Moldova–2012 Article IV Consultation, Concluding Statement
May 17, 2012
This note summarizes the mission’s observations and
recommendations, aiming to elicit views on policy issues that will be
reflected in the staff report to be discussed by the IMF’s Executive Board.
The mission is grateful for the hospitality and collaboration it has
received from the authorities and representatives of the private sector,
labor, and civil society.
Macroeconomic developments and outlook
Over 2010-11, supported by a strong reform program and a favorable
external environment, Moldova’s economy grew by an impressive 14 percent.
Growth was driven by buoyant domestic demand, financed by remittances,
credit, and external capital inflows, and booming exports, spurred by robust
external demand. Exports were further promoted by trade liberalization,
greater access to EU and CIS markets, and investment in new production
capacities. Nevertheless, the current account deficit widened to 12.6
percent of GDP by end-2011, as imports rose strongly as well. Core inflation
stayed close to 5 percent. Headline inflation persisted in high single
digits, pushed up by rising food and energy prices.
Economic activity slowed considerably in early 2012, reflecting
the weakening external demand, and the cold winter. Industrial
production and transportation in the first quarter declined from a
year ago, while exports growth over the same period last year tapered to 6¾
percent. Inflation decelerated rapidly to 4.7 percent in April, partly due
to declining food prices. On the other hand, wages and credit remained
The economy is expected to improve going forward, but there are
serious downside risks. We project GDP growth at 3 percent in 2012,
supported mainly by resilient conditions in Moldova’s CIS trading partners.
Structural reforms and large infrastructure public investment will further
underpin medium-term growth. In the absence of new supply shocks, inflation
would hover around the NBM’s target of 5 percent. However, further
deterioration in external conditions could significantly depress exports,
remittances, capital inflows, and hence growth. Also, delays in donor
support could open large balance of payments gaps.
Moldova has made great strides over the last two years on the way
to restoring fiscal sustainability. In 2010, the authorities embarked on
an ambitious path to bring the fiscal deficit by end-2012 down to a level
that could be sustained without recourse to exceptional official assistance.
They have appropriately chosen current expenditure restraint, particularly
in the public wage bill and spending on goods and services, while raising
social assistance to protect the vulnerable and public investment to promote
growth. As a result, the fiscal deficit declined from over 6.3 percent of
GDP in 2009 to about 2.4 percent in 2011. The 2012 budget, supported by
comprehensive tax policy and expenditure reforms, aimed to bring the deficit
below 1 percent of GDP.
However, the faltering fiscal adjustment in early 2012
necessitated strong corrective measures. Revenue underperformed, partly
reflecting the slowdown in the economy, but also a combination of policy
loopholes and collection problems. In addition, unbudgeted expenditure
commitments and delays in external assistance have put the budget in
jeopardy. To address this situation, we recommend a swift passage of a
package of policy measures that strikes the right balance between
accommodating the revenue effect of the slowing economy and safeguarding the
fiscal consolidation, with a view to keeping the budget deficit within 1.2
percent of GDP. The revenue measures should focus on eliminating policy
loopholes and strengthening tax and customs administration, while
rationalization in current expenditure should reflect the budget’s changing
Over the medium term, fiscal policy should be aimed at
consolidating fiscal sustainability, while raising investment in the context
of declining foreign assistance. The authorities’ plan to maintain
a headline fiscal deficit close to 1 percent of GDP in 2013-15 is
consistent with fiscal sustainability and available financing. Further
reform-based rationalization of current expenditure to the tune of 2-3
percent of GDP and strengthening of tax revenue will be needed to make room
for higher public capital outlays and targeted social assistance in view of
declining external grants. This includes reforming the pension system to
improve the replacement rate by increasing the retirement age, consolidating
the large number of municipalities to reduce public administration costs,
and expanding the education sector reform to improve quality and rationalize
costs. The introduction of a fiscal responsibility framework would further
enhance fiscal discipline and transparency.
Amid a rapidly falling inflation outlook and moderating activity,
the NBM has aggressively relaxed monetary policy. After tightening
during the first three quarters of 2011, the NBM reversed course and cut the
base rate by 550 basis points between November 2011 and February 2012. This
caused a proportional reduction in the T-bill rates, but as yet only a small
effect on commercial lending rates, which remain near 14 percent on average.
After the sizable monetary easing, a pause is warranted. The
inflation outlook over the next two years is consistent with the NBM’s 5
percent target. Since the effect of monetary policy occurs with a lag, a
pause is needed to assess the impact of the enacted policy which is still
making its way through the financial system. Further monetary policy
adjustment would be warranted if the economic outlook deteriorates or
demand-driven inflation pressures re-emerge. In case of supply shocks, we
recommend that the NBM consider their likely pass-through to core inflation
as a guide to adjusting its policy stance.
The general conduct of monetary policy would benefit from further
development and improved communication with the public. Inflation
targeting in Moldova has contributed to reducing the rate and volatility of
inflation. That said, monetary policy remains complicated by a relatively
weak transmission mechanism and volatile food and energy prices which make
up nearly half the CPI basket. The NBM has had at times to respond to shocks
to these prices to anchor inflation expectations. However, to avoid
overreaction, more weight should be given to demand-driven core inflation
trends in determining the policy stance and in communications with the
public. Also, balancing a model-driven outlook assessment with policymakers’
judgment would help take into consideration the uncertainty about the
outlook and prevent policy overshooting.
The current account deficit significantly exceeds its estimated long-term
sustainable level. The large deficit reflects the availability of
substantial private and official external funds to complement low domestic
savings and support much needed investment. It is projected to narrow
gradually to about 9½ percent of GDP in the medium term, as a result of
increased export penetration of international markets sustained by new
investment in the tradable sectors. External debt is expected to stabilize
at 71 percent of GDP, but its elevated level renders Moldova vulnerable to
Further reserve accumulation is therefore warranted at this time. In
view of its highly open economy and dependence on external funding and
remittances, Moldova is exposed to sudden stops in external inflows.
Moreover, the NBM’s international reserves are expected to decline against
standard measures of reserve adequacy after 2012. A gradual increase of
reserves to cover 85 percent of the short-term debt at remaining maturity
would provide a more comfortable cushion against external shocks. The NBM
should seek to accomplish this in a transparent way consistent with its
monetary framework and with due regard to seasonal fluctuations in the
supply of foreign exchange.
The REER appears moderately overvalued. The REER has appreciated by
over 16 percent since early 2010 when it was broadly in line with
fundamentals. This is well above the trend appreciation around 2 percent per
year that could be attributed to the higher productivity in Moldova relative
to its trading partners. IMF methodologies point to overvaluation in the
5–15 percent range, which does not pose an immediate threat to external
competitiveness and has already began to correct itself.
Our analysis suggests that trade, remittances, and private borrowing are
the main transmission channels of external shocks into Moldova.
Banks are relatively insulated owing to low foreign assets and liabilities.
Should an adverse scenario materialize, policies would need to balance
between immediate stabilization needs, demand support, and medium-term
Banks have generally remained liquid, well-capitalized, and profitable.
The non-performing loans (NPLs) ratio has slowly come down from its peak
of 17 percent in April 2010 to 8 percent in September 2011. Since then, the
NPL ratio has increased to about 13 percent by March 2012 mainly due to a
methodological change which added about 2 percentage points, and
deterioration of the portfolio in the majority state-owned BEM. In February
2012, the NBM put the small Universalbank in liquidation after it failed to
resolve liquidity and capital deficiencies. The liquidation has proceeded
well—taking advantage of the recently introduced bank resolution tools—with
no impact on the overall stability of the banking system.
The situation in BEM requires concerted decisive actions. Over the
last year, the BEM has extended some risky loans, raising significantly the
level of its NPLs and hurting its profits. The bank has ample liquidity and
capital buffers to manage the cost, and it has adopted some prudential
measures requested by the NBM to limit further risks. However, urgent
progress is needed to repair its balance sheet and improve risk management.
Governance difficulties with minority shareholders have hindered progress,
while poor coordination between financial sector regulators and the state,
together with weaknesses in legal institutions, have permitted the problem
to fester. The Government should ensure that BEM fully implements remedial
measures including those prescribed by the NBM to clean up its portfolio,
and take decisive measures to put an end to the bank’s risky lending
practices. To this end, it is critical to have a functioning Board of
Directors in place at the BEM. Meanwhile, close monitoring of the bank by
the NBM, including frequent on-site audits, should continue.
Legally dubious bank takeover attempts underscore two fundamental
weaknesses of the Moldovan economy—a weak judicial system and
non-transparent ownership. There is little hope of sustainable business
development and foreign direct investment unless these weaknesses are
addressed. To this end, we are hopeful that the judicial reform will be
implemented without delay. And a speedy passage of the legal amendments to
facilitate disclosure of beneficial owners in banks and their decisive
implementation will test the authorities’ commitment to improving the
business climate. Alongside, the long overdue adoption of legal amendments
to facilitate debt restructuring and execution of loan collateral would
enable a quicker resolution of NPLs by banks, thereby increasing their
willingness to lend and enhancing access to finance for the private sector.
Far-reaching reforms have boosted competitiveness and tapped new growth
sources. Moldova’s main strategic tasks are to complete the transition
to a fully-functioning market economy and converge to average European
income levels. In the last two years, Moldova has embarked on
comprehensive reforms in taxation, civil service, education, pension and
social assistance, energy sector, external trade, and business regulation.
With these reforms, the country has advanced by 18 positions to rank 81 in
the World Bank’s 2011/12 “Doing Business” survey and came second on its list
of top reformers in the year. Completing these reforms will help attract new
export-oriented investment in the period ahead.
However, reforms have lagged behind in several important areas.
Better protection of property rights, a transparent and stable policy
environment, and more efficient trade and investment regime are
essential to attract investors. Steady implementation of the judicial
and customs reforms is a priority to improve the business climate and
raise potential growth to lift Moldova out of poverty. Concerted reform
efforts in these areas can be effective in attracting FDI, and raise
living standards within a few years.
More efforts are needed to advance the energy sector restructuring plan
designed in cooperation with the World Bank. Recent and historic arrears
in the energy sector continue to present a large fiscal risk. More
efforts are needed to resolve the accumulated arrears, improve
collections and establish a reliable payment mechanism.
The state’s presence in the economy should be further curtailed. Despite
potential employment concerns, privatization is often necessary to
promote market-based behavior and ensure the financial viability of
companies. In this context, we welcome the Government’s plan to expand
the list of companies subject to privatization.