Bulgaria’s economic dream team of former bankers, Finance Minister Milen Veltchev and Deputy Prime Minister Nikolay Vassilev, finds that exercising power is tougher than offering advice.
By Tom Buerkle
September 2002
Institutional Investor Magazine
As a London-based investment banker offering debt management advice to the emerging-markets countries of Eastern Europe, Milen Veltchev learned the region’s Finance ministries inside out. They were his prospective clients, after all. So when he was asked to return to his native Bulgaria last year and become Finance minister under newly elected Prime Minister Simeon Saxe-Coburg Gotha, Veltchev didn’t hesitate to accept. He saw a chance to put into practice what he had been preaching. The job offer was, he says, “a unique challenge and a unique opportunity that comes along once in a lifetime.”
One year later Veltchev is finding the exercise of power more difficult than he had imagined. He can claim a major success in restructuring the country’s foreign debt, but in many other areas he has been stymied. Under pressure from the International
Monetary Fund to maintain a tight budget in support of Bulgaria’s currency board, Veltchev has been forced to renege on Saxe-Coburg’s campaign promise to eliminate the corporate tax on reinvested profits, a key demand of the private sector. He has had to introduce value-added taxes on pharmaceuticals and sanctioned big increases in electricity prices; both moves have turned out to be politically unpopular. And his plans for wide-ranging reforms of the country’s education and health systems have been stalled by fierce attacks from opposition parties. The process has been a far cry from the quick decision making of the City of London.
“I did expect to be able to do things faster and more radically, but I’ve learned in the past year that most things are not entirely up to me,” Veltchev allows in an interview. For economic reforms to happen, “there has to be a broad consensus in government and Parliament.”
After gaining power with bold promises to root out corruption, raise living standards and take Bulgaria into the European Union and NATO, Saxe-Coburg tapped a coterie of young, expatriate investment bankers, led by Veltchev and Nikolay Vassilev, deputy prime minister and minister of Economy, to come home from London and New York and run the economy. The combination seemed irresistible. Saxe-Coburg -- the former child king, Simeon II, who was deposed by the Communists in 1946 -- provided the immense personal popularity of a national icon and harked back to a prouder era in the country’s history. His economic ministers represented the cream of a generation of young Bulgarians who went West to pursue their education and careers and would now put their skills and foreign investment contacts to use in the service of the nation.
But this Bulgarian dream team has stumbled. Although the pain of economic reform has hit immediately, prosperity remains a distant prospect and the government’s popularity has plunged. To be fair, Saxe-Coburg and his team are suffering from some factors beyond their control -- like geography. As a Balkan country, Bulgaria shares in the region’s instability, which is why the government is so determined to get in to NATO. Its economy paid a steep price for respecting the embargo on trade with neighboring Yugoslavia during the 1990s and suffered from the recent economic crisis in another neighbor, Turkey. The weak global economy this year has dealt a fresh blow.
But many problems are of the young technocrats’ own making. They sometimes promised more than they could deliver -- the elimination of the tax on reinvested profits, for example. Vassilev’s cocky talk about potential foreign interest in the country’s big remaining privatizations -- he sounded like a banker talking up his book -- has backfired as most major international names have stayed away. And the former bankers’ brash, know-it-all attitude has fired up resistance from rival political parties, notably to a new privatization law, which was delayed for months before being passed in March.
Veltchev and Vassilev “have a lot of expertise in financial markets, but they had a lot to learn about what it means to be a minister,” says Eric Lindenbaum, an emerging-markets analyst who worked with Veltchev in London at Merrill Lynch Europe. “They are facing some exceptionally high expectations about what they can deliver. That for me is the big concern.”
The former bankers acknowledge that their learning curve has been steep, but they are loath to admit mistakes. Vassilev, who wrote much of the government’s economic program while working as an emerging-markets analyst at Lazard Capital Markets in London, insists that the plan was “quite conservative” and did not raise expectations unduly. “We were the only party not talking about doubling pensions,” he says. “What we promised was creating a good business environment that would bring investors here.” He acknowledges that the government may fall short of its target of attracting $900 million in foreign investment this year -- he blames the global slowdown -- but he remains confident that he and his colleagues are laying the proper groundwork with transparent privatization procedures, a crackdown on corruption and some of the lowest corporate and personal tax rates in Eastern Europe. “True, it’s difficult to bring investors, but it has always been difficult to bring investors to Bulgaria. Gradually, the picture should improve.”
In many ways, the picture has already improved dramatically since the dark days of the mid-1990s, when the country was ruled by the formerly Communist Bulgarian Socialist Party. Corruption was rife, reform nonexistent, and the economy suffered from a hyperinflationary spiral. Inflation peaked at more than 1,000 percent in 1997, and one third of the country’s banks subsequently collapsed. In July of that year, a new center-right government of the Union of Democratic Forces adopted a currency board that tied the local currency, the lev, to the deutsche mark (and now to the euro) and imposed tight budgetary discipline. The cold-turkey regime stopped inflation and allowed growth to resume. Inflation stood at 4.8 percent at the end of 2001, and output grew by about 4 percent. But with unemployment at more than 17 percent and salaries averaging the equivalent of E135 ($132) a month, there is little to celebrate. Indeed, even after four straight years of growth, Bulgaria’s real gross domestic product at the end of 2001 stood at just 74 percent of 1989 levels, the lowest of any prospective EU member except Latvia and Lithuania.
The trick for Veltchev and Vassilev is to maintain the macroeconomic gains brought by the currency board while making the difficult structural reforms that will foster growth and attract investment -- among them, privatization, labor reform and the overhaul of the judicial system to ensure that contracts are enforced. Their plans to address those issues are laudable, but their ability to deliver remains in doubt.
“The situation hasn’t substantially improved, but it hasn’t worsened either,” says Nikolay Babev, executive director of the Bulgarian International Business Association, a lobbying group for the country’s leading foreign investors. The organization has drawn up a 110-page blueprint for reform and gets a receptive hearing from senior ministers at weekly meetings instituted by Vassilev. Babev, however, questions whether the young ministers can drive change through a partisan Parliament and a recalcitrant bureaucracy. “They have the experience from London, but they don’t have the experience from Bulgaria,” he says. “They have to fight the whole system here. I sincerely hope they are not discouraged.”
VELTCHEV AND VASSILEV ARE A STUDY IN contrasts. Veltchev, at 36 the old man of the economic team, cuts an imposing if reserved figure. Tall with dark hair and a penetrating gaze, he speaks softly and deliberately, watching his words as carefully as his tax revenues. The diminutive Vassilev, 32, exudes energy and impatience in equal measures. He bounds into a conference room at the Economy Ministry, answers questions and defends his policies with the rapid-fire delivery of a salesman, then abruptly dashes off for his next appointment. But although their personal styles are very different, both men arrived in power by similar paths.
The son of a vice president of Balkan Bulgarian National Airlines, Veltchev studied international relations in Sofia and worked as a junior Bulgarian diplomat at the United Nations before deciding to study business in the U.S. Using his mathematical strengths, a talent for which Bulgarians are renowned, he obtained a degree in financial engineering from the Massachusetts Institute of Technology.
“I didn’t even know about investment banking when I went to the States,” he says. “I didn’t know the difference between commercial banks and investment banks.”
But the first recruiting brochure he picked up at MIT was from Merrill Lynch, and it proved fateful. He joined the firm in 1995 as an investment banking associate in London covering Eastern Europe, the Middle East and Africa.
Former Merrill colleagues recall Veltchev as bright but not particularly productive. He did help Merrill win an advisory mandate from Bulgaria in 1997, but the UDF government never went ahead with the Eurobond deal he proposed. “He wasn’t knocking the cover off the ball here,” says one former co-worker, who spoke on condition of anonymity. But in his new position, the ex-Merrill banker, he quickly adds, “is head and shoulders above at lot of other” Finance ministers. Another old colleague questions whether Veltchev is tough enough to bend the system to his will. “He wasn’t a bruiser at Merrill. He’s too nice, really,” the onetime co-worker says.
Once in office, Veltchev didn’t waste any time putting his debt management skills to work. With yields on Central and Eastern European borrowers’ debt tumbling last year as investors bet on their convergence with the EU, Veltchev and one of his deputies, Krassimir Katev, a former emerging-markets trader at Paribas Capital Markets in New York and Daiwa Europe in London, seized the opportunity. After a competitive bid involving ten banks, they arranged a E250 million, five-year Eurobond last November through Morgan Stanley and J.P. Morgan Chase & Co. The deal went down well with investors but stoked controversy elsewhere. Former colleagues at Merrill were bitter, feeling they had been discriminated against in the bidding, while political opponents in Bulgaria accused Veltchev of favoritism: His brother George works for Morgan Stanley’s private client division in New York. Veltchev shrugs off the complaints. The ministry chose Morgan Stanley, he says, because “they were the only bank that gave a firm underwriting at an aggressive price.” As for Merrill, he readily acknowledges the firm was “at a slight disadvantage” because of his desire to avoid any show of favoritism.
In March, Veltchev and Katev made a bolder move with the first-ever Brady bond swap by an Eastern European country. The government issued $510 million of 8.25 percent bonds due in 2015 and E835 million of 7.5 percent bonds due in 2013 and used the proceeds to redeem $1.32 billion worth of more expensive, floating-rate Brady bonds. The deal reduced the country’s outstanding debt by $79 million, promised debt-service savings of $414 million during the first five years and freed up $200 million in Brady bond collateral to boost the nation’s reserves. The Brady swap also shifted a large chunk of the country’s debt from dollars to euros, aligning it with Bulgaria’s currency board and the bulk of its trade, which is euro-denominated. “These guys said they were going to be more active in debt management, and they did it,” says Merrill’s Lindenbaum.
Vassilev, son of a former head of Bulgarian naval intelligence, has spent much of the past decade on the move. He studied economics at the Budapest University of Technology and Economics, then got a bachelor’s degree in business and finance from the State University of New York at Oswego before going to Tokyo to study tax policy and finance at Keio University. In Tokyo he signed up with thenSBC Warburg as a Japanese market analyst in 1996, then moved to New York and later London as an analyst for European emerging markets. He joined Lazard two years ago.
“He’s an idealist, a Bulgarian nationalist,” says Alistair Kilgour, head of European sales, trading and research at Lazard. “It was a passion of his to try to make the markets transparent.” In an effort to stir foreign interest in the local market, Vassilev launched an index of Bulgarian stocks at Warburg and took it with him to Lazard. But it’s a telling sign of the challenge Vassilev faces that when he left last year, Lazard dropped the index for lack of investor interest.
In London Vassilev also networked with a number of expatriates, notably Kyril Saxe-Coburg, the former king’s son, who was an investment banker at Lehman Brothers. Meeting in pubs in the financial district, the expats formed the Bulgarian City Club, which started out as a social gathering and ended up as a virtual government-in-waiting, providing many of the policy ideas for Saxe-Coburg’s father. Vassilev and the younger Saxe-Coburg also put some money into a tiny fund, Bulventures, to finance start-ups back home. “It was important to show that we ourselves believed in the country. We could tell investors, ‘We are putting in our own money,’” says Saxe-Coburg, who left Lehman in 2000 as part of the firm’s spin-off of GLG Partners, an asset management outfit based in London.
Many of the Bulgarian bankers initially had high hopes for the center-right UDF government of Ivan Kostov, which introduced the currency board in 1997. Three years later Kostov invited the expats to Sofia for a conference to discuss the future of the reform process and ways to stimulate growth and foreign investment. At the gathering Vassilev called for a transparent new privatization process based on open tenders to replace the prevailing method, which favored private negotiations with management insiders and was a rich source of corruption. That call went unheeded, however, and Vassilev and other expats soon grew disenchanted with Kostov. When Simeon Saxe-Coburg formed his cultlike party, the National Movement for Simeon II, two months before the June 2001 election, Vassilev seized the chance to become the former king’s chief economic adviser and asked Veltchev to join him.
The bankers-turned-ministers have a straightforward vision: Institute the kind of policy stability, transparency and legal certainty that Western investors expect, and then let market forces take hold. Bulgaria, in their view, has considerable potential. The country is small, but it could become a trading center with the former Yugoslavia, Turkey and Russia. The country boasts relatively high labor skills, particularly in information technology, from its days as an electronics center for the former Comecon bloc. Tourism is another potential growth driver. Bulgaria’s mountain resorts and Black Sea beaches have already attracted significant foreign investment and are luring vacationers from Germany and the U.K.
Realizing their goals, however, has proved difficult for Veltchev and Vassilev. Their first priority was to reach a standby agreement with the IMF, which drove a hard bargain. It insisted on a tighter budget to support the currency board; out went the new government’s promised abolition of the tax on reinvested corporate profits. The IMF also pushed for the introduction of a value-added tax on pharmaceuticals, a measure Bulgaria needed to adopt before entering the EU. Veltchev agreed, but rather than phase in the tax, he imposed the full 20 percent rate at the start of this year. “There was very little net gain to the Treasury, but it did have a real impact on the people,” says Kyril Saxe-Coburg. “They should have analyzed the repercussions of this in more depth.”
Veltchev also agreed to increase consumer electricity prices by 50 percent over the next three years, bringing them into line with actual costs. The move was long overdue and economically sound -- especially considering the government’s ambition of privatizing the electricity sector next year -- but understandably won few plaudits in the streets. Bulgaria’s inflation will average a little more than 7 percent this year, up from 4.8 percent in 2001, largely because of the increases in drug prices, electricity and excise taxes.
In February the government got its IMF agreement and a promise of $300 million in loans over two years. It also got a painful lesson. “I think they found it very difficult, to their disappointment, that their policy options were limited,” says Kasper Bartholdy, head of emerging-markets economics at Credit Suisse First Boston in London. Veltchev acknowledges the private sector’s disappointment about the promised tax break but insists it was a deal breaker and had to go -- if only temporarily. “I agree we haven’t delivered on it, but we haven’t given up on it either,” he says.
Attracting investment also is proving hard. Since 1989 Bulgaria has received a modest $4 billion of foreign direct investment, or $491 for each of the country’s 8 million people. That’s slightly ahead of Romania but well behind the Czech Republic, which leads Central Europe with $2,570 in FDI per capita, and even Croatia, the pacesetter in the Balkans, at $1,065.
Bulgaria needs $900 million in FDI to plug its current account deficit, projected to be nearly 6 percent of GDP this year. The government aims to garner $300 million through privatizations and $600 million through greenfield investments. But new greenfield investment was less than $50 million in the first quarter and shows little sign of a quick rebound.
The sale of state-owned assets is slowly starting to pick up. By requiring open tenders and banning shady insider deals, the new privatization law, passed in March, brought long-overdue transparency to the privatization process and has been welcomed by business executives, investors and the IMF.
The government aims to sell off nearly 1,700 companies by the end of next year. It scored an early success in June when Bank Austria beat out two other bidders to buy 99.6 percent of Biochim, the country’s fourth-largest bank, for E82.5 million. (The previous government received a single bid of $25 million when it tried to sell Biochim in 2001.) The Privatization Agency, which handles most major privatizations, fared less well in August, however. It sold 80 percent of the State Insurance Institute, DZI, to Kontract-Sofia, a vehicle controlled by the local bank Roseximbank, for just E21.5 million after a rival consortium that included an arm of Germany’s Allianz failed to make a higher offer. But the two biggest tests are yet to come.
The trickiest will be Bulgartabak Holding, the tobacco monopoly, which posted a $25 million loss in 2001. According to a preprivatization audit by Ernst & Young, 15 of its subsidiaries are virtually insolvent. Bulgartabak also carries heavy social and political baggage. Tobacco is cultivated in the ethnic Turk areas of southeast Bulgaria, an impoverished region. At the insistence of the Movement for Rights and Freedoms, an ethnic Turk party in the ruling coalition, the government decided not to allow Western companies to cherry-pick Bulgartabak’s profitable factories and insisted it be sold intact. The government also is requiring buyers to commit to buying a minimum of Bulgarian tobacco at fixed prices and will retain a golden share, giving it a veto over future strategic moves.
The conditions prompted British American Tobacco, the world’s second-largest tobacco company, to drop out of the bidding. Some Western officials privately criticize the government for placing onerous conditions on the sale instead of trying to help ethnic Turks diversify beyond tobacco. Vassilev demurs. “Social concerns are also an economic consideration,” he says. “These are areas where you either grow tobacco or you receive unemployment benefits. Now, what is economically useful for the country? I think it’s useful to produce tobacco and to sell it at a profit for the company.”
The contest for the tobacco company grew murkier this spring when one remaining bidder, Russia’s Soyuzkontrakt Tabak, claimed that the chief executive of Bulgartabak -- a Vassilev appointee -- had sought a $500,000 bribe for himself and Vassilev. The minister initially defended the executive, Georgi Popov, but the Bulgartabak board dismissed Popov in June, and Vassilev was called to the Sofia prosecutor’s office to answer questions.
Vassilev insists that the government is squeaky-clean and that the privatization process “eliminates many of the possibilities for corruption” by ruling out any privately negotiated deals. But the process hasn’t been the paragon of transparency and efficiency that the government promised. “If it was that easy -- just call an international tender and sell it -- we would have done it,” says Alexander Boshkov, a finance minister in the UDF government. “Some fishy, Russian-connected buyer is going to get it. In the long run it is going to be a disaster.”
The plan to sell Bulgarian Telecommunications Co. has avoided such controversy, but it has failed to attract any major telecom players. The three bidders for a 65 percent stake include a Turkish consortium of Koc Holding and Türk Telekomünikasy, the American private equity firm Advent International and an investment arm of American International Group. In 2000, at the height of the telecom boom, Bulgaria’s UDF government rejected a $610 million bid for 51 percent of BTC from Greece’s Organismos Telepikoinonion tis Elladas and Royal KPN of the Netherlands. Today the government has budgeted a mere $100 million in proceeds from the sale.
“The country should have sold the telecoms sometime during the previous ten years, but it didn’t,” Vassilev says. “So now, obviously, the price we get will be much lower. But if we don’t sell, the price next year may be even lower.”
Vassilev’s other big goal is to stimulate the country’s moribund stock market. Bulgaria sold off about 1,000 companies in the mid-1990s through a mass privatization, similar to the Czech Republic’s, in which citizens were given vouchers for shares in state-owned companies. Most of the vouchers were scooped up at big discounts by investment funds, and nearly half of the companies were quickly taken private again in deals that shortchanged minority shareholders. As in the Czech Republic, insiders benefited while small investors learned to distrust the market. Today only about 30 stocks trade with any regularity, and volume amounted to just 140 million leva, or $70 million, in the first five months of this year.
“What we lack are attractive companies,” says Panteley Karassimeonov, head of external relations at the Bulgarian Stock Exchange in Sofia. “We need four or five big issues to be listed here to create some critical mass.”
Vassilev pushed through a law bolstering the rights of minority shareholders earlier this year, and he aims to address the supply issue by offering shares in hundreds of companies to be privatized -- including minority stakes of up to 35 percent in BTC and 13 percent in Bulgartabak -- in exchange for compensatory notes. Nearly $1.5 billion worth of the notes were issued in the 1990s to compensate people whose assets were appropriated by the Communists. Prices of the notes have risen recently in anticipation of the privatization, but few brokers expect a vibrant market to develop. Most Bulgarians have little cash to invest, and rump stakes in big companies are not likely to attract foreign investors. “If you buy shares for your compensatory notes, you will own them forever,” says Evgeni Petkov, a trader at Bulbank.
Even the governor of the Bulgarian National Bank, Svetoslav Gavriiski, is critical of Vassilev’s plan. “I don’t think this use of compensatory notes is the best decision,” he says. “If we offer shares of good companies, in practice the government will not receive real money.”
Vassilev’s best hope to jump-start the stock market was the State Savings Bank, DSK, but his plan to float a chunk of the bank on the market was thwarted by Veltchev, who wants to maximize the Treasury’s gains from the privatization. After heated internal debates, the government decided to seek a strategic buyer for 67 percent of the bank this fall, a transaction that would leave virtually the entire banking sector in foreign hands. The incident also suggests a lively rivalry between the two former bankers. In this case Veltchev’s quiet diligence overcame Vassilev’s outspoken style.
The biggest problem for the stock exchange is its failure to provide financing for young, growing companies. Take Balkanpharma. Formed by private equity firm Efecten und Finanz, which purchased three of Bulgaria’s pharmaceuticals plants in 1999, Balkanpharma moved quickly to modernize production and rebuild Eastern European markets that the country had dominated in the Communist era. But with little prospect of raising cheap money or arranging an IPO in Bulgaria, Efecten sold the company to Pharmaco, an Icelandic drug wholesaler half the size of Balkanpharma. Peter Terziev, executive director of Efecten und Finanz, says it was “unrealistic” to try to develop a domestic equity market. “We need one stock exchange” for all of Central Europe, he says.
This kind of talk frustrates Vassilev. “Very often we speak with the private sector about the capital markets, and they always look to the government,” he says. “But I tell them, ‘Have you done one IPO for the last five years?’ The answer is no. We’re trying to help them. Our laws are very good, and the infrastructure is there. It’s just that the business culture is not mature enough for companies to be listed on the stock exchange. We have to grow this culture.”
One hope for a breakthrough lies with ProSoft, the country’s biggest producer of software and PCs. Unable to raise equity, the company launched Bulgaria’s first corporate bond two years ago, a tiny deal worth 300,000 leva. “There are no real investors in this country,” says Julian Genov, ProSoft’s president. “It’s not just that they don’t have the money. They have been cheated several times.” But the company has had discussions with Vassilev and hopes to make an equity offering late this year. “If we manage to make a successful IPO, then at least a dozen other companies will start to copy that,” Genov says.
The government is making some headway in cracking down on corruption, one of the biggest obstacles to investment. In a bid to cut down on trafficking and customs fraud, Veltchev earlier this year brought in the U.K.'s Crown Agents, a onetime British agency that now advises developing countries on the provision of government services, to overhaul the country’s customs operation. The opposition cried foul because Veltchev awarded the contract without parliamentary approval, but Saxe-Coburg dismissed calls for his minister’s resignation, and the constitutional court rejected a legal challenge. The uproar was “the best sign they’re doing absolutely the right thing,” because reform will hit vested interests, says one senior official at a Western embassy in Sofia. But reform of the judiciary has barely begun. A combination of corruption and lack of commercial training makes it difficult to enforce contracts, and banks are reluctant to lend because they find it almost impossible to seize collateral in bankruptcy cases. “The reform of the judicial system is the No. 1 issue,” says Babev of the International Business Association.
For the government, the crucial test will come at the end of this year. In November NATO will decide whether to admit Bulgaria and six other Central European states. Bulgaria spends more on defense and has more soldiers in NATO peacekeeping missions than any other candidate country. The government sees alliance membership as a key confidence builder -- after all, it’s only been three years since stray bombs from the Kosovo conflict hit Bulgarian soil.
The European Union, meanwhile, has promised to deliver a timetable for Bulgarian membership in December. The government has moved quickly to accelerate negotiations, in a bid to join by 2007, but Günter Verheugen, the EU commissioner for enlargement, cautioned against heady expectations in a recent speech in Sofia.
For Veltchev, these tests are fitting. Unlike Vassilev, who admits to future political ambitions, the onetime Merrill vice president says he aims to return to private finance after his term in office. And he says he wants his record to be judged by “what my reputation is after three or four years -- and more importantly, what it is outside Bulgaria rather than inside.”
Bulgarians had better hope the verdict is a kind one. Their economy depends on it.
