Moldova & IMF IMF Activities Publications Press Releases

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"Logos Press" Weekly Economic Magazine
No. 36 - October 5, 2007


On September, 26th the Administration Board of the National Bank of Moldova has made a decision to raise the base rate by 2.5 percentage points, from 13.5 up to 16.0 percent.

The statement of NBM press-service says: the base rate was increased because of the concern about the prospects on maintaining inflation under 10% by end-2007 and reflects the intention of the central bank to use all tools available at its order to ensure price stability.

The progress in reducing inflation achieved in the first half of year, the press release says, has been hampered by the consequences of the drought, which has led to a significant rise in food prices, as well as to a significant growth of inflationary expectations due to the same factor.

Besides, this year an essential growth of remittances has been registered and the National Bank of Moldova had to purchase currency actively, which has determined the non-compliance with a number of established monetary indicators. The situation was also affected to a certain level by the growth of lending/credits to the economy of Republic Moldova, in particular lending/credits in hard currency.

The increase of the base interest rate has complemented the recent decision of NBM Administration Board to increase gradually the level of mandatory currency reserves of commercial banks by 5 percentage points.

"The undertaken actions aim at weakening inflationary pressures and to determine the decrease of the inflation rate down to the agreed levels", specifies the NBM press release.

We have asked the NBM’s First Vicegovernor, Mr. Victor CIBOTARU, to comment on these decisions and to tell us about prospects:

- Till last year the primary goal of the National Bank of Moldova was to maintain the exchange rate stability. But, bearing in mind the world experience that has proven to be appropriate in most developed countries, the priority goal has changed. According to the amended NBM Law, the primary goal of NMB now is maintaining price stability.

The theories applied by monetary authorities in many countries are based on the belief that a low stable rate of inflation promotes long-term development of economy. The current goal of the National Bank of Moldova is to achieve an one-digit annual growth of inflation in the country. Also, the evolution of inflation should be even, without significant fluctuations.

Why is high inflation "bad"? It is known that first of all inflation "eats up" the budgets of poor people. But also, by and large, it also does not benefit the solvent population. Any momentary "prize" from the upsurge of inflation in most cases turns into a "loss" in the long term. When inflation develops at uncontrollable rates, it destabilizes the situation in the commodity and monetary markets, and, thus, leads to significant growth of risks. Once inflation grows, the population’s interest to save decreases, interest rates grow, investment opportunities worsen. Still, without investments into economy there are no chances for strong long-term development. A low stable rate of inflation creates conditions for investments and for stable inflow of capital to the promising branches of economy, for the development of infrastructure, for projects which have long-term positive consequences for the economy.

It is a rather popular belief that inflation in Moldova has "non-monetary origin", that is, is caused by a rise in prices on the imported goods, drought, inflows of foreign currency to the country... To put it briefly, they talk about reasons outside the sphere of the control of monetary authorities. Consequently, the National Bank of Moldova cannot and should not fight inflation.

To answer the promoters of such point of view, it is necessary to tell: in the long-term inflation always has monetary character. The reason is that, ultimately, the price level depends on the growth or decrease of the money supply. However, it is necessary to understand that inflation is a change of the general price level rather than of separately taken prices for concrete goods or even groups of goods.

When we consider the short-term period, non-monetary factors can and do affect the price level. They can accelerate or, on the contrary, slow down inflation. This was the case with the growth of prices for energy resources or the prices for specific food items. Certainly, they cannot be regulated NBM. But, as a rule, non-monetary factors influencing inflation have no constant character. For instance, this year we had, while next year it is possible that the harvest will be pretty good. Also, it is necessary to take into consideration, that due to the modern development of foreign trade prices in the home market, including in our country, are rather strongly connected with the situation in the international markets.

Speaking about non-monetary factors that influence the price level in the home market, I would like to draw one’s attention that one of the most essential of them is the "inflationary expectations" factor. Edmund Felps, an American economist, and a Nobel prize winner in 2006, has said: "Inflationary expectations generate inflation". The expectations of market participants – the whole range of them - influence significantly the situation in the market. If the level of inflationary expectations raises people spend money easily. Due to this, "the money supply" grows, which determines the price level for the current period.

The central bank of any country can influence the "monetary expectations" factor only indirectly. And I am going to tell more about it a bit later.

During the last four years inflation in Moldova has been balancing between 10 and 15 percent. Since October last year, due to the sustained actions of NBM, inflation has been decreasing constantly. Until June this year. In July and August the statistics has registered appreciable enough jump of inflation. For two months inflation in annual calculation has increased for 3,1 percentage items, up to 13,5 %. Due to this, NBM had to undertake a number of needed measures, to stabilize the inflation rate and reduce inflationary expectations.

Were NBM’s actions an "intervention"? Both yes and no. "Yes" in sense of general influence on the situation in the monetary market. "No in the sense of intervention to establish concrete prices for concrete goods and services in the market. The overall objective of the increase of the base rate and of the requirements on the banks’ mandatory reserves is the necessity to carry out additional withdrawals of excessive liquidity from the market, that, in turn, will lower the monetary supply and, accordingly, the inflation rates. As for the question whether the NBM’s base rate increase will affect the banks’ interest rates, it is possible to answer unequivocally that there is no direct correlation dependence between them, since currently NBM does not lend to banks; quite the opposite, it withdraws from them the "excessive liquidity".

Now we continue to monitor actively the situation and we will, of course, trace the consequences of our recent decisions on the increase of the banks’ mandatory reserves in foreign currency, as well as on the increase of the NBM’s base interest rate. Today NBM works systematically to enhance its ability to analyze and to foresee in a timely manner the possible variants of development of the situation. Unfortunately, while we do not have the means to trace changes in the inflation rate at least every ten days and we have to operate with the data provided by the National Bureau of Statistics, i.e. end-of-month data.

With the purpose to find the most effective and adequate tools of influencing the inflationary processes adequate for the level of our economy, the NBM experts have studied thoroughly foreign experience. Literally last week and IMF technical mission has finished its work. We have had a very useful exchange of opinions about its outcomes. In particular, the mission members - two members of staff of the central Bank of the Czech Republic - have told us about their experience of decreasing the inflation rate and its stabilization in their country, which have been going through a similar period of development seven-eight years ago.

By and large, NBM does not invent anything new. The path we are starting to follow now has been taken by many before us, including the countries of the Central and Eastern Europe. The base interest rate increase is not an end in itself, but rather a necessary condition for the decrease in inflation and, thus, for the establishment of stable low interest rates which will ensure access to credit resources to a broad range of borrowers, including small and medium-size businesses.

Alexander TAKII