The ECF/EFF supported a deep transformation of the Moldovan banking sector.

The ECF/EFF achieved its goal of rehabilitating the banking sector. The 2014 banking fraud exposed severe shortcomings in the banking sector and the ECF/EFF was centered around a comprehensive transformation of the sector. Bank ownership, including ownership of the three largest banks in the country, was transferred to fit and proper shareholders. Currently, 90 percent of banking assets are managed by internationally reputable financial groups. The authorities also implemented an effective regulatory and supervisory framework, strengthened the requirements for the provision of Emergency Liquidity Assistance, and expanded the coverage of the Deposit Guarantee Fund.

The authorities will step up their asset recovery efforts, as proceeds remain insufficient. The 2014 bank fraud resulted in stolen proceeds amounting to around 12 percent of GDP. The recovery of stolen proceeds becomes increasingly difficult as time passes, but the authorities remain committed to combatting corruption and upholding the rule of law. They will therefore work to establish joint investigation teams with the EU, the US, and other development partners to investigate and prosecute the perpetrators of the bank fraud. They will also empower the Criminal Asset Recovery Agency, for which they approved a significant increase in staffing, to represent defrauded banks in international asset recovery actions. Finally, they will step up coordination among all domestic stakeholders under the leadership of the State Security Council.

The program successfully progressed under different governments. The ruling coalition changed twice during the program period of just over 3 years. Despite a period of reform reversal, which delayed the completion of the fourth review, these three coalitions all pushed the reform agenda of the ECF/EFF. The ownership of the program by different coalitions with parties from across the political spectrum illustrates the broad political support for the program. Going forward, the authorities intend to continue their engagement with the IMF by requesting a successor program.

The analysis of challenges in the area of governance provides a basis for the orientation of a successor arrangement. The Moldovan banking sector is in good shape due to the reforms implemented during the program, but deep structural challenges remain in the Moldovan economy. The staff report and the Special Issues Paper show the challenges related to governance and institutional vulnerabilities. The Moldovan authorities welcome staff’s analysis and stress that strengthening the rule of law is their top priority. To deepen their understanding of governance challenges and to inform the design of a successor program, the authorities requested a governance diagnostic assessment, which is expected to take place in the upcoming months. Staff rightfully outlined other structural challenges, such as the implementation of recommendations from the 2019 PIMA report and reforms in the area of non-bank regulation and supervision. For the current review, the authorities amended legislation to stem risks in the non-bank financial sector, including a prohibition to accept deposits, the introduction of a reporting obligation, and the introduction of limits to the total costs of consumer credits.

The Moldovan economy performs well against a background of structural headwinds.

The economic baseline outlook is positive, but deep structural challenges remain. Real GDP growth surprised on the upside in 2019 at 4.2%, which is 0.7%-point higher than projected at the time of the combined 4 th and 5 th review. The growth forecast for 2020 and further remains unchanged at 3.8%. The unemployment rate is projected to remain low at 3.0% over the forecast horizon. The banking sector is well-capitalized, and the recovery of the banking sector resulted in a return of credit growth after a period of contraction following the 2014 banking crisis.

Strengthening potential growth and boosting real convergence towards living standards in other European countries requires deep structural reforms, notably in the area of governance. Governance reforms would help stem the outflow of discouraged young workers, support capital deepening and enhance productivity. Better public investment management and efforts to improve the quality of education would also be beneficial for long-term growth. A successor program would be instrumental for such a growth agenda.

Fiscal policy remained prudent, while there is scope to improve composition and quality.

Fiscal policy was prudent over the course of the program. The ceiling on the augmented general government deficit was met (quantitative performance criterion), as was the ceiling on the general government wage bill (indicative target). Despite changes in government, the primary deficit did not exceed 0.8 percent of GDP during the program period. With public and publicly guaranteed debt at 29.3 percent of GDP in 2019, Moldova’s risk of debt distress is assessed to be low.

There is scope to improve the composition and quality of public expenditures.

• ■ Scaling up public infrastructure to address persistent infrastructure gaps. Low public investment resulted in a decline in the public capital stock. The authorities will increase infrastructure spending in the 2020 budget, which will contribute to a higher budget deficit of 3.9 percent of GDP. The implementation of the PIMA recommendations will improve the quality of public investment expenditure. The planned public capital accumulation will help support potential growth.

• ■ Improving social outcomes through well-targeted social assistance. The authorities missed the floor on priority social spending (indicative target) by a relatively small margin. The underspending was due to a lower than budgeted volume of contracted medical services and a decrease in the number of unemployment benefit recipients. Nonetheless, the authorities want to strengthen the social safety net through enhanced targeting and effective coverage of social assistance programs, including by updating eligibility and benefit parameters, and by implementing active labor market policies. As a prior action, the government implemented legislation to secure the long-term sustainability of the pension system and improve its equity.

Monetary policy is anchored by the NBM’s inflation target of 5 percent.

Inflation is the primary objective of monetary policy. The best way to demonstrate this is by acting on (dis)inflationary pressures using the base rate as their monetary policy tool. Staff and the authorities discussed the timing of a base rate cut in December 2019. The NBM implemented this base rate cut in full accordance with their inflation targeting regime, as they predicted an easing of inflationary pressures. The inflation rate indeed decreased to 6.9 percent in January 2020. In the discussion about the optimal timing of a rate decrease given disinflationary pressures staff thought a base rate cut could have been postponed until incoming data confirmed the disinflationary trend, while the NBM’s assessment was that a December rate cut was the optimal response. The NBM implemented a new FX intervention strategy as an end-December Structural Benchmark to reduce the NBM’s footprint on the FX market. During the program, the institutional structure of the NBM has been strengthened and the authorities are fully committed to safeguarding the independence of the NBM.