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Aide-Mémoire of the IMF Mission to the Republic of Moldova
November 28, 2012
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
1. This aide-mémoire summarizes the discussions held between the IMF mission and the Moldovan authorities in Chişinău during November 7-21, 2012. The discussions aimed at completing the sixth reviews of the authorities’ IMF supported program under the Extended Credit Facility (ECF) and the Extended Fund Facility (EFF) arrangements. For technical reasons, the authorities have requested several months to introduce the policy adjustments necessary to achieve the objectives of the program. This aide-mémoire describes the points of agreement between the authorities and the mission regarding the macroeconomic diagnosis and the specific policy measures for the period ahead. Implementation of these measures, as described below, is critical for the completion of the sixth reviews under the ECF/EFF arrangements in early 2013.
2. The mission would like to thank the Moldovan authorities and technical staff for a warm welcome, constructive discussion, and the positive spirit of cooperation that prevailed throughout the duration of the IMF-supported program.
3. Economic growth came to a halt in 2012, weighed down by a series of adverse shocks. Staunched by a cold winter and the slowdown in Europe, foreign and domestic trade, industrial production, and remittances have stagnated, while agricultural production collapsed after a severe summer drought. The hitherto resilient credit growth is also beginning to show signs of weakening. Real GDP growth is now projected to settle at 0.3 percent in 2012 before rebounding to 4 percent next year on account of recovering agriculture and gradual improvement in external conditions. Nonetheless, downside risks to this outlook remain significant.
4. The ensuing deceleration of domestic demand has narrowed the current account deficit. Declining private investment and stagnating consumption have kept imports broadly flat. As a result, the current account deficit is expected to decline by 1½ percent of GDP to 10¾ percent of GDP in 2012. In the medium term, the deficit should narrow to 9 percent of GDP on the back of sustained reform and export promotion efforts, recovering external demand, and increased access to EU and CIS markets. The real effective exchange rate has depreciated by about 4 percent in the first three quarters of 2012, partially reversing the 9 percent appreciation in 2011.
5. Alongside, inflation declined and is likely to remain broadly stable. A cooling economy and relative stability of food and energy prices have slowed annual inflation to 3.9 percent in October. The expected rise in food prices will likely push inflation to about 4½ percent by end-year, still well within the National Bank of Moldova’s (NBM) target range.
6. While most banks remain sound, declining asset quality and the troubles of the majority state-owned Banca de Economii (BEM) are symptomatic of emerging risks. The nonperforming loans (NPL) ratio has increased from 11 to 14½ percent in the first nine months of 2012 while the system-wide capital adequacy ratio declined somewhat. BEM’s capital has dropped close to a critical level in September, requiring urgent action, and a few small banks’ large exposures have worsened their financial conditions. Nonetheless, the core of the banking sector remains well capitalized and liquid.
7. The authorities and the mission recognize the need to continue with the economic reform agenda to maintain macroeconomic stability and boost the economy’s growth potential. In this context, economic policies need to be adjusted in response to the challenging economic conditions. Specific policy efforts should seek to preserve fiscal sustainability, maintain low and stable inflation, strengthen financial sector stability, increase transparency in the banking system, and deepen structural reforms in education, health care, energy, and privatization, while improving the business climate.
8. The budget deficit is projected to reach 1.9 percent of GDP in 2012. This higher-than-expected level is largely due to lower revenue, stemming from a shortfall in external grants (0.7 percent of GDP), the cyclical weakness of the economy, and under-collection of car registration fees (0.1 percent of GDP) stemming in part from Parliament’s decision to adopt significantly lower than planned road toll rates. The shortfall in grant receipts was partially reflected in lower capital expenditure (0.2 percent of GDP). Moreover, the Government has committed to provide drought-related assistance to agriculture, with 0.1 percent of GDP made available already in 2012.
9. The authorities and the mission agree that the 2013 budget should be amended to target a deficit of 1½ percent of GDP (prior action). The agreed deficit target along with the revised revenue and expenditure composition reflect the impact of the weaker economy while safeguarding fiscal sustainability. In this context, the mission recommends revising revenue down to 37.5 percent of GDP due to lower projected tax receipts, while containing expenditure at 39.0 percent of GDP. Achieving this will require continued strengthening of structural revenue, as well as tax and customs administration, correcting a number of recent permanent spending commitments, and implementation of other planned structural reforms. Specifically:
10. Going forward, the fiscal strategy should remain focused on preserving fiscal sustainability in the medium term. In this context, the authorities share the mission’s concern regarding delayed implementation of several important reforms, and undertake to:
11. The NBM’s current policy stance remains appropriate in the context of low inflation and weak economic activity. The NBM has made significant progress in strengthening its inflation targeting framework, improving communication, and building credibility in the financial markets and general public. The accommodative monetary policy over the past year was successful in maintaining headline inflation within the NBM’s target range. Further accommodation may be necessary if core inflation shows persistent weakness. Conversely, the second-round effects from higher food prices should be monitored carefully for signs of pressure on core inflation. Meanwhile, the NBM’s policies in recent months created an adequate reserve buffer against potential external pressures in the near term. Going forward, the NBM should continue to ensure that reserves cover at least 85 percent of short-term external debt maturing in the next 12 months in a manner consistent with achieving its inflation objective.
12. The mission recommends adoption of the draft legal amendments to the central bank law after careful consideration. The draft amendments approved by the Government strike the right balance between strengthening the NBM’s independence in line with international best practice and recommendations of the IMF and the EC while enhancing the mechanisms of internal control over NBM’s corporate governance. The mission emphasizes the paramount importance of upholding NBM’s independence in the new law and resisting proposals that could restrict it.
13. The mission urges the authorities to overcome delays with improving the transparency of the banking system. Adoption of the legal amendments seeking full transparency and disclosure of ultimate controllers in banks (delayed structural benchmark) is imperative in the face of emerging financial sector risks and recent non-transparent bank takeover attempts. In this context, the mission welcomes the authorities’ agreement to secure Parliamentary adoption of these legal amendments by end-2012 as a prior action, and to apply the new requirements to existing shareholders in the course of 2013-14 with a limited transition period.
14. The mission is deeply concerned over the precarious situation at BEM, which requires the authorities’ urgent and undivided attention. Over the past three years the bank has engaged in dubious lending practices notwithstanding repeated warnings by the NBM. Recent efforts to strengthen the bank’s performance have not brought meaningful results yet. Capital buffers continue to dwindle, the shareholders’ action plan is not fully adequate and its implementation has been slow, and the Financial Stability Committee (FSC) has not been sufficiently engaged in assessing the situation and its implications for the whole financial system. Against this background, the mission and the Government (representing the majority shareholder the state) agree that the following course of action is needed to facilitate the bank’s turnaround:
In addition, the mission recommends that the Public Property Agency consider and approve, in line with applicable procedures, the BEM’s request for the sale-and-leaseback of tangible assets in compliance with Article 18 of Law No.121 and Articles 5 to 8 of Government Decision No.480. Opportunities for the sale-and-leaseback of BEM’s tangible assets should be actively explored by identifying and initiating contractual negotiations with leasing companies.
The mission also recommends that the NBM continue to monitor closely the financial condition of BEM as well as the implementation of the remedial measures imposed on the bank and the action plan adopted by BEM shareholders. It was agreed that the NBM will conduct an on-site audit of BEM based on end-2012 indicators and will communicate its results to IMF staff by mid-February 2013. Furthermore, by end-December 2012, the NBM plans to finalize a contingency plan to be applied in case of further worsening of the situation at the bank.
15. Alongside, the authorities and the mission agree that monitoring and mitigation of financial sector risks in other banks should be strengthened. In particular, on-site supervision should seek to ensure adequate provisioning in banks with rising NPLs and timely unwinding of large exposures to connected borrowers identified in NBM’s off-site analysis of banks’ portfolios. The NBM should closely monitor the sectoral and bank distribution of credit with the view of assessing whether pockets of vulnerability may be emerging. Among other actions:
16. Heavy losses and inefficiencies in many state-owned enterprises (SOEs) underscore the urgency of their restructuring and reducing the state’s presence in the economy. Alongside the plans to continue active privatization of public assets, including through the creation of public-private partnerships, the mission urges the authorities to finalize the long-overdue restructuring plans for a number of large SOEs. In particular, with the privatization advisory work at Moldtelecom completed, it was agreed that the Ministry of Economy should propose by end-2012 a roadmap for introducing private participation in the company and implementing accompanying sector reforms. The mission supports the Government’s plan to adopt a strategic plan for reforming the railway company and a strategy on the privatization of Air Moldova by mid-2013. In close cooperation with the World Bank, the authorities should expedite the implementation of the energy sector restructuring strategy, which aims to reduce costs and raise efficiency in the sector.
17. The authorities and the mission agree that the payment framework in the energy sector requires further strengthening to ensure timely payment of current bills. Substantial progress has been achieved in the course of the program in normalizing the situation in district heating, including by bringing heating tariffs to cost-recovery levels, depoliticizing the tariff-setting process, discouraging disconnections from central heating, and enhancing Termocom’s ability to collect unpaid bills faster. The next step in this process—a government decision enabling reconciliation of individual and collective hot water bills—should be adopted by end-2012. This will eliminate an important source of structural losses for Termocom.
18. Having completed the transition to a system of means-tested social assistance, the authorities are appropriately working to improve its targeting and encourage employment. Specifically, in cooperation with the World Bank, the Ministry of Labor and Social Protection is in the process of revising the eligibility criteria (proxies) for Ajutor Social to ease transition of low-income households from the abolished nominative compensation system. Meanwhile, the Government plans to raise the eligibility criteria for cold-month assistance from 1.4 to 1.6 of guaranteed minimal income (GMI) in 2013. The Ministry of Labor and Social Protection in cooperation with the World Bank intends to complete its analysis and approve an action plan to put other benefits and social payments on a means-tested basis by end-March 2013. And to encourage employment, a draft law allowing local public administrations to engage recipients of social aid in public works is expected to be approved by the Government by end-2012. The mission supports these plans.
19. To boost economic growth and reduce poverty, the new medium-term National Development Strategy (Moldova 2020) should be enacted as soon as possible. The strategy outlines seven priority areas for reforms and development—education, access to financing, road infrastructure, business regulation, energy efficiency, justice system, and social insurance—which will guide the authorities’ reform efforts in the period ahead. Official enactment of the strategy is a necessary condition for completing the sixth reviews of the IMF-supported program.
20. The mission and authorities agree that the policies outlined above are critical to completing the last program review. To allow sufficient time for their implementation, the authorities intend to request a 3-month extension of the program. The mission plans to return to Chişinău in February2013 to review progress and finalize discussions on the completion of the program. This will pave the way for the IMF Executive Board consideration of the final reviews of the arrangements by end-April 2013.
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