IMF Executive Board Concludes 2015 Article IV Consultation and Third Post-Program Monitoring with Moldova

On December 16, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation and Third Post-Program Monitoring¹ with Moldova.

Political uncertainty, large-scale bank fraud, an unsupportive external environment, and adverse weather conditions have taken a heavy toll on Moldova. In that light, economic growth, at 3.6 percent, came in surprisingly strong in the first half of 2015 and was largely driven by net exports. Inflation, at 12.5 percent in September, has risen above its target range of 5 percent ± 1.5 percentage points, yet remains notably contained given the scale of liquidity injections in problem banks. Aggressively high policy rates and reserve requirements have helped reduce pressure on the exchange rate, reserves, and inflation.

Reserves fell by about a third between October 2014 and February 2015, but have been stable since. Net outflows in the financial account surged at end-2014, due to election uncertainty and the banking crisis, but the outflow in currency and deposits tapered off in the second quarter of 2015. Remittances declined by 19 percent in the first half of the year, but their effect on the current account was offset by a significant improvement in the trade balance, reflecting mainly the impact of lower energy prices and lower domestic demand.

The near term outlook is difficult. The economy is projected to contract by 1.75 percent in 2015, followed by a marginal recovery of around 1.5 percent in 2016. Remittances continue to decline, and a drought has sharply affected agricultural production, with lingering effects expected in 2016. Capital expenditure is weak. Financing constraints bind across the economy – credit growth remains negative, external budget support is falling, and yields on short-term government bills have risen from around 10 percent at end-2014 to over 23 percent.

Deep reform is needed in the financial sector. The closure of three insolvent banks in October is a welcome step forward. However, to preserve financial stability, a comprehensive review of the health of the remaining institutions is needed, as well as improvements in the regulatory, supervisory, and crisis management frameworks. Long-standing deficiencies in identifying ultimate beneficial ownership of banks need to be urgently corrected.

Executive Board Assessment²

Executive Directors expressed concern about the recent political, economic, and financial developments in the country, and cautioned that significant downside risks remain to the outlook. Directors regretted that delays in addressing long-identified governance issues in the banking sector ultimately led to large-scale fraud with substantial economic costs. While noting that macrofinancial stability has been broadly maintained despite this and other large domestic and external shocks, Directors urged the authorities to act decisively to address key vulnerabilities in the financial sector, pursue prudent macroeconomic policies, and deepen structural reforms.

Directors welcomed the recent closure of three insolvent banks, and stressed the importance of ensuring the soundness of the remaining financial institutions along with improvements in the regulatory and supervisory frameworks, including in the insurance and non-bank financial sectors and the AML/CFT framework. Directors called for strengthening the governance in the banking sector, and welcomed the external review of the supervisory process in the lead up to the banking crisis. Directors urged the authorities to swiftly enhance the independence, powers, and crisis management toolkits of both the National Bank of Moldova and the National Commission for Financial Markets.

With substantial fiscal costs of the banking sector resolution and the potential for further claims on public sector resources, Directors emphasized the need to pursue credible fiscal consolidation to ensure medium-term debt sustainability. They stressed the importance of containing current expenditures, especially pensions and the wage bill, improving revenue collection, and prioritizing investment projects financed by concessional lending. Directors welcomed the planned increase in targeted social assistance, and called for advancing structural fiscal reforms and reinvigorating the privatization agenda in order to strengthen fiscal institutions and reduce fiscal risks.

Directors agreed that the current monetary policy stance is appropriate and has helped contain the inflationary pressures arising from the massive liquidity injection to problem banks. They considered that a gradual relaxation of the tight monetary policy stance would need to strike a balance between inflationary risks and risks to the real sector. Directors noted that the floating exchange rate has served Moldova well, and that official interventions in the foreign exchange market should be limited to preventing excessive exchange rate volatility, while stressing the need to rebuild foreign exchange reserves.

Directors underscored that steadfast implementation of structural reforms is essential to restore output growth and enhance the economy’s resilience to potential shocks. Priority should be given to strengthening the quality of institutions and governance, ensuring in particular the independence of the judiciary system, a stable regulatory and operating environment, and a level playing field for private sector companies. Directors stressed the importance of ensuring cost recovery of the utility services and the independence of the energy sector regulator.