Macroeconomic development and outlook

The economy went into recession in the second half of 2015 due to a drought, an unfavorable external environment, repercussions of a large-scale bank scheme, and tight monetary policy. As a result, real GDP contracted by 0.5 percent. The unfavorable economic environment was embedded by prolonged political instability which ended with the taking office in January 2016 of a new government led by Pavel Filip.

Although the economic situation has stabilized in recent months, it remains fragile. The slight economic growth forecasted for the coming years will be driven mainly by growth in agriculture and consumption, as remittances remain weak. The authorities also expect an increase in exports in the coming years based on higher quality and broaden and diversified markets, while imports will be restored mainly thanks to the recovery of domestic demand.

Monetary policy

Inflation continues its downward trajectory, from a peak of 13.6 percent in December 2015. On average, inflation will drop to 6.3 percent this year, returning to its target range (5.0 percent, with allowed deviation of ± 1.5 p.p.). Over the medium term, inflation is projected to remain within the target range.

After reaching its peak at 19.5 percent in November 2015, the NBM reduced the base rate on several occasions—the latest in October to 9 percent. However, the monetary transmission mechanism remains weak since the monetary policy easing has not resulted in the expansion of banks’ credit portfolios. The more prudent behavior of banks, still elevated interest rates and subdued domestic demand restrained credit to the economy, while the banks’ increased profitability was largely generated by investments in higher yield government securities.

The floating exchange rate has served Moldova well, providing an adequate shock absorber by insulating the economy against large internal disturbances and external volatility.

Fiscal policy

The difficult economic situation led to significant complications for the country’ public finances. It negatively affected tax revenues, while the interest cost for government debt increased considerably due to a higher risk premium and the hike of the base rate. Moreover, the revenues were significantly affected by the scaled back financial support from development partners. External financing remained low in 2016. The government reacted decisively by aligning expenditures with declining revenues. Spending has been prioritized and significantly cut (8.3 percent in real terms), most prominently in capital expenditures. The authorities target a deficit of 3.2 percent of GDP for this year.

Going forward, the fiscal plans, including the 2017 budget, will be formulated based on the Medium-Term Budget Framework for 2017–19 (approved in August). The framework aims at ensuring a sustainable fiscal path for public debt in a balanced and growth-enhancing manner. Accordingly, the authorities target a budget deficit of 3 percent for the next two years and 2.9 percent for 2019. Although the Fiscal Responsibility Law limits the overall deficit, excluding grants, to 2.5 percent of GDP by 2018, the authorities are planning to use the escape clause in order to support capital investments financed through external concessional sources, with a focus on supporting key projects aimed at pursuing a pro-growth strategy of public spending.

With the restoration of external budget support, the public debt will rise from 43.4 percent of GDP in 2017 to 44.9 percent in 2019, which remains a sustainable level. Focusing on gradually reducing the reliance on external grants and preserving space for social and development objectives, the medium-term fiscal strategy envisages an increase of the tax revenues by about 1.4 percent of GDP through 2019. This is planned to be achieved through further strengthening the tax base, streamlining of various tax exemptions and reduced rates, enhancing tax compliance and revenue collection and improving the efficiency of spending.

Mindful that the current weak pension system represents a threat to fiscal sustainability, further reforms will be launched to make the pension system financially sustainable.

Financial sector

In October 2015, three banks were put under liquidation. Three other major banks (holding 65.6 percent of the sector assets) are kept under a special supervision regime since June 2015, allowing the NBM to avert further spillovers.

Overall the banking system is well capitalized and liquid, but a few banks experience weak asset quality. The share of non-performing loans in total loans reached 15.8 percent in September 2016. However, there is a large disparity of this indicator between banks. The largest share of the increase in NPLs is a consequence of tighter requirements for loan classification. The high level of risk-weighted capital adequacy ratio allowed banks to absorb the related losses.

The banking crisis has brought to the forefront the inefficiency and the gaps of the regulatory framework, including the lack of adequate tools for quick and efficient management of banks in difficulties, alongside serious weaknesses in the oversight. Hence, addressing these deficiencies is a top priority for the newly appointed management of the central bank. In recent months, decisive steps were taken in this regard.

A new comprehensive law on bank recovery and resolution was approved in September, which provides the authorities with adequate tools to prevent insolvency or, when insolvency occurs, to curtail the potential negative repercussions. For this purpose, the new law brings some novelties such as an early intervention mechanism and private sector tools to resolve the banks. Moreover, reforms in line with the 2014 FSAP recommendations, aim at improving the transparency and quality of the banks’ shareholders, banks’ corporate governance and risk management and considerably increase the sanctions for banks’ shareholders and management in case of wrongdoings. At the same time, the recently approved law on Central Security Depository will pave the way for better registration of ownership of shares and securities.

The banks under special supervision are currently implementing targeted remedial action plans which are based on the findings of special external audits. The measures aim at enhancing their core areas of activity, namely: monitoring shareholders and affiliated persons, corporate governance, lending, risk management and prevention of money laundering. In case of noncompliance, the central bank will act resolutely through taking appropriate enforcement measures.

Moreover, in two banks, the NBM removed unfit shareholders, by blocking respectively 43 and 64 percent of concertedly acting shareholders. These measures are in line with the NBM actions to increase the transparency of the bank’s shareholders. In one bank the early intervention regime has been introduced. This will ensure the preservation of healthy and prudent management for the period of removal of deficiencies detected in the ownership structure. A new external diagnostic will be launched to identify the subsequent measures to be applied.

Going forward, the NBM will conduct full-scope on-site inspections and conclude identification of ultimate beneficial owners in all banks. Based on this and on the recently adopted regulations on identification of related parties and related-party lending, relevant diagnostics will be conducted in all banks as well. Additionally, by the end of the year, the NBM plans to design a strategy for addressing key remaining deficiencies in the banking sector identified in the BCP Assessment.

Structural reforms

In light of the structural trend of decreasing remittances, the current growth model based on remittances cannot ensure sustainable economic growth in the long term. Rebalancing the growth drivers requires sustainable progress in promoting higher private sector growth and job creation. The government’s agenda has been centered on improving the overall business climate.

The authorities made progress in diversifying energy supply and improving energy efficiency. The feasibility study on the construction of the connecting gas pipeline between Ungheni and Chişinău has been completed and the authorities started the work on the technical design. In addition, the work on expanding the electricity interconnection with Romania is in progress. With the recent approval of the laws on Electricity and on Natural Gas under the EU’s Third Energy Package, the government laid the foundation of unbundling the energy suppliers from producers and grids. Finally, the new law on Renewable Energy will enhance energy diversification and is expected to attract new investments.