The structural changes and reforms toward the free market pushed through in the countries of Southeastern Europe over the last decade have begun to bear fruit, based mainly on political stability in most states, according to Alpha Bank’s quarterly economic report. Romania and Bulgaria are without a doubt the two countries that stand out for their great progress, while in the rest of the region development is rather fragile with significant uncertainties, notes the report. In fact, the entry of Bulgaria and Romania in the EU, expected in 2007, is believed to carry importance for the Greek economy and its companies with a strong presence in these two countries. According to the bank’s analysis, the marked strengthening of economic activity in the Balkan states is attributed only partly to its low starting point, and mainly to progress in creating the appropriate institutions and organizing a framework for the proper operation of the free market. The results are the upgrading of credit ratings – mainly of Bulgaria and Romania – and the easier attraction of foreign direct investment (FDI). Improved growth prospects now attract foreign investors even to sectors they used to avoid. Enticing FDI is a crucial factor for maintaining and expanding the marked economic development of these countries, given that some of them, mainly Albania and the Former Yugoslav Republic of Macedonia (FYROM), depend to a great extent on emigrants’ remittances. Another important factor supporting economic development in SE European countries is the credit expansion of households and enterprises which is increasing at a high rate across the region. According to Alpha Bank data, the growth rate for loans to the private sector in 2003 was at 60 percent in Bulgaria and 74 percent in Romania. Despite this increase in lending, the credit total flowing toward the private sector remains very low in all countries compared to the EU. Yet the high percentage of credit expansion worries the Balkan states’ central banks and international organizations, mainly regarding the threat of bad debts in banks since a significant part of loans is in euros or other foreign currencies. This is why many central banks are taking measures to contain the credit expansion rate through increasing the key interest rates and the percentage of deposits in domestic and especially in foreign currencies. In many countries of the region, compulsory stocks for deposits in foreign currencies exceed 30 percent. Inflation Another source of worry regarding economic policy is inflation, which in most SE European states remains at rather high levels despite its impressive drop in the last few years. Taming inflation and the continuous effort to bring it down to single digits is these countries’ greatest recent economic policy achievement. The main pillars of this effort are the readjustment of prices of goods and services held by the state on international rate levels and debt reduction by corporations and enterprises that still are under state control. Furthermore, in countries such as Bulgaria and Romania, the effort to cut inflation has been linked closely with the stabilization or appreciation of the local currency’s value, which of course hampers their exports’ competitiveness. Bulgaria Sofia has completed its accession process with the EU and looks forward to its entry in January 2007 and to the eurozone two years later. The local currency (lev) has been pegged to the euro since 1997 at a rate of 1.9558 lev/euro; therefore, technically, Bulgaria could be considered ready to adopt the common currency on its planned date. In practice, however, the macroeconomic situation in Bulgaria shows a mixed picture in the last two years, although in 2003 it had a balanced budget for the first time since 1998. On the other hand, neither the inflation target (at 5.6 instead of 4.8 percent) nor the GDP growth rate (4.8 instead of 5 percent) was met. The strong increase in economic activity over the last couple of years is attributed to the strengthening of exports by 30 percent; 57 percent of all exports is absorbed by the EU. To boost economic activity, Sofia reduced taxes on business profits from 23.5 to 19.5 percent and for 2005, a further reduction to 15 percent is planned. The loss of this revenue is counterbalanced by the increase of selected special indirect taxes, with VAT at a single rate of 20 percent. The Bulgarian government has also secured a new two-year funding program worth $147 million from the International Monetary Fund with the obligation of maintaining a balanced budget for 2004. For its part, the government has asked for an additional increase in budget expenditure by 155 million euros to fund social spending, given that at the end of last September the balance was positive by 665 million euros. Both the central bank and the IMF are concerned about the high rate of lending increase which in the last three years has risen by an average 45 percent, although the percentage of bad loans has fallen to 2.7 percent. The generally positive course of the Bulgarian economy was recently rewarded through the upgrading of the country’s credit rating by both Moody’s and Standard & Poor’s. Romania The high growth rate of the Romanian economy in the last few years has been somewhat overshadowed by persistently high inflation and a rising current account deficit. However, the containment of public expenditure and inflation, combined with the adaptation of a better legal and institutional framework, indicate the emergence of a free market economy. This reality was acknowledged and certified by the European Commission last October, which along with a new, two-year funding agreement with the IMF secure Romania’s EU entry in 2007 even though as of the end of 2004 Bucharest had not concluded negotiations. This is expected early this year, with no consequences for its entry date. The budget for 2005 forecasts a deficit of 1.5-1.6 percent of GDP and a further drop in inflation to 6 percent by the end of the year. These targets are now possible, after the great appreciation of the leu, the local currency, in the last three months, which has its negative effects on the payments balance. Credit expansion to households and enterprises reached 70 percent in 2003, forcing the central bank to raise interest rates – which it then reduced twice in 2004 (at 17.75 percent now) as inflation fell – while also trying to contain the leu’s rise.