Public Information Notice No. 02/93

Public Information Notice: IMF Concludes 2002 Article IV Consultation with the Republic of Moldova

August 26, 2002

On July 10, 2002 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Moldova.¹

Background

After many years of decline, economic activity has turned around. Boosted by a good harvest and continued industrial growth, real GDP increased by 6 percent in 2001, up from 2 percent in 2000. At the same time, end-of-period inflation was cut to 6½ percent in 2001 from 18½ percent in 2000. These developments, which continued through the first quarter of 2002, reflected sound financial policies and a revival in external demand for exports. Nevertheless, Moldova remains one of the poorest countries in the region.

Fiscal policy was tightened markedly following the 1998 Russian crisis. The general government commitments deficit (excluding project loans) was cut to 2½ percent of GDP in 1999 from 8½ in 1998, and narrowed further to less than 1 percent in 2000. A surplus of ½ percent of GDP was achieved in 2001 mainly through a sharp compression of expenditures, and domestic arrears were not cleared as fast as expected. Low foreign financing led to budget sequestration and accumulation of new external arrears during the second half of the year. The budget continued to record a small surplus in the first quarter of 2002, but unbudgeted wages for social sector employees contributed to weaken the fiscal program.

With inflation receding, money demand recovered steadily in 2000-01. Broad money (including foreign currency deposits) grew by 40 percent in 2000 and 36 percent in 2001, resulting in some financial deepening. The rapid growth of deposits allowed a sharp expansion in bank credit to the economy. For the first time in several years, credit grew by 18 percent in real terms in 2000, and 27 percent in 2001. Although the average lending rate stood as high as 25 percent in April 2002, banks apparently had difficulties in finding additional lending opportunities with an acceptable risk-return profile. Ample liquidity in commercial banks enabled the government to lengthen the average maturity of newly issued treasury bills at interest rates as low as 4 percent in May 2002.

From end-2000 to end-March 2002, the Moldovan leu depreciated by 9 percent in real terms relative to Moldova's trading partners. The recent strong performance of exports suggests that the level of the real exchange rate has been broadly adequate for maintaining competitiveness. At end-March 2002, the National Band of Moldova's (NBM) gross international reserves stood at US$223 million (2½ months of imports), broadly unchanged from the end-2000 level, despite dwindling external financing flows, lower-than-expected privatization proceeds, and sizable external debt service payments. A sharp increase in earnings of Moldovans working abroad to about US$221 million allowed the NBM to purchase substantial amounts of foreign exchange without putting pressure on the exchange rate and contributed to a narrowing of the current account deficit to 7½ percent in 2001 from 8½ percent of GDP in 2000. Exports also increased in 2001 by around 19 percent in dollar terms. Moldova joined the World Trade Organization in mid-2001.

Moldova's public and publicly-guaranteed external debt contracted to $940 million in 2001, reflecting a drop in new disbursements, including by IFIs. In terms of GDP, the external debt burden eased to 58 percent, from 69 percent in 2000. Negotiations for more favorable terms on Moldova's commercial debt (outstanding amounts of the 1997 Eurobond and Gazprom notes) are under way.

Progress on structural reforms was slow in 2001, partly due to the change in government early in the year. In early 2002, however, structural reforms received a major impetus with the agreement between the authorities and the World Bank on a structural adjustment credit (SAC-III). The government has begun to implement a wide range of measures aiming at reducing poverty and improving the business environment, including through agricultural reforms and privatization.

In late 2001, Moldova adopted two laws to combat money laundering and the financing of terrorism.

Executive Board Assessment

Executive Directors noted that monetary and fiscal policies have remained sound since the 1998 crisis, and that it is now crucial to promote structural reforms more vigorously to achieve sustainable growth. They therefore welcomed the regained momentum of structural reforms that has occurred in the context of the SAC III negotiations with the World Bank.

Directors noted that the budgetary position remains vulnerable, although fiscal policy has been prudent. They urged the authorities to keep policy tight, and undertake the fiscal reforms necessary to put the budget position on a sustainable footing. Directors cautioned that improvements in tax collection, in addition to lower domestic interest payments, will be needed to support the projected level of non-interest expenditures in 2002. They called on the authorities to refrain from tax rate cuts without prior identification of offsetting measures. Directors expressed concern that expenditure arrears have again started to edge up since late 2001, although these arrears declined during the first five months of 2002. They also stressed that the unbudgeted wage hikes for social sector workers would need to be accommodated within the programmed spending envelope.

Directors supported the NBM's continued tight monetary policy in support of price and exchange rate stability. They noted that the exchange rate has been broadly stable and money demand has strengthened—reflecting lower inflation, the resumption of growth, and some financial deepening. They agreed that a floating exchange rate regime continues to be appropriate for Moldova, given the country's vulnerability to external shocks, and they recommended that the NBM limit its interventions in the foreign exchange market to smoothing sharp exchange rate fluctuations. Directors commended the NBM for its resolve in enforcing prudential regulations and ensuring a sound banking system, especially through raising capital requirement standards and addressing the issue of non-performing loans.

Directors noted that exports still have not regained their pre-1998 level, in spite of the recent recovery. They were particularly concerned that trade diversification remains limited, and that access to key export markets is constrained. Directors encouraged the authorities to resist incipient pressure for protectionist measures and maintain the current liberal trade regime; they underscored that any contingent protection should be strictly in line with WTO provisions.

Directors were concerned about Moldova's heavy external debt burden and emphasized that financial support from the international community—including the private sector—is essential for the success of Moldova's economic program and the sustainability of its external position. In this regard, they were encouraged that the authorities are negotiating actively with holders of the Eurobond and Gazprom notes to reach a mutually satisfactory agreement on the rescheduling of these instruments. Nevertheless, given the structure of Moldova's external debt, Directors stressed that the main impetus toward achieving external sustainability—and fully normalizing relations with creditors—should come from strengthening the fiscal accounts and improving debt management and economic performance in general.

Directors welcomed the recent adoption of several laws that would strengthen the institutional infrastructure for a market-based economy, including the insolvency law and the civil code. They urged the authorities to persevere with structural reforms in other key areas, including privatization, and to improve the business environment for foreign as well as domestic investors. Directors welcomed the recent strengthening of the legal basis for combating money laundering and the financing of terrorism.