How Emerging Europe Came Through the 2008/09 Crisis

Chapter 14. Moldova: Rebounding on Improved Policies

Bas Bakker, and Christoph Klingen
Published Date:
August 2012
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Following a difficult early transition period, Moldova’s economy had been expanding strongly since 2000 from low income levels. Growth became increasingly domestic demand driven, fueled by ever-increasing inflows of remittances and capital. The current account deficit ballooned. Initial hopes that the global financial crisis would bypass Moldova because of the limited international integration of its financial system proved misplaced. A sharp drop of inflows as well as exports forced a severe contraction and rebalancing of the economy, and expansionary fiscal policies soon reached their limits as public finances were exposed as much weaker than presumed during the boom years. Since January 2010, a stabilization program, supported by a three-year arrangement with the IMF, has been restoring viable public finances and competitiveness. The economy rebounded strongly in 2010 and 2011.


Moldova is the least prosperous country of emerging Europe. The first decade after independence in 1991 was marked by sharp economic contraction and high unemployment. This fostered strong outward labor migration, with an estimated 10–15 percent of the population living and working abroad. Migrants’ remittances and worker compensation, equivalent to 10–20 percent of GDP, are considerable, bridging much of the traditionally large shortfall of exports over imports. Moldova benefited from subsidized gas imports from Russia for some time after independence, although less so than other former Soviet Republics for lack of significant heavy industry. Agriculture remains a key sector of the economy, while food processing accounts for more than one-third of the industrial sector. Light industry, such as textiles and clothing, has gained importance over the years.

Following the Russian financial crisis in 1998, Moldova made important headway in achieving and maintaining macroeconomic stability. Inflation was significantly reduced, although it was never brought decisively into the single digits. The National Bank of Moldova’s mandate had traditionally been focused on ensuring nominal currency stability, but from 2007 it shifted to a more active anti-inflationary policy. The fiscal position was roughly in balance. Moldova made much progress shifting to a viable free-market economy, and its private sector now accounts for four-fifths of GDP. Prices were liberalized early on and widespread consumer subsidies were phased out. The relatively small, mainly domestically owned banking system makes for a relatively low credit penetration. The economy returned to economic growth in the year 2000.

The Run-Up to the Global Financial Crisis

Rapid domestic demand growth of some 10 percent propelled GDP growth to over 6 percent annually during 2003–08. Remittances and capital inflows fueled the boom, and so did fiscal policy. The current account balance deteriorated progressively to peak at over 16 percent of GDP in 2008. The seeds for a sharp correction were sown.

Record inflows of remittances and capital widened economic imbalances in 2006–08. True, much of the capital inflows took the form of foreign direct investment and trade credit—normally considered “good” inflows—but they financed mostly imports and investment in the nontradable sector rather than contributing to Moldova’s export potential. Meanwhile, major exports—wine and agricultural products—were hurt by a Russian embargo during 2006–07 and a drought in the summer of 2007. Moreover, Russia announced the phasing out of gas subsidies and sharply raised gas prices over the course of 2006. The real exchange rate appreciated by as much as 46 percent from mid-2007 to early 2009, indicating a serious loss of competitiveness.

On the fiscal front, policy gradually turned procyclical. As buoyant consumption-based taxes lifted revenues by as much as 5 percentage points of GDP during 2004–08, spending was allowed to grow even faster. While the headline budget balance did not deteriorate by much, underlying public finances worsened significantly due to the cyclical nature of the revenue gains. Key fiscal reforms were delayed, such as consolidating the education sector in the face of a rapidly declining student population and putting the pension system on a socially and financially sound footing.

Monetary policy was slow to react to mounting demand and inflationary pressures. In response to the foreign exchange inflows, the National Bank of Moldova accumulated a large stock of international reserves (US$1.8 billion, or five months’ worth of imports, by September 2008). The central bank eventually raised policy interest rates and reserve requirements, but these measures largely played catch-up with inflation developments and failed to mop up enough of the liquidity injections from reserve accumulation. With real interest rates low and the economy booming, credit growth remained high and inflation stubbornly stayed in the double digits.

The financial sector appeared robust in the boom years. Rapidly increasing credit penetration, though from a low base, market-determined interest rates, and a favorable regulatory regime made for highly profitable banks. All of them maintained high capital adequacy and liquidity ratios. Nonperforming loans accounted for a modest 4.6 percent of total loans in September 2008.

A three-year IMF-supported program under the Poverty Reduction and Growth Facility came into effect in May 2006. Initially it helped Moldova maintain macroeconomic stability and promote growth. It also secured a restructuring of Paris Club debt. However, escalating policy slippages in the run-up to the April 2009 general elections put the program off track—no review after June 2008 would be completed.

Impact of the Global Financial Crisis

Moldova felt the first signs of the global financial crisis in late 2008, when external demand and inflows started contracting. However, the authorities only belatedly recognized the full economic implications. The limited foreign exposure of Moldova’s financial system made them believe that the crisis would largely bypass their economy. Amid two rounds of parliamentary elections in April and July 2009, it would take until late 2009 for a coherent anticrisis policy response to take shape.

The global financial crisis indeed did not hit Moldova’s financial sector directly. However, a deep recession would soon lead to a surge of nonperforming loans, which eroded profitability. Still, all banks remained liquid and well capitalized, except for one medium-sized institution that became insolvent in June 2009 on account of unfavorable exposure concentration and risk management irregularities.

The crisis was instead transmitted to Moldova through a sharp contraction of inward remittances, capital inflows, and exports. In 2009, remittances fell by more than 5 percent of GDP, capital inflows corresponding to more than 20 percent of GDP came to a sudden stop, and exports plunged by 20 percent. The overall balance of payments, which had recorded a large surplus up until the third quarter of 2008, came under acute pressure. Robbed of its financing sources, domestic demand took a tumble and the economy fell into recession.

Policy Responses

Fiscal policy was highly expansionary through much of 2009. Public expenditure soared by 13 percent in real terms in the first three quarters of 2009 relative to 2008, reflecting large increases in public sector wages and pensions in the run-up to the elections. With revenues meanwhile falling by some 10 percent as a result of the recession, the budget deficit widened rapidly to 6¼ percent of GDP. While this politically motivated fiscal policy stance might have helped prop up weak domestic demand, it had several drawbacks. First, it soon ran into financing constraints. Heavy domestic borrowing sent interest rates in the shallow domestic T-bill market to 15–25 percent and exacerbated the credit crunch for the private sector. Only the special SDR allocation to all IMF members saved the government from recourse to the printing press or large-scale arrears. Second, spending hikes were neither temporary nor well targeted, leaving a legacy of sharply deteriorated public finances that would take many years to correct.

Monetary policy went from tight to accommodative. Initially the National Bank of Moldova resisted sustained exchange rate depreciation pressures, selling about one-third of its international reserves in the process. This led to a gradual depreciation of a cumulative 8 percent between end-August 2008 and end-April 2009. The central bank also sharply curtailed liquidity. Signs of deflation started to emerge. In response, the National Bank of Moldova changed course in mid-2009 and eased monetary policy through large reductions in its policy interest rates and by cutting reserve requirements in half. The exchange rate did not respond much. The policy changes also did little to ease the credit crunch, since apprehensive banks preferred to park the extra liquidity at the central bank or in the T-bill market.

A more coherent crisis response emerged in late 2009. The elections of July 2009 had brought a four-party center-right coalition to power, sending the communist party, which had dominated politics since the early 2000s, into opposition. Some correction of the current account deficit notwithstanding, the external financing gap was still large and international reserves had suffered. Public finances were on an unsustainable path and the recession showed no sign of abating. This prompted the new government to embark on an adjustment course and to seek financial assistance from the IMF.

Thus, the authorities postponed pre-election plans to increase public sector wages further in late 2009 and 2010, and revised the 2009 budget to bring the deficit in line with available financing. The National Bank of Moldova intervened in the foreign exchange market to replenish its stock of foreign reserves, allowing the exchange rate to depreciate by some 10 percent. The government also scrapped a number of export and import restrictions and simplified customs controls, licensing requirements, and procedures for business registration and liquidation.

In January 2010, the IMF approved a three-year arrangement with financial assistance of US$574 million to support the government’s stabilization and recovery program.1 The program rested on four pillars: (i) fiscal policies to restore sustainability while safeguarding public investment and social spending priorities; (ii) flexible monetary and exchange rate policies to keep inflation under control and facilitate adjustment to shocks; (iii) policies to ensure financial stability; and (iv) structural reforms to raise the economy’s potential.

Fiscal policy aimed to correct the structural imbalances at a pace matching the speed of the economic recovery, relying mainly on reform-based cuts in current expenditure. Key challenges included containing the wage bill—public sector wages were among the highest in the region relative to the economy’s ability to finance them—through consolidation in the public sector and deep structural reforms in the oversized education sector. On the other hand, the program included increased growth-supporting capital expenditure and an expanded social safety net to help mitigate the impact of the recession. On balance, the program envisaged a fiscal tightening of 7 percent of GDP in 2010 relative to the deficit that would have resulted from unchanged policies as of mid-2009.

Monetary policy faced the immediate challenges of breaking the credit crunch and preserving financial stability. Weak monetary transmission channels and the economy’s relatively high degree of dollarization limited the influence of policy measures at first. Despite large policy rate cuts, bank loan rates lingered at high levels, and credit growth remained sluggish until mid-2010. In an effort to buttress the impact of its policies, the National Bank of Moldova accelerated the transition to a monetary policy framework focused on inflation targets and a flexible exchange rate. Proactive supervision and regulation ensured that the commercial banks maintained sufficient capital and liquidity buffers. The program also sought to strengthen financial stability by enhancing the tools for early detection of bank difficulties and strengthening the legal framework for bank rehabilitation and resolution.

Structural reforms were aimed at supporting the fiscal effort, improving the business environment, and liberalizing markets to promote private enterprise and competition. A far-reaching tax administration reform focused on raising compliance and expanding the tax net to the informal sector. Early retirement would be phased out to ensure the sustainability of the social insurance system, and substantial reforms were planned to raise efficiency in public administration and the education system. Energy sector reforms sought to end losses among public enterprises in the regulated energy sector, mainly by depoliticizing tariff setting and entrenching cost recovery.

Economic Outcomes in 2009–11

A difficult international economic environment and the incoherent policy response made for poor economic performance in 2009. Real GDP fell by 6 percent while domestic demand suffered a much larger contraction of more than 18 percent. Credit declined by 7 percent. Prices remained flat over the course of the year. On the bright side, Moldova avoided a financial crisis—exchange rate depreciation remained contained and the banking system stayed stable.

From late 2009, growth returned sooner and with much more vigor than was expected when the adjustment package was put together. The credibility of the policy program and the improved international environment both contributed to this favorable outcome. A strong pickup in industrial production and external trade in late 2009 continued throughout 2010, supported by the rebuilding of business inventories, a recovery among the main trading partners, and the removal of many trade restrictions. A good harvest and rising international agricultural prices helped the export expansion as well. Consumer demand recovered robustly, as capital started flowing back into the country and inward remittances rose. All told, GDP growth reached an impressive 7.1 percent in 2010 and is estimated to have reached 6.4 percent in 2011.

Fiscal policy performed better than programmed. The budget deficits in both 2009 and 2010 were substantially lower than envisaged under the program on account of a robust revenue intake and expenditure restraint. By 2011 the fiscal deficit had been reduced below 2½ percent of GDP. At the same time, vulnerable households benefited from a large increase of funds for social assistance, allowing their guaranteed minimum income to rise by 23 percent in 2010. Enrollment in the new targeted social assistance program expanded steadily as well.

In January 2010, the National Bank of Moldova announced an inflation target of 5 percent with a narrow ±1 percent tolerance band. However, the revival of domestic demand and the pass-through from international energy and food price shocks kept headline inflation around 8 percent during 2010 and pushed it close to 9 percent in the second half of 2011. The National Bank of Moldova responded with interest rate hikes and tighter reserve requirements. This led to a stabilization of inflation in the autumn of 2011, paving the way for a gradual interest rate relaxation toward end-2011 in light of the subdued global economic outlook.

The exchange rate remained broadly flat in 2010, but fluctuations in foreign exchange inflows to the thin domestic market led to increased exchange rate volatility and required the occasional intervention of the central bank. Overall, however, the flexible exchange regime pursued by the National Bank of Moldova has allowed it to replenish its international reserves without compromising its inflation objective.

Banks’ financial standing has been steadily improving as well. Profits began to rise early in 2010. Nonperforming loans peaked at 18 percent of total loans in July 2010 but then fell to less than 11 percent at end-2011 as banks cleaned their balance sheets and new lending resumed. Credit growth reached some 20 percent in 2011 in nominal terms (and corrected for write-offs and valuation effects from exchange rate changes).

Through end-2011, the IMF-supported program remained broadly on track. It is set to expire in January 2013.

Challenges Ahead

The crisis has highlighted the limitations of Moldova’s growth model and its vulnerability to a boom-bust cycle rooted in its dependence on remittances and capital inflows. Remittances may well have peaked in 2007–08, since the earlier high rates of migration cannot be sustained going forward and migrants’ ties with their home country tend to weaken over time. Capital inflows are prone to sudden stops. The outflow of labor and the relatively subdued outlook for private investment limit medium-term potential GDP growth to an estimated 4½–5 percent under Moldova’s current policies, a modest rate relative to Moldova’s vast development needs and poverty reduction objectives.

To boost its long-term growth prospects, Moldova is well advised to develop a “second engine” of growth based on exports. For this purpose, it will be essential to:

  • Maintain macroeconomic stability centered on a sustainable fiscal policy and a flexible monetary policy focused on price stability. This will require significant consolidation and rationalization of the public sector, strengthening of the monetary framework, and deepening of financial markets.
  • Maintain external price competitiveness by keeping real wage growth in line with productivity gains and avoiding policies that could lead to large over-valuation.
  • Seek export expansion opportunities in EU markets in the context of the Association Agreement with the European Union, not least by striving to meet the European Union’s food safety requirements.
  • Lower the costs of doing business by cutting red tape, continuing market liberalization, and strengthening governance to attract private investment in the sectors producing tradable goods.
  • Upgrade the country’s long-neglected infrastructure. In this regard, Moldova has a golden opportunity to make substantial progress in light of the significant amount of international assistance that accompanies the IMF-supported program.
Moldova: Principal Economic and Financial Indicators, 2003–11
Real Sector Indicators
GDP (real growth in percent)−
Domestic demand (real growth in percent)17.12.616.810.49.45.5−
Net exports (real growth contribution in percent)−12.22.7−11.6−7.8−8.6−1.317.2−5.4−3.9
Exports of goods and services (real growth in percent)−12.113.728.6
CPI (end-of-period change in percent)15.712.510.
Employment (growth in percent)−9.9−3.00.2−4.7−0.80.3−5.3−3.5−1.5
Unemployment rate (percent)
Public Finances
Fiscal balance (percent of GDP)−0.2−1.0−6.3−2.5−2.4
Government revenue (percent of GDP)34.035.438.639.941.740.638.938.336.7
Government expenditure (percent of GDP)33.334.637.039.842.041.645.240.839.1
Government primary expenditure (percent of GDP)31.232.735.838.640.840.443.940.038.3
Government primary expenditure (real growth in percent)17.912.517.513.−2.31.8
Public debt (percent of GDP)54.642.834.831.024.619.329.126.523.4
Of which foreign held37.326.120.821.117.412.914.214.0
External Sector
Current account balance (percent of GDP)−6.6−1.8−7.6−11.3−15.2−16.2−8.6−8.3−10.6
Net capital inflows (percent of GDP)
Other investment4.4−−1.26.410.9
Exports (percent of GDP)53.351.050.344.845.541.136.839.445.0
Exports (US$, growth in percent)20.425.713.41.631.024.4−19.714.637.4
Global export market share (basis points)
Remittances (percent of GDP)7.78.513.217.719.117.311.710.510.0
Imports (percent of GDP)87.080.990.991.998.294.273.478.885.5
Imports (US$, growth in percent)−30.114.830.7
External debt (percent of GDP)86.665.160.963.663.355.265.567.367.0
Gross international reserves (US$ billions)
Gross international reserves (percent of GDP)15.318.120.022.830.327.627.230.529.5
Reserve coverage (GIR in percent of short-term debt)
Monetary Sector
Broad money (end of period, growth in percent)30.737.735.023.639.815.93.213.410.6
Monetary base (end of period, growth in percent)16.639.841.3−1.759.325.6−12.58.921.8
Private sector credit (end of period, percent of GDP)20.321.223.627.536.836.436.033.333.6
Of which foreign currency denominated9.310.916.
Of which foreign currency indexed
Cross-border loans to nonbanks (Q4, percent of GDP)
Private sector credit (end of period, real growth in percent)25.37.818.821.341.68.5−
Financial Sector
Assets (percent of GDP)33.938.545.148.857.159.366.258.957.2
ROA (percent)−
ROE (percent)15.420.524.019.9−2.52.611.5
CAR (percent of risk-weighted assets)27.227.829.
NPLs (percent of total loans)
Loan-to-deposit ratio
Cross-border claims by foreign banks (all sectors, percent of GDP)
Financial Markets
Interest rates (end of period, one-year government bond, percent)
CDS spreads (sovereign, end of period, basis points)
EMBIG spread (sovereign, end of period, basis points)
Exchange rate (end of period, domestic currency/US$)13.212.512.812.911.310.412.312.211.7
NEER (index, 2003 = 100)100.0106.5102.297.197.8110.5116.3105.4108.7
REER (CPI-based, 2003 = 100)100.0114.5117.2120.5130.7155.7158.7149.1157.9
REER (ULC-based, 2003 = 100)
Memorandum Items
GDP (nominal, in billions of domestic currency)283238455363607282
GDP (nominal, in billions of US$)
Source: IMF staff.Note: CAR = capital adequacy ratio; CDS = credit default swap; CPI = consumer price index; EMBIG = Emerging Markets Bond Index Global; FDI = foreign direct investment; GIR = gross international reserves; NEER = nominal effective exchange rate; NPLs = nonperforming loans; REER = real effective exchange rate; ROA = return on assets; ROE = return on equity; ULC = unit labor cost.

Financial and capital account balances excluding EU balance-of-payments support, use of IMF resources, and SDR allocations.

Source: IMF staff.Note: CAR = capital adequacy ratio; CDS = credit default swap; CPI = consumer price index; EMBIG = Emerging Markets Bond Index Global; FDI = foreign direct investment; GIR = gross international reserves; NEER = nominal effective exchange rate; NPLs = nonperforming loans; REER = real effective exchange rate; ROA = return on assets; ROE = return on equity; ULC = unit labor cost.

Financial and capital account balances excluding EU balance-of-payments support, use of IMF resources, and SDR allocations.

The main author of this chapter is Gabriel Srour.


The program is a fifty-fifty blend of arrangements under the Extended Credit Facility and the Extended Fund Facility.

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