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1.1 ACTION LINE 1.1: ECONOMIC STABILIZATION AND
IMPROVING OF THE BUSINESS CLIMATE
- 1.1.1
BACKGROUND
- 1.1.2
OBJECTIVES
- 1.1.3
ACTIONS
- ANTI-CRISIS
PROGRAM
- ACCELERATION OF THE
PRIVATIZATION PROCESS
- DOMESTIC AND FOREIGN
INVESTMENT STRATEGY
- ABSORPTION
CAPACITY
- TAX
MEASURES
- ACTIONS AGAINST
SHADOW ECONOMIC AND CRIMINAL ACTIVITIES
- 1.1.4 EXPECTED
RESULTS
1.1.1 BACKGROUND
The economic destabilization and deterioration of
the Bulgarian business environment has seriously restricted the
development of the SME sector. Moreover, not only has the sector
experienced serious governmental neglect, but it has also undergone
direct evolutionary oppression as a result of various official
policies, including the anti-competitive practice of subsidizing
the public sector. While such macro-economic failures affect all
private enterprises, the impact on the SME sector is compounded due
to its general inability to access capital and information.
1.1.2 OBJECTIVES
The objective of this action line is to address the
development of the SME sector vis-a-vis the stabilization and
improvement of the Bulgarian economy. More importantly, this action
line emphasizes the importance of including specific policies and
measures in such macro-economic actions that address the specific
concerns and needs of SMEs. The purpose is not to propose those
specific macro-economic actions necessary to stabilize the economy,
but rather to acknowledge conditions that are essential for the
development of the SME sector and to stress the importance of
addressing SMEs in such macro-economic actions.. These actions are
viewed as a function of several parameters, namely, the
acceleration and expansion of economic reforms, anti-crisis
regulation and stimulation, and the opening of the country to
foreign investors and partners.
1.1.3 ACTIONS
The actions foresee:
1. the development of an anti-crisis program in
which the place and role of SMEs will be clearly and responsibly
stated (ANTI-CRISIS PROGRAM).
2. the development of a strategy for accelerated,
full-scale privatization, with maximum broadening of the applied
privatization techniques (ACCELERATION OF THE PRIVATIZATION
PROCESS).
3. the development of a national strategy for
mobilizing domestic investment and attracting foreign capital,
including decisive measures for improving the general business
climate in the country (DOMESTIC AND FOREIGN INVESTMENT
STRATEGY).
4. the implementation of measures designed to
increase the absorption capacity of the country with respect to
international programs that provide financial aid and support for
the SME sector (ABSORPTION CAPACITY).
5. the implementation of decisive measures
(legislative and organizationally-administrative) for establishing
steady tax policy and practices (TAX MEASURES).
6. the implementation of measures for narrowing the
perimeter of activity and influence of the shadow economy and the
creation of a competitive environment without distortions (ACTIONS
AGAINST SHADOW ECONOMIC AND CRIMINAL ACTIVITIES).
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ANTI-CRISIS PROGRAM
Background
Since the restructuring of the economy which began
in 1989, there has been no consistent and long term strategy for
the development of economic priorities. While continuously stating
the need for structural reform, the government still cannot point
out the sectors it plans to prioritize. All this deprives the
private sector, and SMEs in particular, of the ability to work out
their own strategy, relevant to national economic policy. In
addition, the dialogue between the authorized state institutions
and private businesses has been disrupted, which deprives
entrepreneurs of the ability to influence national economic
priorities.
Recommendation
In recent months, structural reform in Bulgaria has
been spoken of widely. While a discussion of the proposed currency
board extends beyond the scope of this report, SMEs will face
serious consequences either as a result of the board’s
implementation, or lack thereof. Furthermore, the board and various
other structural reform measures that have been independently
mentioned are only several of the essential elements of an
anti-crisis program.
In light of these measures, the successful
development of the SME sector depends largely on how thoroughly
anti-crisis actions embrace the crucial role of SMEs. Specifically,
all measures stated below must incorporate objectives designed to
strengthen the SME sector. While a basic anti-crisis program that
successfully stabilizes the economy will undoubtedly benefit the
SME sector as well, such a process, without specific SME
consideration, will result in a lost opportunity to concurrently
build a strong foundation of SME support and promote its expansion
into the strategic industries of Bulgaria.
To establish a favorable working climate in which
SMEs can thrive, such a program must contain several key components
that also specifically recognize the special needs of SMEs: fiscal
and monetary actions to lower interest rates, inflation and taxes
(particularly of the profit tax); measures to stabilize and promote
the development of the banking system; policies and support for the
benefit of strategic industrial sectors; export programs which
include financial backing and insurance; and foreign investment
strategies that support the overall goals of the anti-crisis
program.
In the framework of common measures, the development
of a real and expedient structural reform package is of critical
importance. In order to finally realize this reform, which for all
these years remained in the sphere of promises and political
speculation, what is needed is a clear, practical and transparent
program for its carrying out.
ACCELERATION OF THE
PRIVATIZATION PROCESS
Background
Experts estimate that the percentage of state owned
property is still well above 90 per cent. Non-competitive state
owned enterprise ("SOEs") business practices crowd out SMEs from
competing in their common industries. SOEs also encumber the
success of SMEs in developing industries by creating a deficiency
of competitive suppliers, distributors, and industrial consumers.
In addition, the slow privatization process has curtailed
international interest in the SME sector and the Bulgarian market
in general. Failure to carry out privatisation measures has
provided fewer opportunities to purchase Bulgarian companies and to
form joint ventures. It has also provided an unfavorable investment
climate since maintaining significant public ownership runs counter
to a free market system.
Further, budget losses continue to pileup from SOE
employee benefit payments and foregone tax revenues. Also,
maintaining state ownership of companies continues to erode both
the value of their assets and their competitiveness. Thus, the
longer an SOE is held, the greater the cost to the state and lower
the price of the sale.
Recommendation
In addition to accelerating the privatisation
process, as a whole, for the well being of the Bulgarian economy,
SME privatisation must be made a priority of the process. While
significant attention has been paid to the "gems" of Bulgarian
industry, the privatisation of most state owned SMEs has been
neglected. Within the economy, only a relatively small portion of
the total national capital assets are "large" enterprises
(statistically, these companies have constituted only 10-15% of the
enterprises of centrally planned economies). SMEs should be sold
off quickly and expeditiously. Consequently, in addition to its
importance to the development of the SME sector, selling such
enterprises will make the privatisation of large SOEs easier.
The relevant authorities need to adopt a simple
policy for the immediate sale of SMEs and other small properties.
Specifically, an accelerated system of sale, similar to those
implemented in most Eastern European countries, must be
established. This includes the establishment of a break even cost
of holding the businesses and a minimum sales price for the
enterprise. Then, following an impartial auction procedure, a
competitive bidding process should be created which would result in
prices at least above the break even level. The break even price
can be estimated by determining the liquidation value of the assets
of the company and subtracting the costs associated with keeping
the company state owned, such as welfare benefits for employees,
financing and other administrative costs. In addition, alternative
forms of sale, such as management buyouts, must be administered. In
many Eastern European privatisation programs, management was
granted the business in return for the preparation of a sound
business plan and long term commitment.
However, while emphasis needs to be placed on SME
privatisation, this does not mean that SME privatisation should
commence at the expense of accelerated large scale privatisation.
The need for a fully functioning market economy is not only
essential to the development of the SME sector, it is imperative
for the success of the Bulgarian economy as a whole.
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DOMESTIC AND FOREIGN
INVESTMENT STRATEGY
Background
Since developmental aid and government-initiated
capital formation have become difficult to acquire, equity capital
for SME development, and the development of the Bulgarian economy
as a whole, must come from the private sector, both indigenous and
foreign.
Commercial bank liquidity problems, a lack of
experience lending to SMEs and poor economic conditions have
created a credit shortage in the country. While SMEs are not the
only businesses suffering from a lack of start up or development
capital, their capital needs are presently being neglected in
favour of large companies. Owners of such enterprises usually rely
on self-generated capital, family or friends. Enterprises can not
establish a long term, stable financial basis from the personal
savings of the entrepreneur, nor does self financing provide
sufficient capital accumulation.
As Bulgaria currently has little or no domestic risk
capital available, it needs to attract capital from abroad. And
therefore, foreign capital must be actively solicited. The
Bulgarian banking system can not currently support the development
of the SME market and other sources of funds, such as the Ministry
of Industry’s Small Business Fund, established in 1991, remain
underutilized. Foreign investment in which effective managerial
control is established also serves to bring badly needed
technologies and managerial techniques to SMEs. Unfortunately,
according to data provided by BNB, foreign investments for the
first half of 1996 amount to USD 49 million, USD 27.6 million less
than the first six months of 1995.
Recommendation
Three areas must be targeted to develop the domestic
investment structure:
- pension and insurance funds investing,
- capital market development, and
- savings mobilization.
Pension and insurance funds maintain large surplus
capital balances which must be invested and often constitute a
large percentage of the investment capital in developed and
developing countries. However, without adequate investment
vehicles, such capital will remain idle or be invested abroad.
While it is unlikely that pension or insurance funds have the
expertise to invest in SME development directly, the creation of a
financial infrastructure in the country will draw large amounts of
currently uninvested assets into financial intermediaries.
Coupled with a committed privatisation process, the
country must turn its focus to creating a liquid and transparent
capital market to provide a mechanism through which public and
private enterprises can raise capital to invest in projects.
Capital markets must be created that offer liquidity
and transparency in each of the following areas:
- the market for government securities;
- the market for stocks and bonds of privatized
enterprises;
- the market for securities issued by commercial
banks;
- the market for municipal bonds; and
- the market for securities issued by private,
non-bank businesses formed outside the privatisation process, such
as private investment funds and other collective investment
vehicles.
This development requires attention to each of the
following areas, many of which are addressed in this paper in
greater detail:
1. Legal Development
- Securities laws (fiduciary responsibilities, truth
in new issues and due diligence requirements, and resistance to
market manipulation)
- Structure of a securities agency (government and
self regulation by association, clear establishment of powers, law
making and enforcement, and staffing)
- Tax basis for companies (laws and regulatory
agencies)
2. Company Development
- Privatisation (elimination of government control
and subsidies, separation of ownership and management,
establishment of corporate by-laws, definition of role of boards
and accounting standards)
3. Securities Industry Formation
- Information and disclosure (accessible, high
quality and timely)
- Laws governing securities firms (capital
requirements, management fitness and responsibility, employee
registration and requirements)
- Roles and regulations of banks (universal,
subsidiary or holding company)
- Market structure (intermediaries, trading
exchanges, registration, clearing and settlement, price disclosure,
and policies towards foreign investors regarding joint ventures and
traded firms, ownership limits)
4. Perpetration and Training
- Time schedule for implementation
- Training people for jobs
- Industry infrastructures (attorneys, accountants,
and dispute settlement/arbitration
Developing the capital markets of Bulgaria will
reduce the risk of the excessive expansion of the country’s already
fragile banking system. Specifically, Bulgarian commercial banks
are unable to meet credit demands because of a country-wide lack of
savings. Policies such as reserve requirements, state or private
banking insurance and other practices to increase the level of
savings in the country must be reviewed and where necessary,
implemented.
The improvement of the institutional conditions
allowing easier access by SMEs to capital markets is extreamly
important. However, the commercial bank will ultimately be the
largest source of financing for SMEs. As evidenced by the obvious
interdependency between commercial banks, capital markets and
pension and insurance funds, simultaneous development of all
sectors is required to provide financing and credit for SMEs.
In addition, to attract investment in SMEs from
abroad, Bulgarian policy makers must make Bulgaria an attractive
investment for international investors. This success relies heavily
on the stabilization of the economy and
political system, privatisation of existing SOEs,
reduced inflation, and the basic building of a better economic
climate for investing. Recent political and economic events had
diverted foreign investors attention to other Central and Eastern
European Countries and foreign markets. In the midst of heavy
competition from other developing economies for foreign investment,
the availability of capital for aiding the SME sector from abroad
may be difficult to attract in large quantities. And therefore,
concrete actions must be executed under the umbrella of a
comprehensive national economic plan.
As an adjunct to attracting foreign investment, the
authorities must focus attention on the process for effecting such
investments. Investors seek returns, which can be dramatically
eroded by a cumbersome investment process that lacks transparency.
Market potential and economic and political climates are all
factored into foreign investment decisions. Governments that ignore
the needs of investors and undermine their confidence risk losing
local SME attractiveness as opportunities for investment. Investors
want well developed capital markets, including a stable banking
system in which commercial banks are capable of assessing risks and
providing capital. In addition, the availability of other forms of
financing, quality information, liquidity, hedging vehicles and an
overall degree of stability add to the attractiveness of a market.
Investors are also attracted to markets in which fiscal an monetary
policies favor stability and policy makers have good governmental
relationships with international donor organizations and banks.
Stable economic indicators are also a sign of a
stable government and governmental policies. Investors want to know
that governments are committed to the well-being of the nation as a
whole. Fears of expropriation, changing regulations, and lack of
support for private business increase as the stability of the
government decreases, regardless of what is written in the laws.
Signs such as frequent changes in Ministers responsible for the
decisions regarding foreign investment in SMEs will cause foreign
investors to reconsider the opportunities available for them.
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ABSORPTION CAPACITY
Background
In light of recent changes in the international
interest in the promotion of SMEs and their role in the development
process, focus must be placed on the implementation of programs
designed to increase the absorption capacity of the country. For
example, the European Investment Bank recently announced that it
would allocate 25 per cent of its investment capital for the
development of the SME sector in developing economies. However,
previous international aid for Bulgarian SMEs has not been
allocated in an efficient or timely manner. Unfortunately, the lack
of an appropriate institutional framework, frequent changes in
government and the crisis in the banking system led to inadequate
utilization of those resources. Specifically, a 22.5 million ecu
PHARE sponsored local structure development program established in
1992 (the only SME support program financed by the European Union
thus far), has been met with serious delays and most of the funds
have been reallocated to other projects within Bulgaria. Further,
of the amount still left for SME development, 7 million ecu
designated for direct firm level financial assistance, (the loan
grant was designed to be disbursed in two tranches to the BNB: one
tranche of 4 million ecu disbursed in the middle of 1995, and the
second tranche to be disbursed pending the allocation of the first
tranche to SMEs before the end of 1996), only 900,000 ecu has been
allocated so far.
Recommendation
Several lessons can be learned from the PHARE
program to increase absorption capacity. First, participation by
competent and committed banks must be sought. The inability for
banks to adequately determine the credit capacity of SMEs not only
leads to bad loans, but is also responsible for the overly cautious
lending habits that result in funds remaining idle. While the banks
that participated as administrators under the BNB in the
disbursement of the SME credit may have been competent, criticisms
have been raised that they have been extreamly "credit-shy,"
despite their indemnity from default risk. Second, there must be
adequate demand for the credit on the terms offered by the lending
banks. The problem of overly cautious banks was compounded by
inappropriate loan candidates. Companies that do not have the
credit capacity to accept current lending terms create log jams of
applications and increase bank costs. Applications should include
self screening tests and minimal processing fees that would be
reimbursed upon the issuance of loans to cut down the number of bad
applicants. Third, banks must maintain the flexibility to set
interest rates to reflect market risks and to cover costs. Fourth,
a time horizon should be set that is large enough to properly
develop such a program. With respect to the PHARE program, the
majority of the 900,000 ecu in loans has been disbursed within the
last two months of 1996, possibly reflecting both the approaching
deadline and movement on the learning curve.
New trends indicate that international donor
organisations, such as USAID, are increasingly turning to
non-governmental organizations ("NGOs") to administer funds and
provide assistance to SME development. Similar initiatives are
being followed by the World Bank and the European Union, and some
of its member states. In Greece, for example, absorption capacity
was increased significantly by virtue of the passing of a law and a
Presidential decree under which NGOs are allowed to manage such
programs.
It is clear that Bulgarian authorities need to
develop a system for involving NGOs in their attempt to increase
the absorption of international funds, including those supplied by
bilateral programs. Fortunately, the implementation of an NGO
absorption program in Bulgaria is a matter of regulation, not
legislation. Specifically, it can be enacted by a decree of the
Council of Ministers that directs the use of NGOs to administer and
assist the absorption capacity of the country. Absent adequate NGO
infrastructure, such funding will bypass Bulgarian businesses.
TAX MEASURES
Background
The most characteristic feature of the widely
accepted practice of carrying out state collections (taxes,
excises, tariffs, customs duties, and other duties) is its chaotic
nature. The inconsistent state policy in this sphere and the
actions of the administration bring about tax disorder, rather than
the required tax culture and discipline.
Recommendation
To increase budget revenue, the priority tax policy
change must be the creation of a steady and predicable tax
environment. It is imperative to finally abolish the practices of
back dated taxes and the constant amendment of tax policies.
Expedient and decisive measures for tightening the financial
discipline must also be carried out, particularly in improving the
work of the tax administration and other financial control
authorities. Finally, as previously stated with respect to the
privatization of SOEs, prompt and resolute cuts in the losses of
the public sector must be completed thought mass privatisation.
Specific action must be taken to address the
following obstacles SMEs face because of current tax policy:
- The regulation of the annual taxation results
(taxable and nontaxable expenses) is decreed by an act of the
Council of Ministers, which allows its easy and perpetual
revision;
- The range of expenses which reduce the annual
amount to be taxed deductible expenses constantly diminishes;
- The use of negative results from previous years is
no longer used in the tax loss carry forward formation of the
positive financial result for the current year;
- Depreciation and amortization schedules are
problematic and should include accelerated depreciation for long
term material assets;
- A practice of accepting limitations introduced with
old dates is being widely accepted;
- Only 10% of education expenses are accepted as
nontaxable expenditure, which is a serious drawback for SMEs, where
education is crucial to their survival and stabilization;
- Expenses common to SMEs, such as the reconstruction
and office, machine, and other improvements are not being
reduced;
- The process of advanced payment of taxes must be
developed and stabilized;
- There is an incredibly slow procedure of recovering
VAT credit with no interest accumulation for blocked funds;
An additional burden for SME activity is the
ineffective and inconsistent work of the tax authorities. In this
respect the following problems must be addressed:
- Arbitrary interpretation of the laws and other
normative regulations by public officers;
- Lack of control mechanisms for the structure of the
tax administration to be used by the MF in supporting the interests
of the economic entities;
- In many cases, tax inspectors are hostile and
aggressive. Errors are sought deliberately, and a percentage reward
is given for every "erred amount."
ACTIONS AGAINST SHADOW ECONOMIC
AND CRIMINAL ACTIVITIES
Background
During the last few years, shadow economies and
criminality have gained considerable influence within the Bulgarian
economy. Among other problems, inadequate tax policies have pushed
SMEs into shadow economics and entrepreneurs are being squeezed
between the so-called "power organizations" and high-level
institutional corruption. Thus, entrepreneurial spirit is being
destroyed by pseudo market conditions. These factors are also
extremely harmful to the activity of foreign investors. For
example, United States Federal racketeering laws prevent American
businesses and persons from engaging in activities such as bribery
outside the United States. Therefore if local business practices
include such activities as part of the modus operandi, American
businesses are effectively excluded from the market.
Recommendation
Resources need to be allocated to protect upstanding
businesses. The problems of corruption needs to be addressed by
both the state and local SME organizations. Educational programs
should be implemented within SME associations to inform member
companies of the economic benefits created in a business
environment which recognizes business integrity and mutual trust
among its members. Specifically, credible accounting procedures and
legitimate business practices provide opportunities to access
additional sources of long-term funding.
1.1.4 EXPECTED RESULTS
This action line will result in governmental
recognition of the important role of SMEs in the development of the
Bulgarian economy, outline the necessary macro-economic conditions
that are necessary for their development, and underline the
importance of including measures that specifically address the
needs of the SME sector in whatever macro-economic actions are
undertaken. The stabilization of the Bulgarian economy through an
anti-crisis program and accelerated privatisation program will lay
the foundations for the development of Bulgaria’s SME sector.
Additional business climate improvements will result from the
availability of financing from international sources, consistent
and enforced tax laws, and credible and legitimate business
practices. Ultimately, The SME sector will become a major
contributor to the economic growth of the country. Providing an
environment suitable for SMEs to conduct business will lead to the
creation of many new jobs necessary to absorb new unemployment
created by restructuring former SOEs, and will also serve to
redistribute income. SMEs will also provide an additional market
for the purchase second-hand equipment from SOEs. They will also
contribute to the success and efficiency of Bulgaria’s large
corporations by providing services that facilitate business. As a
result of these factors, the larger and more developed the
Bulgarian SME sector, the greater the SME contribution to the
growth of the economy.
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