MOLDOVA APPROACHES TRADITIONAL DEFAULT SEASON

Commentary by Alexander Tanas, Infotag economic observer.

Part 1 of 2. DEFAULTS COME IN AUTUMN.

It has become a bad tradition in Moldova to begin talking about default
perspectives each autumn, which is the most dreadful time of the year for a
republic 100 percent dependent on imported energy, when it has to import
more gas, furnace oil, coal, and electricity.

As a matter of fact, this republic has been in a technical default since its
first independence autumn of 1991. Ever since then, this problem has been
like the sword of Damocles, threatening to turn the default from a de-facto
into a de-jure state.

This time, the first one to begin speaking about a default in 2002 was
President Vladimir Voronin himself. He openly stated that, without
restructuring external debts, the country would be unable to meet its
commitments before foreign creditors in 2002. He meant the $227 million of
pressing payments which Moldova would be unable to effect without deferring
at least a part of the huge sum.

Observers assessed the President's statement, published for the first time
ever in The Financial Times, as a signal for the Paris Club member states
which, in Mr. Voronin's opinion, should be more tractable in tackling the
question of Moldovan debt restructuring.

Following the President, Minister of Finance Mihai Manoli began speaking and
then writing about the critical situation with implementing the 2001 Budget.
The press has learnt about another letter Manoli had sent to Prime Minister
Vasile Tarlev.

The minister wrote that the 2001 Budget is going all to pieces, that
revenues keep on shrinking, debts are growing and crushing the republic
down, and it will be extremely hard to meet external liabilities without
debt restructuring. Mihai Manoli did not need to elaborate on arguments, as
the reasons of the skyrocketing budget deficit are sufficiently well known.

First. The 2001 Budget is in a critical condition because lately it has
been short-receiving means noticeably - instead of the traditional daily
revenues of 14 million lei, it has been getting merely 9-10 million lately.

Second: The Government has not still received the $36 million from the
World Bank and European Union that have been projected in the 2001 Budget to
support the payment balance, so the Ministry of Finance is covering this gap
exceptionally with internal resources, mainly with tax revenues, sale of
state securities, and loans from the National Bank.

Third. The Budget has not yet received the 150 million lei which the
Government was projecting to get from privatizing the RED Nord and RED
Nord-Vest electricity distribution enterprises.

Due to these and many other reasons, the 2001 Budget fulfillment has barely
reached a 69 percent implementation level. In such a situation, the Ministry
of Finance has no option but to cut expenditures, and sequestration may
amount to 770-780 million lei.

In his letter, the Minister of Finance urged the Premier to undertake all
possible measures to obtain the $20 million promised by the World Bank, $15
million - by the European Commission, and the $10 million grant from the
Dutch Government.

Mihai Manoli did not follow the example of his predecessor and teacher,
ex-minister Valeriu Chitan who preferred not letters but an open talk. At
least twice (in September 1997 and January 1998) did he portray to the
Cabinet a clear picture of the country's finance, indicated payment
deadlines, and said what should have been done to prevent a default.

Correspondence, however, can hardly be a remedy against insolvency. Most
probably, the minister of finance should rather demonstrate man's firmness
and state in public about what has to be done yet before the end of 2001 in
order to not let the country approach the default line.

Local observers are pointing out that by choosing writing as a means of
communication with Tarlev, the minister of finance seeks to secure his
future career and to stay as remote from the current political power as only
possible. And the correspondence is regarded by many as an extra proof that
the Tarlev's Government is not at all an affinity group working for one
common goal.

In such a situation, the positions seem somewhat strange of both the Prime
Minister, whom ministers have to write letters to, and the President. The
head of state, who is the key decision maker in the country, can well gather
all members of the Government, formed by him, around one table and make them
take decisions and act.

The President is supposed to shoulder responsibility, as it is only him, the
leader of the ruling party, who is able to demand any decisions from all the
rest within a shortest possible time, including the ones pertaining to
fulfilling the provisions of the IMF Memorandum and latest supplements to
it. The head of state, however, is not undertaking any concrete steps, and
his inertia is generating rumors about a possible resignation of the
Government.

In case of a radical Cabinet reshuffling, the finance minister's letters to
Premier Tarlev may play a role of Bickford fuse that may blast up the
situation and blow off the Government. This is exactly what some Communist
Party MPs seek to achieve realizing the entire complexity of the situation
and regarding the Tarlev Government as inefficient.

President Vladimir Voronin has, so far, agreed with his party mates only in
what regards replacing some state officials who have been sitting in their
chairs yet from the previous government's times. And the latest bright
example to this is the dismissal of the MoldovaGas leadership last week.

The President stated he was not going to disperse the whole Government,
although it was first and foremost the Cabinet who was responsible for the
failure of gas-supply negotiations with Russia.

While the Moldovan leadership is busy refuting rumors about possible
government resignation, the Ministry of Finance is putting forth Herculean
efforts to prevent a moment when the republic will be not able to pay its
foreign dues. This is becoming increasingly hard to do, because already now
some 75 percent of Budget revenues has to be converted into foreign currency
and used for debt servicing.

Drafting the 2002 Budget, the MoF has 'booked' in it $110 million for
reimbursing external debts. The Government hopes to restructure another $27
million. However, of all the Paris Club member states, it is only Russia, in
the person of Prime Minister Mikhail Kassianov, which has stated
preparedness to back Moldova in its striving to defer repayments till a
later time.

The draft 2002 Budget, so easily approved by the parliamentary Communist
majority in two readings last week, has been designed to have a deficit of
320 million lei, or 1.4 percent GDP. World Bank experts are saying the
Budget is good, as it is pragmatic, realistic, and well balanced.

Local experts, however, are fairly pessimistic about the Budget's
feasibility. They think IMF and WB representatives are acting as
inconsistent observers, and their diplomatic sayings only mislead the local
public.

The Budget is projected to have 3.59 billion lei of revenues and 3.91
billion lei of expenditures, economic growth is expected to be 6 percent,
the leu's exchange rate should not exceed MDL 13.5 to US$1 by late-2002, and
inflation to be not over 10 percent.

The Moldova's external liability is nearly $1.5 billion, and the repayment
peak will be precisely in 2002.

In case all debts are duly repaid, this may well require 72-75 percent of
all Budget means. This year, the payments are to consume not more than 42
percent.

A technical mission from the international Monetary Fund, which visited
Chisinau recently, came to a conclusion that next year Moldova will be not
able to spend more than 40 percent of its budget means for foreign
repayments. The IMF has thus hinted the Government still has chances for
restructuring a part of its liabilities.

According to our unofficial data, the Government already disposes of several
offers from foreign companies to restructure the Moldova's debts. By
mid-December, the cabinet is supposed to choose a scheme to be used at
restructuring negotiations with creditors.

If Moldova fails to achieve the postponement, then it must be prepared for
repaying $277 million next year. With an account of the projected 22.4
billion lei GDP size, the repayment sum may exceed 20 percent of the GDP
size.

Part 2 of 2. HOW TO AVOID INSOLVENCY?

The Cabinet has worked out a strategy of the country's socio-economic
development till the year 2005 envisaging a GDP growth from 18.6 billion lei
in 2000 to 33.6 billion lei in 2005, i.e. by 38 percent, which indeed looks
quite optimistic.

The Government realizes that to achieve such a height, a whole number of
indispensable conditions need to be met: the industrial output must be
increasing by no less 8.2 percent a year, agricultural production by 7.6
percent, direct foreign investment should be $200-250 million, annual
inflation rate 7 percent.

Despite the obvious iridescence of this forecast, it is quite realizable,
but the chief condition for it should be leadership's firm political will to
conduct economic reforms.

The economic reforms in Moldova can be compared with a walker who makes a
step or two forward, then jibs, then backs all of a sudden, which can be
regarded as an uncertainty, if not stagnation.

A steady advancement is only possible through quick and correct decisions,
as the present-day situation still can be saved if several radical decisions
are taken. They can be compared with a surgeon who is supposed to cut dead
tissues off a still living body. This is a very painful but absolutely
necessary an operation for the body's subsequent recovery. However, the
surgeon has had in fact no possibility to start the operation for many
years, as he spent his precious time not on working but on arguing.

In previous several years, practically any more or less important decision,
be it in parliament or government, was necessarily preceded by heated,
lengthy debates. After the February 2001 parliamentary election, the country
has found itself in a new political situation - favorable and stable, when
the Communist Party has assumed full power for taking and realizing any
decisions.

Yes the Government includes also representatives of other political forces,
but the chief thing is that this republic has a party at power led by
president. So, it is only the Communist Party and its leader, President
Voronin, will bear full responsibility for the Government's work and
situation development in the country.

So, what needs to be made first of all?

First. To immediately sequestrate the 2001 Budget through renouncing a part
of projected budget allocations that the country will be unable to realize
this year.

Second: To urgently eliminate reasons why Moldova has been denied foreign
lending. The Government should work out a new Memorandum on economic and
financial policy to be agreed upon with the International Monetary Fund, and
to adopt SAC-III with the World Bank. For this, one month is enough to pass
the laws recommended by Moldova's chief creditors - the IMF and World Bank.

Third. To give up, at least for some time, the idea of revising the
existing law on social and pension insurance. Instead of this, however, the
Government passed a decision last week on raising pensions.

Fourth. To suspend laws on social guarantees and other financial
liabilities before various consumers, because the Government has no
possibility whatsoever to meet these commitments in 2001 and 2002.

Fifth. To make the tax and fiscal policy unchangeable. This implies that
the State ought to guarantee stable tax rates for 3-5 years.

The State should be consistent in fixing the value-added tax. For
agricultural producers, it should be 10 percent, and for food processing
enterprises -- 20 percent. Apparently, the State should freeze, also for 3-5
years, the practice of collecting a 20 percent VAT on the imports of raw
materials, equipment, components for manufacturing final products which, in
their turn, will be subject to a 20 percent value-added taxation upon
realization.

Sixth. To privatize, once and forever, the energy sector, as its management
by the State does not justify itself. Experts indicate reasons why this
should be done: lack of skilled personnel; poor incentives for energy
enterprises' efficient functioning; lobbying; and, finally, the so-called
state racket (it is no secret that the state property has become a source of
enrichment for private mediators whose interests are lobbied by the elite).
All this upsets investment in the economy's production sector.

Such actions may de-freeze the external lending which envisages a
preferential regime for Moldova. Before, the republic used to receive
credits payable in 10 years at annual interest rates of 7 percent. Now,
loans will be available for 30-40 years with 0.5-0.75 percent p.a. interest
rates.

With the help of such new, advantageous credits, Moldova would be able to
fully repay its compulsory 2001 and 2002 dues. But the chief thing is that
the Government would, at last, get a pause in repaying external debts only
at the expense of domestic sources, which it has been doing continuously for
a second year by now.

The most undesirable variant that can be used by the Government is to borrow
from the National Bank. However, the NBM's potency is not unlimited.
Presently, its hard-currency reserve is over $210 million, including $60
million of the so-called net currency reserve. The International Monetary
Fund, which has been supplying credits to underpin the leu's exchange rate
to the dollar all these years, will prohibit to the NBM to use more than $60
million from its reserve.

Such a way will be only a half-measure that will put off the default for a
while, without solving the problem as such. This will mean that the
operation to cure the Moldovan economy will again be postponed till a later
time. Which time? Only the surgeon in whose hands is the crucial scalpel
knows this.

There is another possible scenario of events which should not be ruled out.
Unless the cooperation with the IMF is resumed, the Paris Club will not
commence negotiations on restructuring the Moldovan debts.

The extent to which the IMF's stance is essential for old and new creditors
was recently demonstrated by the European Union: without hearing the Fund's
approval of the Moldovan Government's actions, the EU decided to not send to
Chisinau its delegation for negotiating a EURO 15 million credit that was
intended to support the republic's payment balance.

Such a scenario will end in a default that will throw Moldova to the very
bottom, after which the Moldovan economy will begin climbing up, recovering
gradually. Some experts presume that this scenario may develop into the
so-called "Bulgarian variant" - with a change of power and announcement of
external governance of the country.

At the present level of development, the latter variant is hardly possible
in Moldova, because it would mean that the authorities will have to
recognize their inability to rule the country. The Communists will never
agree to such a step, and they will need to take other measures. Which ones?
This will be known already very soon.