Economist Lachezar Bogdanov: The economy in 2023 passed without a recession, with falling inflation, but high interest rates

After a series of favorable developments, which step by step solved the energy crisis in Europe, the forecasts for 2023 are no longer so catastrophic, Lachezar Bogdanov, an economist from the Institute for Market Economy, commented in an analysis.

Last summer, the dominant expectation was for new record highs in energy prices, physical shortages of gas and electricity, plant shutdowns and, as a result, recession in the leading industrial economies of the Eurozone. Two publications from this week - of the International Monetary Fund and the Bulgarian National Bank - seem to give light in the darkness.

According to the IMF, global economic growth in 2023 will be 0.2 percentage points higher than the October 2022 forecast, and inflation has passed its peak and will this year be 2.2 percentage points lower than the previous one. For the Eurozone, GDP growth of 0.7% is expected, with revisions to previous expectations for a recession in Germany and Italy, where minimal growth is already expected. The BNB's macro forecast also slightly revises Bulgaria's GDP growth expectations – 0.6 percentage points for 2022 and 0.3 points for 2023. But even after that, real growth is expected to slow to 0.4%, with an expected 3.4% in 2022. Apart from the uncertainty of the external environment and the development of the war, a risk to growth is also the possible significant slowdown of public investments financed by European funds and the National Plan for Recovery and Sustainability.

But this optimism is only compared to the catastrophic scenarios that were considered last spring and summer - there is no change in the consensus that economic activity both in the developed economies in general and in Bulgaria will slow down significantly in 2023. Inflation continues to be high, despite retreating from record highs - in the US, the annual change in consumer prices shrank from a peak of 9.1% in June to 6.5% in December, and in the euro area fell from 10.6% in October to 8.5% in January of this year The direct effect is the cooling of real consumption that has already begun due to the reduction in the purchasing power of household incomes. More important, however, is the demonstration of determination by the Federal Reserve and the European Central Bank that they will not reverse course to raise interest rates and tighten monetary policy at the first signs of falling inflation.

During the week, both central banks raised key rates – the Fed by 0.25 percentage points and the ECB by 0.50 points. The ECB directly states that a new increase in interest rates by 0.5 points is coming in March. Let's recall that until not so long ago, some analysts and market participants were skeptical of the ECB's ability to maintain such tough actions - whether because of the war in Ukraine and the energy crisis in Europe, or because of fear of the effects on highly indebted countries that would suffer severe increase in the cost of credit. Either way, neither these arguments nor the apparent easing of gas, electricity and other key commodity prices in recent months appear to be changing the direction of interest rate moves so far. Moreover, the Eurozone economy is also reporting record low levels of unemployment, so that potential political pressure to reverse course is non-existent at the moment. In any case, however, the "new normal" of monetary policy - after years of zero and even negative interest rates - will inevitably force a restructuring of investment and consumption in the European economy, forcing a period of much lower growth this year.

How does this affect Bulgaria?

The government felt the sting of change back in the fall when it went to the international capital markets and got a loan at significantly higher interest rates. In January, somewhat surprisingly, the Ministry of Finance issued Eurobonds for 1.5 billion euros with a maturity of 10 years and, with strong interest from investors, achieved an annual yield of 4.78%. This also looks good against other countries in the region – such as Romania and Hungary – but it clearly shows that the "free lunch" of near-zero interest rates on sovereign debt is over.

The question that we have been asking ourselves since last year, but in recent weeks has caused more and more conflicting predictions, is whether and when the interest rates on loans in our country will follow this trend. The latest data as of December show that the increase is carried over to business loans - 1.75 points higher interest rates on new loans in euros worth more than 1 million euros and 0.86 points higher on new loans in BGN compared with December 2021, as well as with consumer loans – a 1.1 point increase compared to the end of 2021. At the same time, we see no change in housing lending. If we are looking for a logical explanation, it is likely that in practice mainly mortgage loans with variable rates are offered, tied to the average interest rates on deposits - this is how banks guarantee their interest margin by being able to pass on a possible future increase in interest rates on deposits to debtors. And the data show that interest rates on household deposits are still practically zero, commented Lachezar Bogdanov.

How long will this remain so and can Bulgaria remain something of an "island" of low mortgage rates, fueling more housing purchases and construction? To the extent that the time lag in the transmission of high interest rates from the Eurozone to the Bulgarian financial system is explainable, expecting such "isolation" to continue indefinitely seems a rather risky bet. The correction of the real estate market may have already begun - the data from the real estate registry show, for example, that in the third and fourth quarters of 2022 there was a decline in registered sales in Sofia compared to the same quarters of 2021. For now, however, the number of contract mortgages in Sofia reports growth, although slightly slowed down in the last quarter of 2022. However, with a more significant change in interest rates, as well as with a tightening of requirements for debtors, a significant reduction in the number of new mortgage loans is possible, and hence - in the total market demand, with all subsequent effects on construction and related production and services.