Economic activity contracted sharply when confinement measures were first introduced to contain the pandemic. Travel, accommodation and food services suffered a large contraction. Manufacturing is mostly export-oriented and was hit by initial large volume and price declines. The scarring effects of the COVID-19 shock could be long lived. This makes it essential to press on with reforms facilitating the reallocation of factors of production, which is typical after large shocks.

Employment fell, eroding recent gains. Men and youth were affected the most by job losses. While the government’s wage subsidy scheme protected a high share of jobs, the recovery of employment will require more active labour market policies. The workforce is ageing and the economy can little afford large-scale withdrawals from labour market participation.

A recovery is underway, but uncertainty is high. The re-opening of businesses and relaxation of containment measures over May-June was accompanied by a recovery of activity that gained momentum in July. Business and consumer confidence began to increase. Industrial production has started to recover though it remains below February 2020 levels. However, service and retail sector activity has been held back by consumer income losses, the rise in precautionary savings and continued restrictions on some activity. A continued high COVID-19 caseload could constrain the normalisation of domestic demand.

A sluggish recovery in the global economy is a downside risk. A highly open economy that is dependent on exports, particularly related to the processing and assembly of foreign inputs into manufacturing export goods, Bulgaria’s recovery is vulnerable to further shocks to external demand.

The government has put in place a fiscal stimulus estimated at 3% of GDP. This has reduced job losses, increased the resources for health care and eased financial pressures for the most impacted firms and households. Prudent budget execution prior to the pandemic has provided Bulgaria with ample fiscal space to respond to the crisis. In 2019, a budget surplus was recorded and public debt was lower than in most OECD economies. Fiscal support measures should not be withdrawn prematurely. Increasing investment related to transport infrastructure, energy efficiency, the digital economy and innovation could make for a more robust economic recovery, and are likely to receive substantial resources from the European Union Recovery and Resilience Facility.

Bulgaria is in a strong position to benefit from joining the euro area. Bulgaria joined the European Exchange Rate Mechanism II in July 2020 and the European Central Bank and the Bulgarian National Bank have established cooperation over banking supervision. For over twenty years, it has maintained a currency board with a fixed exchange rate to the euro. Supervision of the financial sector has improved and the sector is well capitalised. Given that the long-term interest rate differential with the euro has fallen to zero, it seems unlikely that euro entry will attract large inflows of speculative funds. The challenge is that wages, which are currently much lower than elsewhere, will rise as Bulgaria converges towards the euro area. To ensure competitiveness and avoid macroeconomic imbalances, labour productivity will have to keep up with real wage pressures.

Boosting income convergence will require ambitious reforms. Several years of robust economic growth has lifted income per capita above half of the OECD average (Figure 2), but productivity had trailed that of faster-converging Central and Eastern European peers. Recovery plans from the pandemic should focus on modernizing the business environment.

Barriers to competition are high. Reducing regulatory barriers and improving competition policy would stimulate business dynamism and support a more efficient allocation of resources in the economy. Public policies should make sure to level the playing field among different stakeholders, particularly by building on significant action to modernise and improve public procurement in recent years.

Insolvency reform has become all the more pressing. The government has identified gaps in the insolvency framework and has set up a roadmap for reforms. A more rapid and effective bankruptcy framework would help non-viable firms in financial difficulties to shut down and avoid zombie firms from holding back resources and impairing banking system credit. Easing access to firm rehabilitation and debt forgiveness proceedings would allow more businesses that face solvency problems to exercise the option of restructuring their financial obligations with creditors outside of a full formal insolvency process. Like in other countries, measures should be put in place to help firms in financial difficulties due to the pandemic, including out-of-court settlements with creditors.

Skills need to be improved. The effectiveness and provision of education and training throughout the lifecycle should be increased. Poor PISA scores (Figure 3), high dropout rates in secondary education, and the large proportion of NEETs (young people neither in employment nor in education or training) are worrying indicators for a country facing ever-shrinking younger cohorts.

The economy is carbon- and energy-intensive. Coal continues to account for almost half of energy production, though the share of renewables has increased above the OECD average. The potential to improve energy efficiency is large. The COVID-19 recovery presents an opportunity to decarbonise the economy, especially the energy mix and housing stock, which could benefit from abundant EU green funds.

Efforts made to fight corruption and organised crime should continue. Important steps have been taken to reform the judiciary, but more is needed to strengthen accountability and safeguard judicial independence, and to establish a coherent public integrity system.

The booming economy translated into robust household disposable income growth. However, income inequality exceeds almost all OECD countries. Regions with large cities are driving growth in Bulgaria, while many rural regions suffer from depopulation and rapid ageing.

Poverty remains elevated, particularly among ethnic minorities, the elderly and children, and in rural areas. Cash transfers to protect the most vulnerable from income shocks are low and restricted. The combined average income tax and social contribution rate for lower-wage workers is comparatively high and does little to reduce income inequality.

Investments in infrastructure and housing reform would help to boost mobility and strengthen linkages to national and international supply chains. Regional income differences in Bulgaria are larger than in most OECD countries and growth has been lower in regions without larger cities. Increasing the long-term value-added of tourism and agricultural activities can assist in local economic development. Improving living standards for all regions will require better coverage and access to public services, notably in health and long-term care.

The Roma, making up one-tenth of Bulgarians, live in socially excluded neighbourhoods. Improving their economic integration is important as the Roma are an increasing share of the working-age population. Most Roma lack proper housing and almost 25% of houses in segregated Roma neighbourhoods remain illegal. Roma face difficulties also in accessing healthcare services and social benefits, and are likely to have weaker education outcomes, often dropping out before finishing school. This is a particular concern among young Roma women.

Health care needs to be strengthened. Hospital capacity is high, but primary care is underdeveloped due to significant gaps in health insurance coverage and large out-of-pocket payments. To address the pandemic, the government made treatment of COVID-19 available to all. Yet, access to health care is restricted in many regions, due to low numbers of general practitioners, which results in frequent hospital visits.

Residential mobility is very low in comparison with OECD countries. While Bulgaria has a high number of dwellings per capita, overcrowding is common and a large share of young adults live with their parents. High homeownership and low affordability are the main obstacles to residential mobility and resolving housing market imbalances. Housing allowances and social housing are underdeveloped. The targeted heating allowance increased substantially in 2019, but is the only support programme of significant size and distorts incentives for energy renovation.