Chapter 4. Macroeconomic Consequences

Milan Cuc, Erik Lundback, and Edgardo Ruggiero
Published Date:
January 2006
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The preceding section explored the motivation behind labor migration and remittances and their use in Moldova. This chapter turns to their macroeconomic consequences, introducing the topic by first looking at how the relevant economic concepts are defined, measured, and accounted for in the balance of payments statistics. Using Moldova balance of payments data, we present a few key stylized facts about Moldova that complement the detailed results of the household survey presented earlier. Discussion of macroeconomic consequences of labor migration and remittances follows.

A. Stylized Facts of Remittances in Moldova

Workers’ remittances are defined here as the sum of two components in the balance of payments: (1) compensation of employees in the income account and (2) workers’ remittances in the transfer account. Compensation captures workers’ wages, salaries, and other benefits earned by nonresident temporary workers.11Remittances are transfers from migrants residing abroad (permanent migrants, or workers staying or expected to stay for a year or more). A third balance of payments component—migrants’ transfers in the capital account—could be included, but these transfers should formally be contra-entries to flows of goods and changes in financial items that arise from migration and, as such, they do not capture money sent to Moldova from workers abroad. This type of transfer is, moreover, insignificant in the case of Moldova.12

Workers’ remittances are inherently difficult to measure, since they involve transactions between and within households, often outside the formal economy, and any statistics on workers’ remittances must be interpreted with great caution.13 This paper relies on two sets of data on workers’ remittances flowing into Moldova: (1) data from a recently conducted survey and (2) officially estimated remittances, as reported in the balance of payments. The survey, described and analyzed in Chapter 3, gives unique insights at the microlevel, which is essential for understanding many aspects of migration and remittances. The balance of payments data compiled by the NBM are the only available source for a time series on workers’ remittances and appear to be of reasonably good quality. In addition to relying on banking statistics, the NBM estimates workers’ remittances outside the banking system using information on individuals’ exchange of foreign currency into lei at foreign exchange bureaus and banks’ foreign exchange counters, and on transactions where foreign exchange is typically used (e.g., purchases of homes and cars). Many, if not most, other countries do not make such efforts.

The survey and the balance of payments statistics give similar estimates of the total amount of workers’ remittance inflows. In 2003, the only full year covered by the survey, gross inflows of remittances are estimated at $460 million (23.5 percent of GDP) by the survey, and at $484 million (almost 25 percent of GDP) by the balance of payments statistics. Remittances are sizable also on a net basis (almost 23 percent of GDP in 2003) and have become the single most important net source of foreign exchange in Moldova. As recognized above, the statistics are uncertain, in particular the estimates of remittances outside the banking system, but the level of remittances flowing into the Moldovan economy is still sizable when only those coming through the banking system are considered. As can be seen in Figure 16, gross remittances transferred through the banking system reached almost 15 percent of GDP in 2003.

Figure 16.Workers’ Remittances Through the Banking System, 1996–2003

Source: NBM.

The amount of workers’ remittances sent to Moldova is large from both a regional and an international perspective. As illustrated in Figure 17, based on balance of payments data, Moldova clearly stands out compared with CIS and Central and Eastern European countries, and also fares well compared with the rest of the world.14Ratha (2003) ranks Moldova as one of the top 10 receivers of workers’ remittances in terms of GDP. Of course, since remittance data are very uncertain, so are comparisons across countries, but there is little doubt that remittances are very important in Moldova, including from an international perspective.

Figure 17.Gross Workers’ Remittances as a Share of GDP in 2003

Source: IMF staff estimates.

The strong upward trend in remittances may have been somewhat weaker than indicated by the data. Trust in banks has improved, and confidence in the leu has strengthened over time as the Moldovan economy stabilized after the 1998 regional crisis. In addition, wire transfers from abroad have become more accessible and cheaper. This could exaggerate the upward trend in two ways. First, stronger banks and cheaper transfers raise incentives to use official channels and, as a result, balance of payments statistics now capture a larger share of all workers’ remittances. Second, a stronger leu and stronger banks encourage people to exchange their idle foreign exchange cash holdings (“money under the mattress”) into lei and deposit the money in banks, increasing estimates of inflows outside the banking system. It should be noted, however, that some of those cash holdings may emanate from unrecorded remittances in earlier years, which only surfaced when confidence in the leu strengthened. Therefore, some unrecorded remittances may have been captured by official statistics in a later year, imparting an upward bias to the estimates of growth in remittances.

The main source of remittances is temporary workers. About 70 percent of all remittances originate from Moldovans working abroad only part of the year (Figure 18). Many of these are likely to be seasonal workers in, for example, construction and agriculture in Russia.

Figure 18.Distribution of Temporary and Long-Term Workers’ Remittances, 2000–03

Source: NBM.

The data on the geographic origin of workers’ remittances flowing into Moldova cover only remittances coming through the banking system. In 2003, about 60 percent of those remittances originated from the European Union (EU), and about 25 percent from the CIS (Figure 19). Of EU transfers, 47.5 percent were from Italy and 17 percent from Portugal. Almost all transfers from the CIS originate from Russia (97 percent). It is not really meaningful to look at underlying trends in the geographic pattern, since the data with respect to remittances through the banking system from Russia are distorted. Before 2000, nonresidents in Russia were not allowed to make any money transfers abroad. Since then, the maximum amount allowed has been gradually increased at the same time as money transfers have become much more available in Russia, with the introduction of several money transfer systems. Money transfers have also increased owing to security reasons. Reportedly, it is dangerous for migrants to bring cash into Moldova across the Russian and Ukrainian borders.

Figure 19.Workers’ Remittances to Moldova by Region of Origin

Sources: NBM; and IMF staff estimates.

B. Economic Growth

Workers’ remittances have played an instrumental role in propelling growth in recent years, through their effect on consumption. As shown in Figure 20, real GDP growth has been driven by household consumption, in turn fueled by remittances. Figure 21 shows a strong correlation between real consumption growth and remittances’ growth, with a correlation coefficient of 0.98 during the period 1999–2003. This high correlation is a direct reflection of the fact that the large inflows of remittances boost income. While GDP has increased relatively fast since 2000, gross national income (GNI) and gross national disposable income (GNDI) have grown even faster (Figure 22).15 Between 2000 and 2003, GDP per capita grew by 13.5 percent on average, GNI per capita by 15.5 percent, and GNDI per capita by 18 percent, mainly reflecting large and rising workers’ remittances.

Figure 20.Contribution of Consumption and Fixed Capital Formation to Real GDP Growth, 1999–2003

Sources: Moldovan authorities; and IMF staff estimates.

Figure 21.Remittances’ Growth and Real Consumption Growth, 1997–2003

Sources: Moldovan authorities; and IMF staff estimates.

Figure 22.GDP, GNI, and GNDI Per Capita, 1999–2003

(In dollars)

Sources: Moldovan authorities; and IMF staff estimates.

Note: GDP = gross dom estic product, GNI = gross national incom e, GNDI = gross national disposable income.

By contrast, the contribution of investment to economic recovery has been very modest. Fixed capital formation is still quite low as a share of GDP and, in terms of GNI and GNDI, has remained virtually flat since 2000 (Figure 23). Investment has not yet recovered from the 1998 recession: at that time fixed capital formation accounted for 22 percent of GDP, but this share fell to 17 percent of GDP in 2003 and is projected to be about 18 percent in 2004. With disposable income boosted by large inflows of remittances, investment could have been growing more rapidly as a share of GDP had the investment climate been more favorable. Without higher investment, Moldova’s long-term growth prospects are bleak.

Figure 23.Fixed Capital Formation, 1999–2003

Sources: Moldovan authorities; and IMF staff estimates.

The current situation, with very high remittances and somewhat disappointing levels of business investment, suggests that Moldova could be stuck in a pattern of migration and remittances reinforcing each other. The cost for Moldovan workers to work abroad is comparatively low for several reasons: (1) Moldova is located close to both the EU and the CIS; (2) there are tight connections between Moldova and other CIS countries; and (3) since many Moldovans already are working abroad, they can facilitate the emigration of others.16 The current trend of persistent emigration leading to rising remittances is, therefore, to be expected under the circumstances. With a favorable investment climate, remittances could be used to finance investment, thus helping create jobs and making it more attractive for Moldovans to stay at home. In a less favorable environment, however, the potential return on investment may not be high enough to compensate for risky projects, making it more attractive for recipients to use remittances to finance the emigration of one or more family members.17 At this point, Moldova appears to be in a situation where emigration is a better option than investing at home.

C. Labor Market

Emigration and remittances have significantly affected the labor market, raising both the equilibrium and the reservation wage. As argued above, emigration costs are relatively low, and, barring introduction of restrictive legislation in host countries, it may become easier to emigrate as emigration increases. From the perspective of a Moldovan worker, the possibility of working abroad fundamentally alters work prospects, raising the equilibrium wage rate in Moldova. Moreover, remittances seem to have also increased the reservation wage, with recipients demanding a higher wage at home.

Emigration has reduced unemployment and led to labor shortages in some sectors. According to the official statistics, labor supply has decreased markedly owing to emigration, while real and dollar-wages have increased rapidly. At the end of 2003, 322,000 people had left Moldova to find jobs abroad (Figure 24). By the third quarter of 2004, this number had expanded to 367,000, which corresponds to about one-fourth of the economically active population. These numbers should be seen as floors, or low estimates, since existing data only cover workers who officially declared that they were emigrating. In fact, the survey results, presented in Chapter 3, show that in late 2004, 399,000 people were working abroad, with another 177,000 back in Moldova after having worked abroad at least once in 2003 or 2004. Consequently, at the same time, employment, unemployment, and the labor force have all declined substantially (Figure 25).

Figure 24.Labor Migration, 1999–20031

Source: Moldovan authorities.

1The number of people who have declared they have migrated to find a job.

Figure 25.Labor Market Indicators, 1998–20031

Source: Moldovan authorities.

1International Labor Organization methodology.

The reduced labor supply has pushed up wages. Starting in 1999, the average real wage increased by 70 percent through 2003, and by almost 80 percent through the first 10 months of 2004. Average monthly dollar-wages rose by 126 percent through 2003, and by almost 200 percent through the first 10 months of 2004. By contrast, real GDP is estimated to have grown by 33 percent from 1999 through 2004, and nominal GNDI (expressed in dollars) is estimated to have grown by 154 percent during the same period. There is also anecdotal evidence of labor shortages in some sectors (construction, transportation, and agriculture), in which employers are not able to find enough workers unless they are prepared to pay very high wages by Moldovan standards.18

Another potential implication of emigration is brain drain, and this may have materialized among permanent Moldovan migrants (see Chapter 3). Many of those with higher education and specialized work skills may find it financially very attractive to leave Moldova. The resulting decline in human capital is likely to hamper economic growth. In this context, it is important to note that investing in higher education may fetch a very high rate of return, in particular for those who migrate. Thus, recipients of remittances in Moldova may conclude that the best way to use the money is to invest in their own education or their children’s education, with a view to finding a job abroad.19

D. Balance of Payments and the Exchange Rate

Remittances have had a major impact on the balance of payments. Exports of goods and services have been growing quite rapidly since 2000, but because imports have grown even faster, the balance of trade in goods and services has deteriorated from about 15 percent of GDP in 1999 to more than 30 percent in 2003 (and was most likely more than 30 percent in 2004 as well). Remittances covered about three-fourths of the trade deficit in 2002 and 2003 (in 2004 the coverage may have been even higher). Because actual inflows could be larger, the coverage may have been even higher, implying that Moldova’s current account deficits were significantly lower than reported. The increasing importance of remittances in financing the trade deficit stands in sharp contrast to the disappointing performance of FDI (Figure 26). Although workers’ remittances have been growing rapidly since 2000, FDI has lagged behind, covering only 10 percent of the trade deficit in 2003—another indication that the investment climate in Moldova is not conducive to private sector activity.

Figure 26.Workers’ Remittances and Foreign Direct Investment, 2000–03

Source: NBM.

The inflows of workers’ remittances are in fact an important factor behind the accumulation of international reserves in 2003 and 2004. At first sight, the external situation looks quite bleak, with a deteriorating recorded current account balance, low FDI, accumulation of government external arrears, and an accompanying low credit rating. Large errors and omissions were recorded in the balance of payments statistics. In the last three quarters of 2003, they amounted to $133 million, or almost 7 percent of annual GDP, and through the first three quarters of 2004 they reached $78 million, or about 3 percent of annual projected GDP. If all errors and omissions were unrecorded remittances, the current account deficit in 2003 would have been $55 million, or less than 3 percent of GDP (compared with almost 7 percent officially reported in the balance of payments statistics). It is reasonable to guess that remittances explain a significant share of this. Part of the errors and omissions could also be a result of underinvoicing of exports and overinvoicing of imports to avoid the existing repatriation requirement, which would also imply that the current account is stronger than reported.

With the stronger balance of payments, the leu has been under appreciation pressure since the second quarter of 2003. The leu has strengthened vis-à-vis the dollar as well as against a trade-weighted currency basket, the nominal effective exchange rate (Figure 27). At the same time, the NBM has stepped up its purchases of foreign exchange, mainly dollars, to dampen the actual appreciation of the leu. Without those interventions, the nominal leu appreciation would have been even stronger. The leu appreciation has also encouraged higher demand for domestic currency, making the appreciation self-reinforcing. With a stronger leu, households may be inclined to exchange their dollar-savings (e.g., from remittances) into lei. Consequently, there has been increasing demand for lei at foreign exchange bureaus; the appreciation pressure has been stronger there than in the interbank market, prompting the NBM to intervene in the cash market in an unprecedented fashion in 2004. There is also anecdotal evidence suggesting that the leu became more desirable as a transaction currency in 2004.20

Figure 27.Moldovan Leu Exchange Rate, 1999–2004

Sources: NBM; and IMF staff estimates.

Note: NEER = Nominal effective exchange rate.

E. External Competitiveness

The leu has also strengthened in real terms, which, in combination with the rapid wage growth and widening trade deficit, has raised questions about Moldova’s external competitiveness (Figure 28). Between end-2002 and end-2004, the real effective exchange rate (REER) appreciated by close to 10 percent and the average dollar-wage increased by 60 percent. Labor migration and workers’ remittances are an important part of the explanation. Labor emigration has helped raise the actual wage (by reducing unemployment) and the equilibrium wage (by increasing the capital-labor ratio in the economy). At the same time, remittances have boosted national disposable income and domestic demand, leading to increases in the price of nontraded goods and services and hence to the real exchange rate appreciation.

Figure 28.Assessing Competitiveness, 1996–2004

Sources: Moldovan authorities; and IMF staff estimates and calculations.

With wages a fraction of the EU average, Moldova has traditionally been regarded as a low-cost country, with much potential—given the right policies and development of a business-friendly environment—to attract FDI and boost exports. Has the recent REER appreciation cut into its external competitiveness? To answer this question, we apply a model of the equilibrium REER developed by Devarajan, Lewis, and Robinson (1993). The model is outlined in Box 3. It is particularly useful in the case of Moldova, in that it explains how changes in sustainable balance of payments flows, such as workers’ remittances, affect the REER (Figure 29). According to the model, the equilibrium real exchange rate should appreciate in response to rising inflows of remittances. The recent appreciation of Moldova’s REER is therefore in line with the model predictions. To judge whether or not the recent appreciation has been excessive, we use the model to simulate the equilibrium REER between 1996 and 2004. Figure 30 shows the cumulative appreciation of the simulated equilibrium REER since end-1996, with the contribution from the change in sustainable trade balance corresponding to the influence of remittance inflows. Moldova also benefited from a modest improvement in its terms of trade during that period, which contributes to the appreciation of the equilibrium REER.21

Figure 29.Import Coverage, 1996–2004

Sources: Moldovan authorities; and IMF staff calculations.

Note: Imports in a given year = 100.

Figure 30.Change in Equilibrium REER1

(Cumulative, 1996Q4–2004Q2)

Sources: Moldovan authorities; and IMF staff calculations.

Note: Assumptions: elasticity of substitution = 0.81 and elasticity of transformation = 0.95.

1Elasticity of transformation and elasticity of substitution values are averages calculated from Devarajan, Go, and Li (1999).

Box 3.Three-Commodity Model1

A small, open economy produces two goods—a nontraded domestic good, D, and an export good, X. It consumes two goods—the domestic good and an imported good, M. The corresponding prices are Pd, Px, and Pm. Goods D and X are assumed to be imperfect substitutes in production—a characteristic captured by the economy’s production possibility frontier, specified as a constant elasticity of transformation (CET) function. Profit maximization by producers implies that the relative supplies of D and X depend on their relative prices, Pd and Px, and on the elasticity of transformation, Ω. Goods D and M are assumed to be imperfect substitutes in consumption, with a constant elasticity of substitution (CES) function. The first-order condition for utility-maximizing consumers implies that relative demands for M and D will depend on their relative prices, Pm and Pd, and on the elasticity of substitution, σ. The domestic prices of the two traded goods (M and X) equal their world prices (πm and πx, respectively) times the nominal exchange rate (E). The world prices are exogenous (small country assumption). Finally, the balance of trade constraint states that the sustainable trade balance (exports minus imports) is set exogenously.

The model can be reduced to three equations:

where c1 and c2 are parameters from the CES and CET functions. Parameter λ in equation (3) is the country’s sustainable balance of trade, or the proportion by which imports can exceed exports.

By log differentiation, where dlog(X)=X̂=dXX, we obtain

The nominal exchange rate, E, is chosen as the numeraire, so that Ê=0,P̂m=π̂m, and P̂x=π̂x. Because the world prices are set exogenously, the only endogenous price in the model is the price of the domestic good (Pd), which also determines the real exchange rate (R). Solving for the real exchange rate, we obtain

Equation (4) shows the real exchange rate—defined as the nominal exchange rate, adjusted for the inflation differential between the home country and its trading partners—as a function of the two right-hand-side terms: the terms of trade and the sustainable balance of trade. Equation (4) makes it clear that the conventional approach—based on the assumption that there is some unchanging equilibrium level for the real exchange rate—is valid only if the two terms on the right-hand side are equal to zero; that is, there is no change in the country’s terms of trade or in the sustainable level of foreign income or capital inflows.

1 Based on Devarajan, Lewis, and Robinson (1993).

Admittedly, the estimated impact will depend on the values selected for the parameters of the model. To gauge the robustness of the model predictions, the results were calculated for alternative supply and demand characteristics of the Moldovan economy, captured by the values of elasticities of transformation and substitution (Table 2). For example, assuming elasticities of substitution of 0.81 and transformation of 0.95, the model estimates a cumulative appreciation of 27 percent in Moldova’s equilibrium REER between 1996 and mid-2004. Figure 31 contrasts the estimated range for the cumulative appreciation of the equilibrium REER with the actual cumulative change in the REER since end-1996.22 It suggests that the cumulative increase in the actual REER (10 percent) was below the increase estimated by the model for the equilibrium REER.

Table 2.Cumulative Change in Equilibrium REER, 1996–2004(In percent)1
Transformation Elasticity, ΩSubstitution Elasticity, σ
Sources: Moldovan authorities; and IMF staff calculations.

Elasticity of transformation (0.95) and elasticity of substitution (0.81)—shaded—are averages calculated from Devarajan, Go, and Li (1999).

Sources: Moldovan authorities; and IMF staff calculations.

Elasticity of transformation (0.95) and elasticity of substitution (0.81)—shaded—are averages calculated from Devarajan, Go, and Li (1999).

Figure 31.Change in REER and Equilibrium REER

(Cumulative, 1996Q4–2004Q4)

Sources: Moldovan authorities; and IMF staff estimates and calculations.

The preceding analysis suggests that the leu is unlikely to be overvalued at present. While the increase in dollar-wages and the nominal appreciation of the leu—particularly against the dollar—have captured public attention, some aspects have received less emphasis: (1) the large undervaluation of the REER following the 1998 regional crisis, implying a large initial gap between the actual and the equilibrium REER; and (2) the role of balance of payments inflows (remittances) in raising the equilibrium REER.

It appears that the REER has some room to appreciate, and will likely do so if Moldova’s economy operates close to its full potential, the labor market remains tight, and remittances continue to grow. Rather than viewing the leu appreciation as harmful to the economy, our analysis suggests that, by raising the returns in the nontraded sector relative to those in the traded sector, it could facilitate a reallocation of resources in the economy that could lay the foundation for long-term growth. With remittances providing an important portion of balance of payments financing, domestic production could be redeployed toward more goods and services needed for domestic investment. The hitherto neglected domestic infrastructure—transportation network, electricity transportation and distribution, communications—could benefit from this reallocation of resources. Over time, the modernization of the domestic infrastructure would help strengthen the economic potential by helping raise productivity growth economywide.

The large trade deficit is not, in itself, evidence that that the exchange rate is misaligned. Exports of goods and services are growing at a healthy pace. Import growth is much higher, but imports are fully financed by workers’ remittances, suggesting that Moldova has a comparative advantage in exporting labor. Admittedly, the current account deficit is relatively large, but if the sizable errors and omissions in the balance of payments were taken into account, the deficit would be much smaller, and declining. On the other hand, it is possible to argue that Moldova is not competitive in a more fundamental way. Because the economic environment is not conducive to private investment and work opportunities are scarce, pushing workers abroad, the export sector cannot fully develop its potential. In a more favorable business environment, small and medium-sized enterprises could thrive, leading to higher investment and increased private sector activity. Moldovan labor, skilled and unskilled, would then find better opportunities at home and exports of goods and services could replace exports of labor.

F. Monetary Conditions and Inflation

The large inflows of workers’ remittances have complicated the task of monetary policy. The official monetary policy objective is to maintain the stability of the currency. In practice, the NBM attempts to achieve several, sometimes conflicting, goals:

  • keep inflation low;
  • preserve external competitiveness by preventing or at least limiting excessive nominal appreciation of the leu against the dollar;
  • accumulate foreign exchange reserves on a precautionary basis, to be able to meet external debt service and to reach a level corresponding to three months of imports; and
  • keep interest rates low, to support private sector development and limit government domestic interest payments.

The NBM is also concerned about its profit level, since it affects the strength of its balance sheet and the amounts that can be transferred to the budget.

It has naturally proven very difficult to keep inflation down, while at the same time achieving the other monetary policy goals in the face of strong inflows of foreign exchange. The NBM can choose to intervene in order to prevent the leu from appreciating by buying large amounts of foreign exchange in the open market, with the added benefit that foreign reserves are built up. However, this boosts money supply and fuels inflationary pressures. Sterilization operations can in principle help, with the undesired consequence of pushing interest rates up. Short-term interest rates (maturities less than or equal to one year) are directly affected by NBM interventions in the money market, and result in higher interest payments for the government. Commercial credits also become more expensive, since a large share of them are short-term, thus discouraging private sector activity. Long-term interest rates could in principle fall, as higher short-term interest rates help lower inflation expectations, but no such effect has been observed in Moldova. Moreover, sterilization operations are costly for the NBM, reducing its profits and its transfers to the budget.

Since late 2004, concerned with effects of workers’ remittances on the nominal exchange rate, the NBM has given less priority to inflation. Until then, the NBM had been trying to strike a balance between keeping inflation down and preventing appreciation, while at the same time building reserves and keeping interest rates down. However, as the inflows of foreign exchange have persisted and the pressure on the exchange rate has intensified, the NBM appears in recent months to have given highest priority to preserving competitiveness. The appreciation of the leu against the dollar was halted in mid-2004 through historically large purchases of foreign exchange; the leu even depreciated somewhat before stabilizing toward the end of the year. Sterilization efforts have been stepped up, but not enough to prevent money growth from accelerating (Figure 32). Inflation has not yet picked up dramatically, but the inflation goal for 2004 was missed and there is clearly a risk of higher inflation in 2005.

Figure 32.Money Growth and Inflation, 2003–04

(Year-on-year, percent)

Source: NBM.

G. Fiscal Consequences

The exodus of the Moldovan labor force and the related inflows of remittances have shaped fiscal performance in recent years and will likely have an impact on fiscal policy in the medium- to long term. In the short run, fiscal performance has been affected through the impact of emigration and remittances on (1) the labor market, (2) revenue collection, and (3) the exchange rate.

  • Labor market changes. As emigration has reduced unemployment, and remittances have provided a social safety net to the poor, pressures on the budget related to unemployment have been alleviated (Figure 33).
  • Revenue collection of the central government budget. The revenue base has grown dependent on remittances. Overall collection has improved significantly over the past few years, largely owing to rising import taxes. Although the declines in labor force and employment have constrained growth in value added, and hence income subject to taxation, rising remittance inflows have boosted imports and import-related tax collection (Figure 34).23 This greater reliance on indirect taxation reflects a faster growth in domestic absorption relative to incomes generated in the domestic economy (or faster growth of national disposable income relative to GDP).24
  • Exchange rate changes. The appreciation of the leu resulting from remittance inflows affects the government’s fiscal position in the short run. For example, a 10 percent appreciation of the leu in nominal effective terms would lead to a deterioration in the government fiscal position of about 0.6 percent of GDP.25 This is a combination of a (negative) revenue impact of 0.9 percent of GDP and a reduction in annual external debt service of 0.3 percent of GDP (assuming that all government spending is on domestically produced goods). Allowing for a partial demand response (higher demand for imports, assuming price elasticity of 0.5), the net effect would be smaller—about 0.2 percent of GDP. In the long run, the initial net negative effect of an appreciation on the fiscal accounts would likely dissipate, particularly if the share of government spending on imports was relatively large.

Figure 33.Unemployment, Unemployment Benefits, and Dependency Ratio, 1998–2004

Sources: Moldovan authorities; and IMF staff estimates.

Figure 34.Tax Revenue Composition, 1999–2004

Sources: Moldovan authorities; and IMF staff calculations.

In the long run, emigration raises fiscal sustainability issues, through its impact on the demographic dependency ratio and on the contribution base. Emigration has affected the balance between the taxable base and the demand for social spending in the domestic economy. The shrinking contribution base resulting from emigration adds to the challenge of safeguarding the viability of Moldova’s pension system in the context of an aging population. The challenge is compounded by uncertainty about the ultimate size of the old-age population expected to depend on Social Fund pension benefits, which will be determined by emigrants’ decisions about whether or not to retire in Moldova. Although the reform of the pension system initiated in 1999 was an important step toward restoring the system’s short-term stability, securing its long-term fiscal sustainability is likely to require future adjustments.

To illustrate possible adjustments in the pension system as a response to demographic changes, two alternative scenarios are presented in Table 3. The scenarios are conceived as a change relative to the situation projected for 2005.

Table 3.Pension System’s Response to Demographic Changes1
Base (2005)Scenario AScenario B
Source: IMF staff estimates and assumptions.

The implied transfer from the budget in 2005 reflects the need for additional financing of the Social Fund, currently provided through drawdowns of accumulated deposits.

Source: IMF staff estimates and assumptions.

The implied transfer from the budget in 2005 reflects the need for additional financing of the Social Fund, currently provided through drawdowns of accumulated deposits.

Under Scenario A, the number of contributors declines by 10 percent (labor exodus) and the number of beneficiaries rises by 10 percent. Under Scenario B, the number of contributors declines by 20 percent, with the number of beneficiaries rising by 10 percent (all relative to 2005). As outlined in Box 4, under a PAYG system, an adverse demographic development, such as an increase in the ratio of the number of beneficiaries to contributors (M/N), necessitates an adjustment in policy parameters—either the contribution rate (α), the replacement rate (β), or the fiscal transfer rate (τ)—to preserve the long-term sustainability of the system. Table 3 shows the required response in these three policy parameters.26

Box 4.Social Insurance and Fiscal Sustainability—Conceptual Framework1


Moldova’s social insurance is administered through the Social Insurance Fund. The pay-as-you-go (PAYG) pension system is its largest component. The 1998 regional financial crisis had a major impact on Moldova’s costly and poorly targeted social protection system, which was already under severe strain. Problems emerged particularly in the pension system, including rising contribution arrears, delays in payments, lack of funds, and growth in in-kind payments.

A pension system reform, launched in 1999, laid the foundation for transforming the system into a sustainable insurance program. The main features of the new system include a new benefit formula, which bases future pensions more on individual contributions than on reported wages and years of service; elimination of most early retirement privileges; a gradual increase in retirement age; and an increase in the minimum required contribution period.

Although the reform helped restore the short-term financial stability of the system, ensuring its fiscal sustainability remains a challenge. PAYG systems need to ensure an ongoing balance between contributions and benefits. Demographic changes, including an aging population as well as increases in life expectancy, require changes to contribution rates or to the system benefits. In the case of Moldova, by raising the demographic dependency ratio, emigration is expected to place additional strain on the system’s fiscal sustainability.


In a PAYG system, current period benefits are financed from current revenues, typically via a payroll tax. For revenues to equal expenditures, the payroll tax rate (α) has to equal the pension bill divided by the wage bill, or the ratio of pensioners (M) to active contributors (N) times the replacement rate (β), where the replacement rate is defined as the ratio of the average pension to the average wage. Thus we can write

Allowing for the possibility of budget transfers, equation (1) becomes

where τ is the ratio of budgetary transfers to pension expenditures (τ > 0 implies transfers from the budget to the pension fund; τ < 0 implies a transfer of the pension fund surplus to the budget). More generally, the ratio M/N can be expressed as a function of the demographic dependency ratio (M*/N*), where M* is the number of people 60 years and older, and N* is the number of people between 15 and 59 years of age:

where γ represents the pension system coverage ratio, with its value depending on the maturity of the system, retirement policies, labor force participation rates, and other labor market conditions.

1 Based on Castello-Branco (1998).

The scenarios highlight the trade-offs that may need to be contemplated in response to possible demographic shifts. If the required adjustment were shouldered fully by contributors, the contribution rate would have to rise from 29 percent to 35 percent in Scenario A, and to 40 percent in Scenario B. Alternatively, the replacement rate would need to fall to 21 and 19 percent in Scenarios A and B, respectively, from 26 percent in the base year. Without changes in the contribution and replacement rates, the state budget would need to increase its transfers to the pension plan from 8 percent of pension outlays to 25 and 33 percent under Scenarios A and B, respectively.

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