Higher energy prices, aggravated by Russia’s war of aggression against Ukraine, and weaker global demand will lower growth in 2023 (Table 1). The Bulgarian economy was rebounding from the pandemic when it started in February 2022 to face new headwinds from the war in Ukraine. As most of the energy supply comes from domestic coal and nuclear energy, reliance on Russian gas was more limited than in many other countries. With the exception of nuclear fuel and oil, Bulgaria had modest trade links with Russia. Interconnection with some neighbouring countries drove up electricity prices in the domestic market and fuelled energy exports, making Bulgaria the third largest exporter of electricity in Europe. After a strong rebound in 2021, growth moderated to 3.4% in 2022 and is anticipated to slow further in 2023 before rebounding.

The global surge in energy and food prices has pushed inflation to levels not seen in decades (Figure 2), but headline inflation is starting to decline very gradually as energy prices moderate. Inflation has become increasingly broad-based with core inflation picking up pace in 2022, on account of second-round effects from higher food and energy prices, strong private consumption and robust wage growth.

There is strong momentum in wages. In recent years, real wages have grown strongly, supported by productivity gains and labour shortages. In 2022, the inflation-induced loss in purchasing power was partly offset by strong and broad-based nominal wage growth, as well as upward adjustments of social transfers. The government increased the minimum wage by around 10% in 2022 and again by 10% in January 2023. These developments create a risk of second-round inflation in the current environment.

Monetary conditions in Bulgaria follow those in the euro area through a currency board arrangement. The Bulgarian lev has participated in the exchange rate mechanism II since July 2020 and the authorities currently aim to adopt the euro in January 2025. While the currency board has contributed to a sound macroeconomic position and a stable exchange rate, this arrangement leaves a central role to fiscal policy in managing inflation.

Fiscal discipline has resulted in low public debt. The deficit is narrowing following the COVID crisis and with energy supports financed by windfall revenues. However, spending pressures related to ageing, upgrading of infrastructure and raising skills will need to be financed by greater tax collection efficiency and higher environmental taxes.

A temporary freezing of energy and water prices for households, an energy subsidy scheme for industrial end-users of electricity and other measures for high energy consumers have been introduced to cushion the impact of the energy crisis. While some measures are targeted, most are not and reduce price signals to consumers. The general government deficit is estimated to have been reduced to 2.9% of GDP in 2022 from 3.9% in 2021. Making the supports more targeted towards the most vulnerable and designing them in a way that keeps up energy saving incentives would help limit inflationary effects of fiscal policy.

Public debt is low, but ageing-related spending pressures are mounting and there are several areas where increases in social spending could strengthen growth and social outcomes. More needs to be spent on education to improve quality and on addressing large infrastructure needs. Substantial amounts of EU funds are expected in the ongoing programming period, but there is no overall public investment strategy. The fiscal council could play a stronger role in ensuring a long-term approach to fiscal policy.

Additional current spending needs could be financed by improved revenue collection efficiency and environmental, property and inheritance taxes. Informality is widespread, particularly in the form of additional undeclared “envelope” wages. Half of all taxpayers are registered at the minimum wage (Figure 3). Reducing the underreporting of revenues for income tax and social security contributions, making it more difficult for multinational companies to shift profit overseas, enhancing VAT compliance and examining shifting the administrative responsibility for collection of property taxes to the central government could all help bring in additional revenue.

Growth is constrained by the low level of investment and unfavourable demographic trends. Productivity has been the major driver of growth in recent years and an ambitious agenda of structural reforms could boost it further.

The investment rate at 20% of GDP is relatively low, while public investment at 3.4% is in line with the OECD average. To attract private capital, procedures around the entry and exit of firms could be streamlined. Educational attainment has improved with 40% of younger cohorts holding a tertiary degree. Raising educational attainment further and improving quality would help realise significant productivity gains in the long term.

Corruption imposes high transaction costs on businesses. Whistle-blower protection is now anchored into law. However, the system detecting and investigating corruption is fragmented, leaving some grey areas. The creation of a new body with investigative powers is welcome, but greater transparency and more stringent regulations would help the detection and reporting of corruption cases. Investigations should not be obstructed and effective mechanisms to investigate the Chief Prosecutor should be established.

Since 2010 the working-age population has shrunk by around 19%, while the number of people aged above-65 has increased by 12.6%. These unfavourable demographic trends reduce the economy’s growth potential.

Average fertility at 1.58 is close to the OECD average, but masks low birth rates among educated women, who have fewer children than they desire. The solid employment rate and the high share of women in management positions, as well as a low measured gender wage gap, imply high opportunity costs of having children for high-skilled women. Childcare is not available countrywide, and its quality is often not considered adequate. Many children are born into disadvantaged families.

Net emigration has contributed to population decline for decades. A more targeted and ambitious effort should be envisaged to make Bulgaria a more attractive place to live and to encourage workers to come, including better engaging with the diaspora to attract people back and revisiting immigration policies.

Even though the population is shrinking, many people do not work. Due to a lack of childcare facilities and homecare for the elderly, many people, mostly women, engage in caregiving and are out of the labour force. A sixth of the workforce is on disability benefits, which are more generous than social assistance and do not require registering with the Employment Agency.

Practical training is lacking in tertiary and vocational education. A significant share of inactive and unemployed people are tertiary graduates, in particular in younger cohorts (Figure 4). Tertiary education has expanded rapidly, but quality has not kept pace, and it is not practice oriented. Vocational training often fails to equip students with practical skills as it is not always workplace based.

The energy intensity of the economy fell in the 2000s and has since remained stable. Emissions, driven by the energy and transport sectors, have stayed at the same high levels for two decades. A comprehensive strategy to reach net zero emissions by 2050 is still to be set out.

Coal remains a major source of energy, despite a sizeable decline over past decades (Figure 5) and there is no roadmap to phase it out. Nuclear power plays a key role in Bulgaria’s energy transition, serving as a baseload source of electricity. Investment in renewables, which account for a fifth of the energy supply, needs to pick up. Investment in upgrading the grid and expanding storage facilities is needed to allow for a more widespread use of renewables.