growth next year will slow down by around 0.6 percentage points in comparison with our main scenario from before Brexit, whereas in the absence of compensatory measures the slowdown will be around 1.1 percentage points.