Nicholas Watson in Sofia -

Battered and bruised by the global economic crisis that hit emerging Europe particularly hard, investors are returning slowly to Bulgaria's capital markets and appear ready to invest in mutual funds that are riskier than the traditional bond and other low-risk funds, according to Sofia-based ELANA Fund Management.

An online survey carried out by ELANA in December and January found an improving attitude of investors towards investing in Bulgarian mutual funds - over 20% of respondents already plan new or additional investments in 2010.

Another trend the survey identified was that investors' appetite for risk is improving. Over 80% of respondents said they are ready to invest in funds that are riskier than the traditional bond and other low-risk funds. More than 50% of respondents claimed they would choose a fund with balanced risk and an annual return of 12-20%, while 48% of respondents would invest in a high risk fund expecting a return on annual basis of over 20%. Only 12% would rather invest in a low-risk fund with an expected return of 5-10%.

This is undoubtedly an improvement in investor sentiment, but still a far cry from the heady days before the global economic crisis swept over the region following Lehman Brothers' collapse in the autumn of 2008. Bulgaria entered the crisis after most of Europe and was harder hit, so it has emerged the other side later and recovered to a lesser degree. The economy contracted 5% in 2009, with the last quarter of the year showing a fall of 5.9% on year, and few expect to see growth before the second half of this year. As such, the stock market's main Sofix Index rallied just 19% in 2009 after falling a huge 80% in 2008. Liquidity remains low, with turnover on the Bulgarian Stock Exchange falling 47% last year. "The problem for our stock market fund industry is that we don't have the huge capital inflows from the world," says Tsvetoslav Tsachev, head of research for ELANA. "Foreign investors are not willing to participate en masse and this lack of portfolio investors is the main reason behind the low liquidity of the market."

The liquidity on the market is so low right now that if there were even a small amount of capital inflows, the stock market would jump and this in turn might attract more inflows. "The stock market rally only really started in August 2009, which was a bit later than the developed markets, which started to rally in the first part of that year," says Ivaylo Penev, a portfolio manager for ELANA's six funds. "I think when our markets start to see flows from foreign investors again, this liquidity will move prices and attract more investors. Most of our mutual funds barely managed to break even last year, but this year we are staring to see some positive year-to-date returns so people might start to put money into this form of savings or at least go directly to stock market."

Undervalued

The Bulgarian market is certainly undervalued on a historical basis, containing some relatively cheap companies that managed to implement some solid cost-cutting programmes during the crisis, while keeping a floor under the widespread drop in sales. Penev picks battery producer Monbat and the paint producer Orgachim as two such companies that have come out of the crisis in relatively good shape and are now trading cheaply.

The market also doesn't seem to have priced in the decision by the International Monetary Fund (IMF) at the beginning of March to revise up its forecast for Bulgaria's GDP performance in 2010 to growth of 0.2%, rather than the contraction of 2.5% forecast in the IMF's October World Economic Outlook. The new forecast is more in line with the Finance Ministry's prediction of 0.3% growth, though still above that of many economists who think GDP will be flat in 2010.

What is continuing to cast a pall over Bulgaria for investors is the fallout from the debt crisis in neighbouring Greece - a big presence in the Balkan region, both in terms of trade and investment. According to the IMF's Direction of Trade Statistics for 2008, Greece accounted for some 8% of Bulgaria's exports and 4.8% of its imports. But probably of greater significance is the potential impact of Greece's problems on Bulgaria's banking system. Greece's four largest banks - Eurobank EFG, National Bank of Greece, Piraeus Bank and Alpha Bank - together own around 30% of the banking sector in Bulgaria. Pessimists argue that if these Greek parent banks can no longer raise the necessary funding in the international markets or if costs become prohibitively expensive because of the credit rating downgrades, their Balkan subsidiaries could end up being starved of the foreign capital they have relied on so heavily.

There is surely some truth in this, but it's overdone, argue many in Bulgaria. Tsachev points out that if there were any real fears about Greek parent banks abandoning their Bulgarian subsidiaries, then this would be reflected in a jump in interbank interest rates, but these are at multi-year lows. "In 2006, Sofibor [the Bulgarian interbank lending rate] was at 5-6% and its historical peak is around 8%, but now it's at 4%."

Of more concern, says Moody's Investors Services, is the adverse impact of the recession on the credit quality and net profits of the country's banks, which is why the rating agency on March 8 put a negative credit outlook on the banking system. It said negative trends in Bulgaria's banking industry, which showed on the lenders' bottom-line profitability in 2009, would continue for the next 12 to 18 months. For example, non-performing loans grew at a very rapid pace during 2009 - bad loans to companies and households stood at 14% of the total, according data released on March 24 - which resulted in high provisioning expenses and reduced net profitability for most banks.

As such, for the past 14 months credit growth has been close to zero, says the central bank. However, Penev says there are signs that this situation is changing already. "When I watched TV a few months ago, it was full of commercials for bank deposits and none for loans; now there are only two ads left for deposits and the rest are starting to promote credit. This rising bank lending will be one of the things will start to improve the economy."

Planes, trains and automobiles

Another positive for the economy is the long-overdue push by the state to build the infrastructure that Bulgaria so desperately needs to develop its economy.

The building of roads and other essential infrastructure has an unhappy history in post-communist Bulgaria. The most glaring example of this failure is the lack of a proper highway that connects the capital of Sofia with the main tourist city of Burgas on the Black Sea coast. Some 280 kilometres of the Trakiya motorway has been in operation since 2007, but the final 90 km or so remains unfinished, the victim of a contract dispute with the Portuguese builder. A fresh tender for the last leg was won in February by Trace Group Holding, owned by local businessman Nikolay Mihaylov, but complaints by the Austrian builder Strabag and the Greek builder Terna have further delayed the signing of this contract.

But it's not just the Trakiya motorway - there are only 418 km of highways in Bulgaria compared with the 5,000 km that's been built in Portugal over recent years. Bulgarian Minister of Regional Development and Public Works Rosen Plevneliev announced in March that the ministry would prepare projects worth €4bn for the 2010-2014 EU programme period, an amount that Carsten Rasmussen, deputy head of the department in charge of the EU funded projects for Bulgaria with the DG Regional Policy of the European Commission, calls the absolute minimum. "Bulgaria has absorbed only 2% of the €5bn allocated in the EU funds for investments in infrastructure, which is rather slow progress," said Rasmussen. "I wish I could say that things are better than last year, but unfortunately it's not true."

Even so, ELANA's Penev says there are hopeful signs that this government under Prime Minister Boyko Borisov, which took office in 2009 promising a more reformist administration, will succeed in making money available for public projects. For example, the government has said the money the state owes to companies for public projects will start being paid out, which will help the corporate sector hugely since Bulgarian firms have high inter-firm indebtedness.

Also, on April 6, Transport Minister Alexander Tsvetkov said the government plans to attract private investment into several major ports, airports and train stations as a way to speed up the modernisation of its ageing infrastructure. The freight terminals of Bulgaria's two largest airports, in Sofia and the southern city of Plovdiv, will be opened up to private investors in coming months, together with four other airports, while concession offers will also be made on parts of the two key Black Sea ports in Varna and Burgas, along with the Danube ports of Ruse, Silistra, Tutrakan, Nikopol, Vidin and Lom. Several train stations, including those of Sofia, Plovdiv and Varna, will also be offered to potential investors.