Moldova & IMF IMF Activities Publications Press Releases

Limba romana                                                                                                      Russian



In response to a common set of inquiries from media outlets, Ms. Armine Khachatryan, Resident Representative of the International Monetary Fund (IMF) in Moldova, recently answered questions from journalists on the financial sector, fiscal policy, and the real economy. The responses help explain the IMF messages and assessment of the Moldovan economy over the last year.

Financial/banking sector:

1.             What are in IMF’s view the main problems in the banking sector?

One of the most important problems stems from opaque ultimate beneficial ownership of banks, which boils down to not knowing definitively who controls banks. This allows individuals or groups to gain control of large banks in Moldova while evading proper supervisory control. The risk – which materialized in the cases of Banca de Economii, Banca Sociala and Unibank – is that these banks are then run to the private gain of shareholders, without proper checks and balances, and put customers and public finances at risk.

Another important problem is political and judicial interference with supervision and regulation of banks. For instance, actions taken by the National Bank of Moldova (NBM) to block shareholders that were acting in concert in a number of banks have been subsequently challenged in courts and suspended. Moreover, NBM’s decision to restrict cross-border interbank credit exposures that was supposed to prevent the fraud in Banca de Economii, Banca Sociala and Unibank has been challenged and suspended by courts several times just in 2014.

The interference with supervision often results in regulatory forbearance –a situation when the supervisory action was needed and was not taken, or the action was significantly delayed. For example, despite the large number of suspicious transactions over the last two years, the National Commission for Financial Market (NCFM), responsible for overseeing registration and transfers of shares in listed banks, has not initiated investigations or raised concerns. Equally, no significant actions were taken by NBM and Financial Intelligence Unit of National Anti-Corruption Center against bank shareholders and managers who violated anti-money laundering regulations.

2.             Could you elaborate more on the issue of “weak governance” in the banking sector which “has heavy economic costs”? (Citing IMF press release from March 1, 2016). Do you refer here to the NBM or to the governance in commercial banks?

Weak governance in the banking sector is a reflection of a complex set of issues, including shortcomings in commercial banks’ risk management mechanisms, deficiencies in the judicial process and legal framework, and the lack of operational independence of bank regulators.

The lack of transparency of the ultimate beneficial owners of banks prevents the supervisor from establishing a key precondition for a sound and well-governed banking sector – the fit and proper nature of bank owners and managers. This, combined with weak internal control systems, opens space for abuse, allowing for transactions to take place that put at risk the stability of the entire banking system.

 Responsibility for a well-functioning supervision framework does not rest with the NBM alone. Good bank governance requires effective legal, regulatory and institutional foundations – which are not strong in Moldova. For instance, the Ministry of Justice interfered with NBM’s regulatory framework. Before entering into force, NBM regulations had to be registered by the Ministry of Justice which performed a legal revision, leading sometimes to substantial amendments. Not only did this interference undermine NBM’s powers and autonomy, but it also created unnecessary delays in implementation of prudential regulations.

The costs of bad governance are high. From a big picture point of view, in Moldova the banking sector as a whole has been unable to deliver on its key role of financial intermediation – channeling savings to productive investment and contributing to growth. Specifically, the cost to society of the fraud that has already taken place has been very high – leading to high interest rates, a loss of reserves, a rise in public debt and interest expenditure, and a loss of confidence of external creditors.

3.             Could you explain what moral hazard is, and why is this so detrimental for Moldova’s financial system?

Moral hazard is a term used to describe how people’s behavior changes when they are insured against possible losses. When people know in advance that damage to their property is fully covered, they tend to take on additional risks, sometimes excessively so. Speaking about the financial sector, if the government always bails out banks, both depositors and bankers effectively have a full government insurance against losses. This gives them an incentive to take more risks and that increases the probability of a financial crisis. While depositors have limited capacity to analyze their choice of banks, bankers have to be fit to make decisions about how to invest other people’s money. And they must face proper consequences in case of bad investment decisions that caused prejudice to their customers.

The bailout of reckless bankers implies large macroeconomic costs, increasing the public debt and reducing government’s ability to use taxpayers’ money for core government expenditures.

4.             Regarding shareholder transparency in commercial banks – why it is so important? What are the main factors that stand in the way of strengthening the transparency of shareholders?

First, let’s clarify why it is so important to have transparency of banks’ shareholders. Shareholder transparency is a critical component in building a safe and sound banking system. Compared to industrial corporations, the transparency in banks’ shareholders is much more critical because bank makes profits not by producing goods, but by borrowing someone else’s money at a low interest rate and lending money at a high interest rate. Therefore, banks maximize shareholders’ investment value by determining the optimal allocation of these investments, and by adjusting financing decisions through risk control mechanisms so not to endanger depositors’ money. As a result, those who would like to become shareholders of banks should be able to prove to the bank supervisor that they are fit for the job. If ultimate beneficial owners are not disclosed, the supervisor is unable to assess connected lending and concerted actions of shareholders, which leaves depositors and the public without an understanding of who the owners are and without an ability to evaluate how much risk these shareholders take.

In Moldova, a major shortcoming has been the inability to definitively prove who stands behind these ownership rights. 

5.             What impact on the economy and on the private sector had the liquidation of 3 banks, significant increase in base rate, and increase in mandatory reserves? What else that we as citizens of Moldova don’t immediately see and observe?

There was a massive injection of liquidity into the banking system through insolvent banks, when liquidity support to those banks went from zero in September 2014 to around 14 billion in March 2015. To counteract that, in order to contain the effects on the currency and on inflation, the NBM aggressively tightened monetary policy. Thus, in less than a year the NBM increased its policy rate in several steps from 3.5 percent to 19.5 percent, and the reserve requirement ratio on leu-denominated liabilities from 14 percent to 35 percent. This was one very obvious cost of the crisis to the private sector–high lending rates and limited availability of credit.

However, without aggressive monetary policy tightening the costs to economy and society could have been much higher. Past banking crises with high monetization (Ecuador, Venezuela, Paraguay in mid 90s) have generated episodes of accelerating inflation often combined with sharp currency depreciation.

In addition, the rise in public debt that taxpayers and future generations should repay is another clear cost. It’s important to note that government guarantees associated with the banking sector bailout and consequently securities issued to replace these guarantees are part of the public debt, which, has gone up from 37 percent of GDP in 2014 to more than 50 percent now.

6.             How do you assess the NBM’s decisions to reduce the base rate? When can the cost of credit to the real economy start to decline?

The base rate has started to come down already. As inflationary pressures are subsiding, the NBM can consider lowering the base rate. So far, the policy rate has been reduced by 4.5 percentage points in 2016, and, going forward, the NBM should exercise caution in the size of the reduction in policy rate, given the significant uncertainty on the outlook, while inflation is falling. The reduction in base rate should ideally translate into a reduction of bank credit rates; however the monetary transmission mechanism has been impeded by distressed banking system. Restoring financial stability and trust in the banking system should help to improve transmission mechanism.  

7.             The authorities are discussing an assessment of the NBM’s performance that has to be done with the help of IMF. Could you elaborate on this? Is this some type of technical assistance?

The authorities (speaker of the Parliament) expressed an interest in independent expert assessment of the central bank supervisory process regarding the fraudulent transactions that occurred during 2012-2014. The assessment will aim to cover all aspects of the supervisory process, including actions taken by the central bank as a supervisor, laws and regulations in place, and the degree of freedom/independence the central bank had. The outcome of this work will be an important input into understanding what went wrong, and what were the fundamental loopholes in the system. While the IMF supports the completion of such a review, this will not be part of technical assistance as the IMF does not have the expertise to conduct such assessments. However, we hope that this process goes forward as planned with the help of competent international experts.


8.              What is the IMF’s assessment regarding the draft 2016 budget? What is your recommendation for the budget deficit? Will it be difficult to achieve?

When it comes to recommendations, let’s look into the budget over a multi-year perspective, because single year in isolation cannot give us enough grounds for an assessment. For instance, if we look back at 2015, the deficit was lower than expected, however this is not necessarily a positive outcome. In fact, what happened was that the revenues were substantially lower than expected, grants have notably fallen and domestic financing has been constrained by very high interest rates, resulting from the need to sterilize injections associated with the large-scale bank fraud. Consequently, the adjustment [i.e. contraction] on the expenditure side has fallen mainly on capital investment, and, as it seems with the availability of more data, resulted in some domestic arrears. As a result, fiscal policy is constrained in its ability to support economic growth!

Looking ahead, we think that it is important to anchor the budget deficit path to a level that is consistent with medium-term debt sustainability. This should be accompanied by structural fiscal reforms, aiming at strengthening fiscal institutions and reducing fiscal risks. Measures to broaden the tax base to support developmental and social goals and to rationalize expenditures should be taken in the near term. The IMF is providing technical assistance for expenditure rationalization policies that should help to achieve good outcomes already in 2017 budget.

9.             Given the scarcity of state budget resources, do you think that privatization of State Owned Enterprises (SOEs) is a pressing issue now? What are your views on the activity of state-owned enterprises? 

SOEs often display a number of inefficiencies, given their multiple and conflicting goals, distorted incentives, lack of management independence and inappropriate reward structure. As a result, these companies may end up operating below their cost recovery level, resulting in losses that eventually have to be covered by higher public debt.

In Moldova, the number of state-owned companies or companies with state participation is quite significant, and it is important to have a good strategy on their governance. Equally important is to have clear and transparent data on SOE’s financial performance. From this perspective, the IMF continues to see the need for an improvement in SOE monitoring and assessment of their financial performance in a transparent and systematic way.

A renewed focus on privatization is welcome. However, successful privatization depends on a number of factors, including having a clear strategy and a proper selection and preparation process. In addition, improving the domestic business environment, rule of law, property rights and overall economic governance may be required to attract reputable investors.

10.         Some experts are talking about an increase in pension age, saying that it’s a recommendation of the IMF. Is this so? Is pension reform needed now?

Pension reform is needed, yes. There are several important issues. One is the very low ratio of a number of contributing workers to pensioners (1.3), which will worsen further given continuing labor migration, aging population and other factors. These unfavorable demographics occur against the rather low replacement rate – the ratio of the average pension to average wage – which is at about 28 percent, compared to an average of 43 percent in CEE/CIS countries.

In such circumstances a balance has to be struck between the fiscal and social sustainability of the pension system. In order to increase pension benefits to a socially acceptable level and to secure long-term sustainability of the pension system, a number of parametric reforms are needed: (i) no further ad-hoc increases in pension benefits; (ii) raising male and female retirement age, with subsequent indexation to advancements in life expectancy; (iii) linking pension contributions by self-employed and farmers to the level of income declared for tax purposes, rather than an arbitrary minimum; and (iv) improving the compliance rates in terms of contribution to the pension system.

This reform agenda cannot be implemented overnight, and require commitment by authorities and support of donors, including IMF, World Bank and others.

11.         How do you assess the tax policy and tax administration system in Moldova?

In general, Moldova needs to implement policies that would broaden the tax base and enhance tax administration. This would allow the country to raise higher revenues for growth-enhancing and social expenditures. Until now the tax authorities made an effort to align tax administration operations with good practice. However, sustaining the tax administration reform and modernization effort in Moldova also depend on the urgency with which the fundamentals are addressed. The key objectives would be to lower taxpayer compliance costs and, at the same time, increase compliance rates. Ease of registration, filing, as well as accuracy in declarations and timely payments should be the anchors of the modernization effort. Furthermore, the reform effort cannot achieve the desired depth and intended objectives until legal amendments to unify the tax service in Moldova are implemented (thus addressing the fragmentation of the local and state tax administration).

IMF technical assistance missions have recommended: rationalizing CIT and PIT exemptions, updating the real estate valuations for tax purposes, improving tax compliance (for instance, through enhancing the performance of the large tax payer office, efforts to reduce underreporting on income), and strengthening the efficiency of revenue administration (including through a unification of the tax service). In addition, standardizing the CIT rates and eliminating tax discounts could provide additional revenues. In fact, the literature suggests that government policies like enhancing product and labor market efficiency, strengthening governance and macroeconomic stability are more important in attracting investments than tax incentives.

The VAT administration system (including refunds) is working reasonably well. For example, the VAT refund system that has received much criticism seems to be providing refunds within the prescribed 45 days. However, some sectors, which have significant exemptions and diversification of VAT rates, are actually draining funds from the treasury on a net basis. Therefore, a further review of the VAT framework is needed in order to stop any such drain of resources.


12.         What is IMF’s forecast of macroeconomic indicators for 2016-2017? Speaking about the macroeconomic outlook, are you more on an optimistic side, or more pessimistic?

Real GDP in 2015 contracted by 0.5 percent, driven by the decline in agriculture on the supply side, and by weaker private consumption and investments on the demand side. We were a bit surprised that the difficult situation in the banking sector didn’t have a more profound negative effect on growth last year – this is something that needs to be better understood. The near term outlook remains difficult. Moldovan economic growth is highly vulnerable, it is affected by external shocks from trading partners and global developments, and by domestic shocks, such as episodes of political volatility, as well as weather/climate related shocks. The slow economic recovery will be influenced by lingering effects of the last year’s drought, seconded by weak recuperation of domestic demand given the slow recovery of remittances, weak capital expenditures and financing constraints across the economy. The recent rather rapid decline in inflation may reflect weak domestic demand – while data is not yet available, it is likely that we are still seeing a contraction in output in the first half of 2016.

13.         What are your views about assigning central securities depository functions to the NBM? Why should NBM deal with this?

We welcome this. There are several shortcomings that impede the development of Moldova’s financial system, and among those is the risk of fraud that continues to compromise the integrity of the corporate securities registration system. The IMF and World Bank have recommended the creation of a single Central Securities Depository (CSD) in Moldova, which in our view should be primarily owned and operated by the NBM, at least during the initial years of operation. This model of development should help to address several important shortcomings that impede the safety and efficiency of the financial infrastructure in Moldova, and help to enhance protection of investors’ rights, which is a basic condition for market development and the overall soundness of the financial system.

The NBM has a significant experience in dealing with government securities market and is able to provide for robust IT solutions and electronic system that would eliminate the risk of fraud in registration and consequently transactions with corporate securities. The CSD with strong electronic framework will also increase transparency regarding investor’s positions, which combined with full-scale financial transparency and accountability framework will reduce the opportunities to commit fraud.

At this stage, IMF technical team is working with the authorities on finalizing a drafting of a separate law on Central Securities Depository, which hopefully will be adopted shortly after.

14.         Do you believe that the Moldovan energy market is transparent and effectively regulated? Are the tariffs at cost recovery? And what shall be the approach towards the huge financial deviations accumulated so far?

Clear and transparent tariff setting mechanisms is critical both for the energy sector companies and for the end customers. Fair tariff adjustment is important for companies, because setting utility tariffs below cost-recovery level does not allow companies to generate enough cashflow to maintain the viability of the system and to invest in the energy infrastructure for enhancing the quality of services. On the other hand, for customers it is important that they receive quality services at a “fair” price, so that they don’t have to pay for the inefficiencies of energy sector companies and to cross-subsidize others.

The utility tariffs in Moldova haven’t been adjusted by ANRE in the last several years. While some adjustments in electricity sector tariffs enabled restoring current financial viability of electricity companies, as a result of delays in tariff adjustment we now observe cascading losses and debts across the entire energy sector. The stock of this debt (called financial deviations) needs to be urgently settled, in order to allow efficient operation of companies. In principle, a reasonable solution could involve passing the accumulated tariff debt through a gradual tariff adjustment, starting with the recognition of the size of the debt and announcing a schedule of future tariff increases. In practice, however, the unpredictability of regulatory decisions has made such an approach less credible.

15.         Free Economic Zones (FEZs) are showing a good dynamics. But are they meeting the rigors of loyal competition? And are they a good example, to be applied to all enterprises of Moldova, ensuring the success of country’s economy?

The impact of FEZs on local economic development has been ambiguous in developing countries. First of all, FEZs are mostly established by large multinational companies, geared towards manufacturing of certain inputs into a larger supply chain. As a result, they have limited exposure to local economy and have done little to reinforce the entrepreneurial foundations of host countries. Secondly, FEZs are like enclaves where exporters are primarily interested in cheap labor and spillovers to the rest of the economy are limited. In addition, the tax, tariff and regulatory incentives FEZs receive create distortions within the host economies. When establishing FEZs, host countries hope that these disadvantages are outweighed by the boost to jobs and trade. In practice, however, many FEZs fail.

Moreover, empirical facts suggest that many developing countries intensively relying on FEZ, have not succeeded in attracting more FDI. The key factors affecting investor incentives include economic and political stability, transparency of legal framework, labor costs and skills. In any case, making Moldova equally attractive for all investors, not just those in FEZ, is the right path to open the country.


May 16, 2016