Romania’s President Klaus Iohannis returned a bill on the ratification of a €150mn loan to Moldova to the parliament on November 9. The loan agreement is “not appropriate” as long as there are no guarantees that reforms in Moldova will continue, a note from the presidency explained.

The loan is urgently needed in Moldova, where public financing is scarce and costly. The country’s foreign development partners froze their financing in the first half of this year due to the ongoing political uncertainty. This worsened after the latest government collapse in October - the second since the November 2014 elections.

Iohannis stressed in a post on his Facebook page that the decision to return the bill to parliament did not mean Romania is backing away from supporting Moldova. It is only a legal procedure to defer the loan until the political situation in Chisinau - where a new government is being formed - is clarified, Iohannis wrote. However, he also implied that the loan will depend on Chisinau’s commitment to European integration.

Romania and Moldova signed the agreement on the €150mn loan in Chisinau on October 7. Both the Romanian senate and the Chamber of Deputies have already passed the bill on the ratification of the loan agreement.

However, on October 29 Moldovan Prime Minister Valeriu Strelet was ousted in a no-confidence vote and a new government has not yet been formed.

After a week of negotiations, the pro-EU Democratic Party (PD) has so far failed to form a new ruling coalition, which makes it less likely that Moldova will quickly appoint a new government. It is unclear whether the new government will be pro-EU.

Romania is also in the process of forming a new government after Prime Minister Victor Ponta, who signed the agreement with Strelet, and his cabinet resigned in November.

The loan is equivalent to 2.8% of Moldova’s GDP and will be extended in tranches, with a €60mn transfer to be made immediately after the law is ratified.

Moldova had expected the first tranche with no prior conditions, while the other tranches were to be conditional on reforms. However, under the current circumstances, Romanian lawmakers might consider adjusting the agreement, for example by making the first instalment dependent on certain achievements – such as the formation of a ruling coalition that supports the country’s international agreements and its commitments to European integration.

Under parliamentary procedures, lawmakers have to decide on the bill within 30 days, after which the president has to endorse it irrespective of its final form.

Currently, Moldova runs a narrow fiscal deficit, of 0.73% of GDP in January-September. The Treasury has to accept yields of up to 25% on domestic public debt issues, and international development funding has been suspended since early this year.

Budget constraints tightened in Q3, as growth turned negative, and might become problematic after the government adds the losses from three troubled banks currently under central bank administration to the public debt. The economy's recovery in 2016, after the expected 2% year-on-year decline this year, critically depends on external financing.

General government budget revenues contracted by a nominal 4.9% year-on-year in July-September, after a 10.3% expansion in the first half of the year. The government was able to cut planned expenditures in line with revenues. However, a further drop in revenues and the rising cost of servicing public debt might put pressure on core public spending including pensions and public sector wages.

Moldova’s government will convert into public debt the MDL14bn (€625mn) emergency aid extended by the central bank to the three troubled banks, Finance Minister Anatol Arapu confirmed on October 28 according to jurnal.md. The debt will be financed by issuing government bonds.

Moldova’s public debt amounted to 28.4% of GDP at the end of September. Of this total, 5.7% of GDP was domestic public debt and 22.7% of GDP was external public debt. The new bonds will triple domestic public debt while bringing overall public debt close to 40% of GDP.