Summary: KEY ISSUES Context: Since the last Article IV consultation in November 2013, a large bank failure and a weakening in the fiscal balance have tested Bulgaria’s hard-won macroeconomic and financial stability. Growth last year was broadly in line with projections, but deflation has been deeper than expected. Looking forward, risks to the outlook have increased. Political divisions and unaddressed governance issues have raised concerns about the prospects for actions needed to set macro-financial policies firmly back on track and to tackle structural rigidities. Weak external demand and regional tensions further weigh on activity, with limited relief from lower commodity prices. Developments in Greece contribute to uncertainty. Key policy issues: The Article IV discussions focused on immediate policy actions to reduce macro-financial uncertainty and on medium-term reforms to support income convergence. Specifically, • Financial sector. Decisive policy action—including through an independent asset quality review (AQR) and more forceful steps to support confidence in supervision, strengthen the resolution framework, ensure an adequate financial safety net, and address system-wide accountability—is needed. Further steps to manage NPLs and advance corporate deleveraging are also critical. • Fiscal policy. While plans for fiscal consolidation following the 2014 slippage are welcome, a more ambitious path should be considered. Faster consolidation would provide room for additional spending in the event of a modest negative output shock and preserve space to cope with contingent risks—particularly important in the context of Bulgaria’s currency board arrangement (CBA). Staff called for a thorough assessment of the impact of pension reforms currently under discussion. • Structural agenda. Priority reforms include addressing gaps in health, education, infrastructure, and energy markets, as well as the fundamental concerns related to corruption and cronyism. Past IMF advice: Previous advice, focused on the need to address structural gaps (including related to governance) to set the foundation for stronger growth and job creation, remains valid, with policy implementation in these areas having stalled. Past advice also pointed to the need for increased attention to medium-term fiscal risks, notably concerning the sustainability of the pension system.

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