Front Matter

Front Matter Page

© 2006 International Monetary Fund

May 2006

IMF Country Report No. 06/185

Republic of Moldova: Poverty Reduction Strategy Annual Evaluation Report 2005

Poverty Reduction Strategy Papers (PRSPs) are prepared by member countries in broad consultation with stakeholders and development partners, including the staffs of the World Bank and the IMF. Updated every three years with annual progress reports, they describe the country’s macroeconomic, structural, and social policies in support of growth and poverty reduction, as well as associated external financing needs and major sources of financing. This country document for the Republic of Moldova, dated 2006, is being made available on the IMF Website by agreement with the member country as a service to users of the IMF website.

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Front Matter Page

GOVERNMENT OF THE REPUBLIC OF MOLDOVA

ANNUAL EVALUATION REPORT ON THE IMPLEMENTATION OF THE ECONOMIC GROWTH AND POVERTY REDUCTION STRATEGY

2005

Chisinau, 2006

LIST OF ACRONYMS

CPAR

Central Public Administration Reform

CIS

Commonwealth of Independent States

DFID

Department for International Development

EBRD

European Bank for Reconstruction and Development

EFA

Education for All

EGPRS

Economic Growth and Poverty Reduction Strategy

FSAP

Financial Sector Assessment Program

EU

European Union

GDP

Gross Domestic Product

GVA

Gross Value Added

HBS

Household Budget Survey

HIV/AIDS

Human Immunodeficiency Virus/Acquired Immunodeficiency Syndrome

ILO

International Labour Office

IDA

International Development Agency

MDG

Millennium Development Goals

MET

Ministry of Economy and Trade

MEYS

Ministry of Education, Youth and Sports

MTEF

Medium Term Expenditure Framework

MMIF

Mandatory Medical Insurance Fund

NGO

Non Governmental Organization

NBM

National Bank of Moldova

NBS

National Bureau of Statistics

PAR

Public Administration Reform

PC

Participation Council

PPP

Purchasing Power Parity

SDC

Swiss Agency for Development and Cooperation

SS

State Securities

SSIB

State Social Insurance Budget

TAU

Territorial Administrative Unit

TB

Tuberculosis

VAT

Value Added Tax

UNICEF

United Nations Children’s Fund

UNDP

United Nations Development Program

USSR

Union of Soviet Socialist Republics

TABLE OF CONTENTS

  • EXECUTIVE SUMMARY

  • INTRODUCTION

  • 1. POVERTY AND INEQUALITY EVOLUTION IN 2002 - 2004

    • Poverty definition and its evaluation

    • Dynamics of poverty and inequality

    • Demographic and other poverty aspects

    • Chronic and subjective poverty

    • Conclusions

  • 2. ECONOMIC DEVELOPMENT TRENDS

    • Macroeconomic evolution and quality of economic growth

    • Conclusions

    • The evolution of revenues and expenditures. Public finance management

    • Funding EGPRS priorities

    • Conclusions

  • 3. ECONOMIC INFRASTRUCTURE

    • Regulatory framework

    • Fiscal policy

    • Financial system

    • Conclusions

  • 4. REAL SECTOR

    • Industry and agriculture

    • Infrastructure

    • Roads and transportation

    • Energy

    • Water supply and sewerage

    • Telecommunications and information technologies

    • Conclusions

  • 5. THE IMPACT OF SOCIAL POLICIES

    • Education

    • Healthcare

    • Social Protection

    • Social Insurance

    • Social Assistance

    • Labor Force market

    • Conclusions

    • Labor Force Market

  • 6. CENTRAL PUBLIC ADMINISTRATION REFORM

  • 7. REGIONAL DEVELOPMENT

  • 8. COMMUNICATION AND PARTICIPATION PROCESS

  • 9. MONITORING AND EVALUATION SYSTEM

  • List of tables

    • 1. Distribution of consumption expenditures between 2000 - 2004

    • 2. Accomplishment of MDG poverty indicators

    • 3. Persistent poverty by area of residence, 2001-2004

    • 4. GDP by categories of resources

    • 5. GDP by categories of use

  • List of figures

    • 1. Dynamics of poverty rate between 1998 - 2004

    • 2. Relationship Final Consumption - Remittances

    • 3. Relationship Final Consumption - Net Export

    • 4. Inflation rate at the beginning of the year

    • 5. Exchange rate evolution

    • 6. Cash availability

    • 7. Direct net foreign investments dynamics

    • 8. Evolution of public revenues and expenditures

    • 9. Credits granted to economy

    • 10. Industrial growth

    • 11. Net rate of enrolment by educational levels, 2000-2004

  • Annexes

    • - Annex A1: Data and methodology for poverty measurement

    • - Annex A2: Statistical annexes on poverty

    • - Annex A3: Government Decision on establishing the Poverty Monitoring System, no. 851, dated 15 August 2005

    • - Annex B: EGPRS monitoring indicators

    • - Annex C: Draft Guidelines for EGPRS monitoring and evaluation

EXECUTIVE SUMMARY

1. Economic growth and income redistribution policies promoted in the context of Economic Growth and Poverty Reduction Strategy (EGPRS) implementation contributed to higher incomes and improved access of population to social services, which led to higher living standards and poverty reduction. During 2002 - 2004, poverty rates decreased by 14.5 percentage points (p.p.). By 2004, only 26.5% of the population of the Republic of Moldova was poor, i.e. their welfare was below the absolute poverty line (as compared to 40% in 2002). The most essential decrease (by 11.4 p.p.) took place in 2002-2003. In this period, extreme poverty decreased considerably (by 11.2 p.p.). However, in 2004 the pace of poverty reduction slowed down.

2. Together with poverty rate, inequality level also reduced. This trend is reflected by the Gini coefficient that measures inequality at country level and income and consumption distribution by quintiles. As a result, in the period of 2000 - 2004 the Gini coefficient decreased from 0.38 to 0.36. However, the downward trend was not so clear and stable, as in the case of poverty rate, inequality remaining at a relatively high level. In 2004, the richest 20% of households had over 40% of the total consumption, while the poorest 40% benefited from less than 20% of the total consumption.

3. Economic growth is a pre-condition for higher living standards and poverty reduction. Between 2003 and 2004, the estimated average poverty elasticity to average consumption growth was 2.1 %. That means that with each percent of growth, the poverty rate reduces by 2.1%. In 2002-2004, two thirds of reduction of poverty rates (which was empirically decomposed into growth of household consumption and redistribution of consumption between households) can be attributed to consumption growth, and one third is due to inequality reduction, i.e. redistribution among households.

4. Under these circumstances, at this stage Moldova manages to achieve the intermediary targets for poverty reduction identified in the Millennium Development Goals, whereas the slowdown of the poverty reduction pace raises concern.

5. The statistical results relating to the socio-economic development revealed a number of increasing trends in most sectors of the national economy in 2005. The GDP increased by 7.1% as compared to the previous year versus 5% provided in the EGPRS. Consequently, starting with the year 2000 the GDP increased by over 43%. In 2005, the GDP per capita exceeded US$860. However, the structure of growth has not improved and some challenging trends in the country’s macroeconomic development were not overcome. Economic and investment growth took place in the context of slow restructuring of the national economy, reduction of the growth rate in industry and agriculture. The accelerated growth of import led to higher share of net production and import duties in GDP, while the share of the gross value added in the GDP decreased.

6. An encouraging trend in 2005 was the increase of gross capital formation (by 11%), which exceeded both the final consumption growth (by 9.5%) and the GDP growth as a whole (by 7.1%). At the same time, the impact of this indicator on the GDP growth increased from 2.4 to 2.9 %, while the input of the final consumption increased from 2.2 to 9.9%. The increased demand, which was primarily generated by the increased inflow of monetary income from abroad as well as by increased domestic income, in the context of insufficient domestic production in terms of quantity and structure, led to increased imports. Given that exports increased less than imports, and the rate of growth of revenues of Moldovan citizens working abroad decreased (by 29% vs. 45% in 2004), the current account deficit increased considerably (from 2.7 % in 2004 to 9.8% in 2005).

7. The high level of remittances (30% of GDP), import growth (77.5% of GDP), trade balance deficit (39% of GDP) and the current account deficit (9.8% of GDP) testify to a higher dependency of economic growth and the overall economic situation on external factors. Under these circumstances, and given the deficient economic reform and low level of investments, the country’s external vulnerability increases, and the perspective of sustainable economic growth and poverty reduction can become uncertain unless immediate actions are taken in order to improve the current situation.

8. In December 2005, the inflation rate was 10% as compared to December 2004, showing a decrease by 2.5 p.p., as compared to the same period of 2004. The reduction of the overall inflation rate was caused by the reduction of the food price growth rate by 4.4 p.p. and tariffs for services - by 5.2 p.p. At the same time, the non-food price growth rate increased by 3 p.p.

9. Another element of macroeconomic stability is the implementation of a fiscal and budget policy that ensures a balance between budget revenues and expenditures. The efforts of improving mid-term financial planning, tax administration, and financial discipline created premises to execute the budget for 2005 at 100.6% for revenues and 92.7% for expenditures. In revenues formation, direct taxes constituted 35.9%, whereas indirect taxes - 44.1 %. In the structure of indirect taxes, VAT represents the highest share of 71.3%, of which VAT for the imported goods is 88%. Thus, consumption and import taxes still represent the main base for public revenues, and this cannot be considered as a budget sustainability element.

10. Improvement and extension of MTEF contributed to a better resource allocation. In 2005 social sectors still had the highest share in public expenditures - 63.2%, of which social insurance and assistance - 30.3%, education - 19.4%, health care - 11.3%. About 14.1% of the public expenditures were made by economic sectors. Despite these developments, the expenditure framework for some sectors was not totally adjusted to the EGPRS priorities. Thus, expenditures for public investments and economic services, that could facilitate economic growth, remained limited.

11. In Moldova, economic growth is still dependent on the consumption growth. Consumption is mainly satisfied by imports and is mainly financed from remittances. Respectively, the maintenance and acceleration of the current growth rates can be ensured by changes in its structure in terms of transforming the productivity factor into the driving force of growth. Consequently, the increased productivity and competitiveness of the national economy, have to be ensured by continued and enhanced structural reforms, and namely by: (a) further simplification and optimization of the regulatory framework; (b) ensuring stability of the legislative and fiscal frameworks; (c) rehabilitating infrastructure, by promoting the public-private partnership, and by increasing public investments, (e) divestiture and efficient use of assets, which are still in public property, (d) improving access to finance.

12. The State Regulatory Reform, initiated by the Government in 2004 and continued throughout 2005, aims at creating an open, flexible and cost-effective business environment, which will facilitate investments and innovations in business. In the period 2004-2005, a number of actions were undertaken to: (a) simplify and centralize the licensing procedure, (b) optimize the registration procedure, (c) reduce conflicts of interest between the role of inspections and the role of testing the control agents. The Law on revising and optimizing the regulatory framework for the entrepreneurial activity (regulatory guillotine) was developed and implemented. This allowed for a significant reduction in the number of normative acts that regulate the entrepreneurial activity and reduced the cost of authorization documents.

13. The experience of the first phase of the regulatory reform, as well as the experience of other countries in this field, testifies to the need to transform the regulatory reform into a continued, comprehensive and systematic effort, which will cover the entire Government, and which will be supplemented with sector-specific reforms. A successful implementation of this complex reform depends to a great extend on the level of commitment of different local and central public institutions, some of which show lack of will to ease the regulatory burden or to give away additional income earned under the current system.

14. In order to diminish the tax burden on the business environment and identify those who are acting in the shadow economy, the share of income tax for legal entities was reduced from 18% in 2005 to 15% in 2006. Starting with 2006, agricultural producers are exempted from a number of taxes for a period of five years and have to pay only the land tax (the amount of the annual share is maintained), the VAT (if the turnover exceeds the amount of MDL 200 thou. per year) and the contributions to the state social insurance budget. Overall, the fiscal pressure as the share of fiscal revenues in GDP for 5 years evolved as follows: in 2000 – 24.6%; in 2001 – 24.2%; in 2002 – 25.6%; in 2003 – 27.3%; in 2004 – 29.5%; in 2005 – 31.9%. The tax burden in Moldova is relatively low as compared that of the countries in the region. At the same time, given that the process of defining the fiscal system has not been finalized, a sufficient level of stability cannot be ensured.

15. The absolute indicators relating to the operation of the banking system are compliant with the economic development of the country in 2005 and this creates, in principle, relevant monetary conditions. Given that the nominal GDP increased by 14.7%, the total assets of the banking system increased by 35.4%, the monetary mass in MDL (M2) increased by 36.7%, credit allocations - by 35%, and deposits - by 40%. As a result, the ratio of assets in the banking system to GDP went up from 42 % in 2004 to 49% in 2005. The economy monetization level also increased.

16. At the same time, some of the qualitative characteristics of the banking activity deteriorated and the economy crediting level remained low. Assets return rate as well as banking activity efficiency decreased. The dynamic of interest rates for credits does not fully meet the objective to considerably increase investments and does not lead to increasing the crediting level to the desired extent and for longer terms. The share of bank credits in the total investments in fixed capital has decreased from 4.8% in 2004 to 2.7% in 2005. In this situation, without accelerating economic reforms and diversifying the banking system, the reduction of interest rate can lead to the reduction of the rate of return of the banking activity. At the same time, a bigger diversity of the banking products and lower interest rates can be ensured by a more serious competition among banks.

17. Industrial sector has a special role in ensuring the sustainable economic growth. In the last five years, the cumulative industrial growth was 67.5%. Nevertheless, the growth rates in 2004 - 2005 went down, amounting to 8.2 and 6.3% respectively, while the share of this sector in GDP remained at a relatively lower level - 17%. The limited progress of the industrial sector, under the relevant EGPRS objective, accounts for the low performance of exports, which are treated as an „engine” of the sustainable economic development. Both the growth and the structure of industry determine the dynamics and the diversity of exports.

18. The performance of imports is closely related to the development of the real sector of the national economy, and especially the industry. First of all, Moldova inherited a structure from the previous economic system that is 70 % dependant on imports. The structural reforms that were implemented from the declaration of independence up to present were not sufficient to change the situation. Thus, more than a half of goods imported to date, especially those that are indispensable for the economic development, cannot be substituted. On the other hand, there is a growth of imports of current consumption goods, such as: chemicals, textiles, foodstuff, drinks and tobacco, plastics, vegetal products, etc. As a result, domestic producers benefit very little from the increased demand, which stimulates economic growth in general. To a great extent, the advantages of this growth are in favour of foreign economies. This testifies to major problems faced in the organization of enterprise activity.

19. The main factors that determine the low performance of domestic enterprises are as follows: deficient corporative management, inadequate productive structures, outdated production capacities and limited access to financial resources. Both legal entities with some state-owned shares and the completely private ones face problems in terms of assets decapitalization.

20. In order to improve the situation, the Government initiated a number of actions to improve the public patrimony management and denationalization. The concept of the Law on management and denationalization of the public patrimony was developed. It identifies the following priorities: enhancement of the public patrimony accounting, optimization of dimensions, structures and methods for the management of public property, especially by introducing corporative management principles. Also, the draft law on amending the law on state enterprises, which is aimed at implementing the corporate management principles in the relevant enterprises.

21. In the same context, the agricultural growth remains to be modest. The agricultural output in 2001-2005 increased by only 16%. In 2005, the agricultural output increased by only 1% (in comparable prices) as compared to the previous year. Agriculture is still characterized by the lowest productivity and remuneration level. It represents almost 18% of GDP and provides jobs to 45% of the total labour force. However, low productivity and small growth in agricultural sector diminished the perspectives for the rest of the economy. Moreover, agriculture has an important role in the context of poverty reduction, as it represents the core activity for many people who are concentrated close to poverty line.

22. Creation of a favourable environment for economic growth in line with the market economy principles depends, to a great extent, on the infrastructure recovery and development, and namely the road network, water supply system, heating system, energy sector, and telecommunications. Following the declaration of independence, public investments in infrastructure were limited and most of them were provided from external resources.

23. Recovery and maintenance of infrastructure implies high costs, which cannot be fully covered by the national public budget. At the same time, delays in the recovery of infrastructure, on the one hand, is dangerous for the economic and social development, and on the other hand, leads to higher recovery costs in the future. In this situation, efforts should be made to increase public investments, especially in those areas where the private sector is not interested to make investments, as well as to develop alternative financing mechanisms such as private-public partnership.

24. The country’s transport network infrastructure was considerably depreciated in the transition period and the current efforts to maintain, recover and build roads are insufficient to upgrade the road network.

25. Achieving the objective related to ensuring energy security is still a serious challenge. The increase in price for energy resources is directly affecting the low competitiveness of domestic production as well as the population’s welfare in general. In the electric energy sector, efforts to increase energy generation capacities failed, the local power stations were not upgraded and the new energy generation capacities were not developed. The heating system, which is the main debtor for gas consumption, is in a more critical situation. In most localities, the heating system faces financial problems, low level of collection, and lack of investments.

26. Water supply and sewerage system reform is being implemented under EGPRS and MDG commitments that envisage “halving the number of people with no sustainable access to potable water by 2015”, which implies that the share of population with access to sustainable water sources should be increased from 38 % in 2002 up to 47.7 % in 2006 and 68.5 % in 2015. Actions undertaken to date are not sufficient, and the achievement of objectives in this area is still a challenge.

27. Access to education has been slightly improved during the last few years. The enrolment rates have been stable except for the enrolment in primary school from the rural areas (NBS data). Children from poor households and from rural households go to school at a later age and leave earlier than children from other households. These children start their school career already with a lag when entering primary school as they missed pre-school... The main reasons for not going to school in case of 3-16 year-old children are the schools that are not functioning (33%) and financial difficulties (27%). Poverty analysis shows that the education level is directly related to the living standards of the individual. Households headed by people without secondary education face a considerably higher poverty risk. As a result, poor children that do not have the possibility to obtain a higher level of education than the mandatory one have all the chances to be poor also in future. In this regard, provision of food to children within education institutions is an effective tool to attract children from poor families in the education system.

28. Moldova made progress in achieving MDG objectives in the health sector. Mortality rate for both infants and children under 5 years decreased both in rural and urban areas. Infant mortality rate reduced from 18.3 per 1000 newborn in 2000 to 12.2 in 2005, while the under-five mortality rate reduced respectively, from 23.3 per 1000 newborn in 2000 to 15.3 in 2004. Immunization coverage of children under two amounted to 99.2% in 2004. The maternal mortality rate reduced to 23.5 per 100,000 live births in 2004 up to 18.6 in 2005. So far, no considerable progress in decreasing TB-associated mortality rate was noted. Furthermore, the increased HIV/AIDS prevalence is a special concern. An important problem is non-contagious disease prevention, which is the main cause of morbidity, disability and premature death in Moldova.

29. Pension system reform is implemented slowly and the financial stability of the Social Insurance Budget raises concern. Slowdown in the implementation of Individual Records system and lack of motivation system for both the employers and employees does not contribute to improving the situation.

30. The average old-age pension in 2005 was adjusted by 18.2 %. The amount of the old-age pension (adjusted to the consumption price index) was 300.9 MDL, and represented an increase by 39%.

31. The social assistance programs have the highest share in the total public expenditures. In the period 2000-2005, the share of transfers to the population in the total discretionary expenditures increased from 28.9% to 31.6%, and their share in GDP increased from 8.7% to 10.4%. The performance of social assistance programs was still low over the last years because of inadequate targeting of resources. The poverty profile shows that the poverty rate among households, whose main income is obtained from social transfers, is higher than the average poverty rate. 36% of population that live in such households is poor and 20% - extremely poor. The households headed by pensioners have a higher poverty risk (31%).

32. Despite the importance and relevance of regional policies in the context of promotion of sustainable economic growth, the progress achieved in this respect is insufficient. So far, no regional development policy was defined. With the support of the development partners, a study was carried out and a main draft law was developed for a further legal framework in this field. In this context, it is suggested to specify the main functions of different central administrative bodies in the field of regional development.

Republic of Moldova: Poverty Reduction Strategy Paper Annual Evaluation Report 2005
Author: International Monetary Fund