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Challenges and Opportunities from a Foreign Investors’ Perspective

27 January 2011

DOING BUSINESS IN BULGARIA

Presentation by Kenneth Lefkowitz

Managing Partner

New Europe Corporate Advisory

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Contents

Section 1 Foreign investors in Bulgaria

Section 2 Challenges

Section 3 Opportunities

Section 4 Conclusion

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Section 1

Foreign investors in Bulgaria

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Overview of FDI in Bulgaria over the years

What has been attracting investors so far?

• EU membership and harmonizing legislation

• Currency board and fixed exchange rate

• Growth of domestic consumption

• Before the crisis: real estate, retail, tourism

• Currently: energy sector

€-

€2,000

€4,000

€6,000

€8,000

€10,000

EUR

billions

Foreign direct investments

€-

€1,000

€2,000

€3,000

€4,000

€5,000

GDP per capita

Source: BNB, Unicredit

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What are the challenges and opportunities ahead

Challenges

1. Regulatory instability

2. Corruption

3. Poor institutional infrastructure

4. Small market

Opportunities

1. European Union and geographic location

2. Low taxes

3. Labor force

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Section 2

Challenges for foreign investors

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#1 Regulatory instability

• Lack of a vision and long-term strategic objectives to shape

regulation. Laws are dictated mostly by EU, which results in

patchwork legislation imposed over outdated texts.

• Policy making is often either too general, or incomplete, or not

entirely economically justified.

• Treatment of foreign investors varies significantly between

the different governments, along with the list of “preferred”

countries.

• Transparency of decision-making is sometimes questioned. It

is often unclear how drafts are prepared and why certain

revisions have been made.

• Communication with interested stakeholders, although

improving, has further potential for development.

Challenges to foreign investors

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#2 Corruption

• Corruption ultimately destroys value for everyone involved.

• Fair-play becomes a competitive disadvantage for certain

investors who refuse to bribe. The Foreign Corrupt Practices

Act (US) and the Bribery Act (UK) could be devastating to

multinationals’ reputations - but they police fair practices where

local authorities fail to do so.

• No visible improvement in fight against corruption over the

last decade. Bribing is perceived as “business as usual”. The

longer this mindset remains, the harder it will be to eradicate it.

Challenges to foreign investors

Bulgaria

Estonia

Poland

Czech Republic

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Corruption Perceptions Index,as measured by Transparency International.

Scores range from 0 (most corrupt) to

10 (least corrupt)

Source: Transparency International

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#3 Poor institutional infrastructure

• Education is unsatisfactory. Local universities provide

education that does not satisfy the requirements of the market.

Innovation is now mainly imported, not fostered locally.

• The legal system is unreliable and too cumbersome to be able

to protect well the rights of citizens and businesses.

• Physical infrastructure is poorly maintained (although

improving) and does not correspond to the needs of the

population.

• Bureaucratic government apparatus is a challenge for most

businesses. Generally, issuing permits, paying taxes, and

trading across EU borders are the most problematic areas.

Electronic applications and submissions are not used to their

full potential.

Challenges to foreign investors

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#4 Small market

• Limited physical market – Bulgaria has just 7.5 million

inhabitants (and decreasing).

• Low purchasing power of the population. Bulgaria is the

lowest-wage EU country, with the lowest GDP per capita. This

means that introducing new products and services has limited

potential. From the perspective of a large foreign investor, the

fixed cost of expanding is not always justified for such a small

market.

• Demographic problems which started from emigration and

which a negative birth rate exacerbates further. The population

is quickly aging, which additionally shrinks most markets.

Challenges to foreign investors

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Section 3

Opportunities to foreign investors

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#1 EU and geographic location

• European Union candidature and membership have proven

invaluable for:

• Improving local legislation and administration.

• Securing funding for private and public projects that would

have otherwise been unavailable.

• Reducing customs formalities, which will be completely

eliminated with entry in the Schengen area.

• Diminishing political and regulatory risks.

• Minimal exchange rate risk, due to currency board and

promised eurozone membership, is a major advantage over

other countries with similar economic profiles.

• Geographic location between Turkey and Europe is important

both as a transit route and as a potential for future growth.

Bulgaria is likely to benefit in the mid to long term from Turkey’s

growth. Bulgaria is also important for the development of the

Balkan countries.

Opportunities for foreign investors

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#2 Labour force

• Well-educated generation Y workforce. Much of the

population born after 1980 has gone to study abroad for higher

education. The combination of visa requirements and economic

crisis has urged many of them to come back. This workforce is

usually flexible, multilingual, and is available for a fraction of the

cost of their counterparties in EU15.

• Language skills are usually strong among all age groups of

the urban population.

• Strong legacy in mathematical fields. Bulgarians deservedly

have an excellent reputation in subjects such as mathematics,

engineering, and information technology. This has resulted in

many firms setting up outsourcing centers in Bulgaria.

• Low costs of employment. Bulgaria has the lowest nominal

wages among EU 27. Laws also mandate low health security

contribution and a modest employer contribution to social

security.

Opportunities for foreign investors

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#3 Low tax rates

• Corporate income tax of just 10%, or 0% in areas with high

unemployment.

• Personal income tax of 10%

• VAT exemption of 2 years for imports of equipment for

investment projects over € 5 million, creating at least 50 jobs

• Depreciation of 2 years for computers and new manufacturing

equipment

• Opportunity to write-off R&D expenditures

• 5% withholding tax on dividends and liquidation quotas (0%

for EU tax residents )

• No restrictions on after-tax repatriation of profits

• Few taxes were raised during the crisis, unlike in neighboring

Romania and Greece.

Opportunities for foreign investors

Source: Invest Bulgaria Agency

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Section 4

Conclusion

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Doing Business in Bulgaria: Challenges and opportunities from Foreign Investors’ Perspective

Conclusion

Unfortunately, challenges remain because:

• Regulatory framework remains largely fluid and unpredictable.

• Corruption is rampant in all areas of life and perceived as

something normal.

• Institutions are in most cases weak and fail to protect or

educate its citizens

• Bulgaria is a tiny country with aging population, which results in

a very small market for most products

But on the bright side, opportunities come from:

• European Union membership, which promises constant

improvement of legislation, a common currency, facilitated

border control, and free movement of capitals.

• One of the most favorable tax regimes in Europe

• Labor force, which is often well skilled, multilingual, foreign-

educated, and comes cheap.

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Thank you for your attention

Questions?

KENNETH LEFKOWITZ

Managing Partner

New Europe Corporate Advisory Ltd.

9 Narodno Sabranie Square, Sofia 1000, Bulgaria

tel.: +359 (2) 988-7390

mob.: + 359 888 637-053

fax: +359 (2) 981-6206

web: www.necadvisory.com

e-mail: kenneth.lefkowitz@necadvisory.com