Republic of Moldova: Requests for an Extended Arrangement Under the Extended Fund Facility and an Arrangement Under the Extended Credit Facility—Press Release; Staff Report; and Statement by the Executive Director for the Republic of Moldova

Since late 2014, Moldova's economy has been hit by a number of domestic and external shocks. Chief among them is the exposure of extensive and wellorchestrated fraud in the banking system, resulting in the closure of three banks at a public cost of 10 percent of GDP. During the following period, confidence collapsed, external concessional financing largely froze, and international reserves fell by onethird, prompting significant tightening of monetary conditions. Domestic political turmoil, marked by three changes in government, constrained solutions and delayed collaboration with the international community on possible financial support.


Since late 2014, Moldova's economy has been hit by a number of domestic and external shocks. Chief among them is the exposure of extensive and wellorchestrated fraud in the banking system, resulting in the closure of three banks at a public cost of 10 percent of GDP. During the following period, confidence collapsed, external concessional financing largely froze, and international reserves fell by onethird, prompting significant tightening of monetary conditions. Domestic political turmoil, marked by three changes in government, constrained solutions and delayed collaboration with the international community on possible financial support.


1. Since late 2014, Moldova was hit by a number of adverse internal and external shocks. A sharp deterioration in the external environment led to a decline in foreign exchange inflows from exports and remittances, offset only partially by falling import prices and a depreciation of the exchange rate. However, chief among these shocks was the massive and well-orchestrated fraud in the banking system, stemming from opaque shareholder structures, bank governance failures, and weak supervision. In its aftermath, three banks have been resolved at a public cost of 10 percent of GDP, external concessional financing has been largely frozen, international reserves fell by one-third, and monetary conditions had to be tightened significantly. Domestic political turmoil, marked by three changes in government, as well as the sudden resignation of the Governor of the National Bank of Moldova (NBM) in September 2015, constrained solutions and delayed the dialogue with the international community.

2. Despite a sharp decline in poverty in recent years, Moldova remains one of the poorest countries in Europe and structural reforms are needed to promote sustainable growth. Income per capita, US$2,220 in 2015, is the lowest in Europe and less than half the average income per capita in the CIS region (US$5,079). Key structural gaps from a cross-country perspective1 broadly correspond to the priorities laid out in the National Development Strategy—these include education, infrastructure, the financial sector, business climate, energy consumption, the pension system, and the judicial framework.

Recent Economic Developments

3. The economy is recovering from the 2015 recession and expected to post modest growth of about 2 percent in 2016. Following a contraction of 0.5 percent in 2015 (Box 1), economic activity expanded by 1.3 percent in the first half of 2016. Growth has been supported by private consumption (2.2 percent) and a buildup of inventory stocks, but dampened by the continuing investment decline (-6.7 percent) as financing remains tight. Following a decline in the first quarter of 2016, exports recovered in the second quarter (3 percent), however the contribution of net exports to growth was still negative. On the production side, manufacturing and trade supported growth in the first half, while a stronger contribution from agriculture is expected in the second half of the year. Unemployment remains low (4 percent in the second quarter of 2016), reflecting widespread labor migration and low labor force participation.


Contribution to GDP Growth - Demand

Citation: IMF Staff Country Reports 2016, 343; 10.5089/9781475552096.002.A001

Sources: Moldovan authorities; and IMF staff calculations.

Effects of the Banking Crisis on the Economy

Notwithstanding its scale and duration, the direct impact of the banking crisis on economic activity was somewhat limited. While isolating the effects of the crisis is difficult, as it coincided with other shocks including a strained external environment and very low growth in key trading partners, the following channels were at work.

  • “Sudden stop” of external financing and the fiscal adjustment channel. Serious economic governance concerns resulted in a “sudden stop” of donor financing. As a result, the shortfall in external financing constrained public consumption and public investment, despite the substantial switch to domestic financing through T-bill issuance. The resulting budget consolidation, assuming a multiplier of one,1 has likely lowered growth by around 1.1 percent in 2015 and 1.5 percent in 2016.

  • Wealth effects. Neither households nor corporates have taken any direct losses from uninsured deposits following the banking resolutions, given the authorities’ decision to issue a blanket guarantee.

  • Domestic credit channel. The decline of bank loans after the crisis reflected mostly a reduction in fraudulent loans in the three failed banks, as well as tighter banking regulation and oversight for new loans. On the demand side, the massive injection of liquidity into the banking system through insolvent banks (see Box 4), required that the NBM aggressively sterilize the monetization of emergency lending and tighten monetary policy through increasing policy rates and mandatory reserves. The resulting strongly positive real lending rates facing the private sector have likely also constrained credit demand. Nonetheless, credit from the banking system has had a limited impact on economic growth, which is primarily driven by agriculture and financed by remittances.


Impact on GDP Growth from external financing shortfall

Citation: IMF Staff Country Reports 2016, 343; 10.5089/9781475552096.002.A001

Sources: Moldovan authorities; and IMF staff calculations.

Credit and GDP Growth

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2016, 343; 10.5089/9781475552096.002.A001

Sources: Haver and IMF staff calculations.

Interest Rates Dynamics Reflect Tighter Monetary Policy to Cope with Bank Resolution Monetization Impact

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2016, 343; 10.5089/9781475552096.002.A001

Sources: National bank of Moldova and IMF staff
1 This assumption is consistent with multipliers used in other program countries and recent literature findings that fiscal multipliers are higher in recession. “Coping with High Debt and Sluggish Growth”, WEO, October 2012 and—Growth Forecast Errors and Multipliers, IMF Working Paper 13/1.

4. Inflation has decelerated sharply in 2016. The rapid fall in inflation from its peak of 13.5 percent in December 2015 to 3 percent in September 2016 reflects lower energy and international food prices, and a stabilization of the currency after its sharp depreciation in the first half of 2015, in addition to a high base effect. With favorable harvest prospects, inflation is expected to remain close to the lower bound of the central bank’s target range of 5 ± 1.5 percent for the rest of the year.

5. Budget execution through July was constrained by weaker-than-expected revenues and tight financing. While the approved budget projected an annual increase in VAT revenues of nearly 12 percent, VAT revenues increased only by 2 percent (y/y) during the first seven months of 2016. Over the same period, external grants declined by 77 percent (y/y), and external budget support loans remained frozen pending approval of a Fund-supported program. Given the relatively large recurrent spending, adjustment has continued to fall mainly on already modest capital investment: less than one-third of budgeted capital investment has been executed during the first six months. The stock of arrears has gradually declined but remained at around ¼ percent of GDP at end-July.

6. The current account continues to narrow, largely on the back of import compression. As of July 2016, exports of goods and services have increased by 0.5 percent (y/y), while imports of goods have contracted by 7.9 percent (y/y) with the decline in global commodity prices and still weak domestic demand. Remittances continue to contract relative to their level in 2015. Overall, these trends are expected to broadly continue in the second half of the year, and the current account is projected to narrow to 3.5 percent of GDP by end-2016.

7. Pressures on the foreign exchange market seem to have abated. After a depreciation of abound 8.9 percent in the first half of 2015, the currency has broadly stabilized, and the real rate is now considered broadly in line with fundamentals. International reserves have increased recently to about US$3.1 billion (about 5.2 months of prospective imports, 133.5 percent of ARA metric). Weak demand for foreign currency driven by a decline in imports, combined with a seasonal increase in the supply of foreign exchange from remittances have allowed the NBM to purchase about US$370 million since the beginning of the year, mostly over the last few months.

Program Objectives and Policies

8. The program aims to tackle upfront the urgent governance and financial stability issues, and advance structural reforms to pave the way for stronger growth and poverty reduction. The financial sector has been under stress for a number of years now, and a key priority would be to bring about an exit from the crisis, so that banks can resume normal financial intermediation. To this end, the program is centered around a successful rehabilitation of systemically important banks and far-reaching improvements to the regulatory, supervisory, and contingency frameworks for banks, including through a fundamental shift in the enforcement and sanctioning regime. Program measures support government efforts in achieving a number of objectives specified in the National Development Plan, namely improving the business climate and promoting competition reducing financing costs for productive sectors, and ensuring the financial sustainability of the energy sector.

9. The macroframework projects a gradual return to a balanced growth path:

  • Growth. Financial sector repair, together with a gradual fiscal adjustment while increasing public investment, sound monetary policy, structural reforms, particularly in utility and SOE sectors, and external financial support are expected to lift economic growth toward its potential by 2019. Restoring effective financial intermediation and relaxing binding domestic and external financing constraints should promote a resumption in both private and public investment following two consecutive years of contraction. Reforms aimed at improving governance and business climate will have a more gradual payoff. The program assumes growth rising to 3.8 percent in the medium term, at a discount to the almost 6 percent average growth achieved over 2000–08, supported largely by capital accumulation. The labor force contribution will remain subdued given labor migration and adverse demographic trends.

  • Inflation. Inflation is projected to remain in its target range over the medium term, as the current deflationary shocks are mostly transitory.

  • External position. As domestic demand recovers, the current account deficit is expected to widen some 1½ percentage points to about -5.1 percent of GDP, broadly consistent with the estimated current account norm. FDI flows are projected to finance slightly under half of the deficit—also assumed to remain initially subdued relative to historical performance.


Program Objectives, Policy Areas, and Key Measures

Citation: IMF Staff Country Reports 2016, 343; 10.5089/9781475552096.002.A001

10. The outlook is subject to several risks (see the Risk Assessment Matrix). Beyond the external shocks, including due to risks of weaker growth in Russia, the baseline of a gradual normalization already in 2016 is contingent on the successful implementation of the bank rehabilitation strategy, which preserves confidence, prevents any further fraudulent activity, and minimizes macroeconomic costs. There is a risk that successful implementation of the banking sector strategy could be undermined by continued judicial interference in NBM regulations and by weak enforcement of the legal protection of NBM staff executing duties in good faith. Underlying all this is the assumption that the political volatility of the last two years will not reemerge in relation with the presidential elections and that the political commitment to reform the banking sector runs deeper than the vested interests.

A. Financial Sector: Strengthening Institutions and the Policy Framework


11. Moldovan banks have long suffered from opaque shareholder structures, related-party lending, and poor internal governance and risk management. This has led to abuse of some banks by their shareholders—a key illustration of which was the failure of Banca de Economii, Banca Sociala, and Unibank in 2014.2 To preserve the assets of the three largest remaining banks (60 percent of system total), the NBM placed these banks under special supervision in July 2015 and required special external audits to ascertain their condition. The audits found similar weaknesses in shareholder transparency, internal governance, compliance with regulation and lending practices as in the intervened banks.

12. The bank scandal also exposed serious weaknesses in the regulatory environment and oversight. Enforcement actions by the supervisor were rare and, when taken, were not been commensurate with the seriousness of the deficiencies. Small fines did not materially affect incentives for bankers, and in some cases de jure compliance was followed by de facto defiance (e.g., removed managers were reappointed as advisors).

13. The incomplete crisis resolution framework limited intervention options. As identified in the 2014 FSAP update, the resolution framework in place was weak, essentially limiting the response to either early intervention (which was often thwarted by court action and lobbying by vested interests) or liquidation (which becomes less desirable in cases of large banks, given the significant systemic financial stability risks and the high costs it entailed).


14. The program aims to ensure long-term financial stability by fostering sound financial institutions, operating within a strong regulatory and supervisory environment. The policies focus on four key areas: (i) taking enforcement actions to address already identified breaches of NBM regulations; (ii) identifying Ultimate Beneficial Owners (UBOs) and related parties, unwinding related-party lending and enhancing governance in the banking sector; (iii) revamping the resolution framework, preparing contingency plans and restructuring banks; and (iv) improving the NBM’s governance and resources. As prior actions under the program (MEFP Table 1), important legal and regulatory amendments have been adopted, enforcement actions taken, and action plans for identification of UBOs and related parties approved, with a particular focus on the largest banks in the system. However, vested interests are still powerful and continuous political support, together with judicial reforms, will be essential to ensure full program implementation.

Table 1.

Moldova: Selected Economic Indicators, 2010–21 1/

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Sources: Moldovan authorities; and IMF staff estimates.

Data exclude Transnistria.

Includes private and public and publicly guaranteed debt.

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Enforcement actions

15. The NBM has taken strong up-front actions to address irregularities identified in bank audits, on-site inspections, and off-site supervision. In particular, the NBM:

  • Removed unfit shareholders in the two largest banks. The NBM has now blocked or cancelled the shares of shareholders of the two largest banks which were found to have acted in concert in violation of the Law on Financial Institutions (Box 2). All potential new significant shareholders (those with equity stakes greater than 1 percent) will be subject to fit-and-proper certification, in line with NBM regulations.

  • Placed a large bank under temporary management. Following the blocking of over 60 percent of second largest bank’s shares, the NBM took control of the bank on October 20, 2016, to protect depositors and preserve value. The bank’s management has been replaced, and a new external diagnostic of the bank will be launched.

  • Strengthened bank governance structures. The NBM has ensured that all banks have a functional Supervisory Board, with fit-and-proper Board members in line with international best practices (MEFP ¶6). This addresses a long-standing vulnerability in one key bank which has been operating without a Supervisory Board—and therefore without a proper governance and risk management structure—since September 2014.

  • Requested and approved time-bound remedial action plans. The two banks that remain under special supervision are now following time-bound remedial action plans that aim to address by end-January 2017 all deficiencies detected in the Special Audit reports. The NBM has developed an interactive supervisory process for monitoring the plans and will conduct full-scope on-site inspections in these banks by end-February 2017. Once compliant with all NBM regulations, banks will exit the special supervision regime, and enforcement actions will be taken against non-compliant banks by end-March 2017 (MEFP ¶8).

Supervisory Actions Against Shareholders Acting in Concert

The NBM’s newly established Shareholder Transparency Unit (STU) has determined that a group of shareholders of the system’s two largest banks, MAIB and MICB, were acting in concert for the benefit of a yet unidentified beneficial owner. The shares were acquired without the appropriate approval of the NBM and in violation of the law.

In MAIB these shareholders held 43 percent of total shares. 1 With powers provided in the Law on Financial Institutions (LFI), these shares were blocked in December 2015 and March 2016, and the shareholders were ordered to sell them within a period of 90 days.2 Since the shares were eventually not sold, MAIB was ordered to cancel these shares and issue a like amount of new shares, which were listed on the Moldova Stock Exchange in late September—with the sales proceeds to be paid to the cancelled shareholders. All new investors, irrespective of size will need NBM approval to acquire the shares.

If no buyers are found within a specified period, the shares will be repurchased by MAIB at face value. Based on the reported book value of capital, the transaction will only marginally reduce MAIB’s capital.

In MICB, the STU established that over 60 percent of shareholders were acting in concert. In line with the newly adopted Bank Recovery and Resolution Law, there was sufficient ground for the NBM to take control, paving the way for placing MICB in temporary management on October 20, 2016.

Blocked and cancelled MAIB shareholders have already initiated legal actions against the supervisory action, which could create uncertainty about its finality and about ownership rights to these shares. To mitigate some of that uncertainty, the authorities amended the LFI to ensure that in the event of court ruling against the supervisory action, recourse will only be in the form of monetary compensation and not trigger the reversal of the share cancellation.

1 1 percent of these shares are in litigation and, while blocked they are not yet cancelled.2 Law No. 550 of 1995, Article 156 on non-compliance with the shareholders’ quality requirements.

Identification of UBOs and related parties

16. Identification of UBOs and related parties, and monitoring and unwinding of above-limit loans to related parties is a critical part of the program.

  • Stronger legal powers to identify related parties. The authorities adopted amendments to the LFI and NBM law strengthening the definitions of related parties (“affiliates”) and granting the NBM explicit powers to presume any person as a bank’s related party on the basis of objective criteria, unless the banks are able to prove otherwise. The new powers should significantly shorten the identification process and provide economic incentives to the banks and related parties to submit information.

  • UBO identification. The NBM has prepared a plan for full identification of UBOs of bank shares. The diagnostics will be concluded by end-December 2016 for the three largest banks and end-June 2017 for the remaining banks (MEFP ¶10).

  • Identification and unwinding of related-party lending. The NBM has adopted regulations on the criteria and the governance of a process for conducting the related party diagnostics. Following the UBO identification process and onsite inspections, related parties will be identified and/or presumed in line with the NBM’s new powers. The banks will be required to submit a plan to unwind above-limit exposures within a period of up to two years (MEFP ¶ 11).

  • Better registration of ownership of shares and securities. New modern legislation on a Central Security Depository (CSD) has been adopted. Once operational, the CSD will reduce the scope for fraudulent changes in bank ownership, which have in the past exploited the lack of cooperation between 10 existing private depositories (MEFP ¶ 12).

Revamping the resolution framework and planning for contingencies

17. The recent adoption of a new Bank Recovery and Resolution Law (BRRL) allows the authorities to resolve any contingency in an orderly fashion. Based on the European Bank Recovery and Resolution Directive (BRRD), the BRRL provides for broad intervention and resolution powers. To adjust to the current environment in Moldova, however, the enactment of some of the BRRD features are temporarily postponed, notably the creation of a resolution fund and conditioning an 8 percent bail-in before providing public funds in resolution.

18. To mitigate potential risks, the authorities have prepared contingency plans for the three largest banks. Fallback contingency strategies make use of the powers provided under the new BRRL and include measures that ensure that depositors and macroeconomic stability are protected. The strategies will be developed further as the related-party diagnostics move toward completion, and aim to avoid any further use of public funds (MEFP ¶14).

19. The National Committee for Financial Stability (NCFS) has been strengthened. The government’s decision on NCFS of October 12, 2016, streamlined the composition of NCFS by excluding prime minister, state chancellor, and the head of economy and budget committee of parliament from its members, and assigned NBM as the secretariat of the NCFS. These changes should help the NCFS to perform its tasks more effectively without undue political influence.

Upgrading the regulatory and supervisory framework

20. Sanctions for breaches of banking regulations, including AML/CFT, have been increased. The maximum monetary fines have been increased substantially. Sanctioned bank directors, managers and employees are now banned from holding any positions in the financial sector for at least 10 years. Furthermore, any persons (including shareholders) can now be held pecuniary liable for the failure of a bank (MEFP ¶17).

21. Once the key financial stability risks are taken off the table, the program will seek to complete the overhaul of the supervisory and regulatory framework, focusing on:

  • Strengthening the implementation of the AML/CFT framework. In particular: (i) strengthen AML/CFT supervision and conduct targeted risk-based on-site inspections of the banking sector to ensure that AML/CFT preventive measures are effectively implemented by banks, and (ii) take supervisory action as appropriate in response to possible breaches of compliance with AML/CFT requirements identified.

  • Preparing a strategy for addressing remaining deficiencies identified in the BCP Assessment of the 2014 FSAP (MEFP ¶18), and namely improving the supervision of risk and risk management processes.

  • Strengthening the safety net. With the current coverage level of 6,000 MDL (US$300), the Deposit Guarantee Fund’s (DGF) contribution to financial stability is negligible. To change this, the authorities will raise the coverage level and establish backup funding for the DGF.

  • Establishing a policy for placement of public sector deposits. The Ministry of Finance will define its procedures for procurement rules in contracting banks for public funds management, and refrain from giving privileged access to public sector funds.

Enhancing NBM Governance

22. The governance of the NBM is being enhanced, supported by sufficient resources and legal protection. Members of the supervisory council and audit committee have been selected and both bodies are operating, and the Executive Board of the NBM has been strengthened by filling the two vacant deputy governor positions (prior actions). However, the NBM is understaffed, and there is priority in retaining and recruiting supervisors, lawyers and other experts. The authorities are committed to ensure appropriate resources to carry out the financial sector agenda. To this end, the NBM law has been amended to enable a review of the NBM’s remuneration system (MEFP ¶19). Legal protection for NBM staff carrying out their duties in good faith has been embedded now in the NBM law, and must be actively ensured.

B. Fiscal Policy: Safeguarding Sustainability

23. The program seeks to strengthen fiscal sustainability in a balanced and growth-enhancing manner, increasing space for priority social and capital expenditure. Even with the substantial public costs of the banking sector crisis, the risk of debt distress in Moldova remains relatively low. Therefore, the fiscal strategy aims to (i) target a fiscal path that ensures medium-term debt sustainability; (ii) provide adequate resources for priority social and capital expenditure to reduce poverty and enhance growth; and (iii) focus on containing fiscal risks from the financial system, energy sector, SOEs, and government guarantees.

24. The 2016 deficit is set to widen modestly to support the nascent recovery, amidst difficult external and financial conditions. The headline cash deficit target of 3.2 percent of GDP in 2016 is expected to be met, including through expenditure rationalization, restraint of the wage bill and containment of other current spending, while safeguarding priority spending on capital investment (MEFP ¶26). Despite excise tax increases and the introduction of wealth taxes on large real estate holdings, weak domestic demand and limited disbursement of external grants—to be unblocked only upon approval of a Fund program—have constrained available resources.

25. Binding financing constraints have given rise to public payment arrears, which will be addressed by early 2017. With the unblocking of external budget support, the authorities are committed to gradually eliminate the stock of domestic arrears (indicative target). Supported by technical assistance from the IMF, the authorities will also work on diagnosing the cause of persistent arrears at both the central and local government levels, and strengthen public financial management to prevent their reappearance.

26. The medium-term framework is built around a gradual fiscal consolidation path that brings the headline deficit down to 2.9 percent of GDP by 2019. The medium-term anchor—the Fiscal Responsibility Law (FRL)—limits the overall deficit, excluding grants, to 2.5 percent of GDP by 2018, with an escape clause for public capital investment funded by external concessional sources (Box 3). In light of the projected low risk of debt distress, the program supports the use of the escape clause given the need for social spending and growth-enhancing investment. A credible path to achieving the headline 2.9 percent deficit target will be mapped out in the Medium-Term Budget Framework for 2017–19 (structural benchmark).

27. The medium-term fiscal framework will be supported by measures to strengthen revenue and preserve space for social and development objectives (MEFP ¶30):

  • Strengthening the tax base. Drawing on recent FAD TA, the authorities plan to review and rationalize VAT, CIT, and PIT exemptions. This includes simplifying and unifying the CIT regime, streamlining VAT exemptions and the two VAT-reduced rates, as well as developing plans to reduce underreporting taxable income and wages. The mechanism of real estate valuation will be revised to broaden the tax base for real estate taxes. Tax administration reform will improve tax compliance through the unification of the state tax administration as well as by enhancing the performance of the large tax payer office and the high-wealth individual program.

  • Improving the efficiency of spending. The rationalization of public sector wages is a crucial part of the authorities’ structural reform plan to make public administration more efficient and competitive. This requires a thorough review of core functions of public administration and an examination of the incentive structures. In addition to the public sector wage bill, following the recent FAD TA recommendations, the authorities intend to rationalize a number of non-targeted categorical social benefits. Fiscal savings from these adjustments should be directed toward (existing) targeted social spending and capital expenditure.

Moldova’s Fiscal Rule and Its Escape Clause

The Fiscal Responsibility Law (FRL) contains important elements to strengthen the medium-term fiscal framework of Moldova, including a fiscal policy rule defined as a general government budget deficit target, excluding grants of 2.5 percent of GDP to be achieved by 2018. Exceeding the deficit ceiling is allowed under an escape clause for public capital investment funded by external concessional sources and when there is adequate domestic absorption capacity.


Capital Expenditure

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 343; 10.5089/9781475552096.002.A001

Source: IMF staff calculations.

Given the relatively low level of public capital expenditure in Moldova, the authorities intend to use this escape clause for additional public capital investment, while remaining committed to ensure a sustainable fiscal path for public debt. This is in line with a headline fiscal deficit of about 2.9 percent of GDP (or 3.1 percent on an augmented basis, ¶26) in 2019.

With external grants projections of around 1.2 percent of GDP in 2018 and 0.7 percent of GDP in the medium term, the proposed fiscal deficit path implies the use of the escape clause of about 1.7 percent of GDP in 2018 and 1 percent of GDP thereafter.


Usage of the Escape Clause

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 343; 10.5089/9781475552096.002.A001

Source: IMF staff calculations.

28. The authorities will also strengthen the framework to monitor and contain fiscal risks, especially those stemming from on-lending arrangements with government guarantees, part of which will be brought into the budget deficit concept.

  • An augmented fiscal deficit, that includes net lending to state-owned enterprises (SOEs) as a budgetary expenditure item, will be used to monitor explicitly on-lending agreements with external creditors to SOEs (MEFP ¶29 and text table).

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  • On-lending arrangements through commercial banks to the private sector do not carry an equivalent risk to the state budget, and hence are only monitored as part of public guarantees in the debt sustainability analysis. Nevertheless, the authorities will tighten the evaluation framework for entering into such contracts—including the capacity of particular sectors to absorb large inflows.

  • Moldova’s risk of debt distress remains low even accounting for the augmented deficit. In line with the previous assessment at end-2015, all indicators for public debt remain well below the debt thresholds under the baseline, standard bound tests, and alternative scenarios as well as under the probability approach. The magnitude of the standard contingency shock is sufficient to capture the size of a combined shock from the financial and energy sectors.

29. Measures will also be taken to improve cash and debt management:

  • The authorities are committed to improve cash management. In particular, strengthening the link between central government transfers and budget executions of local governments will help reduce the interest costs on the central government budget.

  • Regarding debt management, financial instruments are limited and concentrated at the short end of the maturity spectrum. The government securities market is illiquid, with very low trading on the secondary market. Some improvement in communication between the Ministry of Finance and the NBM on high-frequency liquidity forecasting has taken place in recent months, but more needs to be done to institutionalize these improvements.

30. Over the course of the program, a number of structural reforms will aim to strengthen fiscal institutions and reduce fiscal risks (MEFP ¶31):

  • Law on Public Finance and Fiscal Responsibility (FRL). The authorities are committed to reviewing the parameterization of the fiscal target and the escape clause so as to better accommodate social and development objectives all while strengthening the fiscal anchor in the FRL by explicitly linking it with debt sustainability and cyclical trends.

  • Fiscal risks. The authorities will publish a Fiscal Risk Statement (FRS) with the annual budget starting with the 2018 budget, which would help quantify implicit and explicit fiscal risks related to the public sector.

    • State-owned enterprises. On-lending to SOEs is monitored explicitly through the augmented deficit target. In addition, to prevent the emergence of fiscal risks from SOEs, the parliament will adopt the law to conduct a formal annual audit of all SOEs’ financial results (starting with the largest 15 enterprises in early 2017).

    • Utility tariff adjustment. The authorities will contain fiscal risks stemming from the energy sector by adjusting electricity and district heating tariffs towards cost-recovery levels (Section on Structural Reforms and MEFP ¶32–33) and by implementing a transparent and credible private sector solution to the accumulated tariff debt.

  • Social Security System. Given trends in outward migration and demographics, as well as the system’s very low replacement rate, a balance has to be struck between the fiscal and social sustainability of the pension system. The authorities are currently undertaking a comprehensive analysis of the current pay-as-you-go system. Planned reforms in these areas include increasing the retirement age, improving coverage and compliance, and introducing a more systematic indexation of pension benefits without ad-hoc increases (MEFP ¶31).

C. Monetary and Exchange Rate Policy


31. Abating inflationary pressures and excess supply of foreign exchange have allowed the NBM to start loosening the tight monetary policy stance and build up its international reserves. A faster-than-expected decline in inflation on the back of weak domestic demand, prompted NBM to lower its base (policy) rate in several steps from 19.5 percent in February 2016 to 9.5 percent as of late September (Box 4 describes monetary developments in the wake of the banking crisis). Nevertheless, the interest rates remain strongly positive in real terms, and the reserve requirement on leu deposits is still at a record high of 35 percent.


32. The NBM remains committed to containing inflation within the target band. While there are some near-term inflationary risks, notably related to adjustment in utility tariffs, inflation is expected to continue to decelerate in the environment marked by weak credit growth and subdued domestic demand this year. Inflation is expected to stabilize under 5 percent in 2017. This provides space for gradual and cautious cuts in the policy rate in the coming months as long as the external environment remains supportive to meet the international reserve targets. In light of the ongoing financial system rehabilitation, there is some uncertainty about the transmission mechanism of monetary policy, posing a challenge for correctly calibrating instruments to achieve inflation goals. This will be kept under careful review during the program.

33. The program also seeks to maintaining adequate international reserve coverage to guard against external shocks, while supporting exchange rate flexibility. The program’s performance criterion on net international reserves is based on reaching the upper end of the recommended range for the IMF composite measure of reserve adequacy for floating exchange rate regimes, which is 150 percent. The authorities and staff agree that NBM should allow the exchange rate to adjust with market conditions and should limit interventions in support of the lei to smoothing disorderly exchange rate volatility. Recent interventions on the foreign currency market have been effective in absorbing seasonal excess supply of foreign exchange and influencing inflation dynamics; however, purchases should not aim to systematically resist appreciation pressures.

Monetary Developments in the Wake of the Banking Crisis

Between October 2014 (last month before the banking crisis) and October 2015, NBM’s claims on banks have ballooned from almost zero to over MDL 13 billion (11 percent of 2015 GDP). This liquidity injection led to significant pressures on the foreign exchange market. The leu depreciated by 36 percent during the above-referenced period despite the extraordinary amount of NBM interventions, with the sale of around US$900 million, or one third of all gross reserves. A weak external environment, especially the recession in Russia, has further impacted on the supply of foreign currency. The leu depreciation contributed to a rapid increase in inflation, which overshot the upper bound of the target range (6.5 percent) in early 2015.

Sources: National Bank of Moldova and IMF staff calculations.
Sources: National Bank of Moldova and IMF staff calculations.

In response to increasing inflation, the NBM tightened significantly its monetary policy. The NBM’s base (policy) rate was increased in several steps from 3.5 percent in November 2014 to 19.5 percent in August 2015. The reserve requirement ratio on leu-denominated liabilities was also increased in several steps from 14 percent in December 2014 to 35 percent in September 2015. Sharp policy tightening helped contain inflationary pressures and preserve macroeconomic stability.


Contributions of Net International Reserves and Net Domestic Assets to Reserve Money Growth


Citation: IMF Staff Country Reports 2016, 343; 10.5089/9781475552096.002.A001

Sources: National Bank of Moldova and IMF staff calculations.

34. The institutional and policy independence of the NBM is a pre-condition for successful inflation targeting. This requires, inter alia, a viable balance sheet of the NBM, which was hit by the massive emergency liquidity provision to the troubled banks that are now under liquidation. In this regard, the recent adoption of the Law on securitization of emergency lending should help ensure that the NBM’s post-resolution cash flow and capital position allow it to fulfill its mandate of maintaining price stability. In October 2016, government securities were issued in the amount of MDL 13.3 billion (US$672 million) to execute guarantees given for emergency loans extended by the NBM to insolvent banks. Maturities range from one to 25 years; the bonds bear a fixed annual interest rate of 1.4 percent for maturities up to 10 years, and 5.3 percent for longer maturities.

35. The program also envisages several technical improvements to the existing inflation targeting framework. The authorities aim to enhance collaboration and coordination between Ministry of Finance, Ministry of Economy, and NBS with a view to enhance the consistency of macroeconomic data and projections, focusing on discussions of the growth outlook, the drivers of inflation, the inflation outlook, and implications for the inflation objective. Efforts are also under way to improve coordination between the Ministry of Finance and NBM of government debt and liquidity management, including forecasting of aid and privatization inflows.

D. Structural Policies

Utility sector

36. Utility companies will be brought onto a sound footing, including through tariffs set at cost recovery to avoid further accumulation of arrears with energy suppliers, reduce fiscal risks, and ensure an adequate level of investment in the sector.

  • The regulator (ANRE) approved and published the mechanism for gradual repayment of financial deviations accumulated by electricity distribution companies through a sequence of tariff supplements (prior action). While the electricity tariffs were increased to the cost-recovery levels in 2015, these increases did not cover financial deviations accumulated over 2014–15. Authorities recognized the outstanding deviations of MDL 2.2 billion (US$110 million), and adopted a repayment schedule through annual tariff supplements over 2017–20, starting from the first quarter of 2017.

  • While the adopted heating tariff brings Termoelectrica close to its current operating cost recovery, further steps are needed to ensure adequate investment and address a large stock of historical debt. In September 2016, ANRE approved an 8.2 percent increase in the heating tariff, against the operator’s requested increase of 27.4 percent. The approved tariff increase appears sufficient to ensure a small positive cash flow from operations, but the process revealed deficiencies in the methodology as it pertains to rules on asset valuation and investment allowances. An action plan to improve the tariff-setting methodology in the heating sector by end-year has been agreed with the World Bank. As a part of this plan, this new methodology will be applied to tariff decisions in early 2017—a pre-condition for two key projects to proceed: restructuring of Termoelectrica’s debt to Moldovagaz (about US$140 million) and a heating sector efficiency improvement project with the World Bank.

  • The authorities continue to provide financial support to vulnerable households through social assistance programs, Ajutor Social and Heating Allowance, and will work on improving the targeting of this support and its effective coverage. To mitigate the effect of higher energy tariffs on low income households, adequate resources will be allocated in the 2017 budget.


Heating Tariffs for Households


Citation: IMF Staff Country Reports 2016, 343; 10.5089/9781475552096.002.A001

Sources: Country statistics and IMF staff calculations.

37. The introduction of an automatic utility tariff adjustment mechanism will prevent political influence in tariff setting. In close cooperation with the World Bank, a transparent mechanism should be developed and implemented to prevent any discretionary delays and ensure timely adjustments of utility tariffs to the cost-recovery levels (structural benchmark). In cooperation with the Energy Community Secretariat, the authorities should work on improving energy sector regulation, in particular, to ensure that procedures for the appointment of directors are fully transparent and merit-based and establish clear performance indicators on the basis of which independent audits can be conducted (MEFP ¶33).


38. Strengthening economic governance and transparency is a top priority and a necessary foundation for robust economic growth. Weak governance and corruption in a broad range of areas, including implementation of laws and regulations and effectiveness of the judiciary, undermine public confidence in government, discourage foreign investment by raising the costs of doing business, and ultimately constrain economic growth. The authorities are committed to taking stronger actions to address these challenges, strengthening the asset disclosure framework for senior officials and ensuring a robust external oversight process for the National Anti-Corruption Center (MEFP ¶34). In addition, strengthening the implementation of the AML/CFT framework would complement anti-corruption efforts, notably by ensuring that the legal frameworks for anti-corruption and AML/CFT are in line with international standards.

Business climate

39. Encouraging more foreign direct investment (FDI) can play a crucial role in improving the country’s productivity and supporting developmental objectives articulated in the Moldova 2020 strategy. In 2015 FDI reached 3.3 percent of GDP, still significantly below the pre-crisis levels of 11–12 percent. Two thirds of foreign investments are concentrated in service sectors, with financial intermediation taking a lead. Agriculture, a vital sector for the economy,3 attracts only 1 percent. Facilitating FDI in export-oriented sectors is instrumental for improving competitiveness and promoting balanced growth. The energy sector and road infrastructure would also benefit greatly from FDI inflows.


FDI by Industry, 2016Q1

Citation: IMF Staff Country Reports 2016, 343; 10.5089/9781475552096.002.A001

Source: National Bank of Moldova.

40. Improving the investment climate is essential for attracting higher FDI inflows. The main challenges associated with investing in Moldova relate to weak governance and corruption. The bottlenecks in agriculture also include limited supply capacity, highly fragmented farm structure, and restrictions on land ownership for foreigners. Relatively low development of human capital also contributes to the limiting factors. The government has launched a number of initiatives aimed at promoting competition policies and streamlining the regulatory framework, e.g., reforms of the customs administration and risk-based inspection implementation.

Program Modalities

E. Access, Phasing and Conditionality

41. The authorities’ program will be supported by a three-year ECF/EFF blended arrangement4 with access of SDR 129.4 million (75 percent of quota, US$182.7 million). The authorities are expected to have protracted BOP needs, given the breadth of the structural reform agenda, particularly as it pertains to the financial sector, and time that will be needed to build up strong reserve buffers to provide cover against external shocks. The overall size of the external financing package, estimated at US$825 million for the three-year period under the program, would allow reserves to be built up to the top end of the Fund’s ARA metric: providing insurance against external shocks with high standard deviations not properly captured by the ARA metric, and particularly sharp declines in remittances. Some of the Fund’s disbursements will be used for budget support but reflect an underlying BOP need, and the program is designed so that an amount equivalent to foreign exchange purchases from the Fund will be used to meet that BOP need. The program is fully financed and is expected to catalyze:

  • Budget support from the World Bank of about US$45 million in 2016, with subsequent smaller Development Policy operations in 2017–19. The current budget support operation is pending from November 2014 and will be able to proceed following Board approval of a Fund program.

  • Macro-Financial Assistance (MFA) from the EU of €97.4 million over 2017–18, of which €40 million in grants and €57.4 million in concessional loans. Tranches of sector-specific support, for which various triggers have met, will also be unblocked upon program approval in 2016, and will thereafter be subject to meeting performance metrics.

  • Budget sectoral grants from the EU at about €94 million over 2017–18.

  • Bilateral budget support from Romania of about €150 million. The Romanian authorities made the first disbursement of €60 million in August 2016, following the announcement of a staff-level agreement on a program with the IMF.

External Financing Requirements and Sources, 2016–19

(Millions of U.S. dollars)

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Sources: Moldovan authorities; and IMF staff projections.

42. Program monitoring will be guided by semi-annual reviews, semi-annual and continuous performance criteria and indicative targets, and structural benchmarks.

  • Quantitative PCs include a ceiling on the augmented overall cash deficit of the general government, and a floor on NIR, as well as continuous PCs on the stock of domestic arrears and the assumption by the government of losses or liabilities and making of payments on behalf of utilities and other companies. To ensure a healthy expenditure mix, the program also employs indicative ceiling on the general government wage bill and floor on social spending. An indicative target on the non-accumulation of domestic payment arrears will be converted into a continuous PC based on the recommendations of forthcoming technical assistance.5 Monetary conditionality would be embedded in the inflation consultation clause. The inflation consultation bands are set symmetrically around the projected path the 12-month percentage change in the headline inflation, while ensuring medium-term consistency with the NBM’s inflation target. 6

  • Structural benchmarks in the near term are focused on the fiscal and financial sector areas, later shifting to areas that will support growth. Action would be required to further contain fiscal risks and improve the bank regulatory, supervisory, and crisis management frameworks, guided by a comprehensive set of recommendations from the FSAP update. Conditionality would then shift toward boosting competitiveness, with a focus on the business climate and ensuring inclusive growth.

43. An updated safeguards assessment is in progress and is expected to be completed by the first review. The assessment will evaluate the new governance arrangements at the NBM and its current control framework. The NBM publishes its financial statements that are prepared and independently audited in accordance with international standards.

F. Capacity to Repay the Fund and Risks to the Program

44. Moldova is expected to meet its repayment obligations to the Fund. Exposure to the Fund will reach 6.4 percent of GDP in 2016, before declining to 4.1 percent of GDP by the end of the proposed ECF/EFF (Table 6). Total debt service to the Fund will reach 3.2 percent of total exports in 2017. Moldova has a strong track record in repayments to the Fund as indicated by timely repurchases to date, and risks of debt distress remain low.

Table 2.

Moldova: Balance of Payments, 2010–21

(Millions of U.S. dollars, unless otherwise indicated)

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Sources: National Bank of Moldova; and IMF staff estimates.

Includes revaluation changes, which were not captured by changes of gross official reserves in the BOP.

The IMF composite measures are calculated as a weighted sum of short-term debt, other portfolio liabilities, broad money, and exports in percent of GDP. Official reserves are recommended to be in the range of 100-150 percent.

Table 3a.

Moldova: General Government Budget, 2010–21

(Millions of Moldovan lei, unless otherwise indicated)

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Sources: Moldovan authorities; and IMF staff estimates and projections.

In 2013, a change in the scope of government reduces both revenue and expenditure by about 0.5 percent of GDP.

Includes banking sector resolution costs in 2016.

Augmented balance includes externally financed on-lending to SOEs.

Includes mainly central bank liabilities to the IMF.