In 1995, there was progress in Bulgaria's economic development which created expectations of an economic revival.

Nominal GDP reached BGL871.4 billion and was bigger in real terms by 2.6 per cent than in the preceding year (1994). Slow stabilisation of production was accompanied by a significant reduction in inflation. Annualised inflation in 1995 was 32.9 per cent and was, for the first time since the beginning of reform in 1991, below the target envisaged in the state budget's macroeconomic framework. Bulgaria's balance of payments was strengthened. Current account surplus at the end of 1995 was positive - BGL333.8 million, and was particularly enhanced by the trade balance featuring more than US$427.8 million excess of exports over imports.

These signs of revival were, however, short-lived and, since the beginning of 1996, financial stability in Bulgaria has become fragile. Macroeconomic stabilisation achieved in 1995 was not supported by any decisive changes in the real or banking sectors. No fundamental solution has yet been found for long-standing problems faced by this country in its economic development.

These circumstances in late 1995 and early 1996 caused serious liquidity troubles for a number of commercial banks, both state-owned and private, leading in some cases to insolvency, arrears in the payment system, and general intensification of problems faced by the banking system.

What were the causes bringing Bulgarian banks to this plight? We have to look back to the years before the reform. In this period, approximately 70-80 per cent of enterprises' working capital was borrowed. At the same time, all adjustments for revaluation of working capital resulting from price changes went as revenues into the budget, instead of increasing the authorised capital of the enterprises, and thus increased further the share of borrowings from banks. In 1991 domestic credit indebtedness exceeded GDP. In the same year, the base interest rate increased from its level of 4.5 per cent until 24 January 1991, to 54 per cent at the year's end; the average annual interest rate was 45.35 per cent. Enterprises could no longer service their huge loans.

All Bulgarian governments since 1990 either did not want to solve the problem of non-performing loans to enterprises which were growing in a snowball effect, or solved it partially. For example, the 'Law on Settlement of Uncollectible Loans' (in Bulgarian ZUNK) passed by the National Assembly at the end of 1993, solved only the issue of investment loans, and solved it rather to the disadvantage of commercial banks. The Government decided that on the Government Securities given in exchange for the non-performing investment loans extended to state-owned enterprises, banks were to receive in the initial six years a yield, which, though gradually growing, remained rather low compared to the cost of funds attracted by banks for covering their assets. In other words, banks were predetermined by the Government to make losses on this transaction. On the other hand, the 'Law on Settlement of Uncollectible Loans' (ZUNK) did not solve the issue of enormous amounts of working capital borrowings and they remained a burden on enterprises and banks respectively.

No conditions were provided for bankruptcies of enterprises which were defaulting on debts to banks to precede bankruptcies of banks. Because of this, numerous attempts by creditor banks to declare their debtors - state-owned enterprises - insolvent, failed. Eventually banks were compelled to continue lending money to their defaulting debtors to increase the amount of the uncollectible loans, and as a result of all that, go bankrupt before their debtors - the enterprises.

The lack of a sufficient legal basis for collecting claims worsened the collectibility of bank loans. The Law on Collaterals has not been adopted yet, nor is there any collateral register, and for that reason, a large number of banks have piled up bad loans.

In the last five years governments have put off solving the problems in the real sector, namely, to stop the generation of losses in state-owned enterprises which nobody covered and which were transferred to the banking sector. That is the basic reason for the negative net worth, mainly of the old state-owned commercial banks.

Therefore, many 'bad' loans, classified in the Bulgarian banks' portfolios in early 1996, represent firstly, the charged interest which reflects the inflation wave after the start of the transition to a market economy, and secondly, the late solution to the problem concerning the enterprise losses and bad loans.

Since the start of the transition, the Bulgarian National Bank has been fulfilling its legally entrusted functions and pursuing predominantly anti-inflationary monetary policies. Its monetary policy has not allowed credit expansion. For instance, so far the domestic credit to the non-government sector has been growing more slowly than GDP calculated at current prices. It is another matter altogether that the credit structure for the non-government sector is bad, and the main reasons are the accumulating unresolved problems in the real sector.

Overcoming these economic problems and achieving stabilisation are far beyond BNB's abilities alone. The key factor for finding a way out of the situation remains structural reform coupled with the joint resolute actions of the Bulgarian Government and the Central Bank. The concluded stand-by arrangement with the International Monetary Fund in July 1996 exerted a positive effect on the implementation of the full-scale programme which aims to create conditions for the rehabilitation of the real and banking sectors. That arrangement was preceded by an agreement on preliminary conditions and a Memorandum on the Economic and Financial Policies of Bulgaria. Actually, this is a programme of the Bulgarian Government, financially supported by the IMF. That programme is intended:

• to restore confidence in the banking sector by closing banks in the worst condition, improving banking supervision and approving a medium-term strategy for rehabilitation and privatisation of banks;
• to strengthen financial discipline in the state-owned and municipal enterprises by liquidating the unviable ones;
• to reduce inflation by limiting the decrease in economic growth;
• to increase official reserves up to a level sufficient to meet the required service of the debt;
• to ensure fiscal and external viability.

The macroeconomic framework, described in the Memorandum on the Economic Policy of the Bulgarian Government, includes reaching certain targets with regard to inflation, balance of payments, budget deficit and GDP. Apart from these, other technical indicators have also been agreed upon, whose achievement is monitored on a quarterly basis. The strict fulfilment of the commitments undertaken under the Agreement with the IMF aims to increase confidence in the programme and the reform and aims to obtain external refinancing, especially under the FESAL (Financial and Economic Structural Adjustment Loan) from the World Bank.

The current problems in the Bulgarian banking system by no means weaken our attention to harmonising our banking legislation with European laws in the light of future integration in the European Union. It is important to note that the legal framework of the Bulgarian banking system is largely constructed in accordance with the European directives concerning credit institutions and monetary policy. In theory, the framework of the Bulgarian banking legislation is close to The Maastricht Treaty. In practice, however, the Bulgarian National Bank is constrained in its activities primarily because of both the heavily decapitalised banking system and the burden of domestic and foreign debts. The BNB's monetary policy can only be enhanced further by recapitalisation and stabilisation of commercial banks, on the one hand, and improved foreign debt management on the other.