EKIP– Expert Club for Economics and Politics A Different Opinion
Dear readers,
We at EKIP believe that in order for a society to be free and able to navigate the contemporary economic and political situation, it must first and foremost be informed. That is why we decided to start a new monthly column "Macroeconomic Monitor", in which we present an interactive graphical overview and analysis of data on several key indicators for the Bulgarian economy, which are published monthly by the NSI and the BNB. With this, we aim to present you every month with a summarized picture of the state and development of the Bulgarian economy during the year. Therefore, within the framework of this column, we focus on the following monthly indicators, which we find to be the most important: production in the industrial and construction sectors, turnover in the industrial sector, turnover in retail trade, prices of consumer and manufactured goods, credit dynamics, and last but not least - the business climate in each sector of our economy.
If there is a sufficiently high interest in this column, we intend to begin publishing a quarterly version that will examine the data that the NSI publishes on GDP, unemployment, turnover in the services sector, and foreign trade.
The TEAM hopes that you will find the information and analyses we will present in this section interesting and useful. Any comments, criticisms and advice are welcome!
Industry and construction
The first indicators we will focus on are the calendar-adjusted industrial and construction production indices (below). According to the latest NSI data, industrial production grew by 4.30% year-on-year in November, which is 2 percentage points higher than the value reported in October. This is the highest growth of this index since June 2015. It is important to note that the industrial production index measures the average changes in the output of enterprises between two time periods, and not the actual level of their production. The improvement in the main index is mainly due to increased productivity growth in manufacturing, which is the largest of the three main sub-sectors of the industrial industry in Bulgaria (the other two are mining and quarrying and the production and distribution of electricity and gas). Moreover, according to the NSI classification, manufacturing is the largest sector of the country's economy in terms of the number of employees (over 500,000).
Chart 1: Industrial and construction production indices, calendar adjusted
Source: NSI
Looking at the graph, we notice that the long-term trend in industry remains relatively stable. The average growth rate of the main index over the past 12 months is 2.43%, compared to 2.72% for the previous 12 months (12.2014-11.2015). The small difference between the two values is mainly due to the serious decline in the growth of the index reported in May of this year, which is an obvious exception to the overall trend. The dynamics are similar in the sub-sector of manufacturing, but compared to the overall picture there the average growth rate is noticeably higher over the past 12 months – 4.02%.
Turning our attention to the construction sector, we notice that the picture there is relatively more unpleasant – the construction production index has been falling in each of the last 12 months. The rate of decline slowed down significantly in November, but this is to some extent due to the fact that the comparison base (November 2015) is quite low in itself. The construction sector as a whole is highly dependent on the inflow of financing from EU funds, and therefore the decline in activity in 2016 is fully expected, due to the completion of the absorption of funds related to the already completed programming period. In 2017, the absorption of finances from EU funds should increase significantly and this will lead to an improvement in activity in the sector.
Chart 2: Industrial turnover index, calendar-adjusted
Source: NSI
Having examined the dynamics of industrial production, let us turn our attention to the industrial turnover (sales) index. For obvious reasons, the two indicators are closely related – one measures the dynamics of production (i.e. supply) of industrial goods, and the other of turnover (i.e. demand) for these goods. According to the latest data from the National Statistical Institute, the main index of industrial turnover increased by 6.93% on an annual basis in November, which is the highest level since March 2015. It is noted that the growth of turnover on the foreign market reaches one of the highest values in the last nearly four years – 14.08%.
At the same time, the growth of the turnover on the domestic market is significantly lower, 1.87% in November, but in the last few months there has been a noticeable improvement in the growth rates. The overall growth rate of the industrial turnover is much closer to that of the domestic market, due to its greater importance compared to the external one. The long-term trend in the industrial turnover index is generally positive, with a visible improvement in the growth rates during the period June-November 2016. If this trend continues, we can expect to see an acceleration in the growth of industrial production.
Retail
The next key sector to watch is retail. While industry and construction are part of the early stages of an economy’s production structure, retail is part of the late stages. Taken together, these three sectors provide a snapshot of the overall production structure. As we can see in the chart below, the retail trade index excluding motor vehicles, motorcycles and fuels accelerated sharply in November, reaching 8.09% year-on-year. This is the highest growth rate since December 2014. Excluding food, retail trade grew by 5.54%, the highest growth rate since January 2015. Sales of non-food goods, including fuels, are expected to grow at a slower pace, given the decline in oil prices in recent years and the lack of a significant recovery. The accelerated growth in retail sales in November is an expected phenomenon, given the approaching holiday season and Black Friday sales.
Chart 3: Retail trade index, calendar-adjusted
Source: NSI
Sales are likely to continue to grow strongly in December due to the holiday season, but this trend is unlikely to continue in the first quarter of 2017, given the uncertain political situation. Growth in retail sales often means growth in consumer prices, and this is exactly what we see in the following chart (below), which depicts the dynamics of the consumer price index and the producer price index. It is quite logical that after examining the dynamics of demand and supply in the real sector, we should also pay attention to price dynamics.
Prices and lending
After the dynamics of production and sales, it is appropriate to turn our attention to the indicators that monitor price dynamics - these are the consumer price index and the producer price index in industry. Here we should note that price indices suffer from serious defects as indicators. The problems of indicators such as the CPI (consumer price index) are not only technical and methodological. With the very concept of "price level" there are a bunch of problems, purely theoretical in nature, which undermine the very idea that the calculation of general price indices can convey any significant information. Aggregate indicators such as the CPI in most cases hide more information than they show and can very easily leave the reader with a wrong idea about the real dynamics of market prices. However, this is another topic, which is obviously not the focus of this article and is too extensive to be commented on here. In short - the devil is in the details, especially when it comes to the economy, and with aggregate indicators such as the CPI, the details are completely absent.
Despite these problems, price indices are some of the most frequently used and cited indicators by economists, statesmen and central bankers around the world. The policies of central banks and governments are often dictated by the dynamics of these indicators and for this reason they cannot be ignored in any macroeconomic analysis. In the graph below we can see a noticeable slowdown in the pace of decline in both the consumer price index and the industrial producer price index, with consumer prices even increasing by 0.09% in December. The detailed breakdown of the NSI shows that this increase in the CPI is mainly due to a sharp increase in food price inflation, from -0.24% in November to 1.14% in December, accompanied by a noticeable slowdown in price deflation in non-food goods, from 0.58% to 0.18%. It is noticeable that in recent months the two price indices have not shown deflation for the first time since mid-2015.
Chart 4: Consumer Price Index, Industrial Producer Price Index, Loans to Non-Financial Corporations, Households and NPISHs
Source: NSI, BNB
Regarding the industrial producer price index, the main contribution to the sharp slowdown in deflation is made by the prices of goods in the manufacturing industry, which last increased by 0.28% in October and 0.66% in November. October is the first month since 2014 in which prices in this sub-sector have recorded any growth. By now, you can’t help but notice that there is a third (green) line on the graph, which so annoyingly obscures the blue line of the CPI. This line depicts the level of credit granted to Bulgarian households and enterprises, according to the latest data from the Bulgarian National Bank. You are probably wondering why we have included the dynamics of credit in one graph with the dynamics of the price indices? The reason is simple.
We live in an era of credit-dependent economic growth. There is no sector of the economy whose growth these days is not largely dependent on the dynamics of monetary capital that central banks pour into financial markets. And this capital reaches the market precisely in the form of credit granted by private banks. Central banks create new money, which subsequently enters the market in the form of cheaper credit granted by private banks. From there, entrepreneurs and consumers use this credit for investment and consumption, which leads to higher prices for manufactured and consumer goods.
Here again we simplify the real situation and the mechanism of this process, simply because this is a rather extensive topic, which we cannot delve into within the framework of this article. It is enough to remember that the dynamics of money supply and, accordingly, lending are closely related to the dynamics of prices. As Milton Friedman said, "inflation is always and everywhere a monetary phenomenon". This is of course not a permanent or obligatory regularity, but the reality these days is that in most cases price dynamics follow the dynamics of lending.
If we look at the graph again, the relationship between credit growth and price dynamics is visible. When the level of credit (especially consumer credit) falls, this logically leads to lower consumption, which after a certain time lag leads to lower prices of consumer goods (other things being equal - credit dynamics are of course not the only factor that affects price dynamics). Conversely, when credit grows, the CPI (other things being equal) will also grow or at least its rate of decline will weaken under the influence of higher consumption. In the case of industrial sectors, the price dynamics of goods for production there are influenced by the level of credit to enterprises (which stimulates more investment), analogous to the influence that consumer credit has on the consumer price index.
Since April 2016, the decline in the level of granted credit on an annual basis has started to weaken and in October and November it started to grow for the first time in two years. After that, quite expectedly, price deflation also gradually started to ease. Given that there have been no shocks and panics in the Bulgarian banking sector in the near future (as was the situation two years ago) and the ECB decided in December to extend the policy of negative interest rates, there is no reason from the supply side for lending to deteriorate in the coming months.
Demand is another matter, of course. If Bulgarian businesses and consumers’ expectations of future economic conditions worsen, they would be more cautious about their finances and less inclined to accumulate debt. The key factor here is the political uncertainty currently gripping the country. Until it dissipates, consumers and businesses are likely to be more cautious than they would otherwise be. As a result, we are unlikely to see a significant increase in the level of credit granted in the first quarter of 2017. This of course means that price growth will also be relatively anemic and a serious acceleration in the pace of inflation, both in consumer and manufactured goods, is unlikely.
Business climate
And since we are talking about forecasts and expectations, it is appropriate to pay attention to a leading indicator that can tell us what the likely development of the Bulgarian economy is in the coming months. The graph above depicts the dynamics of the business climate by sector – an NSI indicator, which in the form of an index presents the assessment of entrepreneurs about the state and short-term prospects of the sectors in which they operate. In December 2016, an improvement in the business climate was noted in construction and industry, and a deterioration in the retail and services sectors.
The business climate in retail trade is deteriorating the most, which, according to NSI data, is due to the retailers' worsening assessments and expectations of the business situation of enterprises in the near future, as well as to more pessimistic forecasts for the volume of sales and orders to suppliers in the next three months. This deterioration is to some extent expected given the fact that the last quarter is in most cases better for retailers' turnover than the rest of the year, due to the Christmas holidays in December and Black Friday in November. In this context, it is quite natural that expectations for the months immediately following are lower, given the fact that in the first quarter of each year there is no similar concentration of holidays and other factors that would stimulate consumption to the same extent. If we look back in time, we see similar dynamics towards the end of each year.
Chart 5: Business trends by sector
Source: NSI
In the services sector, the uncertain economic environment is cited as the main obstacle, and the majority of managers believe that prices in the sector will remain unchanged in the first three months of 2017. In this article, we present only the business climate in this sector, because the NSI publishes data on turnover in it only on a quarterly basis. Although the business climate is generally improving in the industrial sector, entrepreneurs there are also reserved in their forecasts. The increase in the business climate is due to the improved assessments and expectations for the business situation of enterprises, but this is accompanied by lowered expectations for orders and, accordingly, production activity at the beginning of this year. In construction, assessments and expectations for the business situation are improving, but there, too, like the services sector, the uncertain economic environment is cited as the main obstacle to the development of the sector. Despite this improvement, the business climate in the sector remains lower than the average for the period May-October 2016.
Despite the cautious outlook for the start of 2017, entrepreneurs in each of the four sectors ended 2016 with more optimistic expectations than at the end of any of the previous three years, indicating that the long-term trend of this indicator is positive. The oft-cited "economic instability" is of course not caused only by domestic factors. Brexit, political uncertainty in the EU in the context of the migrant crisis, the rising tide of discontent and parliamentary and presidential elections due in 2017 in countries such as France, Germany and the Netherlands are certainly also having an impact.
Conclusion
Overall, the data indicate a pick-up in economic activity in November, which is unlikely to last beyond December and accelerate further early this year. In the long term, the trend in industrial production is stable, and the growth of industrial turnover has noticeably accelerated in the last few months. This could lead to an acceleration in production growth, but the expectations of entrepreneurs in the sector are reserved for now. Retail trade also accelerated its growth in November, probably stimulated by discounts around Black Friday and the approaching Christmas season. The deterioration of the business climate in this sector is expected and to some extent depends on purely seasonal factors. In November and November, the prices of both production and consumer goods did not show deflation for the first time since mid-2015, which is likely caused by an increase in consumption and investment, as a result of higher lending levels. Overall, the business climate across sectors shows mixed dynamics in the short term, but the long-term trend over the last three years is visibly positive.
