Capital Market: "NBM's decapitalization: true or false"

The National Bank of Moldova has announced for the first 9 months of this year losses amounting to MDL 381 million, determined by the appreciation of the national currency and significant foreign exchange inflows. The amount of announced losses discords strongly with the profit made during the same period of last year, namely MDL 331.6 million, as well as with the last month’s outcome, when the NBM’s balance sheet showed profit of over MDL 200 million.

At first sight, it is a dramatic development. However, in fact, the National Bank has changed the format of the balance sheet, shifting to the ‘net profit/losses’ category the unrealized losses from the exchange rate movement. Real losses have been determined by the difference of the exchange rate applied to the foreign assets of the National Bank  that are computed daily in Moldovan lei, at the official exchange rate. According to the NBM, the value of the NBM’s assets/liabilities as of September 30, 2007 was 16.8 billion lei (USD 1.46 billion), which is higher than during the same period of the previous year by almost 2.9 billion lei (USD 252.5 million), i.e. by 20.8 per cent.

Official reserves of the National Bank have recently reached record-breaking levels, amounting to over USD 1.15 billion as of October 26. Out of these, over USD 356 million are kept in securities, and USD 794.143 million are in sight and time deposits.

The National Bank is presently facing two challenges: on one hand there are the increased hard currency inflows coming from remittances and foreign investments, and this excess of currency  must be taken out of the market to ease the pressure of the appreciation of the national currency, while on the other hand there is the need to wipe out of the market the amount of lei which is massively issued as a result of foreign exchange purchases by the NBM. Taking national currency out of circulation (i.e. sterilization) is accomplished by issuing NBM securities, as well as using other tools. If it had not been done, we would be facing an increased spin of the inflationary process, which is against the main goal of NBM. However, it should be kept in mind that inflation is also a tax on the poor, as the IMF staff have repeatedly mentioned; hence, any price increase hits foremost the vulnerable categories of population.

Thus, NBM sterilizes the excess liquidity by auctioning securities (NBM certificates) to the commercial banks with maturity of 7, 14, and 28 days. For instance, at the auction on November 2 the interest rate set by NBM for its certificates was 15.8 per cent, i.e. it was rather high. One should also take into account that the higher is the sterilization rate, the bigger NBM’s losses are; on the other hand the rate needs to be high enough to make these certificates attractive for the banks, thus decreasing the volume of lei in circulation. The experience of most central banks shows that inflation is, first and foremost, a monetary phenomenon. Currently, one of the factors causing inflation in Moldova is the excessive growth of crediting by commercial banks, and this is the reason why measures are needed to limit such credit expansion – if, of course, reigning in inflation is desired.

On November 1, the Administrative Board of the NBM decided to keep the NBM’s base rate for the refinancing of commercial banks through 2-month REPO purchase operations in the open market, at the level of 16 per cent a year. It is worth reminding that NBM has raised significantly the base rate, from 13.5 per cent to 16 per cent on September 26, also setting the interest rate for overnight lending at the level of 18 per cent a year, and for the overnight deposits attracted by NBM – at 2 per cent a year. At the same time, NBM announced that ‘in conditions of maintained inflationary expectations it will intervene through monetary tools to not allow a new fast increase of the CPI, if needed’.

One should not also forget other prudential measures of the monetary policy undertaken recently by NBM, such as gradual increase of the requirements on the mandatory reserves for assets in both national and foreign currency.

Independent experts believe that another measure meant to decrease the pressure coming from hard currency inflows would be the capital account liberalization (it should be mentioned here that now Moldova has full current account convertibility of the national currency, i.e. for external trade transactions, but not for capital transfers abroad etc.). If, for instance, restrictions for transferring foreign exchange from Moldova abroad would be fully lifted, then a part of the excessive currency in the market could be channeled abroad, hence easing NBM’s task to manage the increased inflows of foreign exchange, consequently   reducing NBM’s losses.

As for the losses announced by the National Bank, the risk of its decapitalization is minimal. Last year NBM’s capital was increased from MDL 200 million to MDL 866.7 million, and the legislation was amended to ensure a sufficient level of capitalization of NBM, being the national monetary authority.

Johan Mathisen, the IMF’s Resident Representative in Chisinau has stated for “Capital Market” that total capital inflows should amount by the end of this year to about USD 700 million, i.e. 16% per cent of GDP (we are talking about investments here, not remittances), compared to 7 per cent in 2006, which is a level comparable with that of the new EU members prior to their accession. Hence, one can observe a continuous growth of Moldova’s BoP surplus, this year being a record-breaking one.

The capital inflows have both positive and negative impact on the national economy.

The negative effects are felt by creating pressures in the domestic currency market and, as a result, we face a trend towards the increase of the inflation rate, which can be eliminated through sterilization of the excess of lei in circulation. In such context, the National Bank, its main goal being to maintain price stability, has to choose between the appreciation of national currency or increasing the interest rates. In the end, we face decapitalization of the National Bank. And this should not scare us, since it’s a phenomenon characteristic of all states having massive capital inflows. No matter if we like it or not, the central bank of a country has to face the consequences of sterilization. Such consequents are imminent, and we just need to be aware of this.

The positive effects of capital inflows are, however, much more significant. In this context, Mr. Mathisen has prompted that the process of income converging towards EU levels has started. Now everything will depend on how this process develops and what kind of investments Moldova is going to attract. The country needs investments to increase labor productivity and this is the only way to achieve competitiveness and income growth.

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