The 10% tax is not enough: Why are foreign investments bypassing Bulgaria?

Greece with average temperatures of over 30 degrees in the summer has attracted Microsoft and Google to build powerful data centers. The electric Citroen C3 will be made in Serbia. And Ford models are being built in Romania. Chinese carmaker BYD is making a plant in Hungary and Intel is investing €4.6 billion in a plant in Poland.

This is just a snapshot of the competition to attract foreign investment in Eastern Europe.

Bulgaria also participates in this competition. However, it often seems that investors look at it and then bypass it. The clearest example in recent years is Volkswagen, which, despite the country's membership of the European Union, chose Turkey. Subsequently, the pandemic and other factors have prevented the German concern from expanding in the region, but the lesson has been learned - Bulgaria has structural problems and cannot rely solely on its EU membership to attract the giants.

Why is investment bypassing us?

Political instability, lack of clear legislation and frequent changes in it, cumbersome administrative procedures, low efficiency of institutions and lack of long-term and strategic planning of investment activity in the country. These are some of the main problems of potential investors, according to Associate Professor of Economics Dimitar Zlatinov, Deputy Dean of the Faculty of Economics of Sofia University. He stresses that each of them is important, as is the growing competition in the region.

In the textile industry, for example, we have missed opportunities to relocate production of leading global brands from Western Europe back to countries in the Far East (such as China, Vietnam and Cambodia), which have benefited countries in the region such as Turkey, Romania and the Czech Republic," the economist points out.

He also cites the failure to attract Volkswagen, which

showed that the small size of the market and the increasingly limited human resources in Bulgaria are also leading problems for investors".

All this leads to one of the most important economic problems Bulgaria has - low investment activity

and this will increasingly be a serious constraint to growth in the digital age we live in".

The delay in Recovery Plan funds is also having an adverse effect, along with the stock of savings in the banking system and the restraint on reinvesting foreign investment profits in Bulgaria. According to Zlatinov, however, the debate on these issues is "sluggish",

suggesting the absence of a long-term strategy for the country's development".

Record investment in 2023?

The new year began with loud statements from the now departed government that record foreign investments were made in Bulgaria last year. This is far from the truth, because the foreign investment attracted is incomparable to what was seen in the period before the global financial crisis of 2007-2008, when, with the momentum of the imminent entry into the European Union, it touched 30% of GDP.

However, statistics show an acceleration in the growth of foreign direct investment (FDI) to 38% annual growth in 2023. Thus, last year they exceeded BGN 7.1 billion and amounted to 3.85% of GDP.

A breakdown shows that most of it is actually reinvested profits from foreign companies already established in Bulgaria. Last year, this amounted to BGN 6.5 billion, and in the years following the COVID pandemic, there has been an increase in the share of reinvested profits from foreign investments.

But outward direct investment income from the country for 2023 is £12.7bn, or 6.9 per cent of GDP. This is an extremely unfavorable trend that is getting worse every year," Zlatinov points out.

According to him, this is what prevents the restructuring and mass application of digital technologies in the production process, which is mandatory for the construction of a modern economic system fully integrated into global supply chains in line with the concept of Industry 5.0.

The structure of foreign direct investments in 2023 shows that approximately 57% of them (about BGN 4 billion) are from four countries - Switzerland (22%), Austria (13%), the Netherlands (12%) and Belgium (10%). Bulgarian exports to these countries account for 8% of the total, reaching BGN 6.95 billion.

Thick clouds over Germany last year led to a contraction in foreign direct investment from there to 2.5% of the total, down from 24% in 2018.

The bulk of all FDI is in the financial sector (42%), of which banks are a part with record profits for 2023. This is followed by manufacturing (36%), which continues to be the structural determinant of merchandise exports, with only 2.3% in professional activities and research, which have the long-term potential for technological renewal of the economy.

In direct correlation with the cheapening of energy resources, foreign direct investment in the energy sector is declining.

Such a structure of foreign direct investment cannot be defined as sustainable and generating potential for long-term economic growth, which is the reason for the high outflow of profits from foreign direct investment from the country," Zlatinov is adamant.

Low tax is not enough

Despite last year's growth, the bigger picture shows that for more than 15 years the accelerated dynamics of foreign direct investment into the country from the period before Bulgaria joined the European Union cannot be restored. Apart from the traditional domestic reasons, the incompletely overcome effect of the global financial crisis as well as the subsequent turmoil in the euro area is still a factor.

It is obvious that maintaining a corporate tax rate of 10% is not enough to attract much more foreign investment," Zlatinov points out.

To compare

In comparative terms, the investment-to-GDP ratio is comparable to the eurozone average, but this is not particularly good given that Bulgaria's purchasing power is only 60% of the eurozone average.

Melting this gap implies much higher rates of economic growth and consequently higher investment activity to drive this growth", Zlatinov points out.

The European Commission forecasts Romania's economic growth to accelerate amid slowing inflation and a substantial increase in investment in the country in 2024 based on funding from EU funds and programmes, which is not expected to happen in Bulgaria.

In both Romania and Croatia, to which Bulgaria is often compared, gross capital formation is higher as a share of GDP than in Bulgaria and ahead of the euro area average.

Deeds are needed, not words

Political and legislative stability, sustainable reforms for quality education and healthcare, a functioning judiciary, channelling EU funds and programmes into projects with long-term potential to develop the economy in a digital and green transition, building road infrastructure. These are just some of the things that the state needs to do in an effort to increase investment activity in the country.

This article was translated with the support of DeepL.