Why we took out debt in dollars – 2024-11-09 20:59:00

Against the background of the latest news about the country’s state budget and in connection with the previous early parliamentary elections, the topic of Bulgaria’s public debt remains in the foreground. Although the level of indebtedness remains below the critical threshold of 60% of GDP, the significant share of foreign currency debt deserves comment and additional comparative context.

Bulgaria is a country with a low public debt to GDP ratio compared to many European countries. However, the structure of the debt is of great importance in conditions of global economic instability and rising interest rates. According to Eurostat, as of the second quarter of 2024, Bulgaria has one of the lowest debt-to-GDP levels in the EU (22.1%), ahead of countries such as Estonia (23.8%) and Luxembourg (26.8%).

According to the latest Eurostat data, 75% of Bulgaria’s debt is denominated in euros. The high percentage of government debt in euro reflects the limited opportunities of the local market, conditioned by the still weak development of financial intermediation and the presence of institutional investors, as well as the scale and profile of the general accumulation of long-term savings of local households and businesses. By issuing debt in foreign currency, Bulgaria has much wider access to financing, which is also related to the many times higher liquidity of the debt markets in large financial centers of foreign markets. It should be noted here that although countries outside the Eurozone have a significant share of debt denominated in euros, Bulgaria clearly stands out with the highest share. Based on this trend, only Romania registers levels close to 50% when we talk about debt in foreign currency.

The role of US dollar issuance

In 2024, Bulgaria resumed issuing bonds denominated in US dollars, with which the country returned to the US market after years of no issuance in this currency, specifically since 2002. The reverse operation was then carried out twice – $1.33 billion in government debt and $866 million in US dollar-denominated Brady bonds were swapped for newly issued global Eurobonds. As a result, the net reduction in debt was $80 million and $243 million, respectively, as the conversion extinguished floating-rate notes and replaced them with fixed-rate notes. With this step, Bulgaria reduced the currency and interest rate risk in front of the Treasury, on the one hand, and at the same time created a benchmark for long-term debt issuance.

The step of issuing bonds in dollars is important and will have structural consequences for the liquidity management of the Bulgarian public debt. The US dollar remains the most widely used reserve currency in the world and provides Bulgaria with access to global capital, attracting a wide range of international investors. The markets where dollar-denominated assets are traded are significantly deeper and provide access to new categories of investors. This, in turn, is a prerequisite for greater liquidity of Bulgarian bonds. Issuing debt in US dollars may also make it easier for Bulgaria to enter into deals with longer maturities and at more favorable interest rates, especially compared to the more limited options of issuing bonds in euros only, for which the scope is still and market depth are more limited. Issues in dollars further contribute to the strategic diversification of currency risk and provide the country with more opportunities for flexible fiscal policy management in conditions of economic challenges.

Comparison with other countries in the region

Romania and Poland also use dollar bonds as part of their debt structure, but each of these countries has specific goals and challenges in the context of this financing. Poland and Romania are moving to raise debt in dollar-denominated markets to raise capital for key projects and to address budgetary challenges, including social and defense spending, which are further straining the budget. In the first quarter of 2024, Romania issued public debt for USD 4 billion to finance maturities on old issues and cover its budget deficit. During the same period, Poland turned to the US market with the issuance of bonds worth US$8 billion, the largest issue of government bonds in dollars for the country. This issue includes three tranches with different maturities, allowing the country to expand its access to global capital and meet its long-term budgetary needs. Poland also plans to issue new dollar bonds next year. In the economies of Poland and Romania, which face the challenge of floating national currency and inflation risk, dollar financing has another key role: reducing pressure on local interest rates and debt costs by accessing the more liquid international market. This creates some stability by allowing these countries to meet short-term fiscal needs without relying excessively on draining domestic savings.

Challenges and opportunities before Bulgaria

Despite the positive aspects of external financing, the use of the US dollar also carries its risks – currency and interest. As US interest rates rise, this would increase the cost of servicing dollar debt – this would be particularly unfavorable when the phases of the US business cycle and the EU common market are out of phase, as high US interest rates would reflect high growth, while at the same moment, the European economy, of which Bulgaria and the rest of the CEE countries are a part, may be in recession. Currency risk reflects the divergence of the dynamics of gross domestic product and public revenue in an economy heavily tied to exchanges with euro-using partners and dollar-denominated debt service costs.

Pavel Patakov, an intern at IPI, worked on the material

Source: Institute of Market Economy