site.btaBulgaria Must Strengthen its Fiscal Discipline to Reap Eurozone Membership Benefits, IMF Mission Recommends

The conclusions and recommendations of the International Monetary Fund (IMF) mission were presented at a press conference in Sofia on Tuesday by the head of the mission in Bulgaria, Fabian Bornhorst. In order to fully realize the benefits of Bulgaria's membership in the euro area, durably raise living standards, and avoid macro-financial imbalances, policymakers need to strengthen fiscal discipline, manage euro transition risks, and accelerate reforms, some of the conclusions of the IMF mission say.

Between September 10 and 23, IMF representatives held meetings with experts from the Finance Ministry, the Bulgarian National Bank, state institutions, including the Budget and Finance Committee of the National Assembly, the private sector, and non-governmental organizations.

“The adoption of the euro is a major milestone for Bulgaria and an opportunity to strengthen institutions, enhance policy credibility, and raise medium-term growth,” the IMF concluding statement says. “Despite a challenging environment, the government has made important progress by securing euro area accession, approving the 2025 budget, and renegotiating the Recovery and Resilience Plan (RRP).”

GDP growth is projected to be strong at around 3% in 2025 and 2026. Economic activity is expected to remain robust, driven by resilient consumption. This expansion is supported by sustained private consumption, underpinned by strong credit growth and fiscal easing.

After contracting last year, investment is also growing again. External demand for Bulgaria’s exports is expected to stay subdued, reflecting slower growth in key EU markets and global uncertainty. As a result, the current account is projected to remain negative in the near term. 

Inflation is projected to decline gradually, but to remain relatively high. According to the IMF projection, inflation is expected to average around 3.5% per year in 2025 and 2026 before moderating. Wage dynamics are a key driver. With labour costs rising faster than productivity, profit margins are being squeezed, reinforcing the passthrough from wage increases to prices.

The IMF expects the transition to the euro to strengthen institutional credibility and investor confidence while reducing currency risk and transaction costs. Some of these benefits are already visible in narrowing sovereign spreads and recent upgrades to Bulgaria’s credit rating. Euro area accession also offers an opportunity to reinforce institutions, bolster policy credibility, and raise medium-term growth through investment.

Past experience suggests that any price effects associated with the currency changeover will likely be small and temporary, the IMF mission says.

On the other hand, reform momentum could fade post-euro adoption, including due to re-emerging policy uncertainty, and put the benefits of integration at risk.

The IMF says the fiscal policy is expected to remain expansionary. The fiscal deficit is projected to stay above 3% of GDP in 2025-2028 before gradually declining. The activation of the national escape clause under the EU’s Stability and Growth Pact will allow for higher defense spending. Capital investments are also set to increase with the implementation of the RRP.

According to the IMF, an adjustment of about 1% of GDP in 2026 would help cool the economy, which would ease inflationary pressures. The recommendations say that moderating public sector wage growth and benefit indexation by de-linking them from average and minimum wage increases would generate significant fiscal savings and ease inflationary pressures. The Fund recommends replacing untargeted subsidies with targeted transfers thus enhance spending efficiency and prioritizing EU-funded investment.

On the revenue side, broadening the tax base, improving VAT compliance, and increasing revenues from property taxation and excise taxes can help secure additional resources. Advancing the increase of social security contributions, planned for 2027, would also strengthen the financial sustainability of the pension system.

In the medium term, more revenues could be raised by increasing tax rates for both personal and corporate income and moving to progressive income taxation, thereby reducing income inequality.

The deficit of the pay-as-you-go pension system is widening as contributions lag rising payments, and population aging will further increase the shortfall, the IMF’s concluding statement says. Strengthening further the link between contributions and payments can raise incentives to contribute, including by removing the ceiling on pensions and phasing out pandemic related benefits. At the same time, improving the adequacy of pensions to reduce old-age poverty remains a priority.

The Fund underlines the need for increasing the consistency and transparency of public policies would reduce distortions and strengthen the credibility of fiscal reporting.

With regard to public debt, Bornhorst said that Bulgaria continues to be among the countries with the lowest debt-to-GDP ratio in the European Union. "Although it has risen slightly recently due to the budget deficit and the recapitalization of state-owned enterprises, we believe that the risk in this area is low," he said in response to a question about whether Bulgaria could fall into a debt spiral.

The financial sector remains resilient. Bank capitalization is among the highest in the EU, reflecting sizable add-on buffers, and liquidity remains ample. Still, rapid growth of consumer credit, particularly mortgage loans, has caused residential property prices to grow at 15%. Some mortgage credit has been used to purchase unoccupied investment properties, further straining the housing market and adding to pockets of diminished housing affordability.

The experts say the macroprudential policy will need to remain nimble. Looking ahead, with the drop in reserve requirements following euro adoption banks can, on the one hand, place excess liquidity in the ECB’s remunerated Deposit Facility, boosting interest revenue. On the other hand, some liquidity may eventually flow into lending and further propel household credit, adding to market pressures.

The IMF welcomes the Bulgarian National Bank's close monitoring of emerging systemic risks on the real estate market. During the press conference, Bornhorst said that the level of household debt in Bulgaria is around 26% of GDP, which is well below the euro area average of over 50%.

Addressing productivity and demographic challenges will require sustained investment in human capital and labour market participation. The IMF highlighted activating untapped labour potential, particularly among the youth and marginalized groups to help mitigate labour shortages.

Improving governance and institutional quality is essential for long-term growth. Advancing reforms to boost competition in procurement, strengthening anti-corruption enforcement, and improving judicial integrity will be critical to enhance the business climate.

Reform is crucial for the transition to a more resilient, more efficient, and cleaner energy sector, with stronger governance and reduced fiscal vulnerabilities. Despite some progress aligned with the Recovery and Resilience Plan, significant fossil fuel reliance, the highest energy intensity in the EU, and untargeted subsidies continue to distort market signals and exacerbate environmental and fiscal risks. A more competitive electricity market would enhance price formation and improve investment incentives. Targeted support for energy-poor households can help address affordability concerns, the IMF team notes.