Moldova's new government gets good marks for anti-crisis reforms

By bne IntelliNews February 22, 2010

Graham Stack in Kyiv -

Moldova has had a good crisis politically, but there is still turbulence ahead in 2010.

The crisis may have come at the right time for Moldova. It helped unseat a stagnating Communist Party administration led by the then-president Vladimir Voronin and gave the incoming government of Prime Minister Vlad Filat a mandate for reforms urgently needed for long-term development. Now, the small republic has signed off on a $574m International Monetary Fund (IMF) package that should shore up its economy in 2010.

Like the rest of the countries in the region, Moldova grew and grew through most of the noughties - mostly due to booming consumption, though not fuelled by cheap credit as much as by employment abroad. From 2000-2008, growth averaged 6%, poverty fell impressively and remittances from Moldovans working abroad hit 30% of GDP in 2008.

After a brief reform bout at the start of the decade, this easy growth led to a slackening of the reform drive and the economy remained overregulated, hampered in particular by price distortions, and unable to create new jobs. The crisis exposed the country's vulnerability, with remittances falling by 40% in 2009. As a result, GDP collapsed by 8.5% in 2009 and household consumption by around 12%. Meanwhile, a bitter election campaign resulting in a hung parliament after disputed elections in April, then rerun in July, meant meaningful steps to counter the global economic crisis were delayed in favour of populist spending by the then governing Communist Party.

This meant that when the new government under PM Filat finally took office in September, the budget deficit was set to hit 16% of GDP. But the Communists were replaced by the right people at the right time - Filat headed a liberal reforming coalition called Alliance for European Integration, favoured by the urban population, and who had a mandate to push on with market changes. "The government has pursued the right policies," says Valeriu Prohnitchi, director of Chisinau's Expert Group. "They have done what could be done rapidly, dismantling trade barriers, liberalizing markets such as the meat market by removing price controls. They froze salary increases for state employees, which was a difficult, but correct, choice. They raised public services prices to reach cost-recovery level, and the National Bank has switched to inflation targeting."

As result of these measures, the government managed to cut the budget deficit for 2009 to 7.8%, and this is due to fall to 7% in 2010. Moreover, there have been important institutional reforms that should bring lasting improvements. For instance, authority for setting energy prices has been passed to an independent regulatory agency.

All this has ticked the right boxes with international financial organisations. "In my view, the government has reacted quickly to respond to the crisis. The results have been impressive but, of course, there is still much to be done," Melanie Marlett, the World Bank's country manager for Moldova, says on her website.

Moldova has also made some important gains in terms of European and international integration. On January 12, the government initiated negotiations with the EU on a new Cooperation Agreement. On January 22, Filat signed the $262m Millennnium Challenge Corporation Compact with US Secretary of State Hillary Clinton. And on January 29, the IMF board approved a $574m program of support. "The IMF aid is crucial, because without it Moldova would have defaulted. It also gave a positive signal to other investors," says Prohnitchi.

Bumps in the road

The outlook for 2010 is still cloudy. Besides remittances from abroad, Moldova's economy has traditionally been dependent on wine exports to Russia. These were cut off in 2006 for political reasons, and though the informal embargo was lifted in 2008, much will depend on how quickly exports recover this year. "Wine exports will also be critical, but there is now a lot of bureaucracy in place, and the new customs union (between Russia, Belarus and Kazakhstan) interrupted wine exports at the start of this year," says Prohnitchi. "But some of our wine producers are diversifying to western markets."

The outlook for remittances is also unclear. Migrants have not, as was feared, come flooding back. Instead, they cut the amount of money they sent home. Recovery in the host European countries would allow remittances to bounce back up, though Moldovan migrants are concentrated in the South European economies of the so-called PIGS - Portugal, Italy, Greece and Spain - as well as in Russia. The PIGS are currently under pressure from spiralling budget deficits and debt burdens.

Another cloud on the horizon, says Anatol Gremalschi of the Moldovan think-tank Institute for Public Policy, are rising prices for Russian gas, which are scheduled to reach European levels by 2011.

Prohnitchi concludes that while there are some signs of the economy bottoming out, the long-term picture is unclear. "There are many risks depending on foreign markets. If the crisis worsens or stays the same there, Moldova will suffer. Our prognosis for 2010 is 1.5% growth, although the [European Bank of Reconstruction and Development] has forecast 4%," he says.

Furthermore, while the government has done good work, political instability may undermine progress in 2010, according to Gremalschi. Moldova remains locked in a constitutional crisis without an elected president since July. Moldova's unique constitution sees the president elected by a three-fifths majority of the unicameral parliament. But the governing liberal coalition falls one MP short of the 61 votes needed, and the now-oppositional Communists have refused to compromise on a candidate. Moldova thus has only an acting president, Mihai Ghimpu, whose day job is speaker of parliament. Various projects have been mooted to change the constitution, but none seem viable. "This means that we are condemned to have parliamentary elections again in 2010," says Gremalschi, "but no one knows when."

The risk for the current government is that a backlash against unpopular, but necessary, budget reductions and price liberalization, could cause them to lose votes at the parliamentary elections later this year. "People see the new alliance, and see the new prices," sighs Gremalschi. "It's a natural reaction."

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