Statement by Jeroen Kremers, Executive Director for Republic of Moldova

This 2004 Article IV Consultation highlights that economic activity in Moldova benefited from a favorable external environment in 2003–04. GDP grew by 6.3 percent in 2003, advancing to 6.5 percent (year over year) in the first half of 2004. Large and rising workers’ remittances underpinned consumption-led growth, helping consolidate Moldova’s recovery from the 1998 regional crisis. Progress in structural reforms remains slow, while high transaction costs continue to hold back private sector-led growth. Some progress has been registered in fiscal reforms, and in revising the legal framework affecting investment, microfinance, audit, accounting, and leasing.

Abstract

This 2004 Article IV Consultation highlights that economic activity in Moldova benefited from a favorable external environment in 2003–04. GDP grew by 6.3 percent in 2003, advancing to 6.5 percent (year over year) in the first half of 2004. Large and rising workers’ remittances underpinned consumption-led growth, helping consolidate Moldova’s recovery from the 1998 regional crisis. Progress in structural reforms remains slow, while high transaction costs continue to hold back private sector-led growth. Some progress has been registered in fiscal reforms, and in revising the legal framework affecting investment, microfinance, audit, accounting, and leasing.

The Moldovan authorities appreciate the staff report and the accompanying Selected Issues paper, which reflect the open dialogue between staff and the government and give an accurate account of economic developments in the country and the challenges ahead. This Board discussion on the 2004 Article IV Consultation is important to shape views on the possible reengagement of a new PRGF arrangement. The authorities attach great value to a program relationship with the Fund, not only because it may pave the way to the Paris Club and unlock donor financing, but also because it is vital for enhancing domestic and international credibility and investor confidence. I would like to transmit the readiness and willingness expressed by the Moldovan authorities to enter into a new agreement with the IMF during the year 2005, that can contribute to bringing their economy to international standards, in line with market practices and also with their intention to move towards joining the European Union.

Medium- and long-term development goals, as well as the strategy to achieve them are set out in the Economic Growth and Poverty Reduction Strategy Paper (EGPRSP), which the Executive Board considered to be a comprehensive document containing crucial steps for attaining sustainable growth and reducing poverty. The authorities acknowledge that major changes in economic and social policies are critical for that purpose, and in the EGPRSP they express their commitment to prudent macro management and a sound reform agenda. The implementation of the strategy has been slow so far, but its pace is likely to pick up after the parliamentary and presidential elections, scheduled for early spring.

Growth

Macroeconomic developments in 2004 were favorable. Growth was robust at 7.3 percent. Inflation, although exceeding the projected rate of 10 percent, exhibited a downward trend. Export growth was strong, international reserves expanded considerably reaching USD 470 million compared to USD 302 million in 2003, and investments, both domestic and foreign, increased.

Moldova’s growth strategy puts special emphasis on revitalizing agriculture - the sector that employs more than 40 percent of the workforce, accounts for about 20 percent of GDP and 60 percent of exports, but currently operates at only half of its capacity. In line with the commitments made in the EGPRSP to increase efficiency and expand agricultural output by creating a favorable environment for the sector and promoting reforms, the authorities have recently launched a new € 2.8 billion program “Moldovan Village”. Its goal is to support development and improve the quality of life in rural areas over the next decade. The program calls for rehabilitation and upgrade of infrastructure, water and natural gas supply, development of small and medium-sized businesses, restoration of vineyards and the food processing industry, and environmental protection. This is an ambitious plan, and the authorities are likely to seek financial and technical assistance from the international community and investors.

The authorities recognize that the Moldovan economy continues to depend heavily on worker remittances. It is positive that these raise disposable income and thus provide at least minimal social protection to many Moldovans; they are also one of the major sources of foreign currency inflows helping to build up reserves and partially offset the large trade deficit. On the other hand, remittances fuel liquidity growth and put upward pressure on the exchange rate, posing difficulties to monetary policy implementation. They may raise the reservation wage lowering labor participation, and boost consumption and imports more than domestic capacity and income, and hence raise prices. As a consequence, over-dependence of the economy on remittances may increase external vulnerability. A useful chapter on remittances in the Selected Issues paper provides a detailed account of the scope and the complexity of the issue. The authorities share the staff analysis and recommendations and intend to address the issue in two ways. First, by enhancing the business climate and making domestic employment more attractive to so as to reduce incentives for emigration. This is critically important from the perspective of growth and capacity building since emigration tends to drain a qualified and skilled labor force. Second, by trying to in part redirect remittances from consumption to investment so that the large inflows are put also to more productive use.

Structural issues

A difficult business climate remains the main obstacle to private sector development and growth. The poverty reduction strategy of Moldova acknowledges that the problems to a large extent are of a structural nature related to weak governance, corruption and excessive government regulations. Institutional and structural measures in these areas coupled with the strengthening of the rule of law are the cornerstone of the authorities’ reform agenda, which they intend to pursue aggressively throughout 2005 and beyond. Downsizing the government together with organizational adjustments followed by restructuring of the compensation and motivation system are considered important measures for attracting professional and highly qualified staff, increasing efficiency of the civil service, and curbing corruption. Possible ways of addressing these issues are being discussed. As a first step towards a compact and streamlined public sector, structural reorganization of the state chancellery has already been launched and reforms in other branches of the civil service are also planned following the upcoming elections. As noted in the staff report, a national anti-corruption strategy has been recently approved, which the authorities are committed to make an effective tool against power abuse and entrenched vested interests.

The authorities have indicated their intention to break with the past practices of excessive regulation and state intervention, and to implement market reforms. With the objective of making Moldova an attractive place for domestic and foreign investments, they plan to deregulate entrepreneurial activities, simplify business licensing and registration procedures, streamline the functions of supervisory bodies and promote fair competition. In this context, as a result of launching the Regulatory Reform in February 2004, the Law on implementation of the ‘guilliutine’ principle was approved in December 2004. According to this law, during a 7-month period, all the relevant by-laws are to be revised according to a set of principles, after which the assessed acts will be included in a special Register. This procedure implies an interaction between the public and private sector, as well as the participation of the society. As a result, the necessary prerequisites for the optimization of the core legislation and of the institutional system of the authorities in charge of regulating the entrepreneurial activity are being set up. The new mechanism and the principles of entrepreneurial activity’s regulation will be incorporated in a new law. Additionally, the new Law on investments in entrepreneurial activity has been adopted, that envisages offering national treatment to foreign investors, the latter having equal rights with the local investors.

With regard to deregulating entrepreneurial activity, it should be mentioned that in accordance with the Law on modification and completion of some legislative acts (no. 432-XV, as of December 24, 2004) the Parliament of the Republic of Moldova approved the amendments to the “Law on regulation of repatriation of funds, goods and services obtained from external economic transactions". One of the goals according to these is to ensure a more simplified repatriation procedure for both legal entities and commercial banks. Commercial banks, the National Bank of Moldova and the Centre for Preventing of Economic Crimes and Corruption were exempted from the control on repatriation. The control function on repatriation will be transmitted from these institutions to the State Fiscal Authority, which will carry out verifications on repatriation within on-site inspections of the legal entities’ economic activity, conducted in accordance with the legislation in force. At the same time, the mentioned Law stipulates extension of general repatriation periods of funds, goods and services up to one year and the reduction of the fine the legal entities have to pay in case of delay of repatriation. The exemption of commercial banks from the control on repatriation will increase the effectiveness of the banking system, as commercial banks are eased from additional burden and accordingly from extra costs.

The authorities also plan to revamp the privatization process. Actual progress in these directions in the near future will demonstrate the degree of ownership of the EGPRSP. It should also be mentioned that the Republic of Moldova became member of the European Charter for Small Enterprises. The first country report was submitted at the end of 2004, and has been placed on the European Commission’s site.

Fiscal Policy

Revenue performance in Moldova has been on an upward trend for a number of years. In 2004, the tax revenue-to-GDP ratio is estimated to have further increased by about 1.1 percentage points reaching 29 percent, which is one of the highest in the region. In order to ease the tax burden and stimulate business activity, as part of a broader tax reform strategy, the authorities have made the decision to gradually lower corporate and personal income tax rates. With persistent efforts to strengthen the administration, they believe that losses from tax cuts will be more than fully compensated through the expanded tax base as lower rates are expected to reduce incentives for tax evasion. Moreover, once the new parliament is elected, the government intends to propose abolition of certain tax concessions that the legislative body did not approve last year.

Given widespread poverty in the country, the budget is geared towards the poor, and the expenditure priorities in the coming years will be guided by the poverty-reduction and social objectives of the EGPRSP in line with the Medium-Term Expenditure Framework. In the absence of a social safety net, the increase in the minimum pensions is intended to provide at least minimal social protection to the most vulnerable. The authorities agree with staff, that profound social reforms will be needed to ensure sustainability of the country’s social system. Similarly, the increase in wages of the public sector to attract and retain qualified staff will be considered in the context of the planned civil service reform.

Good progress was made to normalize relations with creditors and mitigate vulnerabilities stemming from the large external debt. Buyback operations with Gazprom and Hewlett Packard have been finalized, agreements on debt rescheduling with several bilateral creditors have been reached and arrears considerably reduced. The reduction in arrears was strongly favored by discount obtained on the debt buyback. However, arrears to Paris club creditors still remain and need to be addressed in the near future for bringing the overall debt burden to a sustainable level. At the same time, Moldova continued to remain current on all interest payments and its obligations to multilaterals. Consequently, the external debt and debt service indicators have notably improved.

The authorities realize that strong revenue performance and sound expenditure management will be essential to meet their social goals and to continue honoring other domestic and external liabilities. With the established track record in tax administration and additional efforts to curb the shadow economy, they feel confident that their fiscal objectives will be met in 2005.

Monetary policy

Large inflows of remittances have posed challenges to monetary policy implementation. With price stability as an overriding objective, the National Bank of Moldova (NBM) has been trying to strike a balance between reserve money growth and exchange rate appreciation. Interventions in the foreign exchange market have been instrumental in smoothing exchange rate fluctuations, building up international reserves and preserving competitiveness, which has contributed to export growth. The authorities share staff’s view that monetary policy can only have short-term effect on competitiveness and that in the longer-term perspective this objective should be pursued through structural and policy measures aimed at strengthening productivity. However, they also believe that this could be a lengthy process, and meanwhile letting the exchange rate appreciate more rapidly could damage the fragile export sector and dampen growth. Mindful of mounting inflationary pressures due to an expanding money supply, the NBM sterilized part of its foreign exchange interventions through more active use of monetary policy tools including the outright sale of its holdings of discount treasury bills. In addition, to further improve the efficiency of its operations in the money market, the NBM has recently launched a new instrument - the NBM certificates with maturities of 14, 28 and 56 days. These securities were welcomed by the markets and are expected to play an important role in liquidity management.

In closing, I would like to note that the Moldovan authorities consent to publication of the staff report, the Selected Issues paper, the statistical appendix and the Financial System Stability Assessment.

Republic of Moldova: Staff Report for the 2004 Article IV Consultation
Author: International Monetary Fund