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 Moldova Growing Strongly Despite Rising Risks

  IMF Survey online - February 10, 2012

  • Moldova's economy continues to grow strongly, but risks are looming
  • Restoring fiscal sustainability remains key
  • More investment and structural reforms needed to raise long-term growth

Located between Romania to the west and Ukraine to the north, east, and south, Moldova has quietly and steadily been implementing a series of economic reforms, supported by a 3-year program under the IMF’s Extended Credit Facility.

The country, which aspires to deeper integration with the European Union (EU), has been growing strongly for the past two years but is now faced with increasing risks, in part because of the slowing world economy and the ongoing crisis in the eurozone, in part because reforms now need to be taken to the next level.

In an interview, Nikolay Gueorguiev, IMF mission chief, discusses Moldova’s progress and looks at what further reforms are needed to maintain stability and foster balanced and inclusive growth.

IMF Survey Online: Moldova managed to grow by 6 percent in 2011 after growing by more than 7 percent in 2010. What explains this strong performance?

Gueorguiev: The economy performed strongly for a second year in a row thanks in large measure to the government’s successful policies to stabilize the economy and improve the business climate. Private consumption, investment, and exports expanded strongly. Exports, in particular, rose by over 40 percent in 2011 compared to a year ago, aided by new production capacity and improved market access to the EU and the Commonwealth of Independent States. Unemployment also came down and now stands at 5-6 percent, the lowest level since 2008.

IMF Survey Online: What are the main objectives of the IMF-supported program and what has been achieved so far?

Gueorguiev: The program, which was approved in early 2010, has four main objectives. First, restore fiscal sustainability while at the same time raise funds for investment and targeted social assistance. Second, keep inflation under control and rebuild international reserves to cushion the economy from external shocks. Third, maintain financial stability by strengthening the framework for supervising banks. And, last but not least, improve the economy’s ability to grow through structural reforms.

The results achieved so far are very good. The budget deficit has declined by two-thirds since 2009, largely because of a reduction in government spending by over 6 percentage points of GDP. At the same time, public investment has increased by nearly 20 percent in real terms. Spending on programs for social assistance has also been increased considerably.

The National Bank of Moldova’s new inflation targeting framework has strengthened its ability to control inflation. After years of double-digit inflation, it fell to about 8 percent in 2010–11. The central bank’s vigilant supervision and strong regulatory framework made it possible to detect problems at an early stage in a few banks and take swift action. Moreover, gross international reserves reached $2 billion, a historic high.

Yet more remains to be done. First, the government must complete the process of fiscal consolidation. The budget deficit is expected to fall below 1 percent of GDP by the time the IMF-supported program winds down. The plan is also to bring down inflation even further––close to the central bank’s target of 5 percent––by strengthening the inflation targeting framework. Finally, more work needs to be done to facilitate restructuring of nonperforming bank loans and improve transparency regarding bank ownership.

IMF Survey Online: What are the potential downside risks for Moldova in 2012, especially given the worrying developments in the global economy?

Gueorguiev: The main risk stems from a possible further deterioration of the global outlook. For example, a deep recession in the EU spilling over to Russia and Ukraine could push Moldova into a recession through plummeting remittances, exports, and private capital inflows. That would put pressure on the budget and possibly on the banks if borrowers start falling behind on their loans.

That said, the authorities have built comfortable buffers in the past two years, with higher foreign exchange reserves, a low budget deficit, and high bank capital and liquidity indicators. Together with renewed access to official external financing, these buffers can help cushion shocks to the economy.

IMF Survey online: An ambitious reform agenda that includes education and social welfare reform will help the government balance its budget. But are the most vulnerable groups in society being protected?

Gueorguiev: Yes, the IMF-supported program does aim to protect the most vulnerable. In close collaboration with World Bank experts, the program envisages a gradual transition from the old planned-economy system of social benefits—based on categories of citizens, regardless of their income or assets—to targeted, means-tested benefits. Through a gradual transition, including a partial overlap between the two systems, we make sure that no one in need of social assistance is neglected.

In the education sector, reforms are needed to improve quality and reduce unaffordable cost. Moldova spends 9 percent of GDP on education, almost twice the regional average. A large fraction of this spending is wasted on empty schools and small classes―in some cases, with only 5–6 students. Apart from reducing costs by half a percentage point of GDP a year, the reform will also improve the quality of education by channeling more funds to larger schools.

IMF Survey online: Moldova’s banking system is generally sound, but fraudulent takeover attempts of Moldovan banks have raised concern about financial regulation and supervision. What is the IMF advising?

Gueorguiev: In the summer of 2011, anonymous plotters were able to transfer significant share packages from other private shareholders. In response to these incidents, the authorities have enacted a number of amendments to Moldova’s legal and regulatory framework that should help prevent similar attempts in the future. Further work to strengthen disclosure of bank owners, review suitable criteria for shareholders, and impose more effective sanctions is ongoing, aided by technical assistance from the IMF.

IMF Survey Online: The government is proposing to increase GDP growth by 12 percentage points and reduce poverty to less than 15 percent of the population by 2012. Are these goals achievable?

Gueorguiev: Definitely. The new National Development Strategy covering the period 2012–2020 replaces the previous strategy that expired at the end of last year. The main goal is to complete Moldova’s transformation into a fully functioning market economy.

As for the poverty rate and other Millennium Development Goals, Moldova has already met most of the intermediate 2010 targets. The 2015 Millennium Development Goals are certainly within reach, provided the strategy is successfully implemented.