Public Information Notice (PIN) No. 12/116
October 1, 2012

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 September 28, 2012, the Executive Board of the
International Monetary Fund (IMF) concluded the
Article IV consultation with the Republic of Moldova
and endorsed the staff appraisal without a meeting.

Background

Moldova’s economy grew by an impressive 14 percent
cumulatively in 2010-11, spurred by booming exports
and domestic demand, recovering external inflows, and
improved policies. Since January 2010, the
authorities’ efforts to restore fiscal, external, and
financial sustainability and promote growth were supported
by two arrangements with the IMF: the Extended Credit
Facility and the Extended Fund Facility, amounting in total
to SDR 369.6 million (US$562.5 million at
present). Five reviews have been completed so far,
releasing SDR 320 million to support the balance
of payments.

Economic activity slowed markedly in early 2012 due to
weakening external conditions and harsh weather conditions,
driving real GDP growth down to 0.8 percent in
H1 2012 relative to a year ago. The slowdown was
reflected in dwindling exports to the EU and domestic
demand in line with weakening remittances. The economy is
expected to pick up in the second half of the year,
supported by resilient conditions in the CIS and investment
in infrastructure. However, a severe drought that has hit
Moldova over the summer and a deterioration of conditions
in the EU could dampen this outlook. Twelve-month inflation
decelerated to 4.4 percent in August, and is expected
to remain anchored around the National Bank of Moldova
(NBM) target of 5 percent during the remainder
of 2012 and 2013.

Fiscal consolidation in 2010-11 has been strong,
bringing the fiscal deficit down to 2.4 percent of GDP
at end-2011. However, revenue shortfalls, due partly to the
slowing economy and partly to increased losses from tax
loopholes and collection problems, and new spending
commitments have slowed down fiscal adjustment. The
authorities have implemented corrective measures to
safeguard the program’s fiscal consolidation objective in
the context of the fifth program reviews.

Monetary policy was eased aggressively in late 2011
and early 2012 in response to the rapidly falling
inflation, supporting credit growth and thus cushioning the
slowing economic activity.

The banking sector is sound overall. Banks have remained
generally liquid, well-capitalized, and profitable,
although their nonperforming loans (NPLs) have risen
somewhat as the economy slowed. The euro area debt crisis
has had little direct effect on the financial system owing
to limited links with banks in affected countries. However,
risky lending practices and poor governance have
significantly weakened the asset portfolio of the
state-controlled Banca de Economii and necessitated a large
increase in provisions. The bank, which accounts for about
13 percent of total assets in the banking sector,
requires urgent measures to repair its balance sheet.

Executive Board Assessment

In concluding the 2012 Article IV consultation
with the Republic of Moldova, Executive Directors endorsed
staff’s appraisal, as follows:

Moldova enjoyed vigorous economic growth in 2010-11,
supported by appropriate macroeconomic policies and
structural reforms. Implementation of the ECF/EFF-supported
program over that period has been strong.

The economy is slowing down in 2012 due to weakening
external conditions, with serious downside risks. GDP is
expected to grow by 3 percent in 2012, and
inflation should settle close to the NBM target of
5 percent. Economic deterioration in the EU could
significantly depress growth. However, with a lower
structural fiscal deficit, improved monetary policy
framework, and an overall sound banking sector, Moldova is
in a much better position to withstand shocks than
in 2009.

The amended 2012 budget puts fiscal consolidation back
on track, while accommodating cyclical effects and
supporting important reforms. Strong corrective measures
have been taken to close tax loopholes and offset
unbudgeted expenditure commitments that emerged in
early 2012. Continued improvements in tax and customs
administration, and reforms in the key areas of the pension
system, education, and public administration will be needed
to maintain fiscal sustainability in the medium term as
foreign assistance declines.

The current monetary stance is consistent with the NBM’s
inflation target, while the conduct of monetary policy
could be honed further. After the aggressive easing in
early 2012, the financial system has all it currently
needs to support credit demand at advantageous interest
rates. Further policy changes could be warranted if the
economic outlook deteriorates or demand-driven inflation
pressures re-emerge. To avoid unnecessary policy
volatility, more weight should be given to demand-driven
core inflation trends relative to supply shocks in
determining the policy stance and in communications with
the public.

The external position of the economy gives rise to some
concerns. The large current account deficit, rising
short-term private debt, and external risks call for
augmentation of the NBM’s international reserves. The real
effective exchange rate is moderately overvalued relative
to underlying fundamentals, although it is expected to
self-correct gradually, in light of falling inflation,
slowing capital inflows, and a higher pace of reserve
accumulation.

Moldova’s financial system is stable overall, but the
deteriorating situation at the majority state-owned Banca
de Economii (BEM) must be promptly addressed. Banks have
generally remained liquid, well-capitalized, and
profitable. Swift legislation amendments to facilitate
owner disclosure requirements and introduce fit and proper
criteria for bank managers and board members would further
strengthen confidence in the banking system. However,
urgent progress is needed to repair BEM’s balance sheet and
improve its risk management. The new management, the Board
of Directors, and the NBM should ensure that BEM cleans up
its portfolio, quickly disposes of foreclosed collateral,
and ends its risky lending practices before seeking
recapitalization.

The authorities’ efforts to improve the business climate
and promote exports have been productive, but important
challenges lie ahead. Wide-ranging structural reforms have
enhanced competitiveness and fostered investment. However,
further improvements in several key areas, including
protection of property rights, a transparent and stable
policy environment, effective governance, and a reliable
judicial system, are essential to attract investors.

A decisive energy sector reform should finally commence.
The authorities should persevere with establishing payment
discipline among both households and public entities, and
implement their energy sector restructuring strategy to
reduce losses and resolve historic arrears.

Staff recommends completion of the fifth reviews and
approval of the requests for a waiver of non-observance of
the end-March 2012 performance criterion (PC) on the
general government budget deficit and modifications of the
end-September 2012 PCs on the general government
budget deficit, the NBM’s net domestic assets, and net
international reserves. Program implementation has been
generally good. The authorities maintain the commitment and
the capacity to implement their Fund-supported program. The
slippages in early 2012 have been adequately
addressed, and the policies planned for the remainder
of 2012 and beyond, including the requested new
targets, support the program’s objectives. The capacity to
repay the Fund remains strong.