On February 7, 2005, the Executive
Board of the International Monetary Fund (IMF) concluded the
Article IV consultation with the Republic of Moldova.1
Background
Economic activity benefited from a favorable external
environment in 2003-04. GDP grew by 6.3 percent in 2003,
advancing to 6.5 percent (y-o-y) in the first half of 2004.
Large and rising workers' remittances underpinned
consumption-led growth, helping consolidate Moldova's recovery
from the 1998 regional crisis. While strong economic performance
in neighboring countries encouraged exports, the contribution of
net trade to growth was negative. Notwithstanding the recovery,
Moldova is lagging considerably behind its neighbors, partly as
a result of the Transnistria conflict. Moreover, productive
capacity has weakened with the steady exodus of working-age Moldovans following the 1998 crisis.
Twelve-month Consumer Price Index inflation peaked at
17 percent in October 2003, reflecting a transitory flare-up in
food prices, but moderated to about 11 percent by October 2004.
The appreciating leu has helped attenuate the impact from higher
oil prices, but domestic spending pressures and a tighter labor
market have kept non-food goods price inflation up, while rapid
money and credit growth have rekindled inflationary
expectations.
Despite a substantial real exchange rate appreciation,
international competitiveness remains favorable. Dollar wages
are well below those in neighboring countries, and exports have
been growing briskly. Although the real effective exchange rate
appreciated by 11½ percent (y-o-y) during the first three
quarters of 2004, it remained below the end 2000 level. The
official current account deficit widened markedly to 6.8 percent
of GDP in 2003, but the actual deficit is likely to be smaller
on account of unrecorded workers' remittances, underinvoicing of
exports, and overinvoicing of imports.
Following a general government surplus in 2003, the fiscal
stance loosened considerably in 2004. While tax revenues
remained buoyant, owing to more aggressive tax collection
efforts and higher-than-expected inflation, projected nontax
revenues and grants fell short of expectations, and primary
expenditure exceeded original budget projections. The budget was
revised in October 2004, and now staff projects a general
government deficit of 1.1 percent of GDP for 2004, compared to a
deficit of 0.4 percent of GDP in the original budget. With
limited fresh external financing and lower-than-expected
privatization receipts, the government increased recourse to
bank financing and continued to run up arrears to some bilateral
creditors, but resumed interest payments to the Paris Club.
Recent external debt restructuring agreements—notably a buyback
of Gazprom promissory notes—together with the leu appreciation,
resulted in a marked decline in the external debt/GDP ratio.
Monetary policy was also expansionary in 2004, on account of
continued large inflows of remittances. With inflation
moderating in 2004, the National Bank of Moldova (NBM) stepped
up its foreign exchange purchases and, as a result,
international reserves hit a record high of US$392 million at
end- September, finally reaching pre-1998 levels. Despite more
intense sterilization efforts, by end-October both reserve and
broad money were growing at over 30 percent (y-o-y).
Progress in structural reforms remains slow, while high
transaction costs continue to hold back private sector-led
growth. Some progress has been registered in fiscal reforms, and
in revising the legal framework affecting investment,
microfinance, audit, accounting, and leasing. Nevertheless,
despite efforts to simplify licensing and business registration,
there has been no significant improvement in the business
climate. Moreover, the privatization program has stalled, while
corruption remains widespread and governance weak. Government
interference in the private sector—including formal and informal
restrictions on exports of certain agriculture goods—casts doubt
over the authorities' commitment to market-oriented reforms.
The completion of the Economic Growth and Poverty Reduction
Strategy (EGPRSP) is a step in the right direction, but
implementation has been slow and uneven.
Executive Board Assessment
Directors welcomed the recent recovery of the Moldovan
economy, the moderation of inflation, and the strengthened
external position. At the same time, Directors expressed concern
about the fragile basis of the recovery, and agreed that the key
challenge ahead is to create an environment supportive of
private sector development and foreign investment that will help
promote sustained growth, domestic job creation, and poverty
reduction. Accordingly, Directors urged the authorities to
assign top priority to revitalizing structural reforms and
reducing government intervention in the economy, while ensuring
that macroeconomic policies are geared to stem inflationary
pressures and underpin long-term growth. Directors also
highlighted the importance of efforts to resolve the conflict in
Transnistria.
Directors observed that Moldova's recent rapid economic
growth has benefited from a favorable external environment as
well as from large and rising workers' remittances. While the
short-run outlook remains positive, they pointed to the risks of
excessive dependence on remittances, as well as to impediments
to sustained growth in the medium term. These include: emerging
labor shortages and increasing capacity constraints resulting
from large-scale emigration; rising inflationary pressures from
strong inflows of remittances and rapid wage growth; a difficult
business environment; and vulnerability to external shocks.
Directors stressed that the acceleration of structural
reforms will be crucial for sustaining the economic recovery and
improving external competitiveness. They noted that structural
reforms have stalled, and urged the authorities to speed up
implementation of the structural policies envisaged in their
Economic Growth and Poverty Reduction Strategy, with a view to
encouraging investment, reversing the current emigration trend,
and channeling remittances into productive use. This will need
to involve decisive efforts to reduce government intervention in
the economy, revamp the privatization process, phase out
excessive regulation, and reform the public sector, with a view
to improving service delivery. While the recently approved
anti-corruption strategy is a step in the right direction,
Directors stressed that strong implementation of this strategy
will now be essential to demonstrate ownership and underpin the
reform effort.
Directors recommended a tighter fiscal stance than that
envisaged by the authorities. This would support the central
bank's efforts to control inflation and make room for current
external debt service, thereby preventing a further accumulation
of arrears. To ensure sustainability, fiscal policy would
benefit from a more forward-looking perspective and greater
emphasis on a medium-term expenditure framework that provides
for adequate resources for poverty-related purposes. Directors
commended the authorities' efforts to strengthen the budgetary
process and improve tax administration, and also emphasized the
need for measures to broaden the tax base, including through the
removal of tax exemptions. The importance of efforts to
strengthen the long-term viability of the pension system was
also highlighted.
Directors recommended that monetary policy place greater
emphasis on the inflation objective. Given the recent rapid
credit growth and strong foreign currency inflows, it will be
important for the National Bank of Moldova to tighten its
stance, including through greater sterilization efforts, if
needed, to counteract rising inflationary pressures. Ensuring
the independence of the National Bank of Moldova would help
achieve the low-inflation objective. While the buildup of
reserves from low levels was desirable, a number of Directors
suggested that a nominal exchange rate appreciation would be
appropriate if foreign exchange inflows continue to grow
rapidly, and that going forward, a more flexible exchange rate
policy would serve Moldova well in absorbing external shocks.
However, some Directors expressed reservations about allowing
the exchange rate to appreciate at this time, based on concerns
about competitiveness and uncertain flows of remittances. To
improve competitiveness, Directors called for further efforts to
remove remaining impediments to trade.
Directors were encouraged to note that Moldova's financial
sector indicators are largely favorable, but urged the
authorities to address remaining vulnerabilities in line with
the FSAP's recommendations. In particular, they called for a
reduction in the government's role and administrative
interference in the sector, for more transparency in the
ownership structure of financial institutions and corporations,
and for efforts to address remaining weaknesses in the AML/CFT
framework.
Directors commended the authorities for successfully
restructuring some of Moldova's external debt and reducing the
overall debt burden. They welcomed the resumption of interest
payments to Paris Club creditors, but stressed that the
outstanding arrears still need to be resolved, and looked
forward to continued efforts to normalize relations with
external creditors.
Directors noted that Moldova's official statistics are
generally adequate for surveillance. They encouraged the
authorities to address the remaining shortcomings—notably
regarding price and national accounts statistics—with support of
Fund technical assistance.
Directors looked forward to maintaining a close policy
dialogue on the reform priorities with the Moldovan authorities
in the period ahead. They emphasized that the effective
implementation of a credible and well articulated reform program
in line with the EGPRSP, together with restrained short-term
policies, will be essential for building the track record
necessary for securing possible new financing from the Fund.
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