Joint IMF/World Bank Debt Sustainability Analysis Under the Debt Sustainability Framework for Low-Income Countries1

Moldova’s risk of debt distress remains low, as all public external debt and debt service indicators are expected to remain below the relevant indicative thresholds over the long term, notwithstanding the projected relatively large borrowing in the next few years.2 Total public debt is manageable as well. Nevertheless, continued prudent debt management as well as cautious assessment and monitoring of project financing will be required to mitigate the risks to public and publicly guaranteed debt sustainability arising, among other factors, from large private sector debt and potential contingent liabilities related to gas payment arrears of the breakaway region of Transnistria.

Abstract

Moldova’s risk of debt distress remains low, as all public external debt and debt service indicators are expected to remain below the relevant indicative thresholds over the long term, notwithstanding the projected relatively large borrowing in the next few years.2 Total public debt is manageable as well. Nevertheless, continued prudent debt management as well as cautious assessment and monitoring of project financing will be required to mitigate the risks to public and publicly guaranteed debt sustainability arising, among other factors, from large private sector debt and potential contingent liabilities related to gas payment arrears of the breakaway region of Transnistria.

I. Background

1. The results of this debt sustainability analysis (DSA) are similar to those of the previous DSA issued in early 2010.3 The 2010 DSA concluded that the risk of public debt distress was low, but sizeable private external debt, arrears on energy payments, and history of debt distress warrant caution in public borrowing.

2. Indicators of debt burden have improved as a result of a downward revision in near-term borrowing projections relative to the 2010 DSA and an update of the macroeconomic framework. As in the previous DSA, the macroeconomic framework is based on the program supported by a blend of Extended Credit Facility and Extended Fund Facility Arrangements (ECF/EFF). The uptake from commitments pledged at the Brussels Consultative Group meeting of development partners in March 2010 has been lower than expected, in part due to issues with implementation of partners’ conditionality and procedural requirements. In line with recent developments, the baseline assumptions for economic growth, budget revenue, fiscal balance, and net exports are more optimistic, and the projected rate of external debt accumulation is somewhat lower compared to the previous DSA, which affects positively long-term debt dynamics. However, the lower discount rate—4 percent, down from 5 percent in the 2010 DSA as a result of lower global interest rates—raises the PV of external debt across the board.

Moldova: External Public Debt Indicators at End-2010

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Source: IMF staff estimates.

Moldova: Stock of Public and Publicly-Guaranteed External Debt at End-2010

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Sources: Moldovan authorities, and IMF staff estimates.

3. Moldova’s external public and publicly guaranteed (PPG) debt stock remains low despite the increase in the last two years. The PV of debt at end-2010 was 16 percent of the sum of GDP and remittances or 32 percent of the sum of exports and remittances. Pick-up in borrowing partly due to initiation of the ECF/EFF arrangements contributed to a rise in the ratio of external PPG debt to GDP over the past few years. The stock of external PPG debt rose slightly to 22 percent of GDP (US$1.3 billion) at end-2010 from 20 percent of GDP (US$1.0 billion) in 2007.4 External debt service remains low thanks to high concessionality of external borrowing as well as grace periods and low interest rates following the 2006 Paris Club deal. Private external debt—which totaled 45 percent of GDP at end-2010—has increased sharply over the last few years, driven mainly by an increase in trade-related and other short-term debt related to energy imports. At end-2010, about 59 percent of private external debt was contracted on a short-term basis. Private external debt significantly exceeds the levels observed in other developing countries, representing a macroeconomic vulnerability and a potential risk for debt sustainability.

4. Around 81 percent of external PPG debt is held by multilateral creditors, mainly the IMF (US$507 million, 39 percent) and the International Development Association (IDA, 30 percent). About 18 percent is held by bilateral creditors—mainly Russia and the USA. Commercial borrowing comprises the remaining 1 percent of PPG external debt.

5. Domestic public debt has remained rather low. At end-2010, the stock of recorded domestic public debt amounted to 7.4 percent of GDP, similar to 7.0 percent of GDP at end-2007, as the market for domestic government securities is still shallow. However, domestic public debt interest payments are comparable to the ones on external debt due to higher interest rates. Total PPG domestic and external debt stood at 29.8 percent of GDP at end-2010.

II. Underlying Debt Sustainability Analysis Assumptions

6. Box 1 summarizes the medium-term macroeconomic framework underlying the DSA. The baseline macroeconomic projections take into account the expected sizeable fiscal and external adjustment under the program supported by IMF arrangements. Most notably, the baseline scenario—which is based on current policies—projects annual average growth of 4.8 percent in 2011–16, slightly above the crisis-affected average for the last five years. Growth is expected to be supported by pick-up in investment and a rise in net exports. Recent government initiatives to facilitate exports, progress in free trade negotiations with the European Union, and improving economic conditions in other trade partners suggest a positive external outlook.

Baseline Macroeconomic Assumptions (2011–31)

The baseline macroeconomic framework assumes that further development of Moldova’s potential in export-oriented sectors and a strengthening of macroeconomic policies will underpin the economy.

  • Real GDP growth is projected to average 4.8 percent in 2011–16 supported by strong performance in remittances, exports, and investments. Over the longer term, envisaged structural reforms would create an enabling environment, broadening the sources of growth. Correspondingly, the estimate of the long-term potential GDP growth has been revised up to 5 percent from 4 percent.

  • Inflation is projected to stay close to 8 percent in 2011 due to pick-up in global energy prices despite ongoing leu appreciation, and gradually decline to below 6 percent by end-2012. From 2013 on, inflation is expected to moderate to 5 percent, assuming sound public sector policies, absence of further exogenous price shocks, and strong commitment of the National Bank to preserving price stability.

  • The current account deficit is expected to widen to above 11 percent in the near term, as worsening in trade balance is only partially offset by a rebound in remittances. Over the medium and long term, the current account deficit is projected to stabilize at about 8 percent. Exports are projected to accelerate in the medium term, as authorities’ efforts in developing export-oriented sectors come to fruition and Moldova makes full use of its autonomous trade preferences and the forthcoming free trade agreement with the EU. Exports of goods and services are expected to reach almost 49 percent of GDP over the medium term. Imports are projected to be buoyant, reflecting the strong domestic demand and the high import content of exports, and eventually to stabilize at 84 percent of GDP. Remittance inflows—which are among the largest in the world relative to GDP—are projected to rise somewhat in the near term and then gradually decline well below current levels by 2031. The developments in remittances are expected to reflect an increase in domestic employment opportunities and severance of ties between long-term immigrants and the home country.

  • External financing is assumed to shift from concessional to market financing over the long term reflecting economic developments and Moldova’s graduation from low-income status. Given development needs and absorption capacity, public external borrowing is assumed to be about 2 percent of GDP over the long term, compared with 1.6 percent in 2010.

    • Multilateral creditors: Projected loan disbursements in the near to medium term are relatively high due to the recent commitments made at the March 2010 Consultative Group meeting in Brussels, in particular for infrastructure development. From mid-2011, terms on new IDA loans were changed to 1.25 percent interest change, 5-year grace period and a 25-year maturity.

    • Bilateral creditors: Over the medium and long term, borrowing from bilateral sources is projected to decline due to the likely opening of market access.

    • Commercial creditors: Over the long term, commercial borrowing is projected to increase. Economic development and financial integration are likely to widen the range of financing sources, including market access. The terms are assumed to be in line with the recent borrowings of sub-investment grade sovereigns.

  • Fiscal policy is projected to stay on a consolidation path in the medium term. The deficit is projected to narrow to about 0.5 percent of GDP in 2016 from 2.5 percent in 2010 and then to stabilize at this level over the long term. The consolidation is expected to be supported by ongoing tax policy and tax administration reforms and rationalization of primary non-interest expenditures.

  • Domestic debt is expected to increase over the long term driven by deepening of the domestic banking sector and development of local capital market. Real interest rates on domestic debt are projected to average about 4.5 percent compared to the crisis-influenced average of 5.8 percent in 2008–10. The public debt held by the National Bank of Moldova is projected to be gradually repaid over the medium term.

III. Debt Sustainability

A. External Debt Sustainability Analysis

7. Under the baseline scenario, all external debt and debt service indicators remain well below the relevant indicative debt burden thresholds over the projection period (Figure 1 and Table 1). All three external debt stock indicators are projected to be on a declining trend from 2011 onward, reflecting prudent fiscal policy and strong economic growth. Debt service ratios (both as a share of exports and government revenue) rise somewhat from low levels, but remain well below indicative thresholds throughout the 20-year projection period despite falling concessionality.

Figure 1:
Figure 1:

Moldova: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2011-2031 1/

Citation: IMF Staff Country Reports 2011, 200; 10.5089/9781462326426.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2021. In figure b. it corresponds to a Exports shock; in c. to a Exports shock; in d. to a Exports shock; in e. to a Exports shock and in figure f. to a Exports shock
Table 1.

External Debt Sustainability Framework, Baseline Scenario, 2008-2031 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and p = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

8. External debt sustainability is most vulnerable to an export growth shock (Table 3).5 Table 3 and Figure 1 illustrate how a temporary decline in export growth (by one standard deviation in 2012–13) would push the debt service-to-exports-and-remittances and debt service-to-revenue ratios up in the medium term. The ratios would converge to the baseline in the long term.6

Table 2.

Moldova: Public Sector Debt Sustainability Framework, Baseline Scenario, 2008-2031

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

The public debt represents central government direct and guaranteed debt and National Bank of Moldova’s borrowing from the IMF on the gross basis.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Table 3.

Moldova: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2011-2031

(In percent)

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Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

9. Debt dynamics are worse under an alternative scenario in which key variables are at their historical averages in the longer term (Figure 1). The debt burden indicators under the historical scenario evolve non-monotonically: they are below the baseline indicators in the near term, but exceed them in the long term. This profile arises from the difference between the baseline paths of the current account balance and FDI flows and their historical averages. In the near term, the FDI flows are projected to be below the historical averages, but exceed them in the medium and long term due to the expected influx of FDI brought by the improving business climate and privatization prospects. In the past, Moldova experienced severe economic contractions, which lowered FDI’s historical average.

B. Total Public Debt Sustainability

10. Under the baseline scenario, the PV of total PPG debt in percent of GDP and in percent of revenue are both projected to decline over the medium term (Figure 2 and Table 2). Total PPG debt largely consists of the external PPG debt in the medium term hence it closely follows the dynamics of its external component. However, over the long term the structure of PPG debt is projected to shift toward a larger share of domestic debt. The decline in the grant element of new external borrowing would make domestic borrowing relatively more attractive, also taking into the account the exchange rate risks associated with external borrowing and a likely increase in foreign interest rates. The authorities’ effort to develop domestic capital markets are also expected to increase the range of investors and lower the cost of domestic debt. The shift towards non-concessional external borrowing and domestic debt leads to a slight pick-up in debt service ratios in the long term.

Figure 1.b.
Figure 1.b.

Moldova: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2011-2031 1/

Citation: IMF Staff Country Reports 2011, 200; 10.5089/9781462326426.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2021. In figure b. it corresponds to a Exports shock; in c. to a Exports shock; in d. to a Exports shock; in e. to a Exports shock and in figure f. to a Exports shock
Figure 2:
Figure 2:

Moldova: Indicators of Public Debt Under Alternative Scenarios, 2011-2031 1/

Citation: IMF Staff Country Reports 2011, 200; 10.5089/9781462326426.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2021.2/ Revenues are defined inclusive of grants.

11. Public debt ratios are particularly sensitive to a decline in GDP growth (Table 4). A moderation in real GDP growth in 2012-13 (to the historical average minus one standard deviation) would raise the PV of public debt-to-GDP ratio and the PV of public debt-to-revenue ratio to 67 percent and 201 percent, respectively, by the end of projection period from 25 percent and 68 percent in 2011. The impact on the debt service-to-revenue ratio is also a concern, leading to an increase to around 26 percent in 2031.

Table 4.

Moldova: Sensitivity Analysis for Key Indicators of Public Debt 2011-2031

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Sources: Country authorities; and staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

12. Under alternative scenarios, debt dynamics worsen significantly, especially over the long term. One alternative scenario keeps the primary balance unchanged from its 2011 level (the red dashed line in Figure 2). Given that the 2011 primary deficit of 1.1 percent of GDP is significantly larger than the one targeted in 2012 and over the projection period, it is not surprising that the scenario results in deteriorating debt dynamics. The scenario with permanently lower GDP growth (the thin black line in Figure 2) generates even steeper upward path in debt burden indicators. These scenarios underscore the need to conduct prudent fiscal policy and safeguard macroeconomic stability. The scenario with key macroeconomic variables at their respective historical averages has slightly more benign debt dynamics than the baseline, mostly due to the fact that historical average of primary surplus is better than the baseline assumption thanks to large surpluses in the early 2000s.

IV. Scenario Including Transnistria’s Gas Debt

13. This section explores a highly hypothetical alternative scenario—undertaken at the request of IMF Executive Directors—in which the government has to assume the debt of the gas-importing company Moldovagaz, stemming mainly from exposure to the breakaway region of Transnistria. Owing to chronic underpayment by Transnistria’s energy distribution company for the gas imported from Russia, Moldovagaz had about US$2.5 billion of debt related to Transnistria on its balance sheet at end-2010.7 If the debt is called, Moldovagaz would not be able to repay it itself. A number of potential debt resolution scenarios are possible. The possibility examined here—without any prejudice regarding its likelihood—is that the government would need to step in. As accumulation of arrears to the tune of US$500 million a year continues in Transnistria, the debt stock is conservatively assumed to rise further to US$5 billion and be repaid at the relatively high interest rate of 4 percent over a relatively short (for debt of that size) 20-year period with one year grace. The fiscal and balance of payments assumptions are adjusted accordingly. The external PPG debt would consequently surge to about 60 percent of GDP in the year the gas debt is assumed.

A02ufig01

PV of debt-to-GDP+remittances ratio

Citation: IMF Staff Country Reports 2011, 200; 10.5089/9781462326426.002.A002

14. If it materializes, this scenario would lead to a significant deterioration in the debt dynamics, but is not expected to cause a debt crisis. Under the scenario, PV of debt relative to the sum of GDP and remittances ratio would briefly breach the relevant threshold (Figure 3 and Tables 5 and 6). It would also lead to a substantial worsening of debt service indicators over long term, suggesting a large public sector burden. Still, the risk of debt distress would increase only to “moderate” rather than to “high”.8

Figure 3.
Figure 3.

Moldova: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios – Transnistria, 2011-2031 1/

Citation: IMF Staff Country Reports 2011, 200; 10.5089/9781462326426.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2021. In figure b. it corresponds to a One-time depreciation shock; in c. to a Exports shock; in d. to a One-time depreciation shock; in e. to a Exports shock and in figure f. to a One-time depreciation shock
Figure 4.
Figure 4.

Moldova: Indicators of Public Debt Under Alternative Scenarios –Transnistria, 2011-2031 1/

Citation: IMF Staff Country Reports 2011, 200; 10.5089/9781462326426.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2021.2/ Revenues are defined inclusive of grants.
Table 5.

External Debt Sustainability Framework, Baseline Scenario – Transnistria, 2008-2031 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and p = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).