Economic Outlook

The Moldovan economy performs well. GDP growth is solid, estimated at 3.5 percent in 2019 and 3.8 percent in subsequent years. The labor market is strong, with increasing labor force participation, rising wages and unemployment projected to remain low at 3.0 percent. The recovery of the banking sector results in a return of credit growth after a prolonged contraction following the 2014 banking crisis. The strong wage growth and resumed credit growth, together with a fiscal impulse following fiscal slippages, contribute to a projected increase in inflation towards 7.5 percent by end-2019, but inflation is expected to stabilize at the target of 5 percent afterwards.

Fiscal policy

The government implemented four prior actions in the area of fiscal policy to correct for fiscal slippages, repair pre-election policy reversals and create space in the 2020 budget for social spending.

• (1) The government amended the 2019 Budget to target a 3 percent of GDP deficit. Corrective actions were required as pre-election expansionary fiscal measures and shortfalls in EU grants had resulted in an increase in the fiscal deficit. The amended Budget corrects these fiscal slippages and targets a deficit of 3 percent of GDP in 2019, which is consistent with the augmented general government deficit ceiling under the program.

• (2) The government amended the 2018 Capital and Tax Amnesty Law and the tax code to fight tax evasion. A ban on tax audits prior to 2018 in the Capital and Tax Amnesty Law severely reduced the ability of the State Tax Service to exercise its investigative functions. The government showed its commitment to improving governance and fighting corruption with the reversal of this ban. The government also removed the MDL 500,000 deduction from the indirect method assessment of taxable income, meaning that discrepancies in taxable income below MDL 500,000 can also be taxed. Both prior actions help fight tax evasion.

• (3) The government legislated changes in the Tax and Customs Codes, taking effect in 2020, to create room for social spending. Reducing poverty is a key priority of the government, in line with the floor on priority social spending in the program. The pre-election fiscal impulse reduced the room in the budget for social spending. To reverse this impulse, the authorities implemented 9 amendments to the Tax and Customs Codes. This required political perseverance: a number of the measures targeted specific interest groups and reversing such measures is politically difficult. One example is the reversal of the reduction in the VAT rate of HORECA. Box 1 in the Staff report is helpful as it provides a rationale for this reversal. The changes in the Tax and Customs Codes create room for priority social expenditures in the 2020 budget. The government not only wants to create sufficient room for social expenditures in the budget, but also wants to enhance the targeting and coverage of social assistance programs.

Going forward, the government will take measures to increase the efficiency of public expenditure, which will help improve the composition of the budget towards social and investment spending. Public and publicly guaranteed debt remains low at 31.5 percent of GDP in 2019. To structurally support growth and social outcomes while maintaining debt at a low level, the authorities want to increase the efficiency and medium-term orientation of the budget. They will reduce risks related to the government wage bill by developing a comprehensive staff registry and by adopting a plan to reduce the number of reference values. They will integrate the findings from the 2018 spending review of Higher Education and Vocational Training in the medium-term budgetary framework for 2021-2023. They are also planning to undertake a Public Investment Management Assessment.

Financial sector

The process of banking system reform and rehabilitation following the 2014 banking crisis has progressed significantly. The banking sector is in good shape, with strong capital and liquidity ratios, a significantly changed ownership structure and reductions in related party exposures. This is reflected in healthy credit growth. As prior actions, the authorities amended the NBM Act to prevent ELA to insolvent institutions, and the NBM adopted decisions to request the removal of unfit shareholders in two non-systemic banks, which was a structural benchmark for end-March. The structural benchmark to allow a systemic bank to exit temporary administration is the only

remaining structural benchmark related to the banking system. This benchmark marks the completion of the banking sector reform agenda. It was reset from end-October 2018 to end-December 2019 and is the only benchmark from the third review that is still outstanding.

The authorities will make progress on the asset recovery of stolen proceeds from the 2014 bank fraud, and they will strengthen the AML/CFT framework. The authorities realize that the financial receipts of the asset recovery could be limited as it becomes increasingly difficult over time to recover stolen proceeds. But they are strongly committed to prosecute perpetrators with the help of international legal and forensic exports in order to uphold the rule of law. They will also strengthen the AML/CFT framework, including by adopting the Law on Sanctions for violations of ML/TF rules by end-2019 and by initiating a National ML/TF Risks Assessment. Progress on asset recovery and the AML/CFT framework are important elements of the broader financial sector reform agenda of the authorities.

The authorities remain vigilant to risks in the non-bank sector. The increase in financial intermediation by non-banks, in particular microfinance organizations, requires efforts to ensure an adequate regulatory framework. The authorities will therefore prohibit non-bank credit organizations from accepting public deposits, require reporting of new credit activity to credit bureaus, introduce limits on the cost of consumer credit and introduce a sanctioning regime. These measures will help maintain financial stability and strengthen consumer protection.

Monetary policy

The NBM targets an inflation rate of 5 percent and monetary policy stands ready to gradually adjust interest rates if needed to stem inflationary pressures. To strengthen the effectiveness of the inflation-targeting framework, the NBM will develop an FX intervention strategy that reduces the NBM’s market footprint, adhere to the policy rate as primary tool and recalibrate reserve requirements on domestic and foreign currency liabilities.

Towards the completion of the ECF/EFF

The authorities are committed to implementing the final set of five structural benchmarks. Implementation of these five benchmarks will pave the way for a successful completion of the program.

• (1) In the fiscal sector: The government will 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. This benchmark will help fight tax evasion.

• (2) In the financial sector: The authorities will implement the three benchmarks discussed above - they will reduce risks stemming from non-bank credit organizations, the NBM will allow a systemic bank to exit temporary administration in an orderly manner and the NBM will develop an FX intervention strategy.

• (3) In the energy sector: The authorities will adopt gas tariffs based on the existing methodology and on the purchase price of natural gas. This will increase transparency and predictability in the energy sector.

Going forward, the government intends to continue cooperating with the IMF to anchor its reform program. The authorities intend to start discussions with staff on a possible follow-up arrangement during the Annual Meetings. Such an arrangement could help guide their commitment to a more social and growth-friendly composition of the budget, for example through reforms of the pension system to ensure its long-term sustainability, public investment management reforms and improved reporting and management of risks related to SOEs and PPPs.