IMF Concludes Article IV Consultation with the Republic of Moldova

On December 15, 2000, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Moldova.¹

Background

The economic situation remained difficult in Moldova in 1999 and 2000; Moldova was hard hit by the Russian crisis of 1998, and a drought and rising energy prices adversely affected output in 2000. Early indications are, however, that the output decline is bottoming out and growth appears to be within reach.

Moldova's poor economic performance since independence can be partially attributed to external shocks, but also to extended delays in, and the partial nature of, the implementation of structural reforms. The privatization of the country's key economic sectors, notably agro-processing has only just started. In addition, the country's institutional framework is still far removed from what is required for a well-functioning market economy. This has contributed to very low levels of foreign investment and private sector activity. More recently, however, considerable progress has been made in implementing structural reforms. The liquidation of state-owned and collective farms and the transfer of land into private hands accelerated markedly in 1999 and 2000, and has been almost completed. First steps were made in the privatization of the energy sector with the sale of three power distribution companies to a foreign investor in early 2000. In October 2000, the Moldovan parliament adopted legislation that allows the privatization of five wineries and the tobacco companies. It also approved in first reading a new Civil Code, that would establish the overall legal framework for defining property rights and contractual obligations. In the summer of 2000, a policy was instituted requiring all licenses with a value above US$1 million to be approved by the Council of Ministers and to be published in the official gazette.

The Moldovan authorities have been implementing tight fiscal policies. The fiscal adjustment achieved in 1999 and 2000 has been impressive, reducing the general government budget deficit (on a commitments basis) from over 10 percent of GDP in 1998 to less than 3 percent of GDP in 2000. Underlying the fiscal tightening was a large reduction of expenditures, including, after years of delay, major efforts to eliminate excess capacity in the relatively sizable health and education sectors, as well as a partial hiring freeze.

Inflation accelerated in 1999, reflecting the sharp depreciation of the leu following the Russian crisis and a more accommodating monetary policy attempting to minimize the output loss of the external shock; twelve-month inflation reached 44 percent by end-1999. Inflation in 2000 has been close to 20 percent following a tightening of monetary policy.

In 1999, Moldova experienced a dramatic adjustment of its external imbalances; the external current account deficit shrunk from almost 17 percent of GDP in 1998 to 2½ percent of GDP, with both exports and imports declining sharply, reflecting the collapse of the country's traditional export markets and, in parallel with this, its income. The current account deficit widened again in 2000 to 8 percent of GDP; imports have started to increase in line with a gradual recovery of incomes, while exports are lagging somewhat because of the impact of the drought on agricultural production.

The failure to sufficiently contain fiscal and quasi-fiscal deficits combined with large current account deficits in the years prior to 1999 has led to a sharp build-up of external debt. Debt indicators deteriorated further in 1999 due to the sharp depreciation of the leu following the Russian crisis and the drop in output. At end-1999, the stock of public and publicly guaranteed external debt amounted to almost US$1 billion, equivalent to 70 percent of GDP. Adding arrears on energy imports puts the debt stock at over 100 percent of GDP. Meeting debt service obligations places a large burden on the government budget.

Executive Board Assessment

Executive Directors noted that Moldova has been hit hard by the Russian crisis of 1998 and economic problems in other neighboring countries, and, more recently, by rising energy prices and a drought. Directors recognized that in difficult circumstances, the authorities have made a determined effort to preserve reasonable financial stability. Since 1999, they have achieved a large and welcome fiscal adjustment, and have tightened monetary policy. At the same time, Directors noted the obstacles and opposition that Moldova's reform efforts have faced over the past decade, as well as the challenges posed by the high level of its foreign debt. Against such a background, Directors considered that the authorities faced an extremely demanding task. They were encouraged by the renewed commitment to structural reforms, but emphasized that steadfast implementation will be critical to lay the foundations for sustained growth and poverty reduction.

Directors welcomed the authorities' intention to press ahead with fiscal adjustment and reform. They recognized the limited scope for further reduction in government expenditures, as well as the need to find resources to strengthen social programs and to pay down wage and pension arrears. Accordingly, Directors emphasized the importance of improving tax and customs administration, including collection enforcement, as well as of upgrading tax legislation and reducing tax exemptions. They welcomed the recent, and politically difficult, improvements to the social safety net through better-targeted compensation for energy expenditures paid directly from the budget. More generally, they noted the large contribution which energy sector reform can, in various ways, make to strengthening the budget.

Directors regarded the recent increase in the demand for money and credit as a positive sign of greater financial deepening. They cautioned the National Bank, should this process slow down, to stand ready to tighten monetary policy in order to further reduce inflation. Directors considered that Moldova's flexible exchange rate regime was appropriate given its vulnerability to external shocks. They welcomed the central bank's continuing efforts to consolidate the banking sector and noted the importance of addressing effectively any problems posed by weak banks if the need arose.

Directors noted that, in addition to external shocks, faltering structural reform efforts had seriously undermined economic performance over much of the past decade. Against this disappointing background, Directors were encouraged by the recent progress in privatizing the energy sector, liquidating state farms and distributing land, and by parliament's adoption of legislation that allows for the privatization of a number of wineries and the tobacco sector. They also welcomed the authorities' recent steps to strengthen the legal framework and improve economic governance. Directors emphasized the vital importance of maintaining the current momentum of reform.

Directors expressed serious concern about the deterioration of Moldova's external debt indicators, and emphasized the need for close monitoring in the years to come. Achieving sustainability in the medium term will require continued fiscal adjustment and structural policies to stimulate strong export growth. Directors commended the authorities for having continued to meet debt obligations, while maintaining a liberal trade and exchange regime. They were pleased to note Moldova's imminent accession to the WTO.

Directors recommended that the authorities endeavor to further improve the quality and coverage of economic statistics.