IMF Policy Paper: Republic Of Moldova; Fourth And Fifth Reviews Under The Extended Credit Facility And Extended Fund Facility Arrangements, Completion Of The Inflation Consultation, And Request For Extension Of The Arrangements And Rephasing Of Access
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International Monetary Fund. European Dept.
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Publication Date:
25 Sep 2019
eISBN:
9781513515434
Language:
English
Keywords:
ISCR; CR; EFF arrangement; government; energy tariff policy; Executive Board discussion; Moldovan authorities; broad money; foreign currency; government securities; national bank; Wages; Income; Global
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Fourth and Fifth Reviews Under the Extended Credit Facility and Extended Fund Facility Arrangements, Completion of the Inflation Consultation, and Request for Extension of the Arrangements and Rephasing of Access-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Moldova

Abstract

Fourth and Fifth Reviews Under the Extended Credit Facility and Extended Fund Facility Arrangements, Completion of the Inflation Consultation, and Request for Extension of the Arrangements and Rephasing of Access-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Moldova

Context And Recent Developments

1. In mid-2018, Moldova’s ECF/EFF blended arrangement was broadly on track to achieve its key objectives. Substantive progress had been made in addressing governance and stability issues in the banking sector, and fiscal policy was broadly balanced and aimed at tackling pressing social and infrastructure needs. Some advances had been made in improving the business climate and energy policy.

2. Policy setbacks, however, emerged ahead of the February 2019 parliamentary elections. The pre-election capital and tax amnesty and other fiscal initiatives undermined key program objectives and raised governance and tax administration concerns. While some corrective actions were implemented, no reviews were completed after June 2018 as efforts were insufficient to restore policy credibility. The EU paused its macro-financial assistance (MFA) to Moldova over concerns about deteriorating democratic standards and a poor anti-graft track record.

3. The political instability that emerged in the aftermath of the parliamentary elections has subsided and the new government is committed to continue reforms. Inconclusive parliamentary elections led to a three-month political stalemate which ended when two opposition parties—the pro-Russian Socialists and pro-EU ACUM—agreed to form a coalition. The new authorities requested a resumption of the Fund-supported program and agreed to implementing bold measures to reverse policy slippages by the previous government and complete financial sector reforms.

4. Growth remains robust. Real GDP grew 4 percent in 2018, driven by infrastructure and private investments, while rising real incomes and recovering bank lending supported consumption. Growth picked up to 4.4 percent in 2019Q1, driven by agricultural exports. The labor market improved significantly in 201 8, with higher labor force participation, record employment growth in the formal sector, and a drop in the unemployment rate to 3 percent.

uA01fig01

Contributions to GDP Growth

(Percentage points)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Sources: Moldovan authorities; IMF staff calculations and estimates.
uA01fig02

Inflation

(Percent, y-o-y growth)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Sources: Moldovan authorities and IMF staff calculations.

5. Inflation temporarily slipped below the NBM’s band in 2018, but pressures are now building. Inflation slowed in 2018 due to downward adjustments to energy tariffs, lower food price inflation, and exchange rate appreciation (see MEFP 1114). It has picked up sharply in 2019, as these effects dissipated, and pressures mounted from an expansionary fiscal stance and a bout of leu depreciation in response to the political uncertainty. The National Bank of Moldova (NBM) responded by raising the policy interest rate in June, for the first time since December 2017, and again in July.

6. Financial conditions are improving. Bank credit is expanding in real terms for the first time in 5 years, in tandem with growth in deposits. Banks are well capitalized and liquid, with adequate profitability ratios, while NPL ratios continue to fall.

7. Public finances overperformed strongly last year but deteriorated sharply in 2019. The augmented general government deficit was 1.1 percent of GDP in 2018, significantly lower than the 3.5 percent of GDP envisaged in the third review.1 Public debt, at about 30 percent of GDP, also undershot program projections due to fiscal overperformance, non-disbursement of external loans, and favorable exchange rate valuation effects. During 2019H1, however, the augmented general government deficit widened sharply driven by shortfalls in EU grants, under-performance of CIT and excises, and wage bill overruns.

uA01fig03

Cumulative Overall Balance

(Million lei)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Sources: Moldovan authorities and IMF staff calculations.

Fiscal Performance Against Program and Budget

article image
1/

Staff projection based on budget execution rates in 2017-18 applied to the amended 2019 budget.

2/

Includes externally financed net on-lending to SOEs.

3/

Jan-Dec 2018 debt ratio rebased using revised GDP level for comparison.

8. The external position has weakened. The current account deficit deteriorated to over 10 percent of GDP in 2018 on the back of strong domestic demand and real exchange rate appreciation. Robust private financial inflows, however, led to a moderate buildup of reserves that remain adequate at about 170 percent of the IMF composite reserve adequacy metric. The leu appreciated in nominal terms last year but lost some of its strength in 2019H1, in the run-up to the elections and the political uncertainty that followed.

uA01fig04

Current Account and Real Effective Exchange Rate

(Million U.S. dollar)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Sources: IMF WEO and IMF staff calculations.

Outlook And Risks

9. The economic outlook remains broadly positive, provided that the reform momentum is decisively sustained:

  • Growth is projected to moderate to 3.5 percent in 2019, driven by lower than originally planned infrastructure spending and tighter monetary policy. Medium-term growth is projected at about 4 percent.

  • Inflation is projected to peak at around 7.5 percent by end-2019 and stabilize close to the 5 percent target by mid-2020.

  • The current account deficit is expected to moderate to 9.5 percent of GDP in 2019—while the resumption of donor financing will help maintain reserve adequacy—and adjust to below 7 percent of GDP over the medium term, supported by a tighter monetary and fiscal policy mix and financed by strong capital and investment flows as confidence improves. 2

  • Public and external debt to GDP ratios are estimated to preserve Moldova’s low risk of debt distress (DSA supplement).

10. The outlook is vulnerable to significant downside risks. Domestically, a renewed escalation of political tensions, new policy slippages, and complacency or reform fatigue by the temporary coalition government could hurt confidence and resurrect uncertainty about external official financing. Regional and global spillovers from geopolitical and trade tensions also cannot be ruled out. On the upside, resolute progress in tackling outstanding governance concerns would strengthen public trust in state institutions and popular support for the reform agenda.

Program Performance

11. Program performance, despite outdated program targets, was broadly adequate based on end-June and end-December 2018 PCs, while all continuous PCs were observed (MEFP Table 1).

Table 1.

Moldova: Selected Economic Indicators, 2015–2024 1/

article image
Sources: Moldovan authorities; and IMF staff estimates.

Data exclude Transnistria.

Includes externally financed on-lending to SOEs as of 2016.

Includes net on-lending to SOEs.

Includes private and public and publicly guaranteed debt.

  • End-June and end-December 2018: fiscal performance criteria on the ceiling on the augmented general government deficit were met by large margins (about 0.4 and 2 percent of GDP, respectively) on account of large revenue over performance (CIT, VAT, SSC, and non-tax revenue) and significant under-execution of current and capital spending. The indicative target on the ceiling on the general government wage bill was also met. However, the indicative ceiling on the stock of accumulated domestic government arrears and floor on priority social spending were marginally missed; while the indicative floor on project spending funded from external sources were missed by 0.2 and 1 percent of GDP, respectively. Performance criteria on the NIR floor were observed.

  • End-March 2019 indicative targets: the augmented general government deficit target was met by a large margin (0.8 percent of GDP) as revenues exceeded program projections, despite overruns on the general government wage bill and underperformance of excises and CIT relative to the amended budget targets. While the floor on priority social spending was met, the ceiling on the stock of accumulated domestic government arrears and the floor on project spending funded from external sources were missed. The indicative NIR floor was missed (by about $158 million) due to FX sales to counter depreciation pressures ahead of the elections.

  • Inflation consultation band: inflation dropped temporarily below the outer consultation band in December 2018, triggering an inflation consultation with the IMF Executive Board. Whereas the slowdown had been expected, its magnitude surprised on account of lower-than-expected international food prices, further exchange rate appreciation, and larger-than-expected cuts to energy tariffs. Inflation returned within the band the next month and has remained within it since then.

  • Structural conditionality: Three of five SBs have been implemented, albeit one with a delay, and one remains outstanding. The authorities met end-June and end-July 2018 SBs on the new electricity tariffs and the action plans for unwinding related-party exposures. In January 2019, they finalized onsite inspections in banks that are part of foreign groups (end-May 2018 SB). Notwithstanding substantive progress, a systemic bank’s exit from temporary administration remains delayed (end-October 2018 SB).

Policy Discussions

A. Fiscal Policy: Addressing Fiscal Pressures and Policy Reversals

Background

12. A package of pre-election fiscal initiatives and a capital and tax amnesty introduced in July 2018 undermined program objectives and raised fiscal risks.

  • A tax package narrowed the tax base, reduced tax efficiency, and reversed some hard-earned gains from the recent pension system reform.

These included: (i) an introduction of a flat-rate PIT system, undermining income tax progressivity (revenue loss of 0.5 percent of GDP); (ii) a cut in private employers’ social security contribution rates (0.8 percent of GDP), widening the pension fund deficit; (iii) a reduction in the taxable share of capital gains; (iv) a reduced VAT rate applied to hotels and restaurants (HORECA, Box 1); and (v) an elimination of excises on petrol at border crossing points.

Hotels, Restaurants, and Cafes (HORECA) - Trends and Policy Considerations

Moldova’s HORECA industry is growing but remains relatively underdeveloped. It accounts for about 1 percent of formal employment (of which about 80 percent is in restaurants), much smaller than in Romania where it accounts for about 4 percent. Within the industry, the restaurant sector is experiencing an expansion, with annual employment growth averaging about 4.5 percent in 2017-19, underpinned by robust domestic demand. Moreover, average wage in the sector has grown by almost a half since 2016, outpacing economy-wide wage growth by 20 percentage points. The sector’s average wage reached about 70 percent of the economy-wide level, compared to 60 percent ratio in Romania.

uA01fig05

Moldova: Employment and Earnings in Restaurant Industry

(Y-o-y percent change)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

The October 2018 tax changes have not produced expected outcomes. Undertaken with a view to primarily de-shadow the economy, the VAT rate applicable to HORECA industries was halved to 10 percent from the standard rate. The industry also benefitted from the economy-wide PIT and SSC rates cuts. Nonetheless, the wage-related tax policy measures did not lead to a material de-shadowing of labor in the industry. Specifically, growth of the Health Fund contributions—unaffected by policy changes—indicates no level or trend shift in the tax base. Moreover, de-shadowing of sales has not paid off considering VAT revenue loss. Post-reform weighted average VAT rate on sales declined from about 19 to 13 percent, while average VAT rate on inputs remained at about 19 percent. Despite a strong growth of sales, VAT due to the budget has dropped by 60 percent, while the stock of VAT input tax credit has surged from the average of about 5 percent of turnover to almost 20 percent. For businesses that operate under relatively thin margins, carrying a large stock of tax credits is costly in terms of profitability and can also encourage the rise of informality.

uA01fig06

Restaurant Industry: Labor-Related Taxes

(Y-o-y percent change)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

uA01fig07

Restaurant Industry: Sales and VAT Collections

(Y-o-y percent change)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Moldova’s Unified Salary System

article image
Source: Moldovan authorities.

  • A reform of the unified public wage system added to fiscal pressures. While the original draft law was supported by Fund staff, the enacted legislation (effective December 1, 2018) inflated the wage bill (by 0.6 percent of GDP) amid the lack of a proper staff register. Also, as a political compromise, the system introduced ten different reference values for calculating salaries, undermining the reform objective of simplifying a complex wage ladder and improving wage compression.

  • A new capital and tax amnesty—the third in a decade—weakened tax administration and undermined tax compliance. The amnesty legalized undeclared wealth from tax evasion subject to a fee, allowed writing off accumulated interest and penalties for settling tax arrears, and banned tax audits prior to 2018. To address staff’s concerns, the authorities amended the law to (i) narrow the list of individuals who can take advantage of the voluntary declaration by excluding public sector officials and related persons; (ii) increase the tax on cash disclosures from 3 to 6 percent, but short of the 1 2 percent recommended; (iii) withdraw all benefits in cases of incomplete declaration; and (iv) oblige taxpayers to provide evidence that expenses in excess of future reported income are financed out of voluntarily declared monetary assets. These amendments effectively neutralized the amnesty, as few declarations (and of insignificant amounts) were submitted. However, recurrent tax amnesties undermine compliance and encourage delinquency, particularly given that the restriction on tax audits impedes enforcement.

Policies

13. To contain fiscal risks, the authorities adopted in August amendments to the 2019 budget consistent with the augmented general government deficit of 3 percent of GDP (prior action). This deficit target—tighter than 3.3 percent of G DP envisaged in the approved budget—is appropriate given financing constraints, while adequately protecting priority social spending. The amended budget updated for 2019H1 revenue trends and introduced new measures:

A01fig07

2019 Fiscal Deficits: Approved and Amended Budgets

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

  • On the expenditure side (0.6 percent of GDP): (i) redistributed gains from savings on employee vacancies in the budget sector to cover higher wage bill needs from local governments; (ii) reduced net on-lending to SOEs in line with expected project disbursements; and (iii) rationalized capital spending to reflect lower execution during 2019H1;

  • On the revenue side (0.1 percent of GDP): (i) increased excises for heat-not-burn and fine-cut tobacco products; (ii) reduced exemptions on income from lotteries and sports betting; (iii) limited tax-free sales at duty-free shops to travelers leaving Moldova by sea or air; and (iv) removed tax exemptions on petroleum products sold in the customs control area.

14. The authorities also took steps to mobilize resources for development and social spending in 2020. Towards this objective, amendments to the Tax and Customs Codes were adopted in August (prior action) to raise revenue on CIT, PIT, VAT, excises, and property taxes and rationalize tax expenditures. Specifically, the amendments—effective January 1, 2020—have: (i) broadened the capital gains tax base; (ii) increased the VAT rate for HORECA; (iii) phased out the personal allowance for higher incomes; (iv) removed tax exemptions applied to meal vouchers provided by employers; (v) removed VAT exemptions on goods imported by PPPs; (vi) unified excise duty rates for cigarettes with and without filter; (vii) consolidated environmental taxes; (viii) increased PIT rates on tax withheld in advance; and (ix) reduced tax-free personal exemptions on merchandise shipped by mail. These measures are expected to yield about 0.3-0.6 percent of GDP in revenue, not presently included into staff’s projections due to the costing ambiguity. An agreement on the 2020 budget, inclusive of these measures and consistent with program objectives, will be a key precondition for the final program review.

15. The authorities and staff agreed on robust measures to strengthen tax administration and improve tax compliance. First, the Tax Code was amended (prior action) to: (i) withdraw provisions that provided for the deduction of up to MDL 500,000 from the indirect method assessment of estimated taxable income; and (ii) sunset the carryover provision from the 2012 “capital liberalization scheme”. Second, the capital and tax amnesty law was amended (prior action) to allow the State Tax Service (STS) to perform audits and exercise its investigative functions prior to January 1, 2018. Third, the authorities will formally propose a date for the automatic exchange of information with the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes (new end-December SB), with a view to start the automatic exchange of information with other countries by end-2022.

16. The authorities recognize the need to strengthen the unified wage system in the budgetary sector and improve control over the wage bill. In line with staff advice, they will (i) adopt a time-bound plan to phase out multiple reference values with a view to improve budgetary process and medium-term planning; and (ii) develop and operationalize a comprehensive IT-based staff registry.

17. Staff recommended strengthening institutional fiscal frameworks to support medium-term policy and prioritize growth-enhancing spending. To this end, findings from spending reviews (education and agriculture sectors) need to be integrated into the medium-term budget framework and annual budget processes. The fiscal risk statement should be expanded to improve coverage, monitoring, and reporting of risks emanating from SOEs and PPPs. Finally, a comprehensive strategy to strengthen public investment management needs to be developed, supported by forthcoming IMF technical assistance, to improve the efficiency of public investment and scale up public infrastructure.

B. Financial Sector: Completing Banking Reforms and Mitigating Non-Bank Risks

Background

18. Efforts to ensure fitness and probity of banks’ ultimate beneficiary owners are paying off, supporting credit recovery. The sale by a non-transparent shareholder of shares in VictoriaBank (third largest bank) to a Romanian banking group in January 2018 represented a reform milestone. In October 2018, a stake in MAIB (largest bank) was sold to an EBRD-led consortium. In March 2019, majority shares of MICB (second largest bank) were sold to a Bulgarian non-bank investor. In January 2019, the NBM also suspended the legal rights of shareholders acting in concert in two non-systemic banks and appointed a temporary administrator in one of the banks. These changes in the ownership structure contributed to the revival of credit, with total lending registering double-digit growth for the first time since 2016.

uA01fig08

Total Lending Growth

(Contributions to yoy credit growth)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Sources: NBM and IMF staff calculations.

19. The implementation of unwinding of (previous) related-party exposures is proceeding as planned. Time-bound action plans for unwinding these exposures were approved (end-July 2018 SB). By end-April, four out of seven banks had aligned exposures with prudential limits, and remaining banks continue to reduce their gross exposures as planned. Regulations on banks’ transactions with related parties have been updated to calculate such exposures net of loan-loss provisions.

uA01fig09

Foreign Ownership of Banks

(Percent of banking sector assets)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Source: NBM and IMF staff calculations.1/ 41 percent acquired by EBRD-led consortium (October 2018).2/ 63.8 percent acquired by Bulgarian Doverie Fund (March 2019).3/ Majority stakeacquired by Banca Transyvanía and EBRD (January 2018).4/ In process of acquisition by OTP, from Societe Generale (Februaty 2019).5/ Acquired by Intesa Sanpaolo (Ju ne 2017).6/ 100 percent foreign-owned (96 pct German; 3.8 pct Netherlands).
uA01fig10

Unwinding of Banks’ Related Party Exposures

(Percent)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Sources: NBM and IMF staff calculations.

20. The Central Securities Depository (CSD) is fully operational. The single CSD was designed to support increased investments in the local capital market and develop new financial instruments. It is responsible for the registration, safekeeping (as custodian of ownership records of government and corporate securities), and settlement of securities issued by Moldovan entities. The legal records of shares of banks and insurance companies were transferred to the CSD in May. Records of joint-stock companies traded at the exchange and all other joint stock companies will be transferred by end-2019 and 2020, respectively.

21. The authorities continue to strengthen Moldova’s financial safety net, crisis prevention, and contingency planning frameworks. Towards this objective, the governance structure and coverage of the Deposit Guarantee Fund were strengthened by appointing all supervisory board members, raising its coverage limit to MDL 50 thousand (about 31 percent and 97 percent of total deposits and depositors, respectively), and expanding its coverage to legal entities (effective January 1, 2020). Also, the National Financial Stability Committee—established to coordinate the implementation of macro-prudential policy and activities to prevent and remedy financial crises—held its inaugural meeting in January 2019.

22. While not yet systemic, risks in the non-bank financial sector are rising. In particular, lending by microfinance organizations has increased sharply as they exploited regulatory arbitrage (given tighter banking sector supervision) and filled the void created as banks recovered from the 2014 fraud. Weak supervisory capacity, absence of mandatory credit history checks and ineffective consumer protection mechanisms, non-transparent UBOs, and opaque non-resident funding raise concerns about the potential for household overleveraging, predatory lending practices, and money laundering risks. Spillovers to the banking sector could occur through confidence and funding channels.

uA01fig11

Moldova: Non-bank Financial Sector Developments

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Policies

23. The authorities continue advancing efforts to rehabilitate the banking system:

  • MICB’s exit from temporary administration in an orderly manner. The temporary administration regime, in place since October 2016, is expected to be withdrawn once adequate governance structures are in place (end-December SB, reset from end-October 2018). Priority must be given to ensure prudent management of the bank and avoid conflicts of interest or reputational hazards. In this context, the NBM should stand ready to ensure rigorous professional standards for the bank’s new management team and enhanced monitoring of its related party exposures and cross-border transactions.

  • Removing unfit shareholders in domestic non-systemic banks (end-March SB). With an objective to safeguard the banks’ capital and ensure fit and proper ownership structures, and fully in line with the shareholder removal legal framework, the NBM rejected in July a request to further extend the deadline for sale of shares held by unfit shareholders of two banks, thereby triggering the process of cancellation of problem shares (prior action). While the unfit shareholders of one of these banks have challenged the NBM’s concerted action decision in court, the NBM should stand ready to appeal any decision that undermines the irreversibility of its supervisory decisions.

24. The NBM’s operational framework for emergency liquidity assistance (ELA) has been significantly strengthened. Amendments to the NBM Act and other relevant legislations were approved in August (prior action) with a view to ensure that ELA can be extended only to solvent and viable banks. The modified ELA framework is expected to be implemented before end-2019.

25. The authorities and staff agreed on measures to mitigate risks from non-banks.

Specifically, legislation governing activities of non-bank credit organizations will be amended (new end-October SB) to: (i) prohibit them from accepting deposits from the public, per provisions of the Law on Bank Activity; (ii) oblige them to report new credit activity to credit bureaus; (iii) introduce limits on total cost of consumer credits; and (iv) introduce an effective, proportionate, and dissuasive sanctioning regime. Staff also urged the authorities to implement risk-based supervision and to strengthen ownership transparency, governing bodies, asset classification, risk management, and internal control frameworks. The National Commission for Financial Markets (NCFM) capacity to implement reforms should be reviewed, with a view to strengthen the regulatory framework and supervisory capacity.

C. Monetary and Exchange Rate Policy: Keeping Inflation Under Control and Strengthening NBM’s Operational Framework

Background

26. The NBM tightened monetary policy in June, for the first time since December 2017, and again in July. The policy rate was raised by 100 basis points to 7.5 percent, with the NBM citing inflationary pressures from higher wages, credit growth and a positive fiscal impulse. This decision was broadly in line with staff advice to keep inflation within the band around the target. The required reserve ratio on bank’s convertible currencies was raised by 3 percentage points to 17 percent while that on nonconvertible currencies was unchanged at 42.5 percent. Following an appreciation cycle throughout 2018, the leu oscillated substantially in 2019 and, in recent months, the NBM appropriately reduced its footprint in the foreign exchange market.

uA01fig12

Monetary Policy

(Percent, million of U.S. dollar)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Source: National Bank of Moldova.

Policies

27. The NBM should stand ready to adjust its policy rate further, as needed, to maintain inflation within the corridor. A less accommodative monetary policy stance is appropriate given expected inflationary pressures from the expansionary fiscal impulse, nominal currency fluctuations, and adjustments to regulated prices. This should be supported by greater exchange rate flexibility, with FX interventions limited to smoothing excessive volatility in the foreign exchange market and maintaining adequate reserve coverage.

28. The NBM and staff agreed on the need to strengthen its inflation-targeting operational framework. In line with recent MCM advice, the NBM will enhance its liquidity management and the transmission of monetary policy by (i) adhering to the policy rate as its primary tool; (ii) gradually recalibrating the reserve requirement ratios on domestic and foreign currency requirements to disincentivize foreign currency intermediation, while carefully monitoring liquidity considerations; and (iii) adopting an FX intervention strategy consistent with the inflation targeting regime to facilitate two-way exchange rate flexibility and reduce the NBM’s market footprint, consistent with IMF technical assistance (new end-December SB). Staff also recommended that the NBM strengthens its public communication to improve market signaling of policy intentions and ascertain policy awareness and credibility.

29. The NBM’s policy and institutional independence is vital to achieving its mandate.

Operational independence of the NBM plays a pivotal role in sustaining confidence in—and recovery of—the banking system, enhancing the credibility of the inflation-targeting regime, and safeguarding macro-financial stability. In this context, several recent incidents of political pressure on the National Bank of Moldova pose serious concerns. Against this background, staff engaged new political decision makers to stress the utmost importance of safeguarding the NBM’s independence.

D. Structural Reforms

Background

30. Energy sector policies were broadly in line with program commitments last year, but 2019 tariffs were delayed. Electricity tariffs were set by the energy regulator in line with the new methodology and published in the official gazette on June 29, 2018 (end-June 2018 SB). Disputes between the regulator and the major electricity provider over past financial deviations were settled through an agreement on 2018-19 tariffs and investments. However, the regulator failed to promptly approve 2019 gas tariffs, against the background of higher-than-expected import costs for natural gas, turbulent political developments, and changes to the regulator’s top management.

uA01fig13

Moldova: Gas Price Developments

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

31. Recovery of stolen assets from the 2014 banking fraud has been slow. By end-March 2019, the total value of recovered assets in the form of proceeds from bank liquidation (BEM, BS and UB) and confiscation of assets of convicted persons (MAIB and MICB shares) was significantly below the value of criminal cases under investigation (MDL 3.1 billion vs. MDL 8.7 billion). The scope for recovering proceeds becomes increasingly difficult as time elapses.

uA01fig14

Progress with Asset Recovery

(Billions of Moldovan lei)

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Sources: NBM and IMF staff calculations.1/ Represents the total value of state securities issued for the securitization of ELA loans granted by the NBM to three banks as per government decisions (ram November 13, 3014 and March 30. 2015.

32. Further efforts are needed to strengthen the effectiveness of Moldova’s AML/CFT framework. The authorities should ensure that AML/CFT supervision of financial institutions (including on-site inspections) is effectively risk-based and sanctions for AML/CFT violations are effective, proportionate and dissuasive. The quality of suspicious transaction reports (STR) filed by reporting entities (such as banks) need to be improved. Enhanced capacities and resources for the Service for Prevention and Fight against Money Laundering in analyzing STRs will contribute to developing financial intelligence for criminal investigations. The authorities are also encouraged to address deficiencies and implement recommendations in relation to MONEYVAL’s 2019 comprehensive AML/CFT assessment, which is expected to be published following the July Plenary.

Policies

33. The authorities reiterated their commitment to regular reviews of energy tariffs.

Towards this objective, the regulator will conduct regular reviews to promote transparency and predictability in the sector, minimize contingent liabilities and, by end-October, adopt (i) new electricity tariffs based on the February 2018 methodology, and (ii) gas tariffs based on the existing methodology and purchase price of natural gas (new end-October SB). Regular updates of the eligibility and benefit parameters of targeted social assistance programs, such as Ajutor Social and Heating Allowance, will enhance the targeting and effective coverage of social assistance programs, while also mitigating adverse effects of tariff increases on vulnerable households.

34. The new government signaled strong commitment to investigating the 2014 bank fraud and making tangible progress on asset recovery. The authorities plan to initiate an international investigation to prosecute the perpetrators. By end-October, they intend to evaluate appropriate modalities to recover stolen proceeds, including through engaging independent international legal and forensic experts. Staff urged to step up coordination among all relevant stakeholders, including the NBM, the Prosecutor’s office, the National Anticorruption Center, Criminal Asset Recovery Agency, and the AML agency.

35. The authorities are committed to strengthening Moldova’s AML/CFT framework, including by implementing the 2018 AML Law and MONEYVAL recommendations. By end-2019, they plan to adopt the Law on Sanctions for violations of ML/TF rules, developed in coordination with the Council of Europe and European Union. They also plan to engage international partners to initiate a new National ML/TF Risks Assessment. Finally, they are developing new guidelines for exchange of AML/CFT information among all relevant stakeholders and a new IT system for reporting suspicious transactions for all types of reporting entities.

36. Efforts to enhance governance and anti-corruption measures will contribute to improving the business climate and levelling the playing field. The independence and capacities of anti-corruption institutions including the National Integrity Authority should continue to be enhanced. Strengthening the asset declaration system (including with respect to the scope of ownership information and timely and credible verification) should be prioritized. AML tools such as enhanced due diligence for politically exposed persons should also be leveraged to detect and deter corruption.

Program Modalities

37. To ensure that program objectives can be met, staff supports the authorities’ request for the completion of the inflation consultation, an extension of the current arrangements, and a rephasing of access. Staff supports (i) the extension of the ECF/EFF arrangements to March 20, 2020; (ii) the addition of a sixth program review based on end-December 2019 quantitative performance criteria (MEFP Table 1) and new structural benchmarks; and (iii) the rephasing of the outstanding program purchases with SDR 33.6 million and SDR 14.4 million to be disbursed at the time of the combined fourth/fifth and sixth reviews, respectively. This reprofiling reflects mainly changes in the Moldova’s BOP needs due to the expected timing of disbursement of the World Bank Development Policy Operation.

38. Staff proposes updated program conditionality (MEFP Table 2):

  • Six prior actions for the completion of the fourth/fifth reviews were set on: (i) the adoption of amendments to the 2019 budget consistent with the augmented general government deficit ceiling; (ii) the approval of amendments to the Tax and Customs Codes (effective January 1, 2020) to rationalize tax expenditures and raise revenues; (iii) the approval of amendments to the Tax Code to remove provisions for the deduction of up to MDL 500,000 from the indirect method assessment of estimated taxable income, and to sunset by 2022 the carryover provision from the 2012 capital liberalization scheme; (iv) the approval of amendments to the 2018 Capital and Tax Amnesty Law to remove the provision that STS cannot perform audits prior to January 1, 2018; (v) the approval of amendments to the NBM Act and other laws to ensure that ELA is extended only to solvent banks; and (vi) the removal of unfit shareholders in two domestic non-systemic banks.

  • One SB is proposed to be reset. The systemic bank (MICB) is expected to exit temporary administration in an orderly manner by end-December.

  • Four new SBs are proposed with a view to support the structural reform focus of the new government in 2019: (i) for end-October on the adoption of 2019 gas tariffs; (ii) for end-October on the amendment of the legislation governing activities of non-bank credit organizations; (iii) for end-December on the proposal of a date and adoption of an action plan for the automatic exchange of information with the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes; and (iv) for end-December on the adoption of an FX intervention strategy to facilitate two-way exchange rate flexibility and reduce the NBM’s market footprint, consistent with IMF technical assistance.

39. The program remains fully financed, with firm financing assurances in place for the remainder of the program period and the next 12 months. The size of the external financing gap—estimated at US$171 million in 2019—will be fully covered by the resumption of disbursement of EU’s MFA and budget grants (US$124 million, of which up to US$71 million set aside for MFA budget support grants and loans), and Fund disbursement of SDR 33.6 million (US$ 46.5 million), of which SDR 20.1 million (US$27.9 million) disbursed for budget support (ECF: SDR 6.7 million and EFF: SDR 13.4 million). External financing would allow reserves to reach the top of the Fund’s ARA metric by end-2019 (165 percent of the metric). In 2020, the smaller external financing gap, at US$132 million, will be financed mainly by EU funds (US$72 million) and the World Bank’s Development Policy Operation (US$40 million), with the residual gap closed via a disbursement equivalent to SDR 14.4 million (US$20 million) under the ECF/EFF.

40. Moldova is expected to meet its repayment obligations to the Fund and remains at low risk of debt distress. Obligations to the Fund peaked at 0.9 percent of GDP in 2017 and are projected to decline to 0.2 percent by 2024 (Table 5). Payments to the Fund are estimated at 2.1 percent of exports of goods and services in 201 9 and are projected to decline gradually to below 1 percent by 2024.

Table 5.

Moldova: Indicators of Fund Credit, 2011–2024 1/

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Sources: IMF staff estimates and projections.

Assume repurchases are made on obligations schedule.

2/ Total debt service includes IMF repurchases and repayments. 3/ In 2009, does not include Moldova use of the SDR allocation of SDR 117.71 million.

41. Risks to the program remain high but are mitigated by the new government’s commitment to strong prior actions, adequate buffers, and the normalization of relations with donors. The authorities are committed to program objectives, and cognizant of potential risks from reform fatigue or resurgence of domestic political instability. Moldova’s external reserve buffer remains adequate, safeguarding against abrupt external adjustment in the event of intensification of spillovers from regional geopolitical and global trade tensions. Fiscal slippages have been addressed, the monetary policy framework is being strengthened, and the financial sector is on a stronger footing. Normalization of relations with the EU and other donors should help sustain the reform momentum and catalyze external financing.

Staff Appraisal

42. Pre-election policy reversals have been addressed and the program is back on track to achieve its objectives. Despite delays in completing program reviews, the new authorities have taken important actions, affirming their strong commitment to the program amid a complex domestic political environment. However, macro-financial vulnerabilities and important structural impediments remain significant, thereby clouding the outlook for strong and sustainable growth and raising living standards. Also, previous policy slippages show that progress is not irreversible. It is therefore critical that prudent and well-coordinated macroeconomic policies are pursued, and reforms continue, notably to complete the cleansing of the financial sector, improve governance, strengthen institutional frameworks, and ensure transparency and predictability in the energy sector.

43. Significant progress has been achieved in the financial sector’s reform agenda—a crucial pillar of the program, but remaining actions need to be completed. The authorities completed many of the measures to secure shareholder transparency, fitness, and probity of the domestic banking system. Also, good progress has been achieved in improving supervision, regulatory frameworks, unwinding bank related-party exposures, and strengthening financial safety nets. Critical next steps include exit of the second largest bank from temporary administration, addressing rising risks in the non-bank financial sector, and improving the AML/CFT framework. To regain public trust in state institutions, decisive progress needs to be demonstrated on the long-delayed process of asset recovery.

44. The amended 2019 budget and measures to rationalize tax expenditures and raise revenue help mitigate immediate fiscal pressures, but continued vigilance is imperative.

Strong implementation of the agreed budget envelope and continued monitoring of revenue performance following the adopted measures will be key in ensuring fiscal sustainability, while securing the needed fiscal space for priority social and development projects. Policy reversals need to be avoided, and new initiatives carefully costed. Continued efforts are needed to strengthen tax administration and tax compliance, streamline tax expenditures, and reduce risks from SOEs and PPPs. A comprehensive strategy to strengthen public investment management would help improve the efficiency of public investments and scale up public infrastructure.

45. Monetary policy should continue to focus on maintaining price stability, in the context of a flexible exchange rate regime, while the NBM’s operational framework needs to be strengthened. The NBM should continue monitoring the inflation outlook closely and stand ready to adjust its policy rate as needed. The policy rate should be reinstated as the primary signal of the stance of monetary policy, while the reserve requirement framework needs to be gradually recalibrated to favor intermediation in domestic currency. Intervention in the foreign exchange market should be limited to smoothing excess volatility. The NBM should also continue to improve its operational capacity, including by strengthening decision-making, improving coordination across agencies, and reinforcing internal and external communication.

46. Safeguarding the NBM’s independence is critical. Legal reforms enacted in the aftermath of the 2014 banking crisis and supported by the IMF have strengthened the NBM’s governance structure, balance sheet, and autonomy. To protect this hard-earned progress, political decision makers should refrain from any initiative to weaken the NBM’s operational independence or governance framework, as these would undermine its ability to fulfill its mandates of maintaining price and financial sector stability, which are fundamental for sustainable economic development.

47. Progress is needed to unlock Moldova’s economic potential. The new government’s commitment to improving governance and fighting corruption is welcome and critical for boosting long-term growth. Progress towards structural bottlenecks—including weak bank intermediation, non-transparent energy policy, and promoting a business-friendly environment—can boost growth potential and low incomes.

48. In light of progress so far and the authorities’ policy commitments, staff supports the completion of the fourth and fifth reviews under the ECF/EFF-supported program, completion of the inflation consultation, the extension of arrangements, and the rephasing of access. The program remains broadly on track, with strong ownership. While risks to the program remain, the firm commitment by the new government to sound economic management and ongoing reforms warrants continued Fund support.

Figure 1.
Figure 1.

Moldova: Real Sector Developments, 2010—19

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Sources: Moldovan authorities; National Bureau of Statistics of the Republic of Moldova; and IMF staff calculations.
Figure 2.
Figure 2.

Moldova: Money, Prices, and Interest Rates, 2011—19

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Sources: Moldovan authorities; and IMF staff calculations.
Figure 3.
Figure 3.

Moldova: Fiscal Developments, 2009–2018 1/

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Sources: Moldovan authorities; and IMF staff calculations.1/ General government overall balance. Higher education institutions are excluded from the budget from 2013. This results in a sizeable reduction of nontax revenue, offset by lower cu rrent expenditure.2/ Targets are calculated as the absolute value in lei as a percent of current GDP.
Figure 4.
Figure 4.

Moldova: Banking Sector Developments, 2013–19

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Sources: National Bank of Moldova; and IMF staff calculations. 1/ The acquisition of EXIMBANK by Veneto Banca S.pA. in February 2018 required mandatory liquidation of NPLs and loan balances.
Figure 5.
Figure 5.

Moldova: External Sector Developments, 2009–2019

Citation: IMF Staff Country Reports 2019, 305; 10.5089/9781513515434.002.A001

Sources: National Bank of Moldova; Moldovan Authorities; and IMF staff and calculations.1/ Short-term assets include portfolio investment, financial derivatives, trade credits and currency and deposits.2/ Short-term liabilities include portfolio investment, financial derivatives, trade credits, short-term loans by banks and other sectors, currency and deposits, short-term other liabilities by general government, banks and other sectors.
Table 2a.

Moldova: Balance of Payments, 2015–2024

(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 2b.

Moldova: Balance of Payments, 2015-2024

(Percent of GDP, 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, 2015-2024

(Millions of Moldovan lei, unless otherwise indicated)

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

As of 2016, capital transfers are excluded from transfers to economy and recorded under capital expenditure.

Includes banking sector resolution costs in 2016.

Augmented balance includes externally financed on-lending to SOEs.

Starting with combined 4th and 5th review, includes domestic guarantees and domestic debt of SOEs.

Includes central bank liabilities to the IMF.

Table 3b.

Moldova: General Government Budget, 2015-2024

(Percent of GDP, un less otherwise indicated)

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

As of 2016, capital transfers are excluded from transfers to economy and recorded under capital expenditure.

Includes banking sector resolution costs in 2016.

Augmented balance includes externally financed on-lending to SOEs.

Starting with combined 4th and 5th review, includes domestic guarantees and domestic debt of SOEs.

Includes central bank liabilities to the IMF.

Table 4.

Moldova: Accounts of the National Bank of Moldova and Monetary Survey, 2012-2020

(Millions of Moldovan lei, unless otherwise indicated)

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

Monetary accounts are presented at actual exchange rates, unless otherwise indicated.

Table 6.

Moldova: External Financing Requirements and Sources, 2016-2020

(Millions of U.S. dollars)

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Sources: Moldovan authorities and IMF staff projections.

Current account deficit plus amortization on external debt (private and public and publicly-guaranteed).

Table 7.

Moldova: Financial Soundness Indicators, 2012-18

(End-of-period; percent, unless otherwise indicated)

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Source: National Bank of Moldova.
Table 8.

Moldova: Proposed Schedule of Reviews and Disbursements 1/

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Source: IMF staff estimates.

Moldova’s quota is SDR 172.5 million.

Appendix I. Letter of Intent

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Dear Mr. Lipton:

1. Moldova’s new government is committed to restore the functioning of democratic institutions and return the country on the path of sustained growth. Our quick and decisive actions to reverse policy slippages that led to the suspension of international support in 2018 have already improved the outlook for domestic stabilization and international financial support. We are now resuming an ambitious reform program, supported by the Fund’s Extended Fund Facility and Extended Credit Facility Arrangements. We met all quantitative performance criteria and 2 out of

4 structural benchmarks. We expect continued solid economic growth and financial stability, anchored by prudent macroeconomic policies and accelerated efforts to improve governance. This will help foster inclusive economic development, job creation, and poverty reduction. Despite a generally favorable economic outlook, challenges remain.

2. We commit to completing the clean-up of the financial sector, maintaining sustainable fiscal policy while protecting priority spending, and strengthening our institutional frameworks:

  • In the financial sector, we will conclude the transfer of control of the last of the three systemic banks to a fit and proper investor by end-2019, complete the removal of unfit shareholders in domestic non-systemic banks, and strengthen our AML/CFT regime. We will mitigate risks arising from the non-bank financial sector.

  • Our fiscal policy will focus on mobilizing domestic resources, improving spending efficiency, and unlocking donor financing. Our priorities include broadening the tax base, strengthening tax administration and tax compliance, enhancing public investment management, and improving allocation of social spending.

  • We will strengthen the NBM’s monetary policy framework, guided by its inflation targeting regime and underpinned by exchange rate flexibility. We will reinforce the NBM’s emergency liquidity assistance framework. We will refrain from any initiative that would undermine the NBM’s institutional and policy independence.

  • We will accelerate our efforts to recover assets stolen in the 2014 bank fraud. We will engage international partners to investigate and prosecute perpetrators. We will also engage independent and reputable asset recovery experts to recover stolen assets.

  • In the energy sector, we will pursue a predictable and transparent tariff policy based on sound methodologies and enforced by an independent and professionally qualified regulator.

3. On the basis of our performance to date, fulfillment of strong prior actions, and policy commitments outlined in the attached Supplementary MEFP, we request (i) the completion of the combined fourth and fifth reviews under the Extended Credit Facility and Extended Fund Facility arrangements; (ii) completion of the inflation consultation; (iii) the extension of the arrangements to March 20, 2020; (iv) the addition of a sixth program review based on end-December 2019 quantitative performance criteria (Table 1) and new structural benchmarks (Table 2); and (v) the rephasing of the outstanding program purchases with SDR 33.6 million and SDR 14.4 million to be disbursed at the time of the combined fourth/fifth and the sixth reviews, respectively.

4. We remain strongly committed to take additional measures that may become appropriate for the successful implementation of the program. We will consult with the Fund in advance on the adoption of these measures and on any revisions to the policies contained in the attached SMEFP. We will provide information requested by the Fund to assess implementation of the program. Maintaining our commitment to the policy of transparency, we consent to the publication of this letter, the attached SMEFP, and the accompanying Executive Board documents on the IMF’s website.

Sincerely yours,

Attachments: Supplementary Memorandum of Economic and Financial Policies Technical Memorandum of Understanding

Attachment I. Supplementary Memorandum of Economic and Financial Policies

I. RECENT DEVELOPMENTS AND OUTLOOK

1. We are taking decisive steps to bring Moldova back on track for sustained economic development and stability. The political crisis that emerged in the aftermath of the parliamentary elections has subsided, as the transition of power to the new government has been peacefully achieved. We are taking urgent steps to correct policy slippages, strengthen our democratic institutions, and restore international support.

2. Economic growth remained stable. Real GDP grew by 4 percent in 2018 in the context of ongoing demand recovery and a positive external environment. Higher real incomes and a sharp pick-up in investment supported strong domestic demand growth. The external trade deficit continued to widen, with imports significantly outpacing growth of exports. Despite continued appreciation of the leu through 2018, robust financial account inflows facilitated accumulation of international reserves. CPI inflation averaged 3.1 percent in 2018.

3. The 2018 fiscal balance overperformed program targets with a large margin. The augmented overall deficit undershot program target by 2 percent of GDP, reflecting stronger-than-projected revenues and significant under-execution of capital spending. The undershooting of the budget deficit and non-disbursement of external loans led to a decline in the stock of public debt to about 30 percent of GDP.

4. We expect an improved medium-term growth outlook. The prospects for external financial support have improved due to our sustained policy efforts. Strong macroeconomic policies, including prudent management of public finances, are expected to underpin growth, which is forecast at 3.5 percent in 2019 and around 4 percent thereafter. CPI inflation is expected to temporarily overshoot the upper bound of the NBM’s target variation interval towards end-2019 and to return to the NBM’s 5 percent target by mid-2020.

II. POLICY FRAMEWORK

A. Financial Sector Policies

Our overarching goal is to safeguard the hard-earned macro-financial stability and foster financial intermediation for stronger and more inclusive growth. Building on the progress achieved thus far, our immediate objective is to complete the rehabilitation of the banking sector, strengthen financial safety nets, and tackle regulatory gaps and emerging vulnerabilities in the non-banking sector.

5. Moldovan banking sector is resilient. Banks are well capitalized, with the capital adequacy ratio at 26.3 percent in May 2019. All banks remain liquid, with over 51.6 percent of assets held in liquid instruments, with a sizable share of assets held in NBM reserves and government bonds. Profitability ratios are healthy. We recognize the need to further reduce the level of nonperforming loans (NPLs), which remain high at 10.9 percent across the banking system.

6. Regulatory reform implementation has advanced, supported by EU technical assistance. The Law on Bank Activity, transposing EU CRD IV/CRR Directive on credit institutions, is in force since January-201 8 and implementation of the supporting secondary legislation is well advanced. First COREP reports on capital requirements were presented in August 2018, and first ICAAP reports were presented in April 2019. Regulation on large exposures has entered into force in June 2019, and the regulation on related parties has been updated. Regulations on banking supervision have been enacted, including on the supervisory review and evaluation process (SREP, February 2019) and the organization of on-site inspections (January 2019). The regulation on consolidated bank supervision is undergoing public consultation review. Our overarching goal is to implement a fully-fledged risk-based and forward-looking supervision, built around the annual SREP process. We have attained recognition by the European Banking Authority among non-EU jurisdictions with confidentiality regimes equivalent to EU CRD IV, which deepens supervisory cooperation and information exchange.

7. Efforts to rehabilitate the banking sector are paying off. In particular, the transfer of ownership in the three systemic banks is nearly complete:

  • The transfer of control of Victoriabank is concluded, with the special supervision regime lifted in August 2018. Banca Transilvania, Romania’s largest bank, is the largest shareholder in Victoriabank, which together with the EBRD, a minority shareholder, jointly hold a controlling stake of 66.7 percent. The new majority shareholders are implementing appropriate corporate governance, risk management, and controls.

  • The sale of 41.1 percent of Moldova-Agroindbank’s shares to an international consortium of investors (EBRD, Horizon Capital, and AB Invalda) in July 2018 signified another success of the banking sector’s rehabilitation. To facilitate the sale of the shares issued to replace the cancelled shares of unfit bank shareholders, we employed pre-agreed back-to-back purchase and sale of shares to a fit-and-proper investor, thereby effectively minimizing legal risks to the investor. The Supervisory Board members nominated by new shareholders at the General Shareholders Meeting in November 2018 have been certified as fit-and-proper, and the special supervision regime was lifted in April 201 9.

  • In Moldindconbank (MICB), the back-to-back sale mechanism was also employed, resulting in the acquisition of the controlling 63.89 percent stake in February 2019 by Bulgaria’s non-bank Doverie United Holding, a Sofia Stock Exchange listed company. Following a mandatory tender offer to minority shareholders, the new shareholder consolidated its majority stake to 77.62 percent. The General Shareholders Meeting on June 28, 2019 elected a Supervisory Board, which has been submitted for the NBM’s review and confirmation. We remain committed to follow through with ensuring fit-and-proper certification of incoming managers to instill confidence in the bank’s management, consistent with our plan to exit temporary administration regime in an orderly manner.

8. We performed detailed investigations of shareholders of all domestic non-systemic banks and acted decisively on the findings of investigations of concerted action and fitness and probity of the shareholders. In January 2019, the legal rights of shareholders acting in concert in two banks were suspended and a temporary administrator appointed in one of these banks.

9. The implementation of unwinding of related party exposures is proceeding as planned. As per program commitments, time-bound action plans were adopted in July 201 8 for all domestic banks that are not part of foreign banking groups. As of May 2019, three out of seven banks have brought their exposures in line with prudential limits, while remaining banks reduced their exposures in accordance with the action plans. In consultation with the Fund, we updated the regulation on banks’ transactions with related parties to calculate such exposures net of loan loss provisions for the purpose of meeting prudential requirements.

10. We made progress in strengthening our safety nets, crisis prevention and contingency planning frameworks.

  • The coverage limit of the Deposit Guarantee was raised to 50 thousand lei and the coverage was expanded to legal entities (effective January 1, 2020) to better contribute to financial stability. We made initial steps to strengthen governance and operational capacity of the Deposit Guarantee Fund and have appointed all members of its Supervisory Board.

  • We have adopted the Law on National Financial Stability Committee, creating a designated interinstitutional structure tasked with coordinating the implementation of macroprudential policy and activities to prevent and remedy financial crisis situations. In line with the implementation provisions, the Committee’s inaugural meeting was held on January 23, 2019.

11. The Central Securities Depository (CSD) is now fully operational. Secure, efficient, and well-regulated payment and clearing systems for the settlement of financial transactions where counterparty risks are effectively controlled and managed is an important pre-condition for a healthy financial system and its development. Towards this objective, the CSD is designed to guarantee the safety of securities, ensure the transparency of financial markets, and help develop new financial market instruments. The CSD began operations at end-July 2018 with the transfer of public debt securities, followed by the transfer of registers of bank and insurance companies completed in May 2019. The shareholder records in joint-stock companies traded at Moldova Stock Exchange and all other joint stock companies will be transferred to CSD by end-2019, and end-2020, respectively.

12. Looking forward, we will concentrate our efforts and actions in the following areas:

  • Strong and professional financial sector supervision will remain the cornerstone of our country’s financial stability. An appropriately strengthened NBM governance structure and independence has provided the foundation for the successful progress towards the program’s financial sector objectives. In particular, broader and stronger legal powers granted to the supervisors as well as commensurate legal protection of NBM staff are important pre-conditions for supervisor’s ability to act in an impartial and professional way. Safeguarding the NBM’s ability to enforce appropriate supervisory and regulatory actions in a timely manner is key to ensuring stability and soundness of the banking system. To this end, we will amend the Law on the NBM, the Law on Bank Activity, and other relevant legislation to ensure that the NBM’s supervisory function is carried out in an unhindered manner.

  • The NBM will allow MICB to exit temporary administration in an orderly manner (end-December 2019 structural benchmark, reset from end-October 2018). The temporary administration regime, in place since October 201 6, will be withdrawn only once adequate governance structures are in place. A priority will be given to ensure prudent management of the bank and avoid any conflict of interest or reputational hazards. In this context, the NBM will enforce rigorous professional standards for the bank’s new management team and enhanced monitoring of its related party exposures and cross-border transactions. Our supervisory powers, such as dividend payout restrictions, will be exercised based on the supervisory judgement.

  • We will complete efforts to clean up ownership of two domestic non-systemic banks. In line with the shareholder removal legal framework, the NBM adopted decisions requesting to remove unfit shareholders in two domestic non-systemic banks (prior action) and will implement steps prescribed by the framework—including the sequential share price reduction mechanism—for the newly issued shares with a view to attract sound investors, safeguard the banks’ capital, and ensure fit-and-proper qualifications of its shareholders and managers.

  • The NBM will enforce continued implementation of the agreed time-bound unwinding plans for related party exposures. We will ensure continued prudential effectiveness of the NBM’s Regulation on Banks’ Transactions with Related Parties.

  • Financial safety nets, crisis-preparedness, and contingency planning. To further strengthen our legal and operational frameworks for emergency liquidity assistance (ELA), we will approve amendments to the Law on the NBM and other relevant legislation to ensure that ELA is extended only to solvent banks (prior action). We will adopt related secondary legislation and implement the modified ELA operational framework before end-2019. We will also step up our efforts to fully operationalize the National Financial Stability Committee and strive to improve policy coordination among its members.

13. We commit to mitigate risks arising from the non-bank financial sector by strengthening its supervisory and regulatory framework.

  • Non-bank credit organizations. We will adopt measures to strengthen financial stability of the sector, promote consumer protection and responsible lending practices, and mitigate household indebtedness risks. To that end, in consultation with the Fund, we will amend the legislation governing activities of non-bank credit organizations (structural benchmark, end-October 2019) to: (i) prohibit such entities from accepting deposits from the public, as per provisions of the Law on Bank Activity, (ii) oblige non-bank credit organizations to report new credit activity to the credit bureaus, (iii) introduce limits on total cost of consumer credits, and (iv) introduce an effective, proportionate, and dissuasive sanctioning regime. We will also enhance risk-based supervision and adopt necessary regulations to strengthen ownership transparency, governing bodies, asset classification, risk management, and internal control frameworks.

  • In the insurance sector, we will implement the recommendations of the World Bank’s 2018 diagnostics mission. We will tighten regulatory requirements and enhance supervision of capital adequacy and solvency, reserving, and asset valuation. We will take appropriate actions against insolvent companies and imprudent business practices. In collaboration with the World Bank, we will develop and adopt a legislative framework to shift from compliance-based to risk-based supervision over the medium-term.

B. Monetary and Exchange Rate Policies

14. Inflation temporarily breached the lower limit of the inflation consultation clause by a small margin. CPI inflation slowed to 0.9 percent in December 2018—0.1 percentage point below the outer band of the consultation clause—before rising to 2.2 percent the following month. As discussed in the May-2018 Inflation Report, inflation had been expected to ease driven by previous exchange rate appreciation and lower regulated and food price inflation. But the magnitude of the slowdown surprised, given a combination of further exchange rate appreciation, downside news to food prices, and larger-than-expected cuts to energy tariffs. In line with advice from IMF staff, the NBM judged appropriate to not ease monetary policy given that: (i) monetary policy operates with lags and therefore it would have mostly affected 2019 inflation; and (ii) the NBM’s forecast pointed to a sharp inflation pick-up in 2019. Inflation rose in line with expectations in early 2019, reaching 5.4 percent in July, driven by a lower exchange rate at the turn of the year and higher regulated, food and tobacco price inflation. The NBM has since tightened monetary policy, in line with IMF staff advice.

15. The NBM’s monetary policy framework will continue to be anchored by its inflation target. The NBM stands prepared to gradually adjust its policy rate to steer inflation towards the 5 percent target. The June 2019 policy rate increase signifies entering the monetary policy tightening phase. A policy tightening bias is now in place dictated by emerging inflationary pressures. The key drivers of near-term inflation include public and private sector wage growth, expansionary fiscal measures unveiled over the past year, exchange rate fluctuations, and expected adjustments to energy tariffs.

16. The NBM will not resist exchange rate movements driven by fundamentals, intervening in the foreign exchange market only to smooth excessive volatility. Moldova’s vulnerability to external shocks requires having a flexible exchange rate as an effective shock absorber. The NIR targets set under the program are consistent with this commitment. To facilitate two-way flexibility and reduce the NBM’s market footprint, we will develop and adopt a FX intervention strategy consistent with the inflation-targeting regime and IMF technical assistance guidance (structural benchmark, end-December 2019).

17. The NBM will strengthen its operational framework to enhance monetary policy transmission, liquidity management, and domestic currency intermediation. To this end, the NBM will:

  • Adhere to the base rate as its primary monetary policy tool;

  • Gradually recalibrate the reserve requirement ratios and remuneration policy by simultaneously reducing the MDL reserve requirement ratio and increasing the reserve requirement ratio on foreign currency liabilities, to be maintained in MDL, if market conditions allow;

  • Allow further reductions in MDL reserve requirement ratio as structural excess liquidity normalizes.

18. The NBM will enhance its policy communication to anchor inflation expectations and ascertain policy awareness and credibility. Its external communication will give greater prominence to key considerations that weigh on monetary policy decisions. The NBM will continue to refine its forecasting process to strengthen outputs and decision-making. It will also establish regular information exchanges with relevant counterparts and stakeholders.

19. The NBM’s ability to deliver on its policy mandates is conditional upon its institutional and policy independence. To this end, we will refrain from any initiative that would endanger the NBM’s institutional and policy independence. We also commit to not amend the law regulating the securitization of emergency loans extended by the NBM to the three failed banks.

C. Fiscal Policy

20. Our 2019 fiscal plans are consistent with commitments under the program to preserve fiscal sustainability while protecting priority spending. To achieve this objective, we adopted amendments to the 2019 Budget consistent with the augmented deficit ceiling of MDL 6,219 million (prior action), equivalent to 3.0 percent of GDP. The amended budget: (i) redistributes gains from savings on employee vacancies in the budgetary sector towards covering higher wage bill needs of the local governments; (ii) reduces net on-lending to SOEs in line with expected project disbursements; (iii) rationalizes capital spending to reflect lower execution in the first six months of the year; (iv) increases excises for heat-not-burn and fine-cut tobacco products; (v) removes exemptions on income from lotteries and sports betting for winnings above MDL240; (vi) limits tax free sales at duty-free shops to travelers leaving Moldova by sea or air; and (vii) removes tax exemptions on petroleum products sold in the customs control area.

21. Our 2020 fiscal plans aim to facilitate adequate developmental and social spending, in line with an augmented deficit of 3.0 percent of GDP. Towards this objective, we took measures to mobilize resources by rationalizing tax expenditures and raising revenue on CIT, PIT, VAT, excises, and property taxes. Specifically, we approved amendments to the Tax and Customs Codes (prior action) effective January 1 , 2020 to (i) broaden the capital gains tax base to 100 percent for legal persons and 50 percent for individuals; (ii) increase the reduced VAT rate for HORECA from 10 to 20 percent; (iii) remove the personal allowance for annual incomes above MDL 360 thousand; (iv) remove tax exemptions applied to meal vouchers provided by employers; (v) remove VAT exemptions on goods imported by public-private partnerships; (vi) unify excise duty rates for cigarettes with and without filter; (vii) consolidate environmental taxes to increase tax on plastic packaging products by 20 percent; (viii) increase rates on personal income tax withheld in advance, from 7 to 12 percent; and (ix) reduce tax-free personal exemptions on merchandise shipped by mail to 200 euros.

22. We are committed to continued efforts to strengthen tax administration and improve tax compliance. We recognize that repeated past tax and capital amnesties eroded public trust in state institutions and undermined the legitimacy and fairness of the tax system. To demonstrate our commitment to fight tax evasion and strengthen the tax audit and investigative functions of the STS, we will:

  • Amend the Tax Code (prior action) to (i) remove provisions that provide for the deduction of up to MDL 500,000 from the indirect method assessment of estimated taxable income, (ii) sunset by 2022 the carryover provision that allows for off-setting expenditures exceeding reported income against cash declared under the 2012 ‘Capital liberalization scheme’;

  • Amend the 2018 Capital and Tax Amnesty Law to remove the provision that the STS cannot perform audits prior to January 1, 2018 (prior action);

  • Formally propose a date and adopt an action plan for the automatic exchange of information with the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes (structural benchmark, end-December 2019) with a view to start the automatic exchange of information on financial assets with other countries by end-2022; and assess scope for including a General Anti-Avoidance Rule provision to counter domestic and international abusive tax practices;

  • Enhance the completeness and accuracy of the integrated taxpayer register, in collaboration with the IMF and the World Bank; and

  • Undertake a comprehensive review of tax audits with a view to focus on risk-based approaches, strengthen the audit program design, and improve tax debt collection.

23. We will continue strengthening the organizational structure and institutional capacity of the State Tax Service. We see the establishment of the STS in April 2017 as an important step forward in our determination to modernize tax administration in Moldova. We intend to further align its function-based organizational structure, and consolidate divisions and branches around tax administration functions, such as tax payer service, registration, filing compliance, audit, and others. We will enhance the role of the executive council to drive strategic initiatives and reduce involvement of STS senior management in operational activity. The recently created Crime Establishment and Control Division will proactively identify tax crimes, with a clear priority given to the investigation of the most serious cases.

24. We commit to strengthening our unitary pay system in the budgetary sector. Since its introduction in December 2018, implementation of the new salary system has led to wage bill pressures due to (i) the absence of a comprehensive staff registry, and (ii) the adoption by parliament of ten reference values for different categories of budgetary sector employees. To improve control over the wage bill, we will develop technical specifications for a comprehensive IT-based staff registry by December 2019, with a view to have the registry fully operational by end-2020. We will also develop and adopt a time-bound plan by mid-2020 to phase out multiple reference values to improve budgetary process and medium-term planning.

25. We intend to implement reforms to the pension system that ensure its long-term sustainability. To this end, we will consult with the World Bank to evaluate the consequences of reducing the employer social contribution rate in the private sector, and we will refrain from ad hoc measures that put the pension system at risk.

26. We will continue to enhance targeting and effective coverage of our social assistance programs. We will update eligibility and benefit parameters of targeted social assistance programs, such as Ajutor Social and Heating Allowance, in coordination with other income support policies to prevent decline in coverage and to maintain benefits adequacy. We will revisit the list of documents required to apply for targeted benefits and expand the set of active labor market programs to social assistance beneficiaries to help reduce their reliance on cash transfers.

27. To support our medium-term fiscal objectives, we will take measures to strengthen our fiscal institutional frameworks. We will integrate findings from the 2018 spending review of Higher Education and Vocational Training into our MTBF and annual budget processes starting with the MTBF 2021-23. To this end, we plan to integrate spending review guidance into budget regulations. We are piloting our second spending review in the agriculture sector to better evaluate our spending needs.

28. We give high priority to promoting growth-enhancing investment in public infrastructure. Towards this objective, we plan to undertake a Public Investment Management Assessment (PIMA), supported by IMF technical assistance. We will use the findings of this assessment to improve planning, allocation, and implementation stages of the public investment management cycle.

29. We will continue expanding our fiscal risk statement. In particular, we will improve coverage, monitoring and reporting of risks emanating from enterprises fully or partially owned by the state and public-private partnerships, and take actions to reduce those risks.

30. We remain committed to eliminating audited state and local government arrears. We aim to improve the monitoring of arrears and prevent their accumulation. In particular, we will enforce full implementation of Article 67 of the Law on Public Finances and Fiscal Responsibility.

31. The development of the domestic government bond market remains one of our debt management objectives. To that end, the Ministry of Finance will continue to seek to enhance its communication with state securities market participants and extend the maturity of state securities.

32. Greater transparency, predictability, and good governance in the energy sector are our priority. Our objective is to have a predictable and transparent tariff policy based on sound methodologies and enforced by an independent and professionally qualified regulator. This will depoliticize tariff-setting and support medium-term growth by reducing uncertainty and improving the business environment.

  • In the electricity sector, we will adopt in October 2019 tariffs fully based on the February 2018 methodology, including: (i) the settlement of the differences in the assessment of past financial deviations from April 2017-February 2018, and (ii) the approval of the basic costs for the first financial year of the 201 8 methodology.

  • In the gas sector, we will adopt 2019 tariffs fully based on the existing methodology and purchase price of natural gas (structural benchmark, end-October 2019).

  • We will strive to align our energy sector regulatory framework to best European practices to promote much-needed energy investment. We will continue collaboration between stakeholders on energy-related issues, including with the Energy Community Secretariat and the World Bank.

33. We will take measures to strengthen economic governance. Our efforts will include enabling a level playing field for companies through fair and effective competition policies, easing entry into business, ensuring transparent government procurement, strengthening the rule of law and improving regulatory quality. We will promote strong tax, customs, and AML/CFT frameworks; and implement Moldova’s commitments under the DCFTA and the EU Association agreements.

34. We will accelerate our efforts to recover assets stolen in the 2014 bank fraud. We have set up a parliamentary committee to expedite the investigation of activities related to the banking fraud. Going forward, we will:

  • Address the authorities and judicial cooperation bodies of the European Union and the United States of America requesting to initiate an international investigation and prosecution of perpetrators of the bank fraud;

  • Evaluate by end-October appropriate modalities to recover proceeds of the bank fraud, including by engaging independent international legal and forensic experts to (i) initiate civil and criminal proceedings in key foreign jurisdictions, (ii) make claims against parties who have facilitated or benefited from the fraud, and (iii) provide support to regulatory authorities and law enforcement bodies;

  • Step up coordination, under the leadership of the Prime Minister, among all relevant stakeholders, including the NBM, prosecutor’s office, National Anticorruption Center, Criminal Asset Recovery Agency, and AML Agency.

35. Enhance the capacity of National Integrity Authority (ANI) as a truly independent strong pillar of our anti-corruption framework, in cooperation with the World Bank. Asset and interest declarations of public officials will be reviewed in a timely and credible manner. We will adopt guidelines for declarants on the beneficial ownership of assets which should be reflected in the asset and interest declarations.

36. We will further strengthen our AML/CFT framework by implementing the 2018 AML Law and MONEYVAL recommendations. We will:

  • Promote better reporting of suspicious transactions under the new reporting system by ensuring that all types of reporting entities become more familiar with their business-specific ML/TF threats and vulnerabilities, and better equipped to apply risk-based assessment tools and appropriate customer due diligence;

  • Develop and implement a new suspicion-based transaction reporting IT system for all types of reporting entities; the NBM will implement an IT solution for monitoring bank shareholders’ transparency and off-site analysis for AML/CFT purposes by end-2020;

  • Adopt the Law on Sanctions for violations of ML/TF rules, in line with MONEYVAL recommendations and in coordination with the Council of Europe and European Union, by December 201 9; meanwhile, we will take appropriate legislative actions to ensure the NBM’s ability to sanction AML/CFT violations of entities under its supervision;

  • Initiate a new National ML/TF Risks Assessment (NRA), with the support of the international partners, such as World Bank, to be completed by October 2020;

  • Adopt guidelines for the exchange of AML/CFT information among all relevant stakeholders by mid-2020.

37. We remain committed to achieving sustainable and more inclusive growth. Improving the business environment and attracting foreign investments are key to fostering technological advancement and raising investment in infrastructure and human capital. In this context, we will continue reforms in education, health, and social policies, thereby raising human capital and helping counter migration and demographic pressures.

38. Effective policy-making requires timely, accurate, and comprehensive data. To this end, we commit to allocating adequate and sufficient resources to the National Bureau of Statistics.

E. Program Monitoring

39. The program will continue to be monitored through semi-annual reviews, prior actions, quantitative and performance criteria, indicative targets, and structural benchmarks.

The quantitative performance criteria, inflation consultation clause, and indicative targets are set out in Table 1, and further specified in the Technical Memorandum of Understanding (TMU). The prior actions, along with proposed structural benchmarks, are set out in Table 2.

Table 1.

Moldova: Quantitative Performance Targets, June 2018 - December 2019

(Cumulative from the beginning of calendar year; millions of Moldovan lei unless otherwise indicated)

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Indicative targets for September and March.

The NIR target is set as specified in the TMU.

As of January 2017, domestic expenditure arrears exclude local governments.

N/A - target is new for 2018, and thus applicable only going forward.

The NIR Targets for December 2018 and March 2019 have been adjusted as per the TMU for the shortfall in EU Grants and Loans and IMF budget support.

Table 2.

Moldova: Prior Actions and Structural Benchmarks Under the ECF/EFF

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Attachment II. Technical Memorandum of Understanding

1. This Technical Memorandum of Understanding (TMU) defines the variables subject to quantitative targets (prior actions, performance criteria and indicative benchmarks) established in the Supplementary Memorandum of Economic and Financial Policies (SMEFP) and describes the methods to be used in assessing the program performance with respect to these targets.

A. Quantitative Program Targets

2. The program will be assessed through performance criteria and indicative targets. Performance criteria are set with respect to:

  • the floor on the net international reserves (NIR) of NBM;

  • the ceiling on the augmented overall cash deficit of the general government, i.e., the overall cash deficit of the general government augmented by on-lending agreements with external creditors to state-owned enterprises (SOEs);

  • the ceiling on accumulation of external payment arrears of the general government (continuous).

  • the ceiling on absorption by the government of losses or liabilities and making of payments on behalf of utilities and other companies (continuous);

Indicative targets are set on:

  • the ceiling on the general government wage bill;

  • the floor on priority social spending of the general government;

  • the ceiling on stock of accumulated domestic government arrears (continuous);

  • the floor on project spending funded from external sources, to comply with the Article 15.1 of the Fiscal Responsibility Law, starting in 2017 for the 2018 budget.

In addition, the program will include a consultation clause on the 12-month rate of inflation.

B. Program Assumptions

3. For program monitoring purposes, all foreign currency-related assets will be valued in U.S. dollars at program exchange rates. The program exchange rate of the Moldovan leu (MDL) to the U.S. dollar has been set at 19.8698 MDL/US$ (the official rate as of June 30, 2016). Amounts denominated in other currencies will be converted for program purposes into U.S. dollar amounts using the cross rates as of end-June 2016 published on the IMF web site http://www.imf.org, including US$/EUR = 1.1102, JPY/US$ = 102.9, CHF/US$ = 0.976, US$/GBP = 1.3488, CNY/US$ = 6.6445, RUB/US$ = 64.1755, SDR/US$ = 0.711134876. The holdings of monetary gold will be valued at US$1,320.75 per one troy ounce.

C. Institutional Definitions

4. The general government is defined as comprising the central government and local governments. The central government includes the state budget (including foreign-financed projects), state social insurance budget, and health insurance budget. The local governments include the local budgets (including foreign-financed projects). No new special or extrabudgetary funds will be created during the program period. Excluded from this definition are any government-owned entities with a separate legal status.

D. Program Definitions

5. NIR of the NBM are defined as gross reserves in convertible currencies minus reserve liabilities in convertible currencies.

  • For program monitoring purposes, gross reserves of the NBM are defined as monetary gold, holdings of SDRs, reserve position in the Fund, and holdings of foreign exchange in convertible currencies that are readily available for intervention in the foreign exchange market or in the securities issued by sovereigns, IFIs and explicitly guaranteed government agencies, with a minimum credit rating for such securities of AA-.3 Excluded from reserve assets are capital subscriptions to foreign financial institutions, long-term non-financial assets, funds disbursed by international institutions and foreign governments assigned for on-lending and project implementation, assets in non-convertible currencies, NBM ‘s claims on resident banks and nonbanks, and foreign assets pledged as collateral or otherwise encumbered, including claims in foreign exchange arising from transactions in derivative assets (futures, forwards, swaps, and options).

  • Reserve liabilities of the NBM are defined as use of Fund credit by the NBM, convertible currency liabilities of the NBM to nonresidents with an original maturity of up to and including one year, and convertible currency liabilities of the NBM to residents, excluding to the general government and the mandatory FX reserves of domestic banks in the NBM. Liabilities arising from use of Fund credit by the NBM do not include liabilities arising from the use of SDR allocation. For program monitoring purposes, the stock of reserve assets and reserve liabilities of the NBM shall be valued at program exchange rate, as described in paragraph 3 above. The data source for gross reserves and liabilities is the Monetary Survey published by NBM in Moldovan Lei, from which the adjustments for program purposes are made. On this basis, and consistent with the definition above, the stock of NIR of the NBM amounted to US2,292.6 as of end- September 2017.

6. For the purposes of calculating overall cash deficit and augmented overall cash deficit of the general government, net domestic credit of the banking system (NBM and commercial banks) to the general government is defined as outstanding claims of the banking system on the general government (exclusive of the claims associated with accrued interest, tax and social contribution payments by commercial banks, and foreign financed on-lending by banks), including overdrafts, direct credit and holdings of government securities, less deposits of the general government (excluding accrued interest on government deposits, and including the accounts for foreign-financed projects).4 This definition will also exclude the securities issued under Law 235/201 6 on the issuance of government bonds for execution of Ministry of Finance’s payment obligations derived from the State Guarantees Number 807 of November 17, 2014 and Number 101 of April 1, 2015.

Monitoring of this definition will be based on NBM’s monetary survey and Treasury data. The Ministry of Finance will provide data on foreign-financed projects and balances in all other adjustment accounts that are elaborated in footnote 2. On this basis, and consistent with the definition above, the stock of the net domestic credit of the banking system shall be measured from below the line and as of end-June 2016 amounted to MDL 3,508 billion.

7. The overall cash deficit of the general government is cumulative from the beginning of a calendar year and will be monitored from the financing side at the current exchange rate established by NBM at the date of transaction. Accordingly, the cash deficit is defined, as the sum of net credit of the banking system to the general government (as defined in paragraph 6), the general government’s net placement of securities outside the banking system, other net credit from the domestic non-banking sector to the general government, the general government’s receipt of disbursements from external debt5 for direct budgetary support and for project financing minus amortization paid, and privatization proceeds stemming from the sale of the general government’s assets.

8. The ceiling on the augmented overall cash deficit of the general government is the sum of the overall cash deficit (as defined in paragraph 7) and net on-lending to SOEs. Similar to the overall cash deficit, the net on-lending to SOEs is cumulative from the beginning of a calendar year and will be monitored from the financing side at the current exchange rate established by NBM at the date of transaction. That is, the net on-lending to SOEs is defined as the disbursements of on-lending financing from external creditors to SOEs minus their loan repayments.

9. Government securities in the form of coupon-bearing instruments sold at face value will be treated as financing items in the fiscal accounts, in the amount actually received from buyers. On redemption date, the sales value (face value) will be recorded as amortization, and the coupon payments will be recorded as domestic interest payments.

10. For program monitoring purposes, the definition of debt is set forth in point no. 8 of the Guidelines on Public Debt Conditionality in Fund Arrangements (Decision No. 15688-(14/107) adopted on December 5, 2014).6 This definition applies also to commitments contracted or guaranteed for which value has not been received, and to private debt for which official guarantees have been extended and which, therefore, constitute a contingent liability of the public sector. Excluded from this definition are normal import-related credits, defined as liabilities that arise from the direct extension, during the normal course of trading, of credit from a supplier to a purchaser— that is, when payment of goods and services is made at a time that differs from the time when ownership of the underlying goods or services changes. Normal import credit arrangements covered by this exclusion are self-liquidating; they contain pre-specified limits on the amounts involved and the times at which payments must be made; they do not involve the issuance of securities. External debt is defined by the residency of the creditor.

11. For purpose of the program, the guarantee of a debt arises from any explicit legal obligation of the general government or the NBM or any other agency acting on behalf of the general government to service such a debt in the event of nonpayment by the recipient (involving payments in cash or in kind), or from any implicit legal or contractual obligation to finance partially or in full any shortfall incurred by the debtor. As a result, onlending from external creditors to SOEs is treated as public guarantee (and hence, for the purpose of the program, is monitored explicitly from above-the-deficit line). On the other hand, onlending from external creditors to the private sector through commercial banks—which are collateralized and of which credit risks from the final borrower are explicitly borne by the commercial banks—are treated as contingent liabilities.

12. For the purposes of the program, external payments arrears will consist of all overdue debt service obligations (i.e., payments of principal or interest, taking into account contractual grace periods) arising in respect of any debt contracted or guaranteed or assumed by the central government, or the NBM, or any agency acting on behalf of the central government. The ceiling on new external payments arrears shall apply on a continuous basis throughout the period of the arrangement. It shall not apply to external payments arrears arising from external debt being renegotiated with external creditors, including Paris Club creditors; and more specifically, to external payments arrears in respect of which a creditor has agreed that no payment needs to be made pending negotiations.

13. The general government wage bill will be defined as sum of budget spending on wages and salaries of public sector employees—according to economic budgetary classification, including but not limited to employer pension contributions and other social security contributions, and other remunerations (such as bonus payments). This definition of the general government wage bill is in line with current spending reported in line “Wages” of the general government budget according to the program classification of the annual budget except for salaries of SOEs and health care providers that are compensated from the Health Insurance Fund (FAOAM) itself.7

14. The priority social spending of the general government is defined as the sum of essential recurrent expenditures including pension8 and unemployment insurance payments from the Social Insurance Fund (BASS, 9008/00286), the AjutorSocial (social assistance program 9015/00320) and heating allowance (9015/00322) during the cold season from the central government budget, as well as 94 percent of health expenditures from the main fund of the Health Insurance Fund.

15. For the purposes of the program, general government domestic expenditure arrears are defined as non-disputed (in or out-of-court) payment obligations whose execution term has expired and became overdue. They can arise on any expenditure item, including debt service, wages, pensions, energy payments and goods and services. For the purpose of calculating domestic expenditure arrears under the program, local government arrears are excluded.

The overdue debt is a debt arising from non-payment of obligations, which have a fixed payment term, and the actual payment has not been effected up to the set term. In cases when the contract does not have the term of payment of receivables, these shall be calculated according to the provisions of Article 80 Paragraph (2) of the Law on Public Finance and Fiscal Responsibility. The term indicated in the contract, for honoring the commitments of a legal entity or an individual towards a public institution shall not exceed 30 days from the date of receipt of funds in the settlement account (except for construction works and capital repairs).

Assessment and reporting of accounts receivable and accounts payable (arrears) shall be done based on the Methodology of Assessment and Reporting of Overdue Receivables and Overdue Accounts Payable (Arrears), approved through the Minister of Finance’s Order No. 121 as of September 14, 2016.

Arrears between the state, local government, and social and health insurance budgets, are not counted towards the expenditure arrears’ ceiling on the general government.

16. Absorption of losses or liabilities by the government and making of payments on behalf of utilities and other companies. The program sets a continuous ceiling of zero on absorption by the public sector of losses or liabilities from outside the budgetary sector. Absorption of losses or liabilities is defined as direct payment by the government of the losses or liabilities of other parties or coverage of losses or liabilities by other transactions, such as accumulated stock of the financial deviation of the utility companies, debt-for-equity swaps or a write-off of tax obligations or other state claims.

E. Inflation Consultation Mechanism

17. The monetary conditionality will include a set of quarterly inflation targets (measured as the inflation of the headline consumer price index (CPI) published by the Moldovan National Bureau of Statistics) set within tolerance bands. The inner band is specified as +/- 1 percentage point around the central point. The outer band is specified as +/- 2 percentage point around the central point. Deviations from the bands would trigger a consultation with the staff or Executive Board which would focus on: (i) a broad-based assessment of the stance of monetary policy and whether the Fund-supported program is still on track; and (ii) the reasons for program deviations, taking into account compensating factors and proposed remedial actions if deemed necessary.

Should the observed year-on-year rate of CPI inflation fall outside the inner bands specified for the end of each quarter (text table), the NBM will consult with IMF staff on the reasons for the deviation and the proposed policy response. Should the observed year-on-year rate of CPI inflation fall outside the outer bands specified for the end of each quarter (text table), the authorities will consult with IMF Executive Board on the reasons for the deviation and the proposed policy response before further purchases could be requested under the ECF/EFF.

Inflation Consultation Bands

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F. Adjusters

18. The adjusters set in this TMU apply for assessing compliance with the program’s quantitative targets starting from end-December 2016.

19. The ceiling on the augmented overall cash deficit of the general government will be increased by the amount paid in cash for the purposes of maintaining the financial sector stability or by the face value of government securities issued for the same purpose.

The ceiling on the augmented overall cash deficit of the general government will be adjusted upward—that is, the deficit target will be increased—by the amount of any shortfall between the total amount of actually disbursed and programmed budget support from external donors, including MFA (grants) from the European Commission. The upward adjustments for 2019 is capped at the equivalent of MDL 721.3 million, valued at the program exchange rate; and

20. The ceiling on the augmented overall cash deficit of the general government will be adjusted downward—that is, the augmented deficit target will be tightened—by the amount of any shortfall between the total amount of actually disbursed and programmed onlending from external creditors to SOEs.9 The latter is specified in the text table below.

Programmed Onlending to SOEs and Adjustments to Augmented Fiscal Deficit

Programmed Onlending to SOEs and Adjustments to Augmented Fiscal Deficit

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The adjustments for the year 2019 are evaluated at the exchange rate: 17.74 MDL/USD (the forecast of the Ministry of Economy).

21. The floor on NIR of the NBM will be lowered by any shortfall in the official external grants and loans at the equivalent of US$77 million and US$47 million respectively, valued at the program exchange rates. NIR targets will also be adjusted upward (downward) by the surplus (shortfall) in IMF budget support purchases relative to the baseline projection reported in Table 3.

G. Reporting Requirements

22. Macroeconomic data necessary for assessing compliance with performance criteria and indicative targets and benchmarks will be provided to Fund staff including, but not limited to data as specified in this memorandum as well as in Table 1. The authorities will transmit promptly to Fund staff any data revisions.

Table 1.

Moldova: Data to be Reported to the IMF

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1

Nominal GDP was revised upward (by about 17 percent, relative to the third review), which also affected the deficit ratio.

2

While still adequate, reserves are on a lower path in 2019 and over the medium term (compared with the third review) on account of the wider-than-envisaged current account deficit to start with in 2018, buoyed by stronger consumption and higher energy prices. High 2019 FDI inflows are on account of a large transaction of a single company.

3

The credit rating shall be established by applying the average of ratings assigned by international rating agencies (Fitch, Moody’s, and Standard & Poor’s).

4

For the calculation of the net credit of the banking system to general government the following accounts will be excluded: 1711, 1712, 1713, 1731, 1732, 1733, 1735, 1761, 1762, 1763, 1801, 1802, 1805, 1807, 2264, 2709, 2711, 2717, 2721, 2727, 2732, 2733, 2796, 2801, 2802, 2811, 2820 and the group of accounts 2100.

5

Debt is defined as in footnote 4.

6

The term “debt” will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.

7

For the calculation of the total general government wage bill the following accounts for central government, local government, and special funds from the Treasury system in the Ministry of Finance will be used: category 210000 personnel expenditure.

8

The pensions include the following subprograms and activities (excluding distribution expenditures and commission fee for cash withdrawals): 9004 with activities 00258-00266, 00277, 00298, 00344, 9005 with activity 00360, and 9010 with activity 00253.

9

The SOEs explicitly included in this augmented deficit are Termoelectrica, Moldelectrica, Moldovan Railways, and CET-NORD.

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Cover IMF Staff Country Reports
Republic of Moldova: Fourth and Fifth Reviews Under the Extended Credit Facility and Extended Fund Facility Arrangements, Completion of the Inflation Consultation, and Request for Extension of the Arrangements and Rephasing of Access-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Moldova
Author:
International Monetary Fund. European Dept.
Volume/Issue:
Volume 2019: Issue 305
Publisher:
International Monetary Fund
ISBN:
9781513515434
ISSN:
1934-7685
Pages:
86
DOI:
https://doi.org/10.5089/9781513515434.002

Contributions to GDP Growth

(Percentage points)

Inflation

(Percent, y-o-y growth)

Cumulative Overall Balance

(Million lei)

Current Account and Real Effective Exchange Rate

(Million U.S. dollar)

Moldova: Employment and Earnings in Restaurant Industry

(Y-o-y percent change)

Restaurant Industry: Labor-Related Taxes

(Y-o-y percent change)

Restaurant Industry: Sales and VAT Collections

(Y-o-y percent change)

2019 Fiscal Deficits: Approved and Amended Budgets

(Percent of GDP)

Total Lending Growth

(Contributions to yoy credit growth)

Foreign Ownership of Banks

(Percent of banking sector assets)

Unwinding of Banks’ Related Party Exposures

(Percent)

Moldova: Non-bank Financial Sector Developments

Monetary Policy

(Percent, million of U.S. dollar)

Moldova: Gas Price Developments

Progress with Asset Recovery

(Billions of Moldovan lei)
Figure 1.

Moldova: Real Sector Developments, 2010—19
Figure 2.

Moldova: Money, Prices, and Interest Rates, 2011—19
Figure 3.

Moldova: Fiscal Developments, 2009–2018 1/
Figure 4.

Moldova: Banking Sector Developments, 2013–19
Figure 5.

Moldova: External Sector Developments, 2009–2019