The composition of short-term and medium-term adjustment measures will facilitate sufficient short-term adjustment flexibility, and be consistent with medium-term fiscal sustainability. Improving debt resolution instruments will help the banks to regain confidence in lending. Meanwhile, there is a need to consider improvements in its liquidity framework. The main factors that shaped the economic growth model in Moldova in the last decade and the risks of the current growth model are outlined. Public policies can promote growth by identifying and addressing the most binding constraints to development.


The composition of short-term and medium-term adjustment measures will facilitate sufficient short-term adjustment flexibility, and be consistent with medium-term fiscal sustainability. Improving debt resolution instruments will help the banks to regain confidence in lending. Meanwhile, there is a need to consider improvements in its liquidity framework. The main factors that shaped the economic growth model in Moldova in the last decade and the risks of the current growth model are outlined. Public policies can promote growth by identifying and addressing the most binding constraints to development.

Fiscal Consolidation and Structural Reforms in Moldova 1

A. Introduction

1. Moldova faces fiscal sustainability issues as a result of pre-election spending hikes and the global economic crisis that necessitate a genuine fiscal consolidation plan. Large fiscal imbalances arose as a result of sharp pre-election increases in wages and pensions and loss of revenue from the slump in economic activity. Given sizable fiscal adjustment needs, comprehensive fiscal consolidation plans need to be implemented and monitored to maintain confidence in the budget’s ability to finance itself and––in the longer run––fiscal solvency. Failure to do so would destabilize expectations and weaken the effect of the budget support now being provided by the international community.

2. High quality fiscal adjustment measures should be pursued including protecting vital public investment and well-targeted social benefits. 2 Looking at countries’ past adjustment experiences one can draw valuable policy lessons with regard to good quality measures to safeguard fiscal sustainability. Initially, a desirable consolidation plan would focus on expenditure rationalization in government wages, goods and services, and transfers while including important revenue-enhancing measures to broaden the tax base, reduce various exemptions and privileges, and improve tax administration. Sudden large public investment cuts (which may impede growth prospects), across-the board spending cuts (to the extent that they hurt critical spending on social protection or necessary maintenance) and distortionary tax increases should be avoided. Ultimately, securing efficient spending and taxation to promote inclusive growth should be key objectives.

3. Measures, however, need to be complemented by structural reforms in a medium-term setting to secure durable results. While specific short-term expenditure rationalization and revenue-enhancing measures are essential to stop further deterioration of Moldova’s fiscal balances, they need to be complemented by targeted structural reforms to ensure durable solutions. Public sector wages and employment, education, pension and health care as well as revenue administration are key reform areas. A medium-term setting would further allow for some upfront costs to be incurred initially (e.g., costs in optimizing the school network).

4. Furthermore, implementation of difficult structural reforms would be justified given the considerable deterioration of the structural fiscal balance. 3 Weak structural balances emerged in Moldova even before the crisis as a result of discretionary primary current spending drifting substantially upward and the near-elimination of the corporate income tax. With no adjustment, primary deficits would persist well after the automatic (de)stabilizing effect of the current crisis wanes off and the negative output gap closes. 4 In this regard, the significant but gradual and balanced structural fiscal adjustment under the ongoing IMF-supported program (2010–2012) guards against the risk of a deepening recession and an offsetting rise in cyclical deficit if output reacts negatively.

5. Overall, the adjustments sought would includeb: (i) rationalization of current primary spending and measures to increase the efficiency and impact of public sector services through public administration reforms while meeting critical infrastructure needs and better targeting social spending to protect the most vulnerable; (ii) tax policy complemented by tax administration measures intended to broaden the tax bases and improve compliance; and (iii) going forward, reforms aimed at keeping entitlements affordable to alleviate financing pressures on the social security system. 5

The paper is structured as follows. Section II provides an overview of country experiences with large and successful fiscal adjustments to guide Moldova’s adjustment plan. The remaining sections discuss in detail rationalization and reforms in specific areas of spending and taxation. Section III highlights the need for expenditure rationalization and reforms in public administration and the public sector more generally, emphasizing the wage system and the education sector, whilst protecting quality public infrastructure and targeted and affordable social spending. Section IV recommends specific revenue-enhancing measures with a focus on revenue administration reforms. Section V emphasizes medium- to long-term structural reforms focusing on long-run sustainability and reviews risks of rising spending pressures in the social security system related to demographics, pension benefits and health care. Section VI concludes by emphasizing the need for more efficient and equitable medium-term measures to complement short-term measures and highlighting key conditions and institutional approaches expected to contribute to sustained outcomes.

B. Fiscal Adjustment—Design, Country Experiences and Stylized Facts

6. In helping to identify key policy tools for fiscal consolidation, a checklist built from past policy lessons can serve as a point of reference. Issues related to the size, speed, timing and composition of fiscal adjustment are summarized in Box 1. This can serve as a framework to guide the Government in designing and implementing its own specific adjustment plan.

Moldova: A checklist for design and implementation of a fiscal adjustment plan

  • How much to adjust, under realistic budget assumptions? Carefully proposed fiscal adjustment plan would deliver a credible change in the fiscal flow balances while garnering public and markets’ confidence.

  • Is the pace of adjustment sufficiently ambitious to avoid reform fatigue? A balanced frontloading can leverage the post-crisis resolution to restore sustainability.

  • Are the constraints from the financing side taken into account? The scarce financing has acted as a motivator to the size and speed of adjustment in Moldova. Liquidity pressures in 2009 called for relatively fast and large upfront adjustment.

  • Is the operational target for the fiscal adjustment path well-defined and well-understood, and does it have adequate institutional coverage? An improvement in the annual overall fiscal balance as a target is easily understood. A structural adjustment target requires knowledge in how to separate cyclical and long-term movements in activity. Further, consolidated public sector coverage in Moldova is desirable and advantageous as it tends to avoid problems in intergovernmental fiscal relations.

  • Does the composition of adjustment take into account the size of the public sector? Primary expenditures have increased by over 16 percent of GDP in the last decade, moving Moldova considerably up the spending scale relative to neighboring Central and Eastern European Countries (CEEC). With an oversized public sector, past experiences have emphasized consolidation on the expenditure side, relying on cuts in government wages and transfers.

  • Are high-quality measures chosen for the adjustment? Good quality measures that foster long-term growth and efficiency minimize distortions, improve supply side incentives, and are permanent. Choosing such measures is especially important to support a ‘new growth’ model.

Other considerations:

  • Are external factors (if existing) fully leveraged?

  • Are supporting institutional and structural reforms in place?

  • Do sub-national levels of government contribute to the adjustment?

  • Are distributional effects of the adjustment taken into account?

  • Is there a strategy to mobilize broad based political and public support and communicate about the adjustment strategy?

Based on G. Everaert (2010) “A Practical Guidance Note for Fiscal Consolidation”, mimeo, IMF.

7. Large and successful fiscal adjustments yielding sizeable improvements in the structural primary balances are common. More than 20 advanced and 30 emerging economies have achieved improvements in their structural primary balances of at least 5 percent of GDP at least once in the last four decades (IMF 2010a, Tables 5a–5b). Table 1 provides a sample of neighboring countries with large adjustments followed in the past.

Table 1.

Country Experiences with Large Fiscal Adjustments

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Sources: IMF (2010a), World Economic Outlook database and Fund staff estimates.Notes: Cumulative change in cyclically-adjusted primary balance (CAPB) in percentage points of GDP for episodes lasting at least three years. In a given consolidation episode, the CAPB should not be reversed by more than 1 percentage point from one year to the next. The table lists largest adjustments per country, unless episodes for a given country are completely nonoverlapping.

8. Policy lessons from these fiscal adjustments tend to focus on reducing public expenditures and balance a frontloaded and sizeable adjustment based on a multitude of factors. The existing empirical literature generally advocates that current expenditure-based adjustments (especially government wages and transfers) have been more successful. Alesina and Perotti (1997) found that, in successful cases only one-fifth of the spending cuts affected public investment, whereas the largest cuts (accounting for half of the total) focused on wages and transfers. A role for revenue enhancement is also recommended in the early phases of adjustments as quality spending programs take time to establish or in cases where revenue can be raised from initially low levels. Tsibouris and others (2006) found similar consolidation patterns. 6 Other lessons advocate that the adjustment should not be too prolonged to avoid the risk of adjustment fatigue. Finally, factors ranging from external economic and domestic conditions, growth prospects supporting consolidation efforts, consistent monetary and exchange rate policies, and structural reforms have also been found to play a complementing role to the adjustment.

Thus, an appropriate mix of adjustment measures should in general reflect factors, such as (i) the current revenue and expenditure levels, where large expenditure slippages in the past, age-related spending pressures, and weaknesses in tax policy and administration would justify related expenditure- and revenue-based adjustments; (ii) the size of the needed adjustment where large fiscal gaps would need to be plugged with both revenue and expenditure measures; and (iii) the impact of reforms on growth and equity would favor a reform of inefficient, poorly targeted, and inequitable public spending while boosting measures to protect the poor and vulnerable. 7

9. Focusing on the specific conditions of Moldova, the scale and composition of fiscal adjustment would need to be tailored accordingly to ensure feasibility and durability of the plan. In light of the moderate-to-high adjustment needs in Moldova where structural deficits have been built as a result of past expenditure slippages, it would be most advantageous to pursue expenditure measures initially, boosted by needed tax administration reforms.

Based on Moldova’s historical experience, the estimated amount of fiscal action required should be achievable. Ambitious and attainable government policies should reflect consolidation priorities as well as their social, political, and administrative feasibility in delivering the required adjustment. While the specific short-term expenditure rationalization and revenue enhancing measures were essential to stop a deterioration of fiscal balances, the Government realizes the need to further integrate them into a medium-term fiscal framework to achieve more durable solutions. As such, structural reforms options in government wages and employment, education, social transfers and subsidies, and pension and health need to be evaluated and supported by policy actions to generate the desired fiscal savings.

C. Rationalization and Protection in Spending

10. Budget consolidation forms the cornerstone of the recent IMF-supported program, with protection for public investment and essential social spending. 8 Expenditure restraint is also echoed in the Government’s Economic Stabilization and Recovery Plan. In what follows, we review the priority expenditure measures with an emphasis on fiscal impact and implementation and the tradeoffs involved while complementing them with reform options that extend beyond the short term. The areas of expenditure where savings are sought include the public sector wage bill and employment and goods and services. A reexamination of subsidies and transfers to households should provide insights for a new, enlarged and affordable means-tested social assistance scheme. Growth-enhancing capital spending should also be protected given the chronic development needs in Moldovan key industries and sectors. Other important structural reforms dealing with pensions and health are discussed separately in Section V given their longer-term focus.

Current Spending Rationalization

Public Administration and Public Sector Reforms—Emphasis on Wage System 9

11. Implementation of public sector reforms suffers from delays. For instance, reform of the civil service salary system as a first element of reform of the salary system of all public sector employees got delayed by economic and political developments in 2009. 10 Against the backdrop of ongoing uncertainty in the economic environment due to the crisis and the political turmoil over the last two years, the Government is striving to accelerate reforms in this area without unduly stressing the limited resources at its disposal. 11

Despite the relatively low public administration (including general public services, public order and safety and defense) spending ratio (5.4 percent of GDP in 2009 compared to an average close to 9 percent in neighboring countries), there is a perception that the provision of public services is not efficient. This also extends to other general service areas such as education, social protection, transportation and agriculture. The weak public service provision is corroborated by a relatively high level of wastefulness of government spending and corruption concerns in some areas of public offices, as shown in Table 2 and Figure 1.

Table 2.
Table 2.

Wastefulness of Government Spending 1/

Citation: IMF Staff Country Reports 2010, 232; 10.5089/9781455204908.002.A001

Source: World Economic Forum, Global Competitiveness Report, 2008-20091/ Survey with index ranging 1 to 7 with lower values indicating higher public servies inefficiency2/ Includes Estonia, Latvia, Romania, Ukraine, Bulgaria,
Figure 1.
Figure 1.

Moldova: Corruption Impact on Public Services, 2009 1/

Citation: IMF Staff Country Reports 2010, 232; 10.5089/9781455204908.002.A001

Source: Transparency International, 2009 Global Corruption Barometer1/1=not corrupt at all, 5 extreme corrupt2/ Includes Belarus, Bulgaria, Armenia, Romania, and Moldova.

12. Within public sector services, spending on education receives the second largest share after social protection. Education is a main area of concern as spending in this sector has risen substantially to 9.5 percent of GDP in 2009 (almost double a CEEC average of just over 5 percent) or roughly to 21 percent of total expenditures (compared to a CEEC average of close to 13 percent; Table 3). The fast increase in spending on education over the last few years despite a rapidly falling number of students suggests alarming, rampant, and entrenched inefficiencies in the sector (Table 4).

Table 3.

Moldova and Selected Countries: General Government Expenditures by Function, 2008

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Source: Eurostat (countries in italic) and GFS.
Table 4.

Moldova General Government Expenditure by Function, 2005 - 2009

(in percent of GDP and in percent of total expenditures)

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This includes environment protection, housing and community amenities, and recreation, culture, and religion.

In terms of employment, the largest shares of general government employment, excluding the Social and Health Funds’ employees, are in education (62 percent) and public administration (21 percent)—Table 5. As a ratio to population, employment in education is high at 4.1 percent, compared to 2.7 in CEEC.

Table 5.

Moldova Government Employment - Number of staff, 2005-2009 1/

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Number of staff does not include the staff employed in the Social Fund and Health Fund. Employment in the public sector covers civil servants at state and local level (which according to the GFSM 2001 covers general public services (code 701), defense (code 702), public order and safety (code 703)), general service employees (including education, health, and culture) and contractual workers.

13. The public sector wage bill in Moldova rose substantially in 2009 to an unaffordable level of close to 12 percent of GDP, making it the second highest in CEEC. The average public sector wage had also grown by almost 20 percent in real terms, in sharp contrast with other countries in the region—this increase is clearly above the productivity growth rate with an attendant negative effect on competitiveness (IMF Country Report 10/32). Further, the public wage bill accounts for 26 percent of total general government expenditures, high compared to an average of 21 percent in selected CEEC (Table 6).

Table 6.

Moldova and Selected Countries: General Government Expenditures, Economic Classification, 2009

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Source: GFS

This is a component of Social Transfers.

14. This recent surge in wage bill is driven in part by a rapid increase in salaries on the backdrop of political promises. The ratio of average public sector wage to GDP per capita––a key measure of affordability––has surged from 1.2 to almost 1.7 between 2008 and 2009 and is now well above levels observed in countries like Estonia, Latvia and Lithuania (close to 1.0). In most countries public sector wages are normally below the private sector level and Moldova is no different (the ratio was 90 percent in 2009) given higher job security in the public sector.

In the education sector, the combination of salaries paid and current employment levels is unaffordable presenting the Government with a clear if difficult choice of balancing between competitive salaries and current staffing. In terms of salaries paid, the concern lies in the recent and fast rise in wages (close to 30 percent between 2008 and 2009) with possible debilitating carryover effects. The education wage bill, in percent of GDP and as a ratio of total general government expenditures reached 6.1 and 13 percent in 2009, or 52 percent of the total general government wage bill.

15. Relatively large employment in the public sector, education in particular, would also explain the surge in the wage bill. Such an overstaffing problem represents a structural deficiency in delivering services. Public sector employment stood at 6.6 percent of population in 2009 (Table 5). The proportion of public to overall employment is also high at 21 percent. In particular, the Moldovan education system exhibits very unfavorable structural characteristics, suggesting apparent excess employment:

  • A drastic reduction in the number of students was not accompanied by staff reduction or school optimization: while the number of students decreased by 27 percent in 2007–08 compared to 2002–03, the number of schools declined by only about 3 percent over the same period;

  • A student/teacher ratio as low as 13 compared to a European norm of 18;

  • An excessively high ratio of non-teaching to teaching staff—the average ratio is 37 percent which is well above a European average of 27 percent;

  • Lack of financial incentives to reduce staffing levels.

16. The Government aims to bring the wage bill back to an affordable ratio of below 10 percent relative to GDP by 2012-13. This level has long been considered both adequate and necessary to protect critical current non-wage spending and public capital expense. It would also bring Moldova closer to the CEEC average of just below 9 percent (Table 6).

17. Short-term wage bill measures implemented in 2009 contained the wage bill, but supporting longer-term measures to improve the efficiency of the public sector remain to be developed. The main measures range from modifying and postponing unaffordable wage increases, keeping budgetary sector employment to efficient levels, elimination of permanent vacancies, and continuing with the optimization of the number of employees in the budgetary sector. While these measures did set the wage bill on a declining course, the Government still faces a challenge linking those measures to much-needed medium-term structural reforms. The root causes of the imbalances, which are predominantly linked to insufficient control over employment levels, are yet to be addressed. Another issue of concern to the Government is how to maintain competitive wages to attract qualified staff which would contribute to the efficient and effective delivery of public services.

18. Public administration and civil service reform to sharply improve delivery of public sector services should be a policy priority. 12 Previously proposed policy suggestions by the World Bank should be pursued further: (i) finalize a civil service remuneration system, (ii) review the effectiveness and efficiency of service delivery systems that are big spenders (i.e. education) and develop a strategy for streamlining service provision, and (iii) introduce systems of internal controls in public administration entities to raise efficiency and limit corruption. 13

19. While the public sector wage system reform has in recent years emerged as one of the key issues in the public administration reform process, significant work remains to be done. The composition of the salary system is inadequate, non-transparent and quite complicated. In this regard, the competitiveness of remuneration across job categories should be made more consistent and, ideally, the “years in service” element should play less of a role in determining wages in favor of human capital requirements to perform the job (i.e., difficulty and complexity of the work, particularly for public health employees).

20. While reducing identified excess employment in education remains politically challenging, the World Bank’s comprehensive work in this area puts it in a position to provide concrete measures. A recent World Bank pilot study in two rural districts has sought to tighten monitoring and enforcement systems in the overall public education employment registry as a way to identify areas of excess hiring. In conjunction with the Ministry of Education’s optimization strategy (incentivizing class and school mergers), the World Bank’s specific proposals (backed by a Government approval) can help accelerate the ongoing school network optimization activities. An estimate of the fiscal impact of these concrete measures should feature in the Government’s medium-term expenditure framework (MTEF), to improve expenditure planning over the medium-term horizon.

21. Short-term measures should be supported by additional medium-term and long-term measures to improve the efficiency of the public sector.

  • Rationalize the structure and improve the efficiency of government operations. A comprehensive review of the size, functions, and staffing and payment structure of all government organizations should help identify further areas of employment rationalization and better service delivery.

  • Outsourcing non-core functions. Outsourcing of non-civil servant positions in noncore functions such as transport, security and maintenance could be considered. Looking forward, functions in finance, accounting, and information technology and communication (ITC) could also be outsourced in an efficient manner. The source of cost savings would be the increased efficiency with which the private sector can implement these functions. 14

Goods and Services

22. Reduction in budget allocations for low-priority goods and services would also bring substantial fiscal savings. Spending on goods and services reached 10.2 percent of GDP in 2009 (an increase of almost 30 percent from an average of 7.9 percent of GDP over 2001–08), substantially larger than a CEEC average of 7.3 percent of GDP. While some across-the-board cuts have been implemented, caution is needed in safeguarding critical spending on maintenance and inputs for line ministries. 15 The Government should continue soliciting ministerial spending reviews to help it identify areas for efficiency savings, complementing it further with sector-wide spending reviews. Having averaged a growth rate of 26 percent a year between 2001 and 2008, the rate of growth of this expenditure component has moderated to close to 4 percent in 2009, in pace with the economy’s essential spending needs. 16

23. To avoid arrears, controls of the procurement process in goods and services with a view to prevent the assumption of unaffordable commitments should be enhanced. The authorities’ program calls for a substantial reduction in allocations for low-priority goods and services. To avoid higher-than-budgeted spending on goods and services, reforms in procurement and internal financial control, to be introduced by end-2010, will allow reining in spending in 2011 and beyond, keeping it in line with the economy’s essential spending needs. Moreover, closely relating the budgeted allocation of funds for goods and services to final spending can be achieved by strengthening the communication between the MOF and the spending line ministries during the budget process. The ongoing gradual move from an input-based line item budgeting system to a results-based programmatic approach (which will apply to the whole budgeting framework and not just to goods and services) would help in this regard as well.

Protected Areas of Spending

Public Infrastructure Spending

24. Capital spending in relation to GDP which has been rising since 2001 declined for the first time in 2009. Capital spending had averaged about 16 percent of total government spending in 2000–08 or 6 percent of GDP before falling to 11 and 5 percent respectively in 2009 (in close comparison to CEEC averages of 12.4 and 5.1 in 2009). This level is insufficient given Moldova’s large development needs.

25. Although capital budgeting continues to improve from a budget planning perspective, weaknesses in the monitoring and evaluation of approved projects remain. While the annual budget documentation contains detailed lists of proposed investment projects and related maintenance expenditures, considerable fragmentation remains in the institutional framework with a possible overlap in functions. Different units are responsible for donor-financed and budget-financed projects, complicating the planning process. On evaluation and monitoring, it appears that the responsible division in the MOF dealing with capital investment financing faces capacity constraints and seems to focus its attention on ensuring financial compliance rather than progress in achieving project objectives, as routine progress reports are lacking.

26. The road maintenance budget during 2009 was well below the minimum requirement to avoid further depreciation. 17 The reform of road maintenance financing and a large increase in funding for road maintenance have been conditions for road investment financing by external partners for some time.

27. More generally, recent underspending in new construction and maintenance would require timely mobilization of investment funding. Overall capital spending was revised downward from an initially approved ratio of over 7.5 percent relative to GDP in the 2009 Budget to 5 percent. Over the medium-term, the policy target is to bring this ratio back up to 7.5 percent of GDP beginning in 2012. There is a perception that critical infrastructure needs are largely unmet and that state assets, roads in particular, have suffered massive physical deterioration. As such, sustained long-term economic growth and social development is at risk unless the road network is rehabilitated and maintained (World Bank 2010a). In response, the Government has recently mobilized the investment funding to rehabilitate the road network from external sources (including MCC), and, in parallel to mobilize the funding needed for the maintenance of roads.

28. As for areas of further improvement, project prioritization, monitoring and evaluation processes associated with the capital budget should be targeted. The establishment of a single unit to manage investment project planning would go some way to resolving the institutional fragmentation problem. Furthermore, a redirection of the focus on monitoring routine progress in achieving project objectives should be pursued as capacity gets built.

Social Assistance

29. A key reform objective pursued by the government has been the improved targeting of social assistance benefits to ensure that they reach the most vulnerable. This required moving from an old categorical system to a proxy means-tested scheme. The urgency to accelerate this program was recognized in IMF Country Report 10/32 in light of the large adverse social consequences of the global economic crisis on the poor. The phasing out of the nominal compensation scheme is intended to reduce leakages 18 and free up additional fiscal resources to finance poverty-targeted and quality social assistance.

30. The Ministry of Labor, Social Protection and Family has prepared the analytical basis and the infrastructure to support the introduced new scheme. As such, steady work continues towards achieving a take up rate of at least 2/3 by the end of 2010.

31. Some flexibility has been built in the budget to allow for improvement in the social assistance under strenuous conditions affecting the poor. Energy allowances have recently been allocated to low-income beneficiaries while at the same time ensuring the fiscal neutrality of this measure as additional expenses would be covered by newly committed donor funds. Means-tested heating subsidies beyond 2010 would be consistent with the new targeted social support scheme.

D. Tax Structure and Tax Policy Reforms

32. Revenue performance looks reasonably sound and the tax system does not appear to be overly burdensome. 19 The sound performance is due in most part to high revenue from VAT, especially VAT on imports; however, the high VAT collection is in part due to unfavorable treatment of imports of investment goods. On the other hand, both personal and corporate income taxes (PIT and CIT) perform below average (Table 7)—the adoption of a zero-rate on reinvested profits in 2008 reduced CIT revenues to 1.1 and 0.7 percent relative to GDP in 2008 and 2009, further widening the gap relative to other countries.

Table 7.

Moldova and Selected Countries: Tax Revenue Breakdown, 2009

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Source: FAD Tax Revenue Database, and IMF Staff Calculations.

Social Security: Payroll taxes and other Pension Fund own revenues.

The current challenge is one of regaining some of the revenue lost due to crisis and securing more stable sources of revenues, with a tax policy focused on broadening the tax base by reducing exemptions and raising excise rates closer to those in neighboring countries.

33. Regarding tax policy, the authorities’ program relies mainly on adjustments in excises toward the levels in neighboring countries and a reinstatement of the corporate income tax (CIT) from 2012 onwards. The increase in excise rates on alcohol, cigarettes, and fuel in 2010 is expected to yield about ½ percentage points of GDP on a permanent basis. The reinstatement of the corporate income tax from 2012 on––with a low single rate and a broad, uniform base across sectors and regions––is necessary to complete the process of structural fiscal adjustment and diversify the tax base, while allowing the effects of the crisis on corporate profitability to dissipate.

34. While the fiscal adjustment plan has thus far focused on expenditure measures, reforms in tax administration should now be emphasized. Given the uncertainty about the growth strength of the Moldovan economy over the medium-term and its potentially large variation effect on annual budgetary revenues, expenditure-side measures were primarily targeted. Improvements in tax administration are however essential in the context of restoring long-term fiscal stability, increasing economic activity, and providing an attractive environment for foreign investment. The Government expects reforms in tax administration to generate additional receipts to help in partially filling the fiscal gap.

35. Progress in tax administration reform slowed down significantly in 2009. Partly due to the political turmoil in Moldova, substantive modernization objectives of reforming IT systems and organization structures as well as putting in place better tax compliance management systems got delayed—the latter is hampered by the State Tax Inspectorate’s (STI) weak programs for audit and taxpayer services and a lack of a strategy to address major risks to revenue performance.

36. Taxpayer compliance problems, if not treated in time, may lead to revenue losses in addition to those driven by the economic downturn. Heightened compliance risks in the current environment stem from extraordinary financial pressures on businesses and other taxpayers. The economic downturn has directly affected their viability, influencing tax compliance behaviors with regard to timely filing and payments, and correct declaration of income—a large increase in tax arrears in 2009 serves as an example. Other tax avoidance problems are underreporting of wages for social security contribution purposes with lower contributions collected as a result.

37. Assisting the tax administration in its efforts to contribute to resolving the fiscal gap in Moldova, a recent IMF technical assistance mission identified the following reform priorities over the next 2–3 years: (1) modernization of the IT systems, critical for day-to-day work and the prospects for increasing taxpayer compliance and revenue collections; (2) modernization of STI’s organizational structure, and (3) improving taxpayer compliance. To achieve these objectives, the mission recommended:

  • Actively assessing major risks to revenue and prioritizing and allocating resources to address those risks. An agency level compliance strategy that addresses the needs of each key market segment and explicitly protects major revenue tax bases would provide the needed direction. This should be done while balancing between tough enforcement and soft measures in support of businesses hit hard by the recession.

  • Establishing a Risk Management Unit (RMU) and tasking it with coordinating the STI effort to develop and implement a taxpayer compliance strategy to ensure that resources are utilized on measures that provide the maximum impact on facilitating compliance. Modern risk management concepts developed in EU and OECD should be used as a guide while deploying varying measures to mitigate the identified risks depending on the underlying reasons for non-compliance—audit, taxpayer education, law and procedure changes, IT improvements and media coverage as possible actions.

  • Backing up the compliance program by effective and strong risk mitigation tools, including audit programs, large taxpayer programs, arrears collection programs,20 and taxpayer service programs.

  • Garnering significant donor support for a major IT reform program, development of important management tools with regard to compliance risk management.

E. Medium- To Long-Term Structural Reforms Enhancing the Long-Run Sustainability of the Social Security System

Pension System 21

38. Improvement in spending trends is essential to anchor long-run sustainability and prevent deterioration in fiscal balances in the future. In this regard, keeping social security financing pressures in check is key. The near 20 percent increase in pension expenditures in 2009 is alarming and the medium-term effect of potential similar raises in benefit rates on the system’s financial balance can be detrimental unless offset by other reforms. In keeping with responsible fiscal planning, challenges over the next few years and over the long-term should be addressed. 22

39. The pension system seems to be fiscally sustainable but socially unsustainable in light of the low level of pension benefits. This conclusion was reached based on a World Bank’s quantitative analysis of the status quo with no reforms. The same study also presented alternative key parametric reforms with different implications on the pension financial balance—this included changing the valorization 23 cum indexation pattern, reducing pension accrual rate, increasing retirement age followed by equalization across genders and groups, and improving contribution collections while increasing the required contributions for the farmers and the self-employed. 24

40. In 2008, the government drafted a set of strategy documents on further pension system reforms intended to complete an unfinished 1998 pension reform agenda. The objectives were to strengthen the link between benefits and contributions paid, unify the contribution rates, reduce existing privileges, and tighten disability pension rules. The documents were not finalized and concrete policy measures were not specified.

41. Phasing out early retirement privileges in civil service and the judiciary is an important part of reforming the social insurance system and improving its financial sustainability. These measures, which are part of the IMF-supported program, entail raising retirement age for these occupations by 6 months every year, until it reaches the regular retirement age. 25

42. While the pension system ran only moderate deficits over 2005–08, the financial gap surged in 2009 creating an additional funding pressure to the State budget. State budget transfers increased sharply in percent of GDP in 2009 and are projected to edge even higher in 2010 (Table 8).

Table 8.

Pension Contributions and Expenditures

(in percent of GDP)

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Source: Government of Moldova, National Social Insurance House.

Based on Staff estimates of an effective ‘pension’ contribution rate.

Both recession-related and policy-induced factors contributed to the worsening financial gap. Recession-related effect on pension contributions under no changes in the compulsory (pension) contribution rate contributed to a sharply reduced own revenues growth in 2009. But discretionary expenditure policies were primarily responsible for the weakening balances. The indexation rule (a Swiss formula) allowed for a large increase in pension payments in 2009 reflecting sharp economy-wide wage increase in 2008, but some additional top-up in 2008–09 also contributed to this increase. 26 Other factors and policies pertaining to the structure of the system (i.e, minimum pension rates, pension benefit rates, treatment of past valorization) have also played a role.

43. Based on pre-crisis economic developments, projections of a no-reform scenario had shown near-term balances in the pension scheme and long-term financial surpluses (World Bank, 2009b). 27 Model-based simulations had pointed to a positive balance in the pension system that emerges after 2020 and grows constantly in the long run due mostly to a rapid but socially unsustainable decrease in the average benefit replacement rates. Aside from the undesirability of a sharp fall in the replacement rates, these calculations need, however, to be revised to reflect developments in 2009 as well as take a critical look at two important underlying assumptions behind the gradual growth in pension revenues—namely, an expected gradual increase in the size of the workforce (while it has been falling for a number of years) and a faster real wage growth than real GDP in the post-recession period (an average over the past 4 or 5 years might be more appropriate). The opening gaps between contributions and expenditure (Table 8) suggest that the overall effect of such an update could be significant.

44. The challenge in reforming the pension system resides in raising the existing low benefit rates without opening a durable financial gap. Although currently age-related spending pressures appear manageable, the challenge is how to improve the efficiency of this spending and program design at an early stage to ensure that potential pension benefit improvement do not endanger fiscal sustainability over the longer-term.

45. Relatively large pension spending, expected deterioration in pension system dependency ratio and low benefit rates are sources of financing pressures. Pension spending ratcheted up to 7.2 and 9.1 percent of GDP in 2008 and 2009 more than double the 1999 level (4.4 percent of GDP) and is currently above the 2008 CEEC median of 7.3 percent of GDP. The pension system dependency ratio (defined as the ratio of pensioners to insured individuals/contributors) is expected to rise from 59 pensioners per 100 insured persons currently in 2008 to 86 by 2050 due to the declining trend in contributors and early retirement (World Bank, 2009b). On the other hand, Moldova’s pension benefit rates are low but comparable to other countries in the region (Table 9) with an average pension (old-age) at 26.4 (27.4) percent relative to gross wage (35.1, on a net basis, albeit below an ILO standard of 40 percent). This has reflected mainly the non-valorized pension base after 1998 which kept pension costs low but made benefits socially inadequate and evidently in need for enhancement.

Table 9.

Moldova and Selected Countries: Replacement Rates

(mid 1990s and mid 2000s)

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Source: World Bank (2008), Working Paper No. 129.Note: Rates reflect general average of pension benefits in percent of gross wage.

46. Numerous challenges and flaws remain in the pension system.

  • The pension system underperforms in terms of benefit adequacy primarily the result of a lack of valorization of past incomes for new retirees in the pension formula—as a partial and temporary offset, the accrual rate has been raised against the recommendations of the 1998 reforms.

  • In terms of compliance and collection, benefits are determined based on declared wages rather than paid contributions which has weakened tax compliance and created a tax avoidance problem.

  • The incentive to participate and contribute to the system remains weak.

  • Ad-hoc regulation of the pension system through the annual Budget law as well as introduction of benefit increases regardless of the indexation rule may, over the long-run, threaten the system’s fiscal sustainability.

  • Suspension of retirement age increases in 2003 and the lack of action following the Government’s 2008 draft strategy documents leave much work to be done.

47. Pension reforms should aim to at least halt the decline in the replacement rate while safeguarding the sustainability of the system. In this regard, maintaining a reasonable rate of return on pension contributions and an adequate coverage in a manner that does not generate fiscal imbalances is key. While raising statutory retirement should form the starting point of the offsetting reforms, other measures in improving financial balances can be pursued. And while some measures are of a short-term nature, others deal with longer-term structural impediments and require time to implement.

48. Short-term measures can generate relatively quick fiscal savings. For instance, strengthening incentives in the pension system can be pursued through a tighter link between contributions and benefits, avoiding contribution amnesties, improving compliance through adequate contribution enforcement 28, and contribution levels for self-employed and farmers.

49. On the other hand, addressing structural problems are essential to secure fiscal and social sustainability in the long-run. Valorization of past earnings needs to be reestablished in the pension formula, buttressed by an adequate indexation pattern. Pension disability needs to be redefined in compliance with the ILO definition (this is already one of the declared Government measures) to stimulate to the extent possible employment of disability pension beneficiaries. 29 Ad-hoc pension increases need to be stopped—beginning in 2004 and recently, exceptional measures have contributed to a more than doubling of the pension system costs over the last decade. Numerous emerging privileged pension schemes with large differences in benefits from the general schemes should be eliminated. Last but not least, retirement age should be gradually increased for both genders to 65/60 and then equalized at 65. 30 This raising and equalizing policy has been launched by most countries (see World Bank (2009b) for EU10 countries and IMF (2010b) for G20 countries)—as life expectancies at birth continues to improve, the retirement age in many countries has increased, a measure that would help pension finances by increasing the years of contributions and reducing the number of years of pensions in payment.

50. Updated pension reform simulations address both the short-term and medium-term challenges facing the pension system. Proposed pension reforms were discussed in detail in World Bank (2009b). 31 Here we report an update of the quantitative results of representative reform options while reflecting important data and assumption changes pertaining to the post-crisis period (Table 10). Such reforms cover key changes with respect to valorization of wage history, raising retirement age, improving compliance and collection, and minimizing the redistributive nature of the system in an effort to strengthen contribution incentives by all groups.

Table 10.

Moldova: Pension Reform Scenario Simulated with the Pension Model

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Source: World Bank and Ministry of Labor, Social and Family ProtectionNote: Parameters different from Baseline in the reform scenarios are marked in bold.

Pension reform scenario. Valorization is based on a 50–50 wage-price formula, with a stronger (relative to baseline) wage component resulting in larger replacement rates, but also higher pension expenditures and financial gap relative to GDP. If combined with a Swiss type (or a full wage) indexation benefit formula, full wage valorization can result in a fiscally unsustainable system requiring needed offsetting reforms. Accrual rate is reduced by 20 percent in conjunction with reinstalling valorization (in the past high accrual rates were used as an offset to a lack of valorization) to help improve fiscal sustainability. Raising retirement age has a substantive offsetting effect to raising replacement rates, with a huge expected positive impact on the financial balance—legislated increase in the statutory retirement age (gradually in 6-month increments) raises revenues from longer working-age population years of services and postponing benefit payments. While higher compliance and collection rates may further improve financial balances in a meaningful way, in the chosen reform scenario we opt for a more conservative (baseline) contribution collection rate while allowing for its increase for the self-employed and the farmers. A sustainable financial balance is observed along with an improvement of pension social sustainability compared with a baseline of deteriorating replacement rates. The figures below reflect the improved social sustainability conditions post-reform relative to the baseline scenario (Replacement rates: average old-age pension relative to average wage) while maintaining fiscal sustainability as depicted in the positive financial gap over the next 40 years (Financial balance of pension fund is the difference between the reported revenues from contributions 32 and expenditures components).


First Pillar - Revenues From Contributions and Expenditures

(Percent of GDP)

Citation: IMF Staff Country Reports 2010, 232; 10.5089/9781455204908.002.A001

Source: IMF staff calculations.

Average Old-age Pension Rate Relative to Average Wage

(Replacement rates, percent)

Citation: IMF Staff Country Reports 2010, 232; 10.5089/9781455204908.002.A001

Health Care System

51. Public health spending from the NHIC has risen sharply as a share of GDP between 2004 and 2009 (Table 11). Other health-related spending outside NHIC and by the MOF to maintain health facilities, upgrade of infrastructure and equipment and improving quality is reflected in total health expenditure in Table 3.

Table 11.

National Health Insurance Company: Contributions and Expenditures

(in percent of GDP)

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Source: National Health Insurance Company.

52. Moldova embarked on a health sector reform at the end of the 1990s. At that time output health indicators were deteriorating and public health expenditures was only 2.9 percent of GDP. The reforms focused on extending the Primary Health Care (PHC) network, consolidating the health infrastructure, introducing affordable health insurance and breaking the Government’s control of hospitals. By 2008, the ratio of health spending relative to GDP reached 5.4 percent with fast rising average per capita health spending (1833 lei, the highest levels since independence).

53. Despite substantial health sector reforms and notable improvements, reforms are not complete yet with output indicators remaining well below EU averages. The challenge is how to expand basic coverage to a larger share of the population at a reasonable cost, without generating fiscal pressures.

Looking at some vital indicators, the current level of public health expenditures is above a CEEC average but output indicators fare worse, controlling for income levels. From an average of 4.6 percent of GDP in 2005–07, this ratio rose to 5.4 and 6.5 percent of GDP in 2008 and 2009, surpassing a CEEC average ratio of 4.4 percent of GDP in 2008 (Table 3). As for output, Moldova performs worse than an average in selected CEEC in terms of life expectancy at birth and infant mortality indicators. This is controlling for the low per capita income level in Moldova. Moldova infant mortality rate is 11.27 (EU average is 2.5 times lower), and Moldova Life expectancy at birth is 69 years (EU average is 10 years higher).


Health Outcome Indicators in Moldova

Citation: IMF Staff Country Reports 2010, 232; 10.5089/9781455204908.002.A001

Sources: Eurostat IMF World Economic Outlook., World Bank (2009), and IMF Staff Calculations.

54. Areas of weaknesses in providing financial protection and a provider payment system which does not reward good performance need to be addressed.

  • The private sector plays a large role in financing health costs with high out-of-pocket payments and drug costs not covered by insurance. The share of private spending stands at roughly 47 percent (down from 50 percent in 2005 due to increased public subsidies for health insurance). Out-of-pocket payments are high (98 percent of total private health-related spending), which, coupled with a large share of drug costs that are not covered, contribute to a lack of financial protection.

  • With a narrowly input-based funding of services, the current provider payment system does not reward good performance. Performance indicators that can be used to incentivize health facilities managers such as minimizing the cost per unit of service while preserving quality are not in place.

55. Ongoing reforms should be pursued to contain spending growth while ensuring broad access to high quality health care and addressing large remaining inefficiencies in the sector. 33 In this regard, targeted measures with attendant short-term fiscal savings should be consistent with the longer-term reform agenda to ensure fiscal sustainability. Key reforms that need to be accelerated are as follows: (i) introducing norms for per capita funding of public health care promoting the right incentives, while in the medium-term incorporate a standard set of quality/performance indicators into all contracts with providers; (ii) promoting efficiency, quality, and user satisfaction in the provider network, including realigning the remuneration system to focus on performance; (iii) containing the out-of-pocket spending on medicines by basing drug reimbursement on therapeutic value to beneficiaries and cost-effectiveness. Finally, regarding the role of State budget transfers to NHIC, a number of actions are envisaged to be developed and implemented at a policy level within the legislative framework review, namely (a) conducting a means-test review of the 14 categories of population (based on real income and economic vulnerability) for whom the State pays insurance contributions to the Health Fund, and (b) enhancing the cost effectiveness of services rendered by health providers through implementation of a payment mechanism geared toward outcome, performance and complexity of treated cases.

56. The system of granting subsidies to cover drug costs, or granting exemptions for health insurance contributions should be integrated under the new means-tested social assistance scheme. This integration would unify the procedures by which social assistance is provided (whether related to health or other social assistance programs) and strengthen the monitoring and targeting of assistance to the poorest income quintile, a large share of which has no health coverage.

F. Conclusions

57. The composition of short-term and medium-term adjustment measures should facilitate sufficient short-term adjustment flexibility and be consistent with medium-term fiscal sustainability. A further fiscal deterioration or delays in implementing medium-term structural expenditure reforms will require more extensive short-term expenditure rationalization. More efficient and equitable measures should enable the achievement of sectoral objectives at a lower cost to public finances.

58. Strengthened fiscal institutions and arrangements can play a key role in support of fiscal consolidation. This would cover the main elements in the fiscal policy making process such as (i) developing a credible fiscal consolidation strategy by committing to a transparent, comprehensive and binding medium-term fiscal objective that provides sufficient flexibility to accommodate unforeseen shocks—supported by a medium-term budget framework that translates the fiscal objectives into a clear plan for the evolution of public spending; (ii) implementing the consolidation strategy through the budget process—preserve a comprehensive top-down approach to budget formulation in cabinet and allow a role of legislators in the determination of the overall fiscal strategy whilst maintaining sufficient control over budget execution of the multi-year expenditure commitments, and (iii) putting in place a comprehensive, timely, and credible reporting of the current fiscal situation in the government’s financial statements and statistics while providing robust medium-term fiscal projections and comprehensive disclosure and management of fiscal risks.

Appendix 1. Basic Data - Moldova Pension System

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Sources: IMF staff calculations; and national auhtorities.


  • OECD, 2009. “The Benefits of Long-term Fiscal Projections.” OECD Policy Brief. Available at:

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  • OECD, 2010a, “Strategies for Fiscal Consolidation in the Post-Crisis World”, IMF Policy Paper (Washington). Available at:

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  • OECD, 2010b, “From Stimulus to Consolidation: Revenue and Expenditure Policies in Advanced and Emerging Economies”, Staff Paper (Washington). Available at:

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  • OECD, 2010c, “Fiscal Rules—Anchoring Expectations for Sustainable Public Finances”, Staff Paper (Washington). Available at:

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  • World Bank, 2009a, “Moldova: Policy Notes for the Government”, April 2009.

  • World Bank, 2009b, “Policy Options for Further Reforms of the Pension System in Moldova”, World Bank Report to the Government of Moldova, June 2009.

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  • World Bank, 2009c, “Fiscal Impact of Public Sector Wage Reform”, October 2009. (Forthcoming in the Public Expenditures Review).

  • World Bank, 2010a, “Program Document—Moldova Economic Recovery Development Policy Operation”, February 2010.

  • World Bank, 2010b, “Public Expenditures Review”, forthcoming.


Prepared by Philippe Karam (FAD).


See IMF (2010a) and Everaert (2010, mimeo) for policy lessons and a practical guide on fiscal consolidation.


The structural budget balance estimates what the budget balance would be if the economy were operating at its potential. It helps to distinguish short-term budgetary changes driven by cyclical movements in the economy from those budgetary changes expected to persist over the medium-term.


The extent to which some revenue losses are long-lasting and cannot be reversed quickly would also play a role in explaining a continuing deficit.


To assess whether a government’s fiscal structure is sustainable requires looking beyond projections of budget deficit and debt over a medium-term horizon to take into account the economic and fiscal implications of longer-term spending pressures (i.e., major demographic changes) that would strain government finances.


IMF (2010a), Box 2 provides a summary of the empirical literature regarding the composition of large and successful fiscal adjustments. See also IMF (2010b), Appendix Table 15—Experiences with large adjustments.


IMF (2010a), Table 2 illustrates the variation in countries’ adjustment strategies based on these factors.


The fiscal adjustment program is set out in the MEFP (IMF Country Report 10/32) and lays out in detail the strategy for deficit reduction over the course of the three-year program (2010-2012).


This analysis draws from a forthcoming chapter on “The Fiscal Impact of Public Sector Wage Reforms”, World Bank (2010b). The public administration system in Moldova includes State administration offices, autonomous Territorial Administrative Units (TAU), and two Security Funds.


A new and simplified pay system for the public administration initiated by a Government’s draft “Classification of Civil Service Positions and Grading System” is yet to be supported by a draft law on civil service remuneration, which was initially intended to be passed by the end of 2009.


The World Bank (2010a) is supporting the improvement and the efficiency and management of public sector resources in key industry and social areas through its recent Development Policy Operation (DPO) to Moldova.


As part of the Government’s continuing efforts to reform the civil service, a new performance-based wage system for public sector employees will be introduced in 2011, once the pressure of the crisis begins to unwind.


For a detailed set of initiatives to help the government improve the attractiveness and performance of public administration refer to World Bank (2009a).


The Government has already begun to outsource selected services currently provided by public authorities. Looking forward, a full privatization of these operations should be considered as a medium-term objective.


However, imposing some general, across-the-board saving targets may facilitate the political acceptability of reform by requiring all ministries to contribute to the adjustment.


Increased utility bills and slower-than-expected progress in procurement and internal financial control reforms had necessitated an increase in spending on goods and services in 2010.


The Government delayed implementing its own part of the Land Transport Infrastructure Strategy (LTIS). Coupled with the political uncertainty, this led external partners, including the World Bank, EBRD, EIB, MCC and the EC, to postpone disbursement of funds in 2009.


Based on 2007 World Bank analysis of households surveys, more than 60 percent of social assistance payments ‘leaked’ to middle and upper (consumption) expenditure quintiles.


The labor tax wedge was assessed to be low compared to other countries in the region, based on some previous IMF calculations.


At 21 percent of tax collections, the current level of tax arrears (2.2 percent of GDP) is not excessive compared with other transition countries, particularly when taking into account the effect of falling tax revenues as a result of the global crisis. However, the debt has built up in a relative short time following the 2008 tax amnesty when most debt accumulated prior to 2007 was written off. In response, recommendations are made to allow the application of deferment and installment arrangements in cases of inability to pay the debt in full.


This section benefited substantially from World Bank papers (2009b, 2010b), and from discussions with World Bank and Ministry of Labor, Social Protection and Family staff on technical issues. Recent basic pension data is attached in Appendix I reflecting official data as of April 2010.


According to OECD (2009), “… long-term economic and fiscal projections reports, prepared by members to assess fiscal sustainability, offer invaluable signposts to help current government to respond to known fiscal pressures and risks in a gradual manner, earlier than later, and help future governments avoid being forced to adopt sudden policy changes …”.


World Bank (2009b) “… Old age benefits amount is calculated as pension base (average gross wage earned on the basis of all working years) multiplied by the sum of annual accruals. The pension base for the period until 1998 is valorized with wage growth until the year preceding the year of retirement. As for the wages earned after 1999, the pension base is calculated as the average of nominal wages without valorization (indexation of wage history) by either wage or price inflation in that period.” Non-valorization is followed in Moldova only.


The current retirement age for judges and prosecutors is 50 years, while for civil servants it is 52 years for women and 57 years for men. The regular retirement age is 57 years for women and 62 years for men.


The indexation formula is based on last calendar year averages of wages and inflation (2008) to estimate pension entitlements for the period running from April to March of subsequent year (April 2009-March 2010).


The 2009 simulations did not reflect the full impact of the crisis, and as such would be revised to include the post-crisis developments. This said, these projections should not be interpreted as predictions of the most likely future outcomes. Rather, they are simply a set of ‘what if’ scenarios that attempt to illustrate and quantify the implications of leaving the Government’s current pension structure unchanged over time.


Compliance with contribution requirements is low. Average covered wage in 2008 (as per NSIH) stands at 75 percent of average wage which suggests an underreporting of wages for social contributions purposes.


Disability beneficiaries have increased as a share of total pension beneficiaries with a current ratio close to 21 percent, up from 16.4 in 1999. This is well above the EU average (11.5 percent), but comparable to other transition countries in the region.


With men’s life expectancy at only 64.6 at present, equalization can first be targeted at 62 years but later raised to 65, consistent with the anticipated increase in life expectancy (69 years for men by 2025).


Among the previous results reported, raising retirement age significantly increases the sustainability of the pension scheme (expenditures would remain below 8 percent of GDP over the medium-to long-run), and higher compliance and collection (including systemic measures to improve incentives to participate in addition to policing and enforcement measures) also improves the pension balance substantially.


An effective pension contribution rate can be imputed by multiplying the ratio of pension to total social insurance expenditures with the overall social contribution rate of 29 percent. For example, in 2009 this would yield an effective rate of 24 percent (83% * 29%).