Bulgaria: Staff Concluding Statement of the 2025 Article IV Mission

September 23, 2025

Sofia, Bulgaria: An International Monetary Fund (IMF) team, led by Mr. Fabian Bornhorst, visited Bulgaria during September 10-23 to conduct the 2025 Article IV consultation. The team met with a wide range of stakeholders, including senior government officials, private sector representatives, and civil society organizations. The following statement was issued at the end of the visit:

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. 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). Economic momentum is strong, the labor market is tight, and inflation is elevated. High wage growth has supported income convergence, although productivity growth is lagging. Credit-especially mortgages-is expanding rapidly alongside house prices. Economic activity is expected to remain robust, driven by resilient consumption. Against this background, policies need to be calibrated carefully. To fully realize the benefits of euro adoption, durably raise living standards, and avoid macro-financial imbalances, policymakers should strengthen fiscal discipline, manage euro transition risks, and accelerate reforms. A predictable and consistent policy environment will benefit these goals. Specifically:

• Fiscal policy should be tightened and pivot from consumption support toward boosting quality investment. Looking ahead, the focus should be on mobilizing additional revenues to meet rising needs in infrastructure, health, and education, and to help reduce inequalities.
• In the financial sector, continued robust macroprudential oversight is needed to contain credit risks.
• Finally, accelerating structural reforms is essential to boost productivity, deepen integration with the EU single market, strengthen governance, and ensure disbursement of RRP funds.

Outlook

1. Domestic demand is driving a robust expansion. The economy is operating above potential, with tight labor markets. GDP growth is projected to be strong at around 3 percent in 2025 and 2026. 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. However, 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.
2. Inflation is projected to decline gradually. Headline inflation is expected to average around 3½ percent per year in 2025 and 2026 before moderating. Wage dynamics are a key driver: rising wages in the context of tight labor markets, minimum wage increases linked to average wages, and public sector wage indexation are driving income convergence toward the EU average but are also boosting domestic demand. With labor costs rising faster than productivity, profit margins are being squeezed, reinforcing the passthrough from wage increases to prices.
3. Euro adoption prospects provide a near-term boost to the outlook. The transition to the euro is expected 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. Measures such as euro-lev dual pricing, price monitoring, and the ongoing information campaign are key to addressing public concerns and broadening support. Past experience suggests that any price effects associated with the currency changeover will likely be small and temporary.

Risks

1. Risks to the outlook arise from demand pressures and heightened external volatility. Persistently strong domestic demand may lead to overheating and more prolonged inflationary pressures. Rapid credit expansion and banks' growing exposure to mortgage credit could create vulnerabilities. In the absence of carefully calibrated policies, these developments could result in macro-financial imbalances. Reform momentum could fade post-euro adoption, including due to re-emerging policy uncertainty, and put the benefits of integration at risk. Externally, subdued activity in trading partners and heightened geopolitical tensions could weigh more on growth than currently projected, while trade policy tensions and uncertainty could dampen trade and foreign investment.

Fiscal Policy to Anchor Macroeconomic Stability

1. Fiscal policy is expected to remain expansionary in 2025-2026. Increases in current spending are expected under existing indexation practices, further supporting household incomes and consumption. Capital investments are also set to increase with the implementation of the RRP. The activation of the national escape clause under the EU's Stability and Growth Pact will allow for higher defense spending. As a result, the fiscal deficit is projected to stay above 3 percent of GDP in 2025-28 before gradually declining.
2. A non-expansionary fiscal stance in 2026 would help cool the economy. Considering underlying demand strength and the economy's cyclical position, a neutral stance is recommended. This would require an adjustment of about 1 percent of GDP, relative to baseline projections. On the expenditure side, 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. Replacing untargeted subsidies with targeted transfers would enhance spending efficiency. 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. At the same time, prioritizing EU-funded investment would support growth without adding substantially to fiscal pressures.
3. Looking ahead, maintaining fiscal space amid rising spending pressures will require prudent policies and forward-looking reforms. While the overall risk of debt distress remains low, public debt is increasing, owing to sustained deficits and sizeable recapitalizations of state-owned enterprises (SOEs). Addressing spending pressures from aging, defense, infrastructure, and the energy transition will also require fiscal space. Furthermore, expectations for quality public services are growing with income levels, and disparities remain large, requiring investment to improve public service delivery and equitable access. Hence, reforms are needed to preserve fiscal space and buffers against future shocks.

• On the spending side, such reforms should focus on: (i) eliminating untargeted subsidies; (ii) reforming public sector compensation and employment frameworks with a view to containing the wage bill, and (iii) improving spending efficiency in health, education, and infrastructure.
• On the revenue side, continued strengthening of tax administration, including enhanced audit and control procedures and compliance risk management will support revenue collection. However, the revenue-generating capacity of the flat-tax regime appears insufficient to meet increasing demands for quality services. 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.

1. Enhancing the sustainability and adequacy of the pension system will require comprehensive reform. 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. Financial sustainability can be strengthened by increasing contribution revenues, including by removing the cap on income subject to contributions, which has not kept up with wage growth. 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. In parallel, efforts under the Roadmap for Improving the Pension System to strengthen the system's second and third pillars should continue, beginning with offering more flexible risk-return profiles.
2. Increasing the consistency and transparency of public policies would reduce distortions and strengthen the credibility of fiscal reporting. For example, requiring SOEs to pay regular and interim dividends while simultaneously recapitalizing them sends conflicting signals about underlying policy intentions and SOEs' financial health. Moreover, requiring SOEs to transfer all profits to the budget can constrain their ability to reinvest and should be reconsidered. Similarly, the advance collection of future financial sector profit taxes provides immediate budgetary relief but creates future fiscal risks. Furthermore, while efforts to address local government investment needs are commendable, more transparency is needed on the selection, funding, and execution of municipal projects, and on the role of the Bulgarian Development Bank in financing this expenditure.

Financial Policies to Minimize Risks

1. The financial sector remains resilient. Bank capitalization is among the highest in the EU, reflecting sizable add-on buffers, and liquidity remains ample. The non-performing loan (NPL) ratio is falling amid strong credit expansion, while inexpensive funding from a large and growing deposit base has sustained wide interest margins and high profitability. Stress tests show that banks remain resilient to severe hypothetical shocks. However, some consumer credit has been shifting to non-bank lenders, which are subject to less stringent regulation and show higher NPL levels. Other non-bank financial institutions, notably insurance companies and investment funds, continue to play a limited role, requiring concerted efforts towards financial deepening through offering households alternative investment products in the context of rising incomes.
2. Still, rapid growth of consumer credit, particularly mortgage loans, has increased systemic risks in the real estate market. While credit expansion is generally warranted given still-shallow financial depth, household credit growth is outpacing income growth. In particular, dynamic mortgage lending, combined with rising construction costs, has caused residential property prices to grow at 15 percent. 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 BNB's close monitoring of evolving systemic risks in the housing market is therefore welcome.
3. Macroprudential policy will need to remain nimble. Borrower-based measures, appropriately introduced in October 2024, are supporting the gradual cooling of the real estate market. 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. Therefore, macroprudential policy, notably through borrower-based measures, will have to proactively manage credit market risks.

Structural Policies to Raise Medium-Term Growth

1. Addressing productivity and demographic challenges will require sustained investment in human capital and labor market participation. Productivity growth remains relatively low, and structural gaps are large, slowing income convergence, and medium-term growth. Enhancing education quality to lift education outcomes towards EU averages, expanding digital and AI-related skills, and fostering innovation are essential to raise productivity and offset the economic impact of a workforce projected to decline fast over the next 25 years. At the same time, activating untapped labor potential-particularly among the youth and marginalized groups-and attracting foreign workers would help mitigate labor shortages.
2. Growth dividends from scaling up quality public investment and reducing structural policy gaps could be substantial, particularly through the RRP. Expanding and improving infrastructure boosts both current and potential growth, but this requires stronger public investment management. Accelerating structural reforms to lift productivity and deepen integration with the EU single market is equally critical. To fully realize these gains, implementation of the RRP reforms and investments should be an immediate priority.
3. Improving governance and institutional quality is essential for long-term growth. Challenges in the rule of law, public procurement, and SOE governance continue to limit reform effectiveness and public trust. Addressing these issues would strengthen institutional credibility, unlock investment, and improve the efficiency of public spending. While legislative progress has been made on anti-money laundering and combating the financing of terrorism (AML/CFT), exiting the FATF grey list will require effective implementation of the legal framework. Advancing reforms to boost competition in procurement, strengthening anti-corruption enforcement, and improving judicial integrity-alongside faster adoption of Single Market legislation-will be critical to enhance the business climate.
4. 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. Recent legislative changes-including a new electricity pricing mechanism and amendments to the Energy Act-preserve regulated household tariffs and enable continued reliance on coal-fired electricity generation. A more competitive electricity market would enhance price formation and improve investment incentives. Targeted support for energy-poor households can help address affordability concerns. Reducing financial interdependence within the Bulgarian Energy Holding and strengthening its governance would improve transparency, contribute to a more efficient resource allocation, and support the energy transition.

The IMF team thanks the Bulgarian authorities and stakeholders for the constructive dialogue and productive collaboration.