10 years ago the finance minister of Bulgaria Milen Veltchev (former Merrill Lynch employee) has made a debt-swap operation by changing the old "Brady" bonds of Bulgaria with new so called "euro" bonds. The new bonds were with fixed interest of above 8% and much critics said Mr Veltchev has made a bad deal and the country will lose millions of euros. Such type of debates continue even today and they become more interesting as Veltchev-bonds are to be repaid in January 2013 and current finance minister Simeon Dyankov (former World Bank employee) is in difficulty of finding money for this. So now Bulgaria plans a new swap operation of issuing new bonds and repaying with them the old ones.

Even before the deal has started the opposition parties began to criticize Dyankov of issuing debt in a bad moment when markets are crazy of the EU debt crisis. So they predicted high interest rates and a bad deal for Bulgaria.

But in fact Bulgaria will have a good deal in any case. This is so because of the fact that Bulgaria does not need much money. At the moment the overall public debt of Bulgaria is less than 20% of GDP. So even high interest rates will not be a budget problem.

In last 10 years Bulgaria had no problems with the 8% interest of Veltchev's bonds. At the same time Greece had 3-4% interest on its bonds, and Spain had 2-3%. So comparing Bulgaria with Greece, Veltchev could be criticized of paying too much for the debt. But as we saw, Greece defaulted, while Bulgaria is OK.

Now the opposition politics in Bulgaria are trying to impress that any interest higher than 5-6% is a catastrophe for Bulgaria. Obviously they expect an interest of 7-8% and prepare themselves for attack on government (just like the opposition in 2002 attacked Veltchev). But in fact, even a 10% interest will not be a problem for low-indebted countries like Bulgaria. 10% interest on 20% of GDP means 2% of GDP of interests per year. This is 2-3 times lower than in the Spain case with 6% interest on a debt that is unofficially calculated to 95-100% of GDP. So with 6% interest Spain will have to pay 6% of GDP, while with 10% interest Bulgaria will have to pay 2% of GDP. Spain will go bankrupt if the interest goes to 7%. And Bulgaria in fact will not go bankrupt even with interest of 14%. It will have serious problems with 14%, but in fact, it will not default even then, having to pay only 2,8% of GDP as interest expense.

But generally this is only a theoretical calculation. Bulgaria will not reach nor 14% nor even 10%. It is most likely it will reach the previous rate of 8%, may be even lower - between 7 and 8%. This will be enough for opposition to attack Dyankov and may be even succeed in removing him from power. But this will not be a problem for the country that will refinance its debt successfully.

The reason of this is very simple. Bulgaria went bankrupt in 90-s and since 1997 has a very conservative deficit and debt policy. In fact its current debt is the old debt inherited from the communist era that ended 1989. Since then the governments avoided taking new loans and use them generally for swapping with old (communist) loans. So since 1997 the debt/GDP ratio constantly decreased from over 100% to 15% in 2009. So when your debt is low, the interest rate is not a problem for you. Even if it is at level that bankrupts bigger and richer countries in EU.

It is not a question only on interest. It is a question on the debt size, and mainly - on the wisdom of long term policy of not borrowing too much.

In fact the success of Bulgaria came from conservatism. It rejected the loan based Keynesian strategy of spending as a way of generating growth. Instead Bulgaria had chosen the conservative "Hayek" strategy of budget surpluses and low taxes. As a result - the GDP rose very fast and this way the Bulgarian debt became lower, compared to GDP. If fact, there was a nominal decrease of the debt, due to using budget surpluses for preliminary repayments. But the main reason of decreasing the debt/GDP ratio was the economic growth. It increased the size of GDP this way decreasing the relative level of debt.

This is the same that EU is dreaming about now. No one in EU wants spending cuts. Much governments dream for GDP rise that will lower the debt/GDP ratio. And much politicians are trying to persuade us that spending is needed for generating growth. There are even theories of the "downwards spiral". Government savings undermine the growth, this lowers the tax-income, and this leads to new savings and so on. But in fact the truth is exactly the opposite. Conservatism in government budget really leads to GDP-growth and this way - to decreasing the debt/GDP ratio.

 So let's look at the country where "high interest" threat means nothing, and we will see the decision for the countries that are shaking with fear on every 0,1% move on markets...

Dobri
April 21st 2012