After the Berlin Wall: Low Labor Costs and Market-Minded Pols Make Bulgaria a Hot Emerging Market

Communist rule and strife in neighboring countries have hampered the Balkan nation, but now it's looking to make a comeback.
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On the day the

Berlin Wall

began to crumble, the political committee of Bulgaria's

Communist Party

insisted the country's leader of 35 years,

Todor Zhivkov

, leave office. His resignation ushered in a new era of democracy and integration with the West.

But unlike some of its former partners in COMECON -- the acronym that was more widely recognized than the unwieldy full name,

Council for Mutual Economic Assistance

-- Bulgaria's first five post-Communist years were not a free market boon of

Levi's

and

Cokes

.

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Instead, conflicts in neighboring countries helped mark the early 1990s with plunging living standards. The Balkan and Gulf wars led to sanctions against strategic trading partners Serbia and Iraq, and the sanctions, coupled with poor economic programs, pushed Bulgaria into a full-blown crisis.

Now, the country is morphing yet again. This time, Bulgaria is emerging from crisis to the prospects of

European Union

membership. In the process, it is becoming one of the hottest small countries in Eastern Europe.

The centerpiece of the country's economic transformation has been the establishment of a currency board, which tied the Bulgarian lev to the German mark in July 1997 after the pro-reform

United Democratic Forces

, or UDF, beat the Socialists in early elections spurred by public demonstrations. The UDF immediately set about implementing necessary and difficult market-oriented changes.

All of this marks a significant change from the stagnation of the previously elected Socialist government, under which privatization slowed and contradictory tax and investment policies scared off investors. Even foreigners, who were keen on emerging and transitional markets, shunned Bulgaria because of persistent high inflation and currency depreciation. At its peak in December 1996, the

Bulgarian National Bank

hiked its base interest rate to 300% a year.

With the worst behind them, Bulgarian officials had been looking forward to a year of positive economic news. Unfortunately, the war in Kosovo flared, blocking key trade routes, crimping tourism and costing Bulgaria an estimated $275 million -- an amount the EU and the U.S. agreed to grant the country, which is part of

NATO's Partnership for Peace

program.

Alliances like these, while sometimes costly, are helping push Bulgaria fully into the sphere of Western Europe. It helps that the violent ethnic conflicts that have wreaked havoc in other Balkan states are absent from Bulgaria, and that the political elite plays up its Western orientation.

On track for EU entrance, Bulgaria will begin full-membership talks next year, and the UDF government is more than willing to swallow the bitter pill of further reforms to qualify.

"To become members, to continue the process of modernization and Europeanization of the country, we need a second mandate," said Industry Minister

Alexander Boshkov

in a September interview with

The Wall Street Journal

. "So we better do the unpopular things now."

In the meantime, Bulgaria is expected to benefit from a European economic rebound as Western Europe accounts for a greater share of its trade. Russia once comprised 70% of Bulgaria's trade; now it is barely 7%. Peter Botoucharv, Eastern European analyst for

Robertson Stephens

, estimates that exports will grow by 6% and imports by 7% next year. (In the first half of 1999, Bulgaria registered a $357 million trade deficit.)

Moreover, foreign direct investment is following further privatization. FDI is forecast at $750 million for 1999, just shy of the total for the period between 1991 and 1996.

Bulgaria will also profit from its status as the lowest labor-cost center of Europe, as Western companies continue to search out the best-educated workforce for the lowest price. A targeted industry for development could be software, because Bulgaria was once a vital source for Soviet software products.

For now, foreign investors are focusing on Brady Bonds, one of the few international Bulgarian securities. Institutional investors are increasingly overweight Bulgaria, citing the wide spreads due more to Bulgaria's continued junk rating rather than the country's fundamentals.

Moody's Investors Service

cited high foreign-currency debt, as well as structural weaknesses in the enterprise and banking sectors to explain its B2 rating.

While that might seem a less-than-ideal combination, investment bankers say the country is a good bet. "It has its financing needs covered and is a prime candidate for Brady retirement through debt management," notes a report from

J.P. Morgan's

emerging markets research team. "We hold Bulgaria overweight for the current yield and capital gains potential with buybacks."

As privatizations are completed by the end of 2000 with the help of the EU, and Sofia plans greater liberalization of exchange and trade regimes -- including the elimination of export taxes -- investment opportunities in Bulgaria should blossom in the next millennium.