Statement by Age F. P. Bakker, Executive Director for the Republic of Moldova and Victor Yotzov, Advisor to the Executive Director

The Moldovan economy is recovering steadily following the recession triggered by the global crisis. The key challenge is to ensure fiscal, financial, and external sustainability while igniting new engines of growth. Monetary policy strikes the right balance between keeping inflation low and supporting the recovery. The monetary policy framework could benefit from more flexibility. Stepping up exports is a key to achieving high and sustainable growth over the medium term. Bringing the energy sector to financial sustainability should remain high on the government’s agenda.


The Moldovan economy is recovering steadily following the recession triggered by the global crisis. The key challenge is to ensure fiscal, financial, and external sustainability while igniting new engines of growth. Monetary policy strikes the right balance between keeping inflation low and supporting the recovery. The monetary policy framework could benefit from more flexibility. Stepping up exports is a key to achieving high and sustainable growth over the medium term. Bringing the energy sector to financial sustainability should remain high on the government’s agenda.

July 16, 2010

The Moldovan authorities appreciate the constructive dialogue with the Fund management and staff over the years. They attach great value to the close relationship with the Fund, whose advice continues to support the policy formulation process in Moldova.

Recent Developments

Growth has outperformed earlier expectations. Real GDP rebounded strongly since the last quarter of 2009 and now the authorities project a higher GDP growth of 2.5 percent this year. In spite of this, with still tight credit conditions and ongoing structural reforms, growth is likely to increase only gradually to about 5 percent in 2012. Exports and investment are expected to drive activity in the near term, strongly supported by recent trade liberalization reforms and a more favorable external environment. Due to the adjustment of energy tariffs, depreciation of the leu, and higher excise rates, twelvemonth inflation spiked to over 8 percent in early 2010, but is gradually subsiding now. It is expected to return to mid–single digits in 2011 as the effect of the above mentioned shocks dissipates.

The fiscal position improved significantly over the last months. A solid revenue rebound in late 2009 and some expenditure savings contained the budget deficit to 6.4 percent of GDP in 2009. Revenue continues to outperform in the first quarter of 2010 as well and now the authorities project additional fiscal revenue of 0.7 percent of GDP and lower overall deficit this year relative to the program.

After a sharp crisis–driven drop to single digits in 2009, the external current account deficit is expected to widen to slightly above 10 percent of GDP in 2010–11, before resuming its adjustment. In the medium term, robust export growth and recovering remittances should steer the current account deficit towards its estimated equilibrium of about 7–8 percent of GDP. Meanwhile, the recovery of FDI, as well as strong international assistance, is expected to provide adequate support for Moldova’s external financing needs. At the same time, as the economy’s borrowing space is being filled quickly, further external borrowing will proceed at a measured pace to contain external debt.

With regard to the performance under the program, all PC and indicative targets for end– March 2010 were observed, and all structural benchmarks were implemented. In particular, the authorities put in place an action plan for a speedy expansion of a meanstested social assistance scheme, which has already led to increased enrollment. The NBM analyzed and shared with Fund staff the results of the diagnostic studies of all banks completed by an external auditor, which confirmed the banks’ stable condition. The NBM also prepared legal amendments to the laws on financial institutions and deposit insurance to strengthen the bank resolution framework. These amendments have been approved by the Government and submitted to Parliament for adoption.

Fiscal Policy

The Moldovan authorities are committed to developing a fiscal policy framework that is commensurate with the country’s resources and geared toward promoting growth. Accordingly, the fiscal strategy, as underscored in the original MEFP as well as in the recent supplement, is based on four main pillars:

  • Essentially eliminating the large structural fiscal deficit over several years, at a pace matching the economy’s speed of recovery;

  • Achieving fiscal adjustment mainly through restraints on the unaffordable public sector wage bill and low priority current spending;

  • Strengthening revenue primarily through improved tax administration to broaden the tax base and reduce fraud and abuse; and

  • Using the created fiscal space to increase infrastructure investment and provide well–targeted social assistance to the most vulnerable.

Consistent with this strategy, and reflecting the improved revenue outlook, the authorities adopted a revised 2010 budget to a deficit of 5.4 percent of GDP – down from 7 percent as envisaged in the original program. Moreover, fiscal consolidation efforts through restraints on current spending will continue next year. To advance the ongoing structural fiscal adjustment, the authorities aim to reduce the budget deficit further to 3.4 percent of GDP in 2011, while creating room to expand the strategically important capital expenditure. This will be achieved mainly through further rationalization of current spending, supported by limiting budgetary sector employment. The budget is also expected to take advantage of gains in revenue (up to 1 percent of GDP) stemming from the strengthening economy, increased grant assistance, and higher tax collection.

In addition, to improve control over budget execution, the authorities have already drafted a law on internal financial control, which will create internal audit units in central administration agencies. It is expected that the law will be passed by Parliament by end– September 2010 and the units to be fully operational by end–December 2010.

Monetary and Exchange Rate Policies

The NBM continues to develop its new monetary policy strategy focusing on inflation as a single nominal anchor. Despite some short–term challenges, steady efforts by the NBM to improve its communication and forecasting capacity will help increase effectiveness of monetary policy in the medium term. Furthermore, the NBM is considering increasing its operational flexibility, including by extending the policy horizon and widening the target range to accommodate high underlying uncertainty and the still underdeveloped transmission mechanism. At the same time, the NBM is planning to propose amendments to the central bank law that further strengthen its monetary policy framework, including by shortening the lag between the adoption and effective dates of policy changes The main challenge for the central bank is bringing inflation to mid–single digits while avoiding premature tightening. On current trends, the likely overshooting of the end–2010 objective of 5 ±1 percent should be short–lived. The recent NBM interest rate hikes have contributed to stabilizing inflation expectations (thus alleviating second–round effects from the cost–push shocks) and calming the foreign exchange market. As domestic demand does not generate inflation pressures at present, the monetary authorities believe that a pause in monetary tightening appears appropriate to reassess the inflation outlook. Further monetary tightening may be considered if domestic demand recovers strongly and/or sustained depreciation pressures emerge. Meanwhile, NBM’s interventions in the foreign exchange market will continue to aim only at smoothing erratic movements, but not resisting sustained depreciation pressures.

Financial Sector Policy

Limited financial integration has kept Moldova insulated from the international financial turmoil. Banks have remained liquid and well–capitalized, and exposure to foreign assets and institutions in distress is minimal. Moreover, low interdependency limits the systemic threat from individual bank failures. However, nonperforming loans, currently above 17 percent of total, remain high and give cause for some concern.

Notwithstanding the abating immediate financial sector tensions, the authorities have embarked on strong contingency planning to guard against future risks. In addition to the forthcoming strengthening of the bank resolution legislation, further institutional action should ensure appropriate interagency coordination and demarcation of responsibilities. In this context, a high–level Financial Stability Committee, including senior policymakers from the institutions likely to respond to financial emergencies, has been recently established and is already operational.

The authorities focus on removing impediments to bank credit through facilitating resolution of problem loans and strengthening contract enforcement. They are also studying how resumption of credit can be facilitated by enhancing the speed and predictability of collateral execution by banks and by strengthening regulatory incentives for banks to restructure nonperforming loans. To this end, the authorities consider making NBM regulations more supportive of debt restructuring, including by allowing faster reclassification of restructured loans into lower–risk categories.

Structural Reforms

The authorities’ general goal remains cutting red tape and stimulating private investment and exports. To this end a number of export and import restrictions and simplified licensing and custom control procedures have been implemented. In addition, the authorities plan to implement additional measures, including simplifying the VAT regime for exporters; lowering cost of doing business by reducing the frequency of inspections of enterprises by various state agencies and simplifying access to digital signatures. Also, the authorities continue to review and streamline business regulations and permit requirements.

To promote trade, the authorities plan to extend the “one stop shop” provision of business services to the customs administration while also creating adequate IT capabilities to enable automated data exchange and electronic document processing. The Export Promotion Organization will be strengthened further with a view to turn it into a one stop shop with a wide range of consultancy services for exporters and investors.

The authorities are strongly committed to a credible strategy to resolve structural problems in the energy sector. A long history of politicized heating tariff setting has already bankrupted the heating company Termocom, created large domestic and external gas payment arrears, with snowballing effects from underinvestment and inadequate coordination between creditors, utility companies, and the authorities. To remedy the situation, the government is working on a strategy that would include a general agreement between all interested parties on a restructuring plan for the sector as a whole. Until then, Termocom’s ability to operate will be preserved through a credible creditor coordination framework.

With the external investment climate gradually improving, the government will revive efforts to divest its noncore assets. By end–2010 the government, with assistance from international financial institutions, will seek to select an advisor to explore and propose options to develop the telecommunications sector, including through divestiture of Moldtelecom. At the same time, by end–2010 the authorities plan to review the list of state assets and prepare a timetable for the divestiture of other public companies to facilitate liberalization of key sectors, particularly air and rail transportation.

The authorities fully acknowledge that a modern economy requires efficient and motivated civil service and are strongly committed to raising efficiency of the public sector. In this regard, the main objective is introducing a new merit– and performance-based wage system for public sector employees. As a first step, by end–2010 the Government will put efforts to finalize the descriptions of job functions and responsibilities and assess the needs to restructure institutions and offices. The new system should not lead to a marked increase in the public sector wage bill and will be put in place by end–September 2011

Finally, the Moldovan authorities believe that the policies set forth in the SMEFP are well designed and sufficient to achieve the objectives of the program. At the same time, they stand ready to take any further measures that may become necessary. In accordance with the Fund’s policy, the authorities will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in the SMEFP.

Republic of Moldova: 2010 Article IV Consultation and Staff Report for the 2010 Article IV Consultation, First Reviews Under the Extended Arrangement and Under the Three-Year Arrangement Under the Extended Credit Facility, and Request for Modification of a Performance Criterion: Staff Report; Staff Statement and Supplement; Public Information Notice and Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Moldova.
Author: International Monetary Fund