OREANDA-NEWS. This announcement replaces the version published on 3 June 2016 to include an additional relevant criteria report dated 12 August 2014.

Fitch Ratings has affirmed Bulgaria's Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at 'BBB-' and 'BBB', respectively. The Outlooks are Stable. The issue ratings on Bulgaria's senior unsecured foreign and local currency bonds have been affirmed at 'BBB-' and 'BBB', respectively. The Country Ceiling has been affirmed at 'BBB+' and the Short-Term Foreign Currency IDR at 'F3'.

KEY RATING DRIVERS

Bulgaria's 'BBB-' rating is supported by its relatively low government debt - pushed closer to the 'BBB' median by one-off costs to fund Bulgaria's Deposit Insurance Fund in 2014 - and improving external balance sheet. However, as one of the poorest countries in the EU, Bulgaria faces structural challenges to boost its long-term potential growth rate and improve GDP per capita to levels in line with similar and higher rated peers.

Bulgaria's external finances are supported by sustained current account surpluses (1.4% of GDP, 2015) and high level of foreign reserve assets covering 7.8 months of current external receipts (CXP), which provide stability to the country's existing currency board regime. For 2016-2017, we continue to forecast current account surpluses for Bulgaria close to 2.2% of GDP, driven mainly by the gradual narrowing of Bulgaria's trade deficit. Exports will benefit from a diverse export base, weak euro and economic recovery in key trading partners.

Bulgaria's net external debt (7.7% of GDP, 2015) is higher than the 'BBB' median net debtor ratio of 4.4% of GDP. However, this ratio has significantly improved since peaking at 45.3% of GDP in 2009. The improvement has been mainly driven by the private financial and non-financial sectors, which have repaid external debt and accumulated external assets.

Fitch forecasts Bulgaria will grow 2.1% in 2016, after real GDP growth of 3.0% in 2015. A slower rate of growth reflects our forecast for a contraction in investment this year, consistent with the ending of the 2007-2013 EU funding cycle. Lower public investment will weigh on the contribution from domestic demand on headline GDP. However, momentum in household consumption is forecast to pick up. Employment growth and higher levels of disposable income should boost private consumption growth to around 2.0% in 2016 from 0.8% in 2015. Meanwhile, forecasts are for net exports to remain the key driver of GDP.

Bulgaria's potential economic growth rate is estimated to be around 2.5%, low relative to rating peers. Reaching this growth rate is feasible in 2017-2018. Structural weaknesses in the labour market, such as high long-term unemployment (61.2% of total unemployment, 2015), skills mismatches, and low productivity growth constrain the pace of Bulgaria's GDP per capita convergence towards levels of richer EU states. Lender and borrower caution is a short-term constraint on growth.

Bulgaria's governance indicators fall in line with the 'BBB' median, but a pattern of unstable governments is a partial weakness for the rating. The departure of left-wing Alternative for Bulgarian Revival from the ruling coalition on 10 May now leaves a minority government led by centre right Citizens for European Development and junior partner Reformist Bloc. In Fitch's view, it is unlikely that early parliamentary elections will be held before the presidential elections in October 2016, although the position of the government is certainly weaker and this could slow progress on reforms.

Bulgaria's fiscal finances compare favourably against the 'BBB' median. Both the headline fiscal deficit (2.1%, 2015) and general government debt (26.7%, 2015) are below the median ratios of 2.6% and 42.4% of GDP, respectively. For 2016, Bulgaria's fiscal deficit is forecast to stay around 2.0%, while an increase in the debt ratio to 33.2% is expected on the back of government pre-financing. In March 2016, Bulgaria issued a EUR2.0bn (BGN3.9bn) dual-tranche Eurobond, proceeds of which will finance a EUR950m Eurobond maturing in July 2017, while EUR1bn of which will act as a contingency liquidity buffer for the banking sector.

Bulgaria's banking sector is a weakness for the sovereign's credit profile. While good progress has been made in implementing a sector-wide asset quality review (AQR), with results to be published August 2016, weaknesses in the governance and supervision of Bulgaria's local banks, highlighted by the bankruptcy of KTB in 2014, are a concern. Headline indicators show the system to be adequately liquid (system-wide liquid assets represented 37.1% of liabilities in 1Q16) and well capitalised (average regulatory capital/risk-weighted assets ratio at 22.9%, 1Q16). However, the AQR could identify some banks short of adequate provisioning against a high ratio of non-performing loans (20.2% of total gross customer loans at end 1Q16). Fitch cannot rule out the local banking sector as a potential contingent liability on the sovereign's balance sheet.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Bulgaria a score equivalent to a rating of BBB on the Long-term FC IDR scale.

Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:

- Macroeconomics: -1 notch, to reflect Bulgaria's weaker potential growth prospects relative to

'BBB' median, held back by weak credit growth, low private sector investment and structural rigidities in the labour market.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main factors that could, individually or collectively, trigger positive rating action include:

- Stronger potential GDP growth and progressive convergence towards average EU income levels.

- Sustained improvement in external finances.

- Credible fiscal consolidation that supports the long-term sustainability of public debt dynamics.

- Sustained improvement in governance and strength of institutions.

The main risk factors that, individually or collectively, could trigger negative rating action are:

- Re-emergence of instability in the banking sector, which may increase pressure on government fiscal finances and economic growth.

- Higher fiscal deficits than projected that threaten the long-term sustainability of public finances.

KEY ASSUMPTIONS

Fitch assumes that Bulgaria's currency board arrangement will remain in place and that governments will continue to pursue policies consistent with it.