Building a better future at home: remittances in Moldova

In today’s world, economic integration goes beyond international trade and capital movements and increasingly involves the movement of labor, too. A case in point is
Moldova, where large-scale labor emigration and remittance flows have played a dominant role in shaping the country’s recent economic evolution. A new IMF Special Issues paper takes a closer look at the kinds of policies that would allow Moldova to maximize the benefits of its remittance inflows.

After the collapse of the former Soviet Union, Moldova began a profound transformation as it moved from a centrally planned to a more market-based economy. The resulting
dislocations led to a sharp contraction in output and massive job losses. These were compounded in 1998, when the shock waves from the Russian financial crisis hit Moldova particularly hard because of the strong trade links between the two countries. As Russia’s domestic demand collapsed, Moldova’s exports to the countries of the former Soviet Union—the destination for two-thirds of its exports— declined by 50 percent in the second half of 1998 compared with the same period in 1997. The cumulative GDP loss reached 10 percent between 1997 and 1999, and it is estimated
that the poverty rate rose sharply, to over 70 percent by 1999 from 47 percent in 1997.

With few viable options at home, many workers were forced to seek job opportunities outside Moldova to support their families. Between 1998 and 2000, the number of Moldovans working abroad doubled, and remittances rose from $122 million to $172 million. In turn, these inflows, by providing an important supplement to household disposable incomes, helped accelerate a subsequent domestic recovery.

What is striking about Moldova’s experience to date is that migration has persisted even after the domestic economy recovered strongly (see chart). Since 2000, Moldova’s
domestic economy has shown marked improvement, with GDP rising by a cumulative 30 percent by 2004. Nonetheless, migration and remittances have continued to intensify, with
new migrants benefiting from the informal support of a growing expatriate community. In 2004, official estimates put the total gross inflows of workers’ remittances at $700 million,
almost 27 percent of GDP (see chart, right)—high in comparison even with other countries with significant remittances. At the same time, Moldova’s gross national disposable income per capita—a measure that includes net income and transfers from abroad—more than doubled between 2000 and 2004, reaching close to $1,000. In addition, the country’s poverty rate declined from its peak of 73 percent in 1999 to
about 26 percent by 2004.

Large and stable inflows

At end-2004, Moldovan migrant workers, both temporary and permanent, accounted for about 17 percent of Moldova’s total population. They send large portions of their earnings home, which their families have used chiefly to meet their basic consumption needs and to finance housing and education, investing smaller amounts in business activities. As is common in other countries that receive remittances, Moldova’s remittance inflows are likely to remain a stable and countercyclical source of foreign exchange in the short run. And, as more migrants settle abroad permanently, portfolio choice considerations may become more important.

Migration and remittances have important macroeconomic consequences, too. They drive growth through household consumption; reduce the labor supply and put pressure on wages; finance a large and widening trade deficit; put pressure on the exchange rate to appreciate; fuel inflationary pressures; contribute to higher tax revenues, particularly through higher value-added tax collection on rising imports; and threaten the sustainability
of the pension system.

Indeed, the study’s microeconomic survey confirms that households spend most of their supplemental income on consumer goods and housing construction. This spending has provided a strong short-term boost to domestic demand that has helped drive GDP growth in recent years. Ultimately, however, ensuring sustainable growth will require a more balanced composition of aggregate demand—with a greater contribution from
business investment in particular.

Policy choices are critical

In Moldova’s public debate, the issues of migration and remittances have tended to be framed in terms of good or bad. For the longer term, however, what matters more are
the underlying reasons for these phenomena and the policy response. In principle, the greater mobility of capital and labor permits a more efficient allocation of resources. In that sense, a wider choice of employment opportunities, both at home and abroad, for Moldova’s workers is welcome. At the same time, policy choices in three broad areas—fiscal, monetary, and structural—become critical for maximizing the potential benefits of labor migration and remittances.

For fiscal policy, Moldova’s key short-term challenge is to help safeguard macroeconomic stability and resist procyclical spending temptations in the face of surging tax revenues. Reduced unemployment and improved household incomes from higher wages and transfers from abroad ease social spending pressures. Over the longer term, considerations of fiscal sustainability become critical, as the government grapples with shifts in the demographic structure through the loss of some of its economically active population. At present, the pay-as-you-go pension system, which relies on contributions from the current generation of workers to finance retirement benefits for current retirees, is coming under pressure, as the exodus of workers reduces the base on which the contributions are levied.

Monetary policy has a key role to play in creating a stable macroeconomic environment, but it needs greater support from fiscal and structural policies to be effective. At this point, a strategy geared to maintaining a flexible exchange rate regime, paired with
a clear focus on low inflation as the overriding goal of monetary policy, appears to be a reasonable option. Improving and maintaining external competitiveness are inextricably
linked to the over-riding policy challenge of accelerating economic development. In that sense, competitiveness should be viewed not only in terms of safeguarding external sustainability but also in terms of Moldova’s ability to build solid economic growth by attracting much-needed foreign direct investment.

On the structural side, the short-term benefits of remittances for the domestic economy should not be allowed to obscure the need to implement an effective structural reform
agenda. Moldova’s problem today is that much of the impetus to migrate stems from the lack of opportunities at home. In the end, only by making Moldova a more attractive place for both labor and capital can the government ensure that its resources—most important, the skills and talent of its population—will be used to their full potential for the benefit of present and future generations. A determined and sustained effort to improve the business environment would enhance Moldova’s attractiveness as a destination for foreign capital and stimulate larger foreign direct investment inflows, which have been relatively modest to date. It would also create incentives that would help channel migrant remittances increasingly toward productive uses. This aspect will assume greater importance over time because more migrants are likely to work abroad permanently and consider investing their savings in their host country.