IMF Executive Board Concludes 2007 Article IV Consultation with the Republic of MoldovaPublic Information Notice (PIN) No. 08/37
March 18, 2008
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On March 12, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Moldova.1
Moldova is doing well, despite a series of consecutive shocks, which included the doubling of the price of imported natural gas and Russia's ban on imports of Moldovan wine in 2006, and a severe drought in 2007. Growth is estimated at 5 percent in 2007 and is projected to increase to 7 percent in 2008. Investment is picking up, and is beginning to replace remittances as the main source of growth—an encouraging sign that the earlier model of consumption-driven growth is changing.
Moldova increasingly faces the challenges experienced by other transition economies. Improved growth prospects have come with strong appreciation pressures from foreign exchange inflows, and a widening trade deficit. Foreign direct investment (FDI) has picked up and is estimated to have reached 12 percent of GDP in 2007, compared with 7 percent in 2006.
The main macroeconomic concern is inflation, which at 13 percent remains high for the region.
A deterioration in the merchandise trade balance due to strong import growth has been offset by improvements in net income and transfers, with a small improvement in the current account deficit to 12 percent of GDP. A resumption of wine exports to Russia in October was a major positive development, although volumes are likely to recover slowly.
Fiscal policy remained tight, ending 2007 with a modest deficit of 0.3 percent of GDP. Strong revenue performance was driven by robust VAT on imports, while expenditure was kept in line with the budget. However, the tax cuts introduced in 2008 may undermine the favorable fiscal position.
Monetary tightening in 2007 was complicated by the strong inflow of foreign exchange. The National Bank of Moldova increased reserve requirements from 10 to 15 percent, and raised policy interest rates by 2.5 percentage points. Nevertheless, the possibility of second-round effects from the drought, liquidity pressures from growing remittances and FDI, and the continued strong growth in credit and broad money suggest that upside risks to inflation are not yet fully contained.
Executive Board Assessment
Executive Directors welcomed the improved growth prospects and decline in poverty in Moldova, and commended the authorities for their reform efforts and balanced macroeconomic policies. Developments in Moldova appear to mirror increasingly those in other transition economies, with large capital inflows, appreciation pressures on the national currency, and a widening trade deficit. Directors underscored the importance of maintaining macroeconomic stability and improving the business environment to support private sector development and to help reverse the emigration of labor.
Directors considered that inflation remains high relative to that in other countries in the region, even after accounting for the drought. They cautioned that with strong foreign exchange inflows and rapid credit and reserve money growth, upside risks to inflation remain. The recent monetary tightening by the National Bank of Moldova (NBM) was welcomed, as was its commitment to establish price stability as its sole monetary policy objective. Directors noted that with considerably lower labor costs and higher productivity growth in Moldova compared to the region, there is scope for further exchange rate appreciation without undermining competitiveness. They urged the central bank to allow greater exchange rate flexibility.
Directors commended the authorities for their disciplined fiscal policies. Modest deficits are an appropriate compromise to balance development and disinflation objectives. Directors welcomed the authorities' efforts to strengthen tax administration and to increase social and investment spending, while maintaining the deficit target. At the same time, they stressed that the budget should remain tight until low single-digit inflation is firmly reestablished, and that any spending related to potential overperformance on the revenue side should be conditional on achieving the inflation objective.
Directors welcomed the authorities' plans for reducing the size of the public sector, introducing a transparent and competitive remuneration system for the public service, and consolidating education and health care networks. These were seen as important steps toward a leaner government structure to ensure efficient management of scarce public resources, and to allow more room for pro-poor and pro-growth spending.
Directors welcomed the authorities' commitment to bolster structural reforms aimed at improving the investment climate and clarifying the role of the state in the economy. They were particularly encouraged by the efforts to streamline the business licensing and registration procedures, to improve the transparency of regulatory agencies and reduce red tape, and to strengthen bankruptcy procedures and competition legislation. Directors supported the government's decision to revitalize the privatization process, including the intention to sell remaining large state enterprises, which would help to reduce the weight of the state in the economy and provide a catalyst for private sector growth.
Directors considered modernization of the energy sector as a high priority. They welcomed the strengthened independence of the energy regulator and establishment of heat tariffs at a cost recovery level, which will be critical for the financial viability of the utilities. At the same time, they stressed that timely introduction of a new targeted social assistance scheme will be essential to ease the burden of higher tariffs on the poor.
Directors noted that the financial sector is stable, and urged the authorities to be vigilant in addressing the remaining vulnerabilities in the sector. Strengthening the supervisory and regulatory framework and increasing the transparency of bank ownership will be crucial to ensure the soundness of the banking system. Directors welcomed the authorities' efforts to accelerate privatization of Banca de Economii, which will help to enhance competition in the banking sector and attract additional banking expertise. They urged the authorities to ensure that the new Anti-Money Laundering/Combating the Financing of Terrorism law is implemented effectively.