Economic stabilization in Moldova has continued since the 2015 recession. Economic growth was robust in the last two years, and the growth momentum is expected to be maintained during 2018 and 2019, supported by increasing consumption and investment. Despite being an election year, the authorities are committed to fiscal discipline. The authorities’ broad reform agenda, supported by the ECF /EFF arrangement, continues to focus on maintaining macroeconomic and financial stability, and promoting structural reforms to unlock the potential for private sector growth and job creation. The program is successfully being implemented, in particular with regard to the clean-up of the banking sector, and enjoys broad ownership and political support.
Economic performance in 2017 was robust. Financial sector consolidation, lower interest rates, as well as strong domestic demand and a favorable external environment, propelled growth to 4.5 percent in 2017. Exports were supported by strong agricultural production and increased manufacturing exports to the EU, reflecting the impact of new foreign direct investments. Imports growth, however, outpaced exports, which widened the current account deficit. The budget outcome was well within program targets and public debt is estimated to have decreased to 37 percent of GDP, from 41.9 percent in 2016.
Economic growth is expected to remain strong in 2018 and beyond. The authorities now project real GDP growth of 3.8 percent in 2018, compared to 3 percent at the time of the second review. While private consumption is expected to remain the main driver of growth, the ongoing recovery in capital spending, higher exports to the EU, new free trade agreements, and additional foreign direct investment, will further support growth. With external competitiveness improving, the current account deficit, will gradually decline over the next five years. Inflation continued its downward path from 7.3 percent at end-2017 to about 3 percent in May 2018 and is projected to return to target in 2019. Monetary policy will continue to focus on maintaining price stability in the context of a flexible exchange rate. Gross reserves increased substantially, reaching 2,9 billion US dollars in April 2018, equal to 5.2 months import coverage.
With improved fiscal performance, program objectives will anchor future budget plans. Better fiscal compliance and buoyant foreign trade led to a double-digit nominal year-to-year increase in fiscal revenues in 2017. This, together with spending delays, reduced the fiscal deficit to 1 percent of GDP in 2017, well below the projected 3.2 percent. The recently approved amendments to the 2018 budget incorporate higher than planned fiscal revenues generated largely by higher growth and better compliance. These additional fiscal resources will be channeled to investment (mostly in infrastructure) and priority social spending. The amendments are consistent with the program augmented deficit ceiling of 3.5 percent, which was revised slightly to reflect changes in the timing of external grant disbursements.
Going forward, annual budgets will aim at preserving fiscal sustainability and focusing on growth-friendly spending. They will remain consistent with the parameters of the Medium-Term Budget framework (2019-21), which will be based on realistic revenue assumptions and the progressive tax system. Following the publication of the first Fiscal Risk Statement at end-2017, the authorities will continue their efforts aimed at enhancing the fiscal framework, including through undertaking spending reviews, unifying the salary system in the public sector, strengthening public investment management, modifying the structure of PIT and social contribution rates, and further developing the domestic government bond market. Special efforts will be directed to the development of the Single Account module within the Single Taxpayer Account system, advancing with the online service for paying taxes and fees by individuals.
While the banking sector remains stable, financial intermediation is still subdued. The banking system reports strong prudential indicators. Significant capital reserves, in part thanks to the strict dividend policy, give the banks a comfortable cushion to absorb potential losses and transitioning to a new system of risk capturing (Basel III). The capital adequacy ratio stands solidly above 30 percent (compared to the prudential requirement of 16 percent). The quality of bank assets is improving, reflecting the measures taken by banks in order to reduce non-performing loans. Liquidity in the system remains very high (about 57 percent as end of March 2018) and is still growing due to an increased level of deposits, and a double-digit increase in remittances and export inflows. Despite these benign developments and the favorable monetary conditions – with the gradual reduction of the NBM’s policy rate from 9 to 6.5 percent – credit to the economy remained subdued. Although the lending activity became somewhat more dynamic in 2017-2018, with newly issued loans increasing from month to month since mid-2017 and the total loan portfolio increasing since March 2018 y-o-y for the first time since the recession, it is still not sufficient to recover the banks’ intermediation role.
The authorities acknowledge the importance of a well-functioning banking sector, with high-quality shareholders, in fostering financial intermediation. Considerable progress has been made towards securing shareholder transparency in the banking sector. The transfer of ownership from a non-compliant shareholder in the third largest bank to a strategic investor (Banca Transilvania, Romania) in January 2018 was the first significant break-through. Moreover, the transaction of acquisition by a consortium of three reputable foreign investors of 41.09 percent of problem shares in the largest bank is materializing: the National Bank of Moldova (NBM) issued the purchase permission, the EBRD and co-investors have obtained the necessary internal approvals, and the Government has approved the transaction and signed a pre-contract with investors on June 22, 2018. Furthermore, the implementation of the sale of a 64 percent share in the second largest bank was started, as the newly issued shares have been put up for sale on the Stock Exchange and are actively promoted to potential buyers. The authorities also progressed with streamlining the shareholder removal process. Recent revisions by Parliament to the law on shareholder removal will improve the environment to expedite this process so that unfit shareholders are removed from the entire banking system within a clearly determined period. In addition, the NBM is finalizing the on-site inspections and related party exposure controls of all banks and will continue the work on bringing the related party exposures into compliance with prudential limits while further strengthening the governance and risk management frameworks.
Further enhancing the banking legal framework is a priority for the NBM. The new Law on banking activity became effective on January 1, 2018, transposing the Basel III principles and being in line with the EU CRD IV/CRR Directives on prudential requirement for credit institutions and their supervision. A package of by-laws to support the implementation of the law has been approved by the NBM. Moreover, in line with the approved provisions, banks developed and implemented their individual strategies for transition to Basel III principles. Following the implementation of the methodology for verification of the integrity of legal records of shareholders to be channeled to the Central Security Depository (CSD), rules on the transfer of the data to the CSD will be developed. The operationalization of CSD, envisaged for end-October 2018, will enhance the transparency of the financial market, including in banks and other public interest entities, and will help develop new financial instruments.
The investigation and asset recovery strategy from the bank fraud continues. Following the completion of the investigation by an international consortium, which provided a full tracing analysis of the embezzled assets, the general Prosecutor’s Office published on June 13, 2018 its recovery strategy. The strategy sets out the way forward to recovery the stolen assets, modalities related to civil and criminal cases with application in the country and foreign jurisdictions, as well as a time-bound action plan. MDL 1.14 billion of stolen assets have been recovered up to date from the failed banks and the authorities are committed to expedite their efforts in this regard. The amounts of recovered assets are reported monthly on the website of the Ministry of Finance.
Despite these important positive developments, challenges remain. While substantial progress has been achieved with the implementation of the structural reform agenda, the authorities are committed to continue advancing structural reforms to promote sustainable and inclusive growth. They aim at further improving the overall business climate – including through stronger customs and AML /CTF frameworks – attracting investment, and enhancing competitiveness and the country’s growth potential. Building on recent progress, the authorities will focus on further reducing the shadow economy. A new strategy “Moldova 2030” is under discussion, which will contain several priorities for the economy, regional and rural infrastructure and development, but also in education, health, and social protection, which will support the build-up and retention of human capital.