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© 2005 International Monetary Fund

February 2005

IMF Country Report No. 05/54

Republic of Moldova: Selected Issues

This Selected Issues paper for the Republic of Moldova was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on January 21, 2005. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of the Republic of Moldova or the Executive Board of the IMF.

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Front Matter Page

INTERNATIONAL MONETARY FUND

REPUBLIC OF MOLDOVA

Selected Issues

Prepared by Milan Cue, Erik Lundback, Anita Angelovska-Bezoska, and Edgardo Ruggiero (EUR), Lawrence Bouton and Maya Sandu (World Bank)

Approved by the European Department

January 21, 2005

Contents

• Overview

• I. Macroeconomic Consequences of Workers’ Remittances in Moldova

  • A. Introduction

  • B. Stylized Facts on Remittances

  • C. Patterns of Remittances and Migration in Moldova

  • D. Macroeconomic Consequences of Migration and Remittances

  • E. Policy Implications

  • F. Conclusions

• Figures

• 1. Gross Workers’ Remittances

• 2. Workers’ Remittances Through the Banking System

• 3. Distribution of Temporary and Long-Term Workers’ Remittances

• 4. Workers’ Remittances to Moldova by Region of Origin

• 5. Gross Workers’ Remittances as a Share of GDP in 2003

• 6. Contribution of Consumption and Fixed Capital Formation to Real GDP Growth

• 7. Workers’ Remittances and Real Consumption Growth

• 8. GDP, GNI, and GNDI per Capita

• 9. Fixed Capital Formation

• 10. Labor Migration

• 11. Labor Market Indicators

• 12. Workers’ Remittances and Foreign Direct Investment

• 13. The Moldovan Leu Exchange Rate

• 14. Money Growth and Inflation

• 15. Unemployment, Unemployment Benefits, and Dependency Ratio

• 16. Tax Revenue Composition, 1999–2004

• Box

• 1. Social Insurance and Fiscal Sustainability—Conceptual Framework

• Table

• 1. Pension System’s Response to Demographic Changes

• References

Overview

1. Large-scale labor emigration and the associated workers’ remittance flows increasingly shape Moldova’s economic and social landscape. At least ¼ of Moldova’s economically active population has emigrated. Moreover, workers’ remittances are large by any yardstick—they now amount to some 25-30 percent of GDP. Shedding light on the origins and effects of outward labor migration should help inform current and future policymaking in Moldova, and this paper’s first three chapters focus on this topic. The remaining three chapters deal with other pertinent policy issues and challenges, namely fiscal reforms, privatization, and corporate taxation.

2. Chapter I discusses the macroeconomic impact of workers’ remittances using balance of payments data. The rising trend in remittances started on the back of the 1998 regional crisis, which encouraged a process of large-scale emigration that has persisted to this day. Indeed, the analysis suggests that emigration and remittances have reinforced each other. On a net basis, remittances are currently the single most important source of foreign exchange for the country. As such, they have significantly affected economic growth, the labor market, the balance of payments, and the exchange rate, while complicating the conduct of monetary, exchange rate, and fiscal policies. The chapter concludes that the macroeconomic problems raised by remittances reflect structural bottlenecks, calling for the acceleration of structural reforms to improve the business environment.

3. Chapter II focuses on Moldova’s labor emigration since the late-1990s using survey data designed to shed light on the economic and social consequences of migration. The survey results are broadly consistent both with the findings from balance of payments data and with the stylized facts in the labor migration literature. In particular, the survey finds that, at end-2004, migrants accounted for about 39 percent of the economically active population and that they have a strong attachment to Moldova, remitting large portions of their earnings home. These transfers are primarily used to meet basic consumption needs and to finance housing and education, with only relatively small amounts invested in business activities. Remittances are likely to remain a stable and countercyclical source of foreign exchange in the short run. However, as more migrants settle permanently abroad portfolio choice considerations may become more important. Again, a determined and sustained effort to improve the business environment could facilitate the allocation of remittances into productive uses.

4. Following the sharp real appreciation of the Moldovan leu in recent years, external competitiveness has become a growing concern. Chapter III examines various indicators to assess the appropriateness of the current exchange rate level. It concludes that the leu is still likely to be undervalued, notwithstanding the recent strong real appreciation. While the real exchange rate appreciation has been in line with the experience of other transition countries, it has been reinforced by Moldova-specific factors, notably the rising inflows of migrants’ remittances, which have raised the level of the equilibrium exchange rate. Insofar as the real appreciation reflects an increase in the equilibrium exchange rate, resisting the rise in the leu exchange rate, particularly by central bank foreign exchange market interventions, is likely to be ineffective, and possibly undesirable.

5. Chapter IV reviews the implementation of fiscal reforms since the late 1990s and identifies the challenges ahead. Important progress has been achieved in tax administration and public finance management, notably with improvements in the treasury and budget system. The Economic Growth and Poverty Reduction Strategy Paper 2004-06 and the comprehensive medium-term expenditure frameworks provide a basis for strategic medium-term planning, identifying priority areas and guiding the budgetary process. In conclusion, the chapter suggests areas for further strengthening within the budget system and tax administration and underscores that these reforms will require strong government ownership and commitment to deliver maximum benefits.

6. Privatization has stalled in the last few years, and needs to be re-energized as part of a structural reform package to improve the business environment and foster private sector development. Chapter V provides an overview of Moldova’s privatization program, results achieved to date, and the government’s recent efforts to move the agenda forward. It concludes that although the recently adopted poverty reduction strategy includes acceleration in the privatization program as a priority action, actual implementation of the program is key to foster confidence in the privatization program and improve Moldova’s damaged international reputation in this area.

7. The government’s plan to cut corporate income tax (CIT) rates in half in several steps between 1998 and 2006 aims at encouraging private sector activity and raising tax compliance. Chapter VI explores the relation between CIT rates and CIT revenue. The chapter concludes that the recent strong corporate tax performance may partially reflect better tax compliance, but also owes much to an improvement in overall business profitability that accompanied the recovery from the 1998 regional crisis. The analysis cautions that future corporate tax rate cuts carry the risk of revenue losses unless backed up by steps to broaden the tax base, including by reducing tax exemptions.

Contents

• II. Migration and Remittances—A Micro Perspective

  • A. Introduction

  • B. Remittances: Stylized Facts

  • C. Migration: Stylized Facts for Moldova

  • D. Survey Results

  • E. Conclusions and Policy Implications

• Figures

• 1. Number of People Working Abroad

• 2a. Population Density, 2001

• 2b. Share of Urban Population, 2002

• 3. Real GDP and Poverty Rate

• 4. Migrant Contingent, Distribution by Gender and Age

• 5. Migrant Contingent, Country Distribution by Gender

• 6. Education Level of Migrants and Working Population

• 7. Geographical Distribution of Permanent, Non-Permanent and Seasonal Migrants

• 8. The Year of First Departure

• 9. Main Migration Directions

• 10. Earnings Received by Migrants

• 11. Percent of Earnings Sent to the Family

• 12a. Use of Remittances by Year

• 12b. Use of Remittances by Category

• 13 a. Use of Remittances by Year: Breakdown by Type of Savings

• 13b. Use of Remittances by Year: Breakdown by Type of Business Investment

• Boxes

• 1. Travel Costs and Migration Channels

• Tables

• 1. Category and Gender of Migrants

• References

• III. External Competitiveness

  • A. Introduction

  • B. Estimating the Equilibrium Exchange Rate

  • C. Conclusion

• Figures

• 1. Assessing Competitiveness

• 2. Real Exchange Rate vis-à-vis Main Trade Partners

• 3. Foreign Trade Composition, 1994 and 2003

• 4. Transition Economies: Exchange Rate Relative to Its Purchasing Power Parity

• 5. Actual and Equilibrium Wage, 1992–2004

• 6. Monthly Wage in Manufacturing, 1992–2004

• 7. Import Coverage

• 8. Change in Equilibrium REER

• 9. Change in REER and Equilibrium REER

• Boxes

• 1. Estimating the Equilibrium Wage Based on the Capital/Labor Ratio

• 2. Outline of a Three-Commodity Model

• Tables

• 1. Capital/Labor Ratio, 1995–04

• 2. Cumulative Change in Equilibrium REER

• References

• IV. Fiscal Reforms

  • A. Introduction

  • B. Tax Administration Reforms

  • C. Public Finance Management Reforms

  • D. Conclusions

• V. Enterprise Privatization

  • A. Introduction

  • B. The Privatization Program as of 2001

  • C. Changes to the Privatization Process Since 2001

  • D. Privatization Performance Since 2001

  • E. Unsuccessful Privatization in Telecom and Energy Sectors

  • F. Conclusion

• Tables

• 1. Enterprises in the Privatization Program, as of 2001

• 2. Distribution of State Shareholdings, as of 2001

• 3. Privatized Enterprises, 2001–04

• VI. Enterprise Profitability, Income Tax Rates, and Income Tax Revenues

  • A. Introduction

  • B. Economic Recovery and Enterprise Proftis

  • C. A Model of Business Profits

  • D. Conclusions

• Figures

• 1. Corporate Income Tax Collection

• 2. Corporate Income Tax Rate vs. CIT Collection Indices, 1997–2003

• 3a. Economic Profitability of Companies (I)

• 3b. Economic Profitability of Companies (II)

• 4. Components of Profits, Nominal GDP, and CIT Revenue Collected by General Government

• 5. Income Tax Rate vs. Effective Rate of Collection

• Tables

• 1. Components of Profits, 1998–2003

• 2. Labor and Profit Shares, 1998–2003

• 3. Change in Unreported Profits, 1998–2003

• 4. Change in Unreported Profits Required to Keep Tax/GDP Constant, 2003–05