Abstract
Moldova’s economy has nearly recovered from the 2009 recession, with GDP growing by almost 7 percent in 2010. GDP rebounded by 6.9 percent in 2010 after declining by 6 percent in 2009. The key objectives for 2011 are to advance fiscal consolidation, keep inflation under control despite adverse shocks, and support balanced growth. The growth momentum is expected to continue in 2011 and beyond, leading to a temporary widening of the current account deficit. The 2011 budget seeks to maintain the pace of fiscal consolidation with emphasis on permanent reduction in current spending.
The Fund-supported program has played an important role in stabilizing the Moldovan economy and rebuilding investor confidence. The authorities appreciate the constructive dialogue with the Fund’s staff, whose advice continues to support the policy formulation process in Moldova. They believe that the policies described in the Supplementary Memorandum of Economic and Financial Policies (SMEFP), dated March 24 2011, are adequate to achieve the program’s objectives. Nevertheless, the authorities stand ready to take any further measures that may become necessary to respond timely to unexpected changes in the external or internal environment and will consult the Fund on the adoption of such measures and in advance of revisions to the policies contained in the SMEFP.
The implementation of the program has proceeded generally well so far. The 2011 budget, consistent with program objectives, was adopted at the end of March 2011, as a prior action for the completion of this review. All end-September 2010 quantitative performance criteria (PCs) were met. Most indicative targets for end-December 2010 were observed as well, except the reserve money target that was missed by a small margin because of strong money demand, spurred by higher-than-expected economic growth. Implementation of six structural benchmarks, which have been delayed due to the 2010 elections, is now advancing, and three of them have already been completed. The government is committed to expeditiously implementing the new reforms set in the SMEFP as well. The authorities have prepared the Annual Progress Report on their poverty reduction strategy and have circulated it to the Board for information.
Since the Board consideration of the second review takes place in early April 2011, the authorities would like to request waivers of applicability of the relevant end-March PCs under the EFF for this review. The third program review, assessing performance based on the end-March PCs and relevant structural benchmarks, is envisaged for June 2011.
The authorities remain committed to improving the well-being of the population through reforms that promote sustainable growth and reduce poverty. The political environment remained unchanged following parliamentary elections in November 2010. The centre-right coalition increased its presence in the parliament, but electing a president remains a challenge, although the partners are responsibly engaged in an intensive political and policy dialogue.
Recent macroeconomic developments, outlook and risks
The Moldovan economy has almost recovered from the recession. The 2010 GDP growth outperformed the program projections, reaching 6.9 percent. It was driven mainly by domestic demand, itself fueled by recovering remittances, capital flows, and bank credit. External demand also improved, and exports grew faster than imports in 2010. Nevertheless, surging domestic demand widened the current account deficit to 12.7 percent of GDP, but it is projected to decline gradually in the medium term. Gross international reserves of the central bank rose steadily.
The recovery of the labor market, however, lagged behind the GDP trend. The 2010 average annual unemployment rose by one percentage point to 7.5 percent, but the labor market situation started to improve recently. The 2010 average monthly wage in dollar terms remained below its pre-crisis level and this helped to contain inflation to single digits. Headline inflation declined from 8.1 percent y-o-y at the end of 2010 to 5.5 percent y-o-y in February 2011, with core inflation down to 3.3 percent.
The growth momentum is expected to continue in 2011 and beyond, moderating to a sustainable pace of 4.5–5 percent. In the medium term, it will remain driven by private domestic demand, gradually complemented by strengthening exports, supported by the expected free trade agreement with the EU and the reform-generated supply response.
Despite the progress achieved, Moldova’s recovery remains vulnerable to a number of risks. The authorities are aware that the unresolved political uncertainty and increased external liabilities in the breakaway region of Transnistria weigh on the investment climate, although Moldova’s sovereign risk of debt distress remains low. The recent surge in commodity and fuel prices could reignite inflationary pressures and exacerbate external vulnerabilities. A weaker-than-expected demand and/or lingering sovereign debt problems in key European partners may also affect Moldova’s exports. The Fund program continues to serve as an important anchor of reforms and helps mitigate undeniable risks.
Given the robust growth momentum, the focus of macroeconomic policies is gradually shifting from supporting the recovery to preserving macroeconomic stability and growth sustainability. The authorities are striving to achieve the targeted fiscal adjustment, rein in inflationary pressures, strengthen financial stability, and roll out some long-awaited structural reforms that would support Moldova’s reorientation toward export-led growth.
Fiscal Policy
The fiscal package launched in 2010 focused on reducing current expenditure, where Moldova spends considerably more than its peers, while safeguarding priority social spending and investment. Its implementation has been very good so far. The 2010 budget deficit of 2.5 percent of GDP came well below the deficit envisaged under the program, as revenue benefitted from the strong demand growth and current expenditure remained restrained, while capital expenditure undershot due to capacity constraints, which the authorities are working to relax. The over-performance of the 2010 budget targets improved the structural budget deficit by almost two percentage points of GDP relative to 2009 and allows for a more gradual speed of adjustment during the remainder of the program period. The 2011 budget also maintains a strong pace of fiscal consolidation with emphasis on further permanent reduction in current spending and targets a deficit of 1.9 percent of GDP. The projected reduction of the structural deficit of 1 percentage point of GDP relative to 2010–half of the remaining adjustment targeted under the current program–brings Moldova closer to being able to manage its fiscal accounts without exceptional foreign assistance. The budgetary performance until end-February has proven the strong commitment of the authorities to the program.
Compared to the previous program projections, both revenue and expenditure in 2011 budget are projected to decline relative to GDP because the sharp increase in prices in the largely untaxed agricultural sector boosted GDP, and because slow recovery in employment dampened revenue from direct taxes on labor and social security contributions. The budget revenue will be reinforced by a 50 percent hike in excise duties on tobacco and alcohol. Consolidation of the public sector, improvements in the social insurance system, and reforms in procurement and internal financial control will help rein in current spending.
The authorities remain committed to protecting the most vulnerable of the population against raising food and energy prices. The Guaranteed Monthly Minimum Income will be increased by 8.5 percent from July 1, 2011 and enrollment in the targeted social assistance scheme will be expanded to 50 percent of eligible households by the end of 2011. Heating assistance has already been extended to over 540,000 low-income beneficiaries.
Monetary and Financial Sector Policy
In view of the strong economic recovery and rising food and energy prices, the National Bank of Moldova (NBM) has started monetary tightening. It raised its policy rate at the end of 2010 from 7 to 8 percent and the reserve requirement ratio from 8 percent to 11 percent in February 2011, consistent with the NBM’s objective to bring inflation to 5 percent by the end of 2012. The central bank is ready to consider further tightening, if stronger food and energy shocks threaten price stability or credit growth accelerates substantially. Given that the central bank reserves are still moderate relative to standard reserve adequacy measures, the NBM may use sterilized reserve accumulation operations, if inflows of remittances and capital exceed the program projections. The NBM will also continue to strengthen both legal and operational aspects of its monetary policy and prudential framework in its ongoing transition to inflation targeting.
Although conditions in the financial sector have improved, the authorities remain committed to enhancing their crisis and debt resolution framework. At the first meeting in 2011 of the recently established high-level Financial Stability Committee, concrete steps and measures have been designed to put in place crisis preparedness contingency plans for each participant by the end of June. Specific modalities of the operation related to the Banca de Economii are currently being discussed along the lines described in the SMEFP and the authorities are strongly committed to settle this issue. Amendments to the debt resolution framework are in train as well to meet the structural benchmark set in the SMEFP for September 2011.
Structural Issues
The main objectives of the authorities are to increase effectiveness of the public sector, improve the business environment, and remove barriers to trade. The short-term priority in the public sector reform is to eliminate excess capacity in the education sector and create a better-equipped education system with adequately trained and paid staff, which meets the changing demand of the modern economy. The reform of the civil service will continue in a way that increases efficiency without destabilizing the fiscal position. With regard to the energy sector, the authorities will strive to achieve a stable framework for payments of current bills, finalize their comprehensive restructuring strategy, and prepare its implementation together with the World Bank and other partners.
The authorities will continue their reform efforts to cut red tape, safeguard competitiveness, and stimulate investment and export. The temporary wheat export ban introduced in response to dwindling grain stocks in early 2011 will be abolished as soon as possible, and no new barriers to trade are envisaged. Efforts to promote active labor market participation will continue. By the end of April 2011, an action plan will be adopted to phase out most of the obsolete nominative compensation social system, which is being replaced by a means-tested one, in line with program objectives. By the end of June 2011, amendments to the legislation and regulation related to unemployment insurance will be adopted with the view of using actual wages for calculating unemployment benefits, and tightening eligibility criteria to prevent abuse.