- At the moment, fighting inflation is the cornerstone of financial
policy in Moldova, which was coordinated with the IMF. Nevertheless
prices grow at "shock" rates. At the same time, lending interest rates
increase, which, naturally, affects the local producers’ possibility to
develop. Why does fighting inflation appears to be more important than
- I understand this concern. It is very
difficult to fight inflation in such environment. But if we speak from
the point of view of economic activity, it is necessary to go back and
to explain why inflation is bad, indeed. It is a question of balancing
long-term and short-term objectives. It is necessary to find a
compromise because for the short-term the decrease in interest rates
might increase production . But the experience of other countries shows
that practically immediately such actions lead to the growth of prices,
wages and of various other costs in the economy. That means even higher
inflation. Going this way would result in decreased investment inflows,
lower growth and less well-being of citizens.
If we look at the level of crediting in
Moldavian economy, it is rather high. Last year total crediting grew by
almost 52%. At the same time, the national currency got stronger. I did
not analyze the situation in Moldova since independence, but if you look
at the last five years it is obvious that such growth is
record-breaking. It means that there is no shortage of means for
crediting business. Actually, probably one can argue that on the
contrary there is too much credit in economy, and loans are too easy to
get. Certainly, we are not talking here about stopping crediting, but it
is necessary to just dampen growth.
- Why attract even more foreign
investments if you are saying that there is enough money in the country
and under favorable conditions local business can invest it itself? And
then local business will develop rather than foreign business.
- Actually here the issue is not the
money supply as such or resources for crediting. The idea is that,
according to the experience of other countries, in particular new EU
members, foreign investors by themselves or in cooperation with local
businessmen bring into the country not so much money but capital, which
includes knowledge, established trade links, new technology. And,
consequently, foreign investments lead to faster development of economy.
The overall level of investments into the Moldovan economy last year was
1/3 of GDP.
If we compare Moldova to the countries
with similar situation, namely with the countries with low and average
level of income, here the situation is somewhat better than in other
countries. And this indicator is significant enough. Especially if we
pay attention that since independence till 2004 the average total amount
of investments was 18% a year. Thus, we witness a sharp change of
situation and very strong growth of investments.
Today it is not a question of reducing
investment growth or stopping investment – investments are necessary,
both domestic as well as foreign ones. The challenge is to try to dampen
domestic demand to ensure long-term and midterm sustainable economic
growth. When we speak about measures which could be implemented to lower
inflation, we do not necessarily refer to a distant perspective. The
experience of other countries shows that if there is will and
appropriate measures are taken inflation can be lowered literally in
several months. Once inflation decreases and the situation is
stabilized, interest rates will quickly come down.
- Did I understand you right that
measures for fighting inflation lead to rapid growth of foreign
investments, so that local business is slightly frozen, and foreign
business gains in strength, especially if we take into account that
foreigners have access to much cheaper financial resources?
- No. We probably need to try to define
what investments are. Because there is some misunderstanding in the
public about the difference between direct foreign investments and
private investments. Foreign direct investments is a concept related to
the balance of payments, these are monetary flows coming to Moldova as
income - for example, when a private foreign investor buys some firm and
the building where it is located. These operations are not reflected in
statistics, in national accounts. It is not a direct foreign investment
because the money was used to buy a building that was already there.
Production extension, new buildings will be reflected as the direct
foreign investments. And for the national economy it is very important
that it is the level of direct foreign investments that grows, in the
sense as it is reflected in national accounts.
- But local business can build or
expand production if they have access to resources.
- This is not a win-lose situation.
Experience of other countries shows that when foreign investors come and
start to develop on territory of the country by themselves or in
cooperation with local business, if they are effective in their activity
it tends to increase productivity and income in the economy as a whole.
Economists use such concept as "the general pie". Very often the public
thinks that the economy is a kind of slicing a pie. But actually it is
not absolutely accurate. Because when the economy develops, the pie
grows. At the same time, if no measures are taken to fight inflation,
the economy stays at the current level, it might even grow. But then the
flow of foreign and local investments can decrease.
Therefore it is necessary to ensure
macroeconomic stability, so that any businessman could plan his actions
without the need to factor in measures to prevent the uncertainty risks.
Here again we come back to the beginning: the volume of crediting grows
in the country too fast and it is a concern for us. During discussions
with Moldovan authorities we have come to the conclusion that they are
When we analyze these things we operate
with such concepts as supply and demand. If constant inflow of money to
the economy compensates constant demand growth, then we end up with
higher inflation and price growth. Let me give you an example. Let’s
assume that there are 10 kinds of goods in the economy, and the price
for each of them gradually grows every month. But during a certain
period the price of one kind , say of fuel grows faster than the price
of the others. And if there is enough money in the economy accommodate
this supply, that is people are capable to pay this price, we would end
up with a general increase of prices. It is much more preferable that
this increase of prices is not compensated fully. It can be done only by
containing the growth in money supply. That is, in order to keep a low
rate of inflation it is necessary that the prices of other kinds of fuel
grow more slowly than before. The only way to achieve it by monetary
means is to dampen the growth of crediting, that is the possibility of
having more money in circulation.
- But while we aspire to
macroeconomic stability and we do not allow production to grow, mostly
speculative investments come into the country. As a result, trade grows
almost exclusively. They build mostly trading complexes to sell imported
goods. And thus we continue to support foreign manufacturers.
- What you call “speculative
investments” are actually profit driven investments, which are a common
European practice. If we have a look at Europe we can see that there
investors are interested first of all in the financial sector: banks,
insurance companies. And trade, where it is possible to be competitive
due to wholesale deliveries. Yes, the consumption level in Moldova grew
very sharply last year. But growth of consumption is an obvious sign
that it becomes more profitable to sell in this market, just because the
economy is growing. Bu definition, GDP is the general level of
production, which should be equal to the general level of income. A
large share of aggregate income is used for consumption in practically
- But the gap between export and
import keeps growing in our country. How effective are traditional
inflation-fighting measures in Moldova, bearing in mind that most
inflation is imported? Wouldn’t such monetary policy promote an even
wider gap? Import grows, and consequently prices grow?
- Actually, it is the other way round.
Demand very quickly grows in an open small economy, and it is followed
by a sharp growth if import. And to some extent investments grow just as
quickly. It is expected that this year investments will exceed $2
billion And most investments probably have a high import component. For
decrease import it is necessary to try to dampen demand. For the fiscal
sector, this means that it is necessary to spend less that it is earned.
And from the point of view of private sector it is necessary to dampen
the growth in demand. Actually there are only three ways which make it
possible to achieve this. These are: increase of interest rates,
increase of the level reserve requirements and stability of the exchange
rate. During the last years the exchange rate in Moldova has really
changed, which is good for consumers. This phenomenon can be observed in
all countries in the region. From the point of view of national currency
import becomes cheaper. And it is logical that import grows.
- But this way local producers are
restrained by high lending rates , while private consumption of import
is not restrained – a growing flow of remittances keeps coming.
- Money transferred as remittances from
abroad does not influence the economy very much. If all this money is
used for consumption of import then the money comes from abroad and then
it goes abroad again. If the interest rate increases however, many of
the people who would buy, say, an imported car, would get an additional
incentive not to spend money, but rather to save it by placing the it in
a high-yield deposit. And the money remains in the country then. This
money will be used for the development of economy. Banks can use this
money as credits. On the other hand, for enterprises it is more
advantageous to use money they have, reinvest it, rather than keep it in
As experience shows, the only
opportunity to lower interest rates and to achieve efficiency of economy
after decrease is to lower inflation first. For example, let’s see what
happened in Poland during the last 8 years. Inflation in 2000 was
approximately 20%. To fight high inflation interest rates went up to
24-25%. Inflation decreased below 10% in several months, and for the
last 5 years inflation did not rise above 5%. And interest rates went
down too. Now they are below 10%.
- But there are also other examples.
Bulgaria: growth of consumer prices – 7.8%, the refinancing rate of the
Central Bank – 3.9%, Lithuania: prices growth – 5.4%, refinancing rate –
4.8%, Latvia: inflation – 9.6%, the refinancing rate – 5.8%. Why is
inflation 12.5% and the rate of refinancing of NBM 15% in Moldova?
- To get an accurate picture when you
compare these figures ypu need to look also at the credit growth. And
then you will see that in Moldova crediting grows much more quickly than
in these countries. In Moldova the volume of crediting has grown by 52%.
And the overall money supply monetary by more than 40%. It is a lot. To
fight inflation it is necessary to dampen growth in demand.
- This insistent policy of IMF
applied to all countries very much reminds of centralized Soviet
- It is very seldom that the IMF is
accused that their policy reminds of the centralized system of planning.
The hope that bringing down interest rates will lead to increased
productivity, which would lead to lower inflation is a myth. It is
related to a group of theories which work only with the supply side and
has deep roots.
You see, there are many people,
including top officials, who favor the decrease of interest rates when
inflation is high, and not only in Moldova. And this reasoning is
typical for former Soviet republics. Because attention is paid only to
the supply side: supporting producers and production. Certainly, lower
interest rate will fuel production, but it is necessary to take in
consideration the demand side to see the full picture. With such a high
level of credit growth, spending increases more than production, hence
we have higher inflation! Look, the increased production cannot keep up
the pace with the increased demand fuelled by the credit boom, as there
is too much money chasing too few goods..
The alternative is to contain credit
growth—through tighter monetary monetary policy—in order to balance
money supply with available goods. This worked well in the pre-EU
accession countries, why not here?.