Republic of Moldova: Recent Economic Developments
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International Monetary Fund
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Publication Date:
25 Jan 2001
eISBN:
9781451824957
Language:
English
Keywords:
ISCR; CR; Moldova; public spending; debt; debt indicator; U.S. dollar; gross domestic product; rate of return; monetary policy; Imports; Exports; Arrears; Tariffs
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This paper analyzes the recent economic developments in Moldova by reviewing the real, fiscal, and external sectors developments; money banking; and structural policies. The study provides a statistical analysis on the composition of fiscal adjustments in the country, and describes the recent trends in social spending and social indicators in Moldova and in other transition economies in the 1990s, the methodology for estimating efficiency in public spending on education and health care, and assesses the current account determination in the country.

Abstract

This paper analyzes the recent economic developments in Moldova by reviewing the real, fiscal, and external sectors developments; money banking; and structural policies. The study provides a statistical analysis on the composition of fiscal adjustments in the country, and describes the recent trends in social spending and social indicators in Moldova and in other transition economies in the 1990s, the methodology for estimating efficiency in public spending on education and health care, and assesses the current account determination in the country.

II. Recent Economic Developments

A. Real Sector Developments

Output and demand

7. Real GDP1 is estimated to have fallen on average by around 10 percent per year since 1991, bringing the cumulative decline to about 60 percent by 2000 (Figure 1). The declines in 1998 and 1999 reflected a collapse in exports following the Russian crisis in August 1998, as well as a slump in domestic demand (Table 1). In 2000, the economy again faced external shocks; this time in the form of a drought and rising energy prices. On balance, real GDP is expected to remain flat in 2000, or grow marginally at most, reflecting a drop in agricultural output but a recovery in industrial production.

Figure 1.
Figure 1.

Moldova: Output Indicators, 1992-1999

Citation: IMF Staff Country Reports 2001, 022; 10.5089/9781451824957.002.A002

Source: Moldovan Department of Statistics; and Fund staff estimates.
Table 1.

Gross Domestic Product, 1993-2000

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Source: Moldovan Department for Statistical and Sociological Research; and Fund staff estimates.

8. On the demand side, rough estimates of GDP by expenditure indicate a drop in the share of final consumption by around 6 percent of GDP in 1999, reflecting a dramatic fiscal correction and a deterioration of the purchasing power of the population. Gross capital formation also declined in 1999 by 3 percent of GDP. The external resource imbalance was drastically reduced in 1999 to nearly 10 percent of GDP, reflecting a major drop in imports (by over 40 percent) that outweighed a further decline in exports. (Appendix Table 29). In the first half of 2000, with incomes augmented by large worker remittances, final consumption increased by over 10 percent of GDP while gross capital formation dropped by 8 percent of GDP, as compared to the same period last year. The trade balance worsened in the first half of 2000; the recovery in imports was stronger than that in exports, with the latter recovering only slowly because of the drought.

9. On the supply side, agricultural production declined by 8 percent in 1999 relative to 1998. This reflected a 10 percent decline in crops and a 3 percent decrease in livestock. The former was mainly due to a drop in the production of grain, sugar beets, and fruits (Appendix Tables 30 and 31), while the latter was mainly concentrated in pig and sheep production (Appendix Table 32). Industrial production fell further by 12 percent in 1999, mainly during the first half of the year, while the second half saw a modest recovery (Appendix Tables 33 and 34). The decline was severe in the heavy industry sector, while output in light industry grew. The food processing sector continued to experience the impact of the Russian crisis, while incomplete reforms continued to limit export potential to non-CIS markets. In the first half of 2000, agricultural production fell further by 4 percent over the same period in 1999, while total industrial production increased by 8 percent.

Impact of Drought on GDP

10. In May-June 2000 Moldova experienced a severe drought; precipitation amounted to only 30 percent of the usual level for the period. Since the agricultural sector accounts for one quarter of GDP, and agro-processing is the dominant part of the country’s industry, the drought is expected to reduce real output of the Moldovan economy. Our estimate of the impact on GDP growth is based on the information from surveys of agricultural farm enterprises conducted for the drought assessment project financed by USAID, as well as available GDP data for the first half of 2000.

11. Two surveys were carried out: one shortly after the drought in July, and the second in late August when most of the harvest had just been completed. At the time of the second survey expectations were generally more optimistic than before the harvest; farmers reported a higher estimated annual crop output than initially. In order to estimate the impact of the drought on GDP growth, the 1999 actual output and 2000 expected output reported in Table 2 were weighted by 1999 unit prices. The resulting drop in agricultural output was estimated to be 3.7 percent. The impact on the agro-processing sector is assumed to be one-to-one,2 resulting in an adverse impact on real GDP of about 1½ percentage points. An 8 percent growth rate is assumed for industries other than agro-processing and activity in the service sector is assumed to be unchanged in real terms, in line with developments during the first six months. With these assumptions, overall GDP is projected to remain flat in 2000, although some growth would be inside the margin of error.

Table 2.

Output of Principal Agricultural Crops Across Surveyed Farms

(in thousand tons)

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Source: “Assessment of the Negative Impact of the 2000 Drought in the Republic of Moldova”, Center for Strategic Studies and Reforms, and Center for Private Business Reform, September 2000

Labor markets

12. Official labor statistics are not regarded as particularly reliable. Unemployed workers were officially recorded at 34,900 at end-1999, or less than 2 percent of the civilian work force (Appendix Table 35). By July 1, 2000 the number of unemployed decreased to 33,200, which was near the level of mid-1998. However, in 1999 a new labor force study according to ILO methodology produced an unemployment rate of 11.1 percent. This number may still understate unemployment, as unpaid leave (officially about 140,000), and part-time employment (officially 28,000), compounded by payments difficulties (arrears and payments-in-kind) constitute a well documented and widespread phenomenon.

13. Agriculture continues to be the largest employer (in reporting enterprises of 20 or more workers), at over 30 percent of total employment, followed by education and manufacturing at 16 percent and 13 percent, respectively. Employment appears to be shifting to the informal sector (and/or small businesses), though, as overall employment reported has declined by over 30 percent since 1995 (Table 3).

Table 3.

Employment by Sector, 1995-99

(in thousand)

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Source; Data provided by the Moldovan authorities.

Wages and Prices

14. Official economy-wide wage data indicate an average monthly wage in 1999 of MdI 305, or US$29, down from US$47 in the previous year as a result of the depreciation of the leu. The trend to widened wage differentials continued in 1999, with wages in the financial sector averaging more than 3 times the level in the next highest industry group (Appendix Table 36). The lowest wages were recorded in forestry (around US$16/month), with wages in the health and education sectors the next lowest (around US$18/month). The average monthly wage in the first five months of 2000 reached MdI 351, remaining roughly stable in dollar terms.

15. Reflecting a disciplined monetary policy, inflation had been on a steady downward path since the introduction of the leu in 1993 until the Russian crisis in August 1998 (Appendix Table 37). However, since then inflation picked up, reaching 39.3 percent (average CPI) in 1999. Prices for food, non-food, and services rose by 33 percent, 38 percent and 63 percent, respectively. The much sharper rise in the price of services reflected adjustments in tariffs for energy and utilities and telecom tariffs. In the first ten months of 2000 prices rose by 16 percent, which is 12 percentage points less than during the same period a year earlier.

B. Fiscal Sector Developments

Background

16. Between 1995 and 1998, Moldova’s overall fiscal position severely deteriorated (Table 4 and Figure 2). The fiscal deficit4 on a commitment basis was very high; 7.7 percent of GDP in 1995, oscillating between 11.2 percent of GDP in 1996 and 6.4 percent of GDP in 1997, and reached 10.6 percent of GDP in 1998. The cash deficit fell slightly from 5.8 percent of GDP to 5.7 percent of GDP in the same period, mostly because of nonpayment of expenditure obligations that led to an increase in the stock of arrears on pensions and wages. The stock of those arrears increased markedly from 7.9 percent of GDP in 1995 to 10.6 percent of GDP in 1998.

Figure 2.
Figure 2.

Moldova: General Government Budget Position and Financing, 1995-2000

(In percent of GDP)

Citation: IMF Staff Country Reports 2001, 022; 10.5089/9781451824957.002.A002

Source: Data provided by authorities; and Fund staff estimates and projections.
Table 4.

General Government Budget, 1995-2000

(In percent of GDP)

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Sources: Moldovan authorities; and Fund staff estimates.

First two quarters.

17. Total revenues fluctuated between less than 32 percent of GDP (in 1996) and 34 percent of GDP (in both 1995 and 1997). In 1997, in particular, positive economic growth widened the size of the tax base, thereby increasing total revenue collection. However, over all, collection enforcement remained poor and the stock of tax arrears increased steadily to 14.3 percent of GDP in 1998 (from 10.9 percent of GDP in 1995). Expenditures, on a cash basis, oscillated in the same period around 40 percent of GDP while, on a commitment basis, expenditures fluctuated around 42 percent of GDP. Only in 1997, did the ratio of public outlays to GDP fall significantly (to slightly more than 40 percent). As collection improved, higher revenues were partially used to clear previously accumulated domestic expenditure arrears equal to 2.9 percent of GDP.

18. In the period 1995-97, the bulk of financing requirements was met by external sources, varying between 5.1 percent of GDP in 1996 and 2.9 percent of GDP in 1997. Domestic financing obtained by sales of treasury bills to both commercial banks and nonbank institutions increased steadily from 1995 to 1997, when it reached 2.7 percent of GDP. In 1998, both external financing and financing from commercial banks and nonbank institutions turned negative and reliance on central bank financing increased markedly to 7.9 percent of GDP, up from 1.4 percent of GDP in 1997. Finally, privatization receipts have contributed to the financing of the deficit since 1996, reaching a high point (2.4 percent of GDP) in 1997.

Overall Fiscal Performance in 1999 and in the first three quarters of 2000

19. In 1999 Moldova achieved an impressive and unprecedented reduction in the fiscal deficit, largely through a sizeable rationalization of public spending. The fiscal balance on a commitment basis improved by nearly 5 percent of GDP compared to 1998, reaching 5.3 percent of GDP. The cash deficit declined to 5.4 percent of GDP, down from 5.7 percent of GDP in 1998. The upward trend in expenditure arrears was sharply reversed, as a result of the authorities’ commitment to clear the stock of arrears on pensions and wages. The stock of domestic arrears fell to 8.1 percent of GDP, down from above 10 percent in 1998. Underlying this achievement was the streamlining of expenditure commitments by more than 12 percent of GDP. The bulk of the reduction was concentrated in the bloated health care and education sectors and in public sector employment (see also Chapters III and IV).

20. In the first three quarters of 2000 fiscal policy remained tight as a consequence of the lack of external financing and the negative economic impact of the drought. Total revenues were in line with the 2000 budget, largely as a result of higher than expected transfers of profits from the central bank. Both commitment and cash expenditures were necessarily compressed given the absence of foreign financing. Priority was given to the payment of around MdI 147 million of arrears on pensions and wages, to debt service obligations and to the planned increase in public sector wages, especially in the social sector.

21. In 1999, deficit financing came primarily from central bank credit to the government and World Bank loans. Around 30 percent of total financing was met by central bank credits in the amount of 1.6 percent of GDP. Other domestic financing was slightly negative (-0.3 percent of GDP) in 1999. Net foreign financing turned positive as well, as opposed to 1998, and contributed to the deficit financing by 3.1 percent of GDP. Privatization receipts in the amount of 1 percent of GDP were used to fill the remaining financing gap.

22. In the first three quarters of 2000, as no external financing was available, the budget deficit was financed mainly by privatization receipts and the issuance of treasury bills to banks. This allowed the net repayment of central bank credits to the government in the amount of 1.7 percent of annualized GDP.

Revenues

23. In 1999, total revenues of the general government decreased markedly compared to 1998. As a share of GDP, revenues declined by nearly 6 percent to 27.3 percent, down from 33.1 percent in 1998. Tax revenues fell from 28.3 percent of GDP in 1998 to 22.2 percent of GDP in the following year. This fall in revenue was primarily due to a large reduction in netting operations, which were not compensated by a rise in cash collection; tax offsets fell from 6.7 percent of GDP in 1998 to 2.3 percent of GDP in 1999 (or from 23.5 percent to 10.2 percent as a share of total tax revenues). Excluding these netting operations, tax revenues still fell by 1.7 percent of GDP relative to 1998, as a consequence of mixed tax collection performance and a relatively sharper drop in income related revenues (social fund contributions and VAT). The stock of tax arrears went up to MdI 1.5 billion, but its share on GDP declined from 14.3 percent in 1998 to 12.5 percent in 1999.

24. In 1999, the bulk of the reduction in tax revenues came primarily from indirect taxes which reached 10.1 percent of GDP, down from 14.5 percent of GDP in 1998 (Appendix Table 39). VAT revenues fell to 6.9 percent of GDP, down from 10.8 percent of GDP in 1998. Social fund contributions showed a marked decline as well, from 7.6 percent of GDP in 1998 to 5.7 percent of GDP in 1999. However, foreign trade taxes increased from 1.1 percent of GDP to 1.7 percent of GDP despite the compression in imports, as a result of improvements in collection.5

25. Nontax revenues and grants increased from 4.8 percent of GDP in 1998 to 5.1 percent of GDP, as MdI 112 million in grants were available in 1999. However, excluding grants, nontax revenues fell to 4.3 percent of GDP. The decrease in nontax revenues is primarily a consequence of the decline, relative to 1998, in central bank profits transferred to the general government budget.

Expenditures

26. On a cash basis, expenditures fell to 32.7 percent of GDP in 1999, down from 38.7 percent in 1998. However, on a commitment basis, expenditure declined more rapidly from 43.7 percent of GDP to 32.6 percent of GDP. This reduction in public spending was achieved primarily through the curtailment in current expenditures, including a rationalization of energy consumption by budgetary institutions, the implementation of structural reforms for local governments, and the elimination of excess capacity in the health and education sectors.6 Capital spending was also streamlined with the elimination of non-priority projects. As a share of GDP, capital expenditures fell from 2 percent in 1998 to 0.8 percent in 1999 and the public outlays associated to World Bank project loans increased to 2.7 percent of GDP, up from 2.0 percent of GDP. See also Appendix Table 40.

27. Rationalization of social spending brought Moldova’s share of GDP devoted to health care and education in line with the world average and with the rest of transition countries. Education spending (on a cash basis) reached 4.2 percent of GDP, down from 6.1 percent of GDP in 1998. Health care expenditures (also on a cash basis) declined from 3.8 percent of GDP in 1998 to 2.4 percent of GDP in 1999. Excess capacity in the social sector was reduced by closing over 60 underutilized local hospitals, streamlining public employment by 12,500 in education and 5,000 in the health sector (mainly at the local level), increasing the average number of students per class to 24, raising pre-school fees in order to recover 50 percent of the cost of food, and introducing accommodation fees for both graduate and post-graduate students.

28. Public sector wages that had remained frozen in nominal terms in the period 1995-99 were increased by an average 30 percent during 2000, especially in the social sector. In 1999, total public employment was reduced by more than 10 percent compared to 1998, thereby contributing to the overall reduction in expenditure commitments. A partial hiring freeze has been introduced, which allows to hire only one civil servant for each two that retire or leave. The reduction in the wage bill brought a decline in the public expenditure categories not related to the social sphere. The only expenditure item that increased markedly is interest spending; this reached 6.6 percent of GDP in 1999, up from 4.1 percent of GDP in 1998. Moreover, the composition of interest spending changed over time. The share of expenditures for foreign interests rose to 52 percent of the total, up from 41 percent in 1998 as a result of the depreciation of the leu.

29. Several institutional reforms aimed at rationalizing public sector operations and strengthening intergovernmental fiscal relationships have been implemented since 1998. The Law on the Administrative and Territorial Reform reduced the number of sub-national government levels to 11 regions, from the existing 38 rayons, eliminating overlapping functions and helping to streamline public sector employment and reducing the size of the wage bill. In 1999, the Law on Local Public Finance assigned expenditure functions and revenue sources to the new regional and local governments, increasing the degree of decentralization and autonomy with a view to enhance the degree of efficiency of public spending and to reduce regional inequalities.

Social Fund Operations

30. The Social Fund remained an area of concern for the consolidated budget during 1999 and in the first half of 2000. Despite the reform of the pay-as-you-go pension system and the replacement of the many existing compensation and privilege schemes with a better targeted subsidy scheme for energy consumption in collaboration with the World Bank, the state budget transfers to the Social Fund were still very large. In 1999 slightly less than half of the cash deficit of the consolidated budget or 0.9 percent of GDP was transferred to the Social Fund to pay for social assistance benefits (including energy compensations). In the first half of 2000, the state budget transfers rose to 1.3 percent of GDP, the same level of 1998 (Table 5 and Figure 3).

Table 5.

Social Fund Operations, 1995-2000

(In percent of GDP)

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Sources: Moldovan authorities; and Fund staff calculations.

Includes fines and penalties.

First two quarters.

Figure 3.
Figure 3.

Moldova: Social Fund Budget Position, 1995-2000

(In percent of GDP)

Citation: IMF Staff Country Reports 2001, 022; 10.5089/9781451824957.002.A002

Sources: Moldovan authorities; and Fund staff estimates.

31. In 1999 overall Social Fund revenues, including transfers from the State budget, fell dramatically compared with 1998. As a share of GDP, Social Fund revenues reached 6.6 percent in 1999, down from 9.1 percent in 1998 (a relative decline of 26 percent) and declined in the first half of 2000. The decrease in revenues was caused by a reduction in both social contributions and state budget transfers. The former fell from 7.7 percent of GDP in 1998 to 5.7 percent of GDP in 1999. The latter reached 0.9 percent of GDP in 1999, down from 1.4 percent of GDP in 1998. Lower social contribution collection was due, in part, to the reduction of in-kind collection which fell from 2.9 percent of GDP in 1998 (31.8 percent of total revenues) to 1.6 percent of GDP in 1999 (24 percent of total revenues), in line with the aim of their complete elimination in 2001.

32. In 1999 Social Fund expenditures (including pensions, family allowances, unemployment benefits and other minor social assistance benefits and subsidies) were still the second largest expenditure category in the general government budget, accounting for slightly less than one quarter of the total. Almost 85 percent of total Social Fund expenditure is accounted for by pensions. On a cash basis, Social Fund expenditures fell by 2.3 percent of GDP in 1999, to 6.5 percent of GDP and reached 6.2 percent of GDP in the first half of 2000. This trend primarily reflects the freeze in the nominal value of pensions and the slight decline in the number of beneficiaries of social insurance. On a commitment basis, however, expenditures fell from 9.7 percent of GDP in 1998 to 6.7 percent of GDP in 1999 and continued to decline to 5.4 percent of GDP in the first half of 2000. As a consequence, the stock of arrears of the Social Fund reached 1.5 percent of GDP in the first half of 2000, down from 2.7 percent of GDP in 1998 and 2.3 percent of GDP in 1999.

C. Money and Banking

Monetary policy and developments

33. Monetary policy faced a difficult challenge in 1999. It needed to find the right balance between containing inflation and restoring confidence in the leu in the aftermath of Russian financial crisis of August 1998 on the one hand, and accommodating the impact of this large external shock to prevent an all-too-dramatic output loss on the other. This task was further complicated by recurrent domestic political tensions, as well the need to service the country’s large external debt obligations.

34. The results for 1999 were mixed; reserve money as well as broad money (M3) grew by over 40 percent in 1999 (Table 6 and Appendix Tables 41 and 42), twelve-month inflation accelerated to 44 percent by year-end and the exchange of the leu vis-à-vis the U.S. dollar depreciated by 40 percent. Figure 4 underscores the close relationship between money and inflation in Moldova.

Table 6.

Moldova: Key Monetary Indicators, 1995-2000

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Sources: National Bank of Moldova; and Fund staff estimates.
Figure 4.
Figure 4.

Moldova: Inflation and Base Money Growth, 1994-2000

(Six-Month Growth Rates)

Citation: IMF Staff Country Reports 2001, 022; 10.5089/9781451824957.002.A002

Sources: Moldovan authorities; and Fund staff estimates.

35. Half of the increase in reserve money in 1999 stemmed from central bank credit to the government. This reflected a burst in credit to the government in April and again in December, with the latter used to finance external debt obligations. In the second half of 1999, large inflows of foreign exchange allowed the NBM to start rebuilding its stock of international reserves, which had fallen sharply in the months following the Russian crisis. Reserves increased to US$181 million by end-1999, up from US$143 million at end-1998. The NBM, however, did not fully sterilize these inflows through open market operations, partly out of concern that this would reverse the downward trend in interest rates in the treasury bill market (see below).

36. Within the overall context of continued economic and, even more so, political uncertainty, the public’s demand for domestic money (M2) did not recover in 1999, although it did stabilize. Demand for overall broad money (M3), however, did almost return to its pre-crises level, indicating a further dollarization in 1999. The dollarization of the economy, and of the banking sector in particular, had deepened considerably following the Russian crises. The share of foreign currency deposits in M3 increased further to almost 30 percent by mid-1999 (compared to levels of around 10 percent in early 1998), about equal to the share of deposits denominated in lei.

37. Monetary policy was successfully tightened in the first half of 2000, however; reserve money grew by less than 8 percent during this period, and broad money by 11 percent. As a result, the rate of depreciation of the exchange rate slowed down and the rate stabilized in the second quarter. Money demand increased markedly in the third quarter. Strong foreign exchange inflows caused the leu exchange rate to appreciate. The NBM chose to absorb this excess supply of foreign exchange to accommodate the strong demand for lei balances and lei credits. As a result, base money grew by 9 percent in the third quarter and M2 by 15 percent. Central bank credit to the government declined in the first nine months of 2000, as the government was able to repay some loans extended in 1999. The strong foreign exchange inflows allowed the NBM to further rebuild its stock of international reserves to US$190 million by end-September 2000, despite large debt service obligations.

38. Throughout much of 1999, credit developments also reflected the depressed state of the economy, as well as the banks’ general reluctance to lend. Bank lending to enterprises and individuals fell by 7 percent in 1999, which in real terms implied a one-third drop. Credit expanded by 17 percent in the first nine months of 2000, however, slightly higher than the rate of inflation. This first increase in real credit since 1996 appears to signal a turnaround in economic activity. Foreign currency denominated loans accounted for almost half of the banks’ credit portfolios by mid-2000 (compared to about 20 percent before the Russian crisis). Banks did gradually return to the market for Treasury bills, however, which they had left in 1998. This took place notably in the second half of 1999 and the first of half of 2000 when the liquidity position of banks improved steadily, partly associated with the increase in minimum capital requirements that brought in new funding.

39. Interest rates on treasury bills, which had risen sharply in 1998, remained at around 50 percent for 3-month bills throughout the first half of 1999, reflecting weak demand for these titles as well as higher inflation. As demand for treasury bills improved slowly but steadily in the summer; interest rates fell to around 20 percent at the end of the third quarter (well below the twelve-month rate of inflation). Demand for maturities longer than three months remained virtually non-existent, however. Interest rates on government securities rebounded to close to 30 percent at year-end in response to the political crisis in November, but they resumed their downward trend in 2000 in response to a period of relative economic and political calm. By end-September, interest rates on three-month Treasury bills had again fallen to around 20 percent. The NBM base lending rate generally followed market developments, but rate adjustments have been much less pronounced.

40. Commercial bank lending rates moved much less than the interest rates on government securities; they had risen less sharply in 1998 and came down much slower in 1999/2000. Rates for three-month loans had gone up to close to 40 percent in early 1999, compared to levels of around 30 percent in early 1998, and they gradually declined to around 30-35 percent in late 1999. Apparently, commercial banks adjusted volumes more than prices in response to economic developments. Another factor might have been that bank lending rates are more closely linked to the NBM base rate than to interest rate developments in the market for government securities. Lending rates suggest a considerable risk premium when compared to government securities, even for such short maturities as three-months, reflecting high credit risks. Still, in real terms, when measured by discounting nominal rates by twelve-month inflation rates, lending rates did not appear excessively high in 1999 and early 2000. For part of this period, real rates even have been negative.

41. With the gradual revival of the market for government securities, the NBM was able to increase its use of market-based tools to manage bank liquidity. Excess liquidity was (partially) mopped-up through repo operations and outright sales of Treasury bills to banks. Reserve requirements, which had been tightened following the Russian crisis, remained at 15 percent, with at least 13 percentage points of the required reserves to be held continuously in a separate account (instead of on banks’ correspondent accounts), while cash in vaults can be counted towards the residual. In September 2000, however, banks were again permitted to hold required reserves in their correspondent accounts, with reserve averaging allowed. In addition, the rate of remuneration was gradually increased to reach 90 percent of the NBM’s base rate in early 2000 and further to 100 percent of the base rate in September 2000 to reduce the burden imposed on banks. The additional liquidity requirement to hold 10 percent of a bank’s assets in government securities, which had been introduced in December 1998, was reduced to 5 percent in March 1999 and abolished in February 2000. Hardly any use was made in 1999 and 2000 of the Lombard facility.

Banking system developments

42. Moldova’s banking sector is relatively small and underdeveloped. Total banking sector assets amounted to somewhat over 20 percent of GDP in mid-2000 and total loans only to about 10 percent of GDP. In addition, while the sector is dominated by a few larger banks (the largest five banks account for two thirds of total banking sector assets), each bank as such is small; in mid-2000, total assets of the five largest banks were on average equivalent to about US$ 40 million per bank.

43. The NBM, in 1999 and 2000, continued its policy of steadily increasing the minimum capital requirements to stimulate banking sector consolidation, i.e., to establish a smaller number of bigger banks that would be able to compete and invest in building the institutional capacity and infrastructure to effectively support private sector development. The minimum capital requirement for banks with a general license (C) was raised from MdI 24 million at end-1998 to MdI 36 million as of end-June 1999, and further to MdI 48 million as of end-December 1999 and MdI 72 million as of end-June 2000 (about Euro 6 million)7. As of end-December 2000, banks with a general license must have a minimum capital of MdI 96 million (minimum capital requirements for banks with the lowest license level (A) are one-third of the requirement for banks with a general license). At end-June 2000, total banking sector capital amounted to about US$98 million, roughly US$4½ million on average per bank.

44. The impact of the 199S Russian crisis continued to be felt by the banks throughout most of 1999 and resulted in more banks being deemed problem banks. In early 1999, 14 out of a total of 22 commercial banks had been assigned to the NBM’s Bank Resolution Unit (BRU), compared to 10 out of 22 banks a year before.8 During 1999, the NBM withdrew the licenses of three commercial banks (eight in total so far). In mid-2000, the banking sector consisted of 21 banks. Of these, 12 were still assigned to the BRU, with total assets accounting for about 40 percent of total banking sector assets. At that time, only 4 banks had a CAMEL rating of 4 or 5, though, together accounting for 4 percent of total banking sector assets.

45. Somewhat paradoxically, according to official figures, the risk-weighted capital adequacy ratio is well over 40 percent, compared to a minimum required ratio of 12 (raised from 10 as of end-1999), suggesting a very healthy banking system. However, because of the required levels for the amount of regulatory capital and the effect of risk-weighting of bank assets in accordance with the Basle Capital Accord and NBM regulations based on that, the capital adequacy ratio currently has less meaning. What is does signal, is that bank lending in Moldova is at very low levels, given the size of commercial banks’ capital. Two interrelated factors are at play:

  • A lack of attractive investment opportunities. This is reflected also by the low average real rate of return on banks’ loan portfolios. According to the banks’ income statements, in 1999, the average rate of return (interest plus commission) on credits was close to 24 percent. Taking into account that about half of the loans are in foreign currencies and the interest rate on dollar denominated loans was around 12 percent, the average rate of return on leu denominated loans was roughly equal to the rate of inflation.

  • A general reluctance of banks to lend. Apart from the low real rates of return on loans, this is caused by deficiencies in the legal and institutional framework; property rights and contract obligations are not easily enforceable, and the necessary infrastructure to facilitate credit risk management, such as registers of mortgages and pledged movable property, are still under development, adding to the cost of banking.

D. External Sector

46. Moldova’s external position deteriorated dramatically during 1998, due to the trade impact of the Russian crisis, and the current account deficit widened to 16.7 percent of GDP. This was partially reversed in 1999 when the the current account deficit decreased to 2.6 percent of GDP, as in addition to a further decline in exports, imports fell sharply as well. The current account deficit started to widen again in early 2000, with imports recovering in line with incomes, while exports remained sluggish due to the effects of the drought. By end-1999, the level of gross official reserves had recovered to the equivalent of three month of imports of goods and non-factor services. Moldova’s overall external performance has deteriorated during the last few years. Several factors help explain this: (i) the high dependency of Moldova’s exports on BRO markets, which made the impact of the 1998 Russian crisis particularly severe; (ii) adverse terms of trade shocks combined with Moldova’s high dependence on energy imports; (iii) repeated instances of poor weather conditions, the most recent in 2000, which directly affected agricultural export performance.

47. The stock of public and publicly guaranteed debt increased to 72 percent of GDP by the end of 1999. Moreover, given the high dependence on energy imports, especially from Russia, Moldova accumulated external payment arrears on imported energy supplies during 1994-99. At the end of 1999, the stock of energy arrears was estimated at US$416 million (or 32 percent of GDP).

Balance of payments

48. In 1999, Moldova experienced a dramatic correction of its current account balance. The current account deficit, which had deteriorated dramatically to US$323 million in 1998, due to the 1998 Russian crisis, shrunk to US$34 million in 1999. This correction was both large and traumatic. With the collapse of Moldova’s export markets, exports fell by a further 27 percent; exports, largely of wine, spirits and agricultural goods, to the main trading partners in the BRO (Russia, Ukraine, and Belarus) contracted by 45 percent. The associated drop in incomes, combined with the depreciation of the leu and the large fiscal adjustment caused imports, including energy, to decrease dramatically in 1999, by 41 percent (see Appendix Table 43).

49. Preliminary data for 2000 indicate a widening of the current account deficit to about 8 percent of GDP, largely due to higher imports, which started to recover in line with incomes. Exports remained more sluggish due, in part, to the effects of the drought and to some import restrictions imposed by Romania (the second main export market after Russia). In the first nine months, exports increased only by 5.1 percent over the same period in 1999, while imports increased by 34 percent. Other major developments in imports during the first three quarters of 2000 are: (i) a significant increase of imports of capital goods (31 percent in dollar terms with respect to the same period in 1999); (ii) a significant decrease of imports from Russia by 35 percent in nominal terms over the same period in 1999.

50. The depressed economic environment also impacted on the capital account balance. In 1999, partly due to the stalled privatization process, the level of foreign direct investment reached a low of US$34 million (2.6 percent of GDP). Large capital outflows took place in the form of debt amortization (US$107 million) and short-term capital flight (US$133 million) (see Table 7). These outflows were, however, partially offset by larger disbursements of medium and long term loans (US$197 million), in particular from the World Bank and the EBRD. In 1999, Moldova was also able to buy back, at a deep discount, US$140 million in bonds previously issued to Gazprom.

Table 7.

Moldova: Financing of Current Account Deficit and Amortization, 1995-99

(In millions of U.S. dollars)

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Sources: National Bank of Moldova; and Fund staff estimates.

51. In 2000, the capital account showed an increase in foreign direct investments to US$ 143 million (10 percent of GDP), but this was partially the result of the sale of the majority share of Moldovagas to Gazprom by the government (equal to US$ 47 million) to clear energy arrears (see Table 8). Moreover, three out of five electricity distribution companies were sold to a strategic investor. However, neither of these transactions resulted directly in capital formation in Moldova.

Table 8.

Moldova: Quarterly Balance of Payments 1997-2000

(In millions of U.S. dollars; unless otherwise indicated)

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Source: National Bank of Moldova; and Fund staff estimates

52. Direction of trade statistics indicate that Moldova has yet to start the process of reorienting its exports away from BRO countries towards new markets, especially those in the EU and Eastern Europe. In the last three years, exports to non-BRO markets have remained fairly stable in dollar terms (although they increased in percent of total exports, reflecting the collapse of exports to BRO markets) (see Table 9). Moldova, therefore, remains highly vulnerable to fluctuations in BRO external demand.9

Table 9.

Direction of Trade, 1994-99

(In percent of total)

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Sources: Moldovan Department for Statistical and Sociological Research.

53. Moldova’s principal exports are agricultural products, in particular wine and tobacco. However, some progress in export diversification away from agricultural products toward manufactured goods, especially textiles, has been made in the last three years. In 1997, the share of agricultural exports was 55 percent of the total; in 1999 it dropped to 42.5 percent (Appendix Table 44). Over the same period, textile exports, as a share of total exports, increased from 6.7 percent to 14 percent.

54. Import composition in Moldova is heavily biased toward energy products. Heavy dependence on energy imports (in particular natural gas, electricity and oil), which represented 38 percent of Moldova’s imports in 1999 in dollar terms, has been the Achilles’ heel of the country’s external sector. The trend in recent years to increase imports of capital equipment and machinery up from 9.8 percent of the total imports in 1994 to 19.1 percent in 1998 in order to update manufacturing capabilities, was temporarily reversed in 1999, when the share dropped to 12 percent of total imports (see Appendix Table 44).10 The main countries of origin of imports are still the BRO countries who were responsible for 40 percent of Moldova’s imports in 1999. However, the share of Moldova’s non-BRO imports has increased since 1997: in particular the EU share has increased from 19 percent in 1997 to 27.5 percent in 1999, while that of Eastern Europe has increased from 20 percent in 1997 to 25 percent in 1999.

Trade regime

55. Moldova has a liberal trade regime, rated 1 on the Fund staff’s ten point index of trade restrictiveness (with a higher score indicating a less open regime). Moldova moved rapidly to liberalize its trade regime in the mid-1990s. By late 1995, it had eliminated all import and export quotas and export taxes and had reduced tariff rates dispersion. Trade liberalization was an integral part of the Fund supported EFF program (EBS/96/68). In 1996, the simple average tariff rate was 6.3 percent (Table 10). However, some restrictive measures (principally an increase in the tariff rate on capital goods and industrial inputs from zero to 20 percent) raised the simple average to 11.6 percent in 1997. Moreover, exports of unbottled wine, cereals, sunflowers seeds and non-fermented tobacco were temporarily restricted in October 1997. These restrictive trade measures were eliminated in 1998. Efforts toward further trade liberalization continued in 1999, when Moldova decreased the maximum tariff rate from 50 percent to 15 percent. The 1999 tariff structure featured three bands (5, 10 and 15 percent) and the simple average tariff rate equaled 8.6 percent.11 A temporary minimum tariff of 5 percent was introduced in the 1999 budget law for fiscal reasons and eliminated in January 2000. During 2000, the authorities introduced two more bands (6.5 and 8 percent), while still maintaining the maximum tariff rate at 15 percent. In addition, some items were shifted towards the 0 and 5 percent bands from higher rates. As a result, the simple average tariff decreased to 7 percent. In November 2000, Moldova eliminated restrictions on grain exports that had been introduced earlier during the year in response to the drought.

Table 10.

Import Tariff Developments, 1996-2000 1/

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Sources: Information provided by the Moldovan authorities; and Fund staff estimates.

Based on 4,015 import categories, excluding alcohol, tobacco, and vehicles.

Excluding a temporary minimum tariff of 5 percent eliminated in january 2000. The simple avarege becomes 9.5 after the temporary minimum tariff.

56. Moldova is negotiating accession to the WTO with a view to membership in early 2001. Moldova has free trade agreements with all BRO countries and Romania. It has also signed an agreement on partnership and cooperation with the EU in late 1994 which became effective in March 1996.

External debt

57. Moldova’s external public and publicly guaranteed debt has grown at a rapid pace, from almost zero in the early 1990s to an estimated value of US$936 million at end-1999, equivalent to 71.8 percent of GDP. Including external payment arrears on imported energy supplies and private debt, the total external debt amounted to about US$1.5 billion at the end of 1999 (112 percent of GDP). See Table 11.

Table 11.

Moldova: External Debt Indicators, 1994-99

(In millions of U.S. dollars)

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Sources: National Bank of Moldova; and Fund staff estimates.

58. This indebtedness reflected the accumulation of large, and growing, external current account deficits in the mid-1990s. Debt indicators deteriorated further following the sharp depreciation of the leu in the aftermath of the Russian crisis. On average, these obligations were contracted on only moderately concessional terms; the net present value of the public and publicly guaranteed debt was estimated at US$895 million (68.7 percent of GDP) at end-1999. The estimated NPV of debt-to-export ratio and the debt-to-fiscal-revenue ratio (central government) reached 112 percent and 365 percent, respectively, while the debt service on public and publicly guaranteed debt represented 33 percent of exports of goods and non-factor services.

59. More than half of Moldova’s outstanding public debt was owed to multilateral institutions, including to the Fund (US$175 million, 19 percent of the total), the World Bank (US$287 million) and the EBRD (US$72 million). Debt owed to bilateral official creditors represented 28 percent of total debt, including Russia (US$83 million),12 the United States (US$65 million), the European Union (US$62 million) and Japan (US$37 million). Other official obligations amounted to about 15 percent of the total and included a five year US$75 million Eurobonds (issued in 1997 with bullet repayment in 2002) and a number of direct and publicly guaranteed credits from foreign banks (US$60 million).

60. Moldova has also accumulated large external payment arrears on imported energy supplies (gas, electricity, and oil) during 1994-99. By end-1999, the stock of energy arrears was tentatively estimated at US$416 million (32 percent of GDP), of which upto US$273 million are obligations of state-owned companied and some US$150 million are owed by private operators.13 The main creditors were Russian for gas imports, Ukrainian and Romanian for electricity imports and Romanian for oil imports.

61. In 2000, steps were taken to reduce arrears on debt service obligations and energy payments. In March, an agreement was reached on US$137 million of arrears due to Gazprom. These arrears were settled through: (i) the issuance of promissory notes in value of US$90 million with a 7-year maturity, 2 year grace period and 7.5 percent interest rate to pay off the debts resulting from natural gas deliveries in 1996 and 1997; and (ii) the agreement on a debt-equity swap in the gas sector, whereby Gazprom acquired 51 percent of Moldovagas in return for the clearance of US$47 millions of arrears. In April, a rescheduling agreement with the Russian authorities covering the total of Moldova’s debt to the Russian Federation, including that to Oneximbank, was signed, in the amount of US$122.1 million (including penalties and overdue interest), including US$30.4 million owed by the Transnistria region.14 On April 12, 2000, a separate agreement was signed between the Moldavian authorities and the administration of the Transnistria region on the settlement of the debt of Transnistria to the Russian Federation. According to this agreement, the administration of the Transnistria region acknowledges its indebtedness in the amount of US$30.4 million to the Russian Federation and agreed to the same debt repayment schedule and terms negotiated by the Moldovan authorities with the Russian government.

62. Also, rescheduling discussions were successfully launched with a number of commercial creditors on government guarantees, including to German and Italian creditors.

Exchange market and exchange arrangement

63. From its inception in November 1993 until the Russian crisis in August 1998 the Moldovan leu has shown remarkable stability (Table 12). However, the leu became under pressure following the ruble crisis in August 1998. In an attempt to stabilize of the exchange rate at MdI 4.8 per dollar, the NBM intervened heavily in the market. Despite this, the exchange rate depreciated by 25 percent between August and October of 1998. In November, the NBM stopped supporting the leu and allowed it to float. Moldova’s gross official reserves at the end of 1998 stood at US$140 million equivalent to 1.4 months of goods and non-factor services (in comparison, at the end of 1997, the gross official reserves stood at US$366 million or 3.1 months of imports of goods and non-factor services). The leu stabilized at around MdI 8.5 per dollar at the end of 1998 after having reached MdI 10 per dollar in November. The leu continued to float freely during 1999, with intervention by the NBM limited to smoothing out short term fluctuations and to meeting reserve targets. At times, however, foreign exchange intervention by the NBM exceeded what was strictly needed to meet reserve targets. As a result, the NBM was able to increase its reserve holdings to US$181 million at end-1999 (equivalent to three months of imports of goods and nonfactor services). The leu depreciated by almost 39 percent in nominal terms vis-a-vis the U.S. dollar in 1999 (end-period), implying a small real appreciation, partly correcting the sharp real depreciation in late 1998. Exchange rate movements were, to a considerable extent, linked to periods of political tensions both at home and abroad as well as to domestic credit expansion. The sharpest movements took place in May-June, following the extension of large NBM credits to the government and a renewed period of political uncertainty in Russia. The rate again came under pressure in November following the resignation of the government.

Table 12.

Moldova: Exchange Rates, 1993-2000

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Sources: National Bank of Moldova.

64. In 2000, the leu rate stabilized in April and since then has been slowly appreciating, reflecting strong foreign exchange inflows and a strong demand for lei, linked inter alia to inflows of worker remittances and the increase in minimum capital requirements for banks. These inflows allowed the NBM to increase its gross official reserves further to US$190 million at end-September 2000. On balance, during the first three quarters of 2000, the leu depreciated by about 5 percent in nominal terms vis-à-vis the U.S. dollar, implying a real appreciation of roughly 7 percent.

65. Moldova accepted the obligations of Article VIII of the Fund’s Articles of Agreement on June 30, 1995. The NBM announced in November 1998 that it was ceasing its intervention in support of the leu. Moldova is a member of the Payment Union with the CIS. Proceeds from exports must be repatriated no later than 180 days from the issuance of the custom declaration.

E. Structural Policies

66. Structural reforms suffered some setbacks in the second half of 1999, but accelerated markedly during 2000. Political developments prompted a temporary standstill in reforms by end-1999, in particular with the failure of parliament to pass the necessary legislation for the privatization of five major wineries and the tobacco sector. However, in 2000 substantial progress was achieved in the energy sector and land reform has remained been broadly on schedule.

67. A key bottle-neck to the reform process has been the privatization of economically important winery and tobacco sectors. Parliament had refused to pass the necessary legislation in November 1999 and, again, in April 2000. The current government continued to insist on reform and the bill on privatization of wineries and tobacco was finally approved by parliament in October 2000.

68. An important achievement of the authorities has been the privatization of three electricity distribution companies to a strategic foreign investor in early-2000. The sale of the two other distribution companies and the power generation companies is underway. Moldovagas was also privatized with the sale of the majority share to Russia’s Gazprom. In addition, measures were taken to improve efficiency and transparency in the sector, in particular, there was a further increase in energy tariffs in mid-2000 and, with the help of the World Bank, the replacement of generous energy privileges with targeted assistance.

69. With respect to the Telecommunications sector, preparations for Moldtelecom’s privatization have proceeded slowly. In the third quarter of 1999, unexpected complications with donor financing of an investment advisor occurred. However, an independent telecommunications regulatory agency was established to assist tariff reform and restructuring in the sector.

70. The break-up of the old state and collective farms under the land reform program has been all but completed. In total, close to 95 percent of all state farms—or 996 farms—have begun distributing their land and property to individual beneficiaries, and of these, 804 farms were fully liquidated and put into private hands. There was a significant acceleration of land reform in 2000. Four hundred farms (or almost half of the 996) started restructuring during the first 10 months; the number of individuals receiving ownership doubled to 950,000 persons; and the registration of land parcels in the Cadaster system was close to 1.2 million titles by end-September 2000 (or about half of the final target), up from less than a quarter million by end-1999. Table 13 demonstrates the changes in ownership of land during the 1990s.

Table 13.

Structure of land use 1990-1999

(percent of agricultural land, end of year data)

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Source: Cadastral land balances

71. An indispensable factor in going ahead with farm restructuring was the solution to the large state farm debt overhang. The land reform program had been delayed by the unresolved claims of creditors of the old state farms, because the existing bankruptcy procedures had proved inadequate to deal with land restructuring. With the adoption of the Debt Resolution Program (DRP) in 1999, land and movable assets (farm machinery and livestock) were kept outside the debt resolution procedure; these were guaranteed to remain in the hands of the individual beneficiaries who had received or were intended to receive legal title to their land. The outstanding debt was settled from the remaining assets of the farm enterprise, in the following way: enterprise-owned social assets (schools, hospitals, etc.) were transferred to local municipalities in settlement of the debt to the government; enterprise-owned housing were privatized to worker-members in settlement of wage arrears; and inventories, cash, receivables, other current assets, and all farm fixed assets (storage, farm buildings, processing facilities, etc.) were used for settling the debts to commercial creditors. Any residual debt was settled through the state budget by offering future tax credits to commercial creditors with unsatisfied claims. As the main creditor was the state, much of its debt was written off in the process of transferring state property into private hands.

72. Firm restructuring and bankruptcy procedures have been formally initiated for a number of firms with large debts to the budget, some of them long outstanding. Progress to date has been marginal, mainly due to weak political support, something that has been compounded by the inadequacy of the legal framework. Very few firms have been restructured, recovery of past arrears to the budgets has been minimal, and firms continue to default on current payments.

73. Further progress in the reform of the legal and regulatory environment is indispensable for improving governance and the investment climate in Moldova. The adoption in mid-2000 of a law that requires cabinet approval for any license involving more than US$1 million represented a needed step in improving transparency and governance. The first reading of a new civil code was approved by parliament in November 2000.

1

Although national accounts data are compiled according to the 1993 SNA methodology, the coverage of the reporting system remains narrow and a sampling system is not yet in place. The GDP used in this report excludes Transnistria, but includes an additional adjustment for the shadow economy.

2

The agro-processing sector relies for almost 100 percent on domestically produced agricultural products for its input. Therefore, output loss in agriculture is assumed to affect agro-processing to an equal degree.

4

The time series of Moldova’s consolidated general government budget have been recently revised in order to include off-budget expenditures related to foreign project loans. Privatization receipts up to 1999 were also reclassified as a financing item. See also Appendix Table 38.

5

See Appendix Table 45 for a summary of the tax structure in Moldova and a recent changes since 1998.

6

See Appendix Table 46 for a summary of the main policy measures to rationalize public expenditures since 1998.

7

A basic license (A) allows a bank to perform domestic banking services, a B license adds foreign exchange operations, and a C license further adds trust services and trading in equities.

8

Banks assigned to the BRU comprise all banks with CAMEL ratings of 4 and 5, as well as some banks with a 3 rating. AH banks assigned to the BRU are provided with an enforcement document which details the problems that need to be addressed and assign a reasonable time frame for solving them. Progress in satisfying the enforcement document is assessed frequently. CAMEL is an acronym for Capital adequacy, Asset quality, Management, Earnings, and Liquidity, asset and liability management. The ratings range from 1 to 5, with 1 reflecting a sound and stable institution and 5 an institution which is ready for receivership/liquidation.

9

The possibility of gaining further market shares in EU will crucially depend on the improvement in the quality of goods and the country’s ability to penetrate the EU food market.

10

In terms of non-energy imports the share of imported capital goods went up from 17 in 1994 to 25 percent in 1998. In 1999 it dropped to 16 percent.

11

This number does not account for the 5 percent temporary minimum tariff. The simple average tariff rose to 9.6 with its inclusion.

12

Moldova’s debt vis-à-vis Russia consists of a restructured loan of US$ 88.6 million granted in 1996 stemming from of two previous Russian credits, and a US$15 million loan extended by the Oneximbank in 1996 and guaranteed by the Russian government.

13

A full auditing of Moldova’s external arrears on energy imports has yet to be completed. Accordingly, the actual outstanding public obligations or potential government contingent liabilities on energy imports are an estimates. Accordingly, the reported amount of energy arrears should be considered as an upper limit.

14

The net amount (US$91.7 million) is reflected in the tables; Moldovan data are exclusive of the Transnistrian region.

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Cover IMF Staff Country Reports
Republic of Moldova: Recent Economic Developments
Author:
International Monetary Fund
Volume/Issue:
Volume 2001: Issue 022
Publisher:
International Monetary Fund
ISBN:
9781451824957
ISSN:
1934-7685
Pages:
122
DOI:
https://doi.org/10.5089/9781451824957.002
  • Figure 1.
    View in gallery
    Figure 1.

    Moldova: Output Indicators, 1992-1999

  • Figure 2.
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    Figure 2.

    Moldova: General Government Budget Position and Financing, 1995-2000

    (In percent of GDP)

  • Figure 3.
    View in gallery
    Figure 3.

    Moldova: Social Fund Budget Position, 1995-2000

    (In percent of GDP)

  • Figure 4.
    View in gallery
    Figure 4.

    Moldova: Inflation and Base Money Growth, 1994-2000

    (Six-Month Growth Rates)

Figure 1.

Moldova: Output Indicators, 1992-1999
Figure 2.

Moldova: General Government Budget Position and Financing, 1995-2000

(In percent of GDP)
Figure 3.

Moldova: Social Fund Budget Position, 1995-2000

(In percent of GDP)
Figure 4.

Moldova: Inflation and Base Money Growth, 1994-2000

(Six-Month Growth Rates)