The Moldovan economy faced an unprecedented mix of crises in 2022, but thanks to proper crisis management and external support it entered 2023 stronger and with good prospects for a speedy recovery. Stagflation, on the background of the energy crisis, draught and war in Ukraine, called for unprecedented and rapid policy responses. Thus, within months, the Government adopted a series of bold policy measures that contained the shocks. In order to support the demand amid the unprecedented increase in energy tariffs, it was introduced the mechanism of compensation to cover part of the energy tariffs for households; in order to support the businesses, it was increased the capitalization of the programs implemented by the Organization for Entrepreneurship Development; in order to address the energy crisis, for the first time in the history of Moldova, alternative sources of natural gas and electricity were used and natural gas has been stored as measures to increase energy security; in order to support the budget stability, the government switched to financing the budgetary deficit, primarily, from external sources, which were available due to the generous support from development partners. At the same time, the macro-financial stability was preserved, due to a prudential monetary, foreign exchange and regulatory policy, which kept the national currency stable, the banking sector well capitalized and robust and that allowed inflation to start decelerating by the end of 2022. 

The effects of Russian aggression in Ukraine, the energy crisis, persistent inflation and drought have put firms under severe cost and competitiveness pressures. As a result, 2022 brought an economic downturn of 5.9%, with the economic sectors most affected being agriculture, construction, real estate and industry. The main challenges for firms were related to: (i) the loss of markets and suppliers in Russia, Ukraine and Belarus, (ii) the need to rebuild many logistics routes with the loss of access to the port of Odessa, (iii) the substantial increase in transport and logistics costs as Moldova became a major transit point for goods to and from Ukraine, (iv) higher costs for energy resources, (v) more expensive financing because of monetary policy tightening, and (vi) lower sales on the domestic market because of erosion of the purchasing power of the population.

The economic outlook for the coming years is marked by historic opportunities, but also risks. The baseline scenario of the current forecast horizon is based on an economic recovery in 2023 of 4.7% and economic growth in the following years (5.4% in 2024 and a growth corridor of 4-5% in 2025-2027). For the coming years, the main assumptions considered for economic growth are the stabilization of the security situation in the region, the improvement of energy and mobility connectivity with Romania and the start of EU accession negotiations. The materialization of these opportunities can create an enormous synergy effect for attracting investment and modernizing the country. At the same time, risks remain an important variable and these include the risk of escalation of the war in Ukraine, volatility in the energy market, a global recession, hybrid threats from the Russian Federation, but also the behavior of policy makers and currently limited administrative capacities. 

In the structure of the population's income, the share of labour earnings is increasing, while the role of remittances is decreasing, although they continue to play an important role. Between 2012 and 2022, the ratio of remittance inflows to GDP decreased from 21% to 13.8%. Additionally, the share of remittances in disposable income has fallen from 16% to 12%. During the same period, the share of labour earnings increased by 8 p.p., from 42.7% to 50.7%. In the medium term, income growth will be supported by an increase in labour earnings. In addition to economic growth, the increase in salaries will be driven by the mismatch between labour supply and demand. In order to attract qualified employees, firms will be forced to increase labour costs.

The mismatch between labour demand and supply may favor labour earnings’ growth for a certain period, but in the long term, it is necessary to increase labour productivity. The labour supply in Moldova is largely provided by unskilled workers. In this context, increases in labour earnings in the Republic of Moldova will lead businesses to shift towards other markets where unskilled labour is cheaper or to automate their activities. To ensure decent wages and salaries in the long term, it is necessary to increase labour productivity, by reforming the tertiary education and the research sector, and improving the investment climate. 

For 2023, maintaining fiscal sustainability will continue to be challenged by the regional context that still fuels uncertainty. The Government has already committed a substantial deficit for 2023 (6% of the GDP), resulting from a budget construction aiming to sustain critical social and economic priorities. The higher planned expenditures are not accompanied by commensurate revenue increases, therefore further war spillovers or other shocks could pose additional risks to the budget. For the next period, the fiscal policy tends, on the one side to ensure sufficient liquidity for SMEs and stimulate private investments, while on another, focuses on strengthening fiscal discipline in a manner that will boost revenue mobilization and reduce the shadow economy.

Moldova should seize the opportunity offered by its EU candidate status and capitalize on the openness shown by the development partners. In the short and medium term, the fiscal space remains limited, being estimated at around 1.5% of GDP. Securing additional grants and concessional financing from donors and creditors will remain an important requisite for funding new policy initiatives and new public investment projects. The credibility and predictability that the EU candidate country status offers to the Republic, will further mobilize financial assistance. However, this background also sheds light on the current problems related to the limited capacity of authorities to assimilate foreign assistance. Thus, issues related to strategic planning, correlation of foreign assistance with development needs, management, and implementation of capital investment projects should be eliminated.

The Moldovan banks entered the crisis of 2022 well capitalized and prepared to bear such shocks, given the strengthening of the regulatory framework and improving banks’ governance after the banking crisis of 2015. As a result, the banking sector proved to be robust to the shocks of 2022, emerging more resilient from the crisis, with improved liquidity and capital adequacy indicators. The credit risk, which significantly increased in 2022 given the economic recession, inflation and uncertainty around the war in Ukraine, has been adequately managed by banks. The share of non-performing loans (NPL) remained relatively low (lower compared to the pre-pandemic period), suggesting an adequate quality of the banks’ loan portfolios. This is reinforced by comfortable liquidity and capital adequacy indicators, which, despite the shocks, remained at comfortable levels. Also, all liquidity indicators remained in the safe zone, in much better situation compared to the regulatory requirements. These indicators suggest that the banking system not only overcame well the crisis of 2022, but emerged even stronger from it, being well-capitalized, with sufficient liquidities, which can support the economic recovery of 2023-2024. 

The banks remained profitable during the crisis, despite shrinking interest margin. The monetary policy tightening had a much stronger effect on the interest rates of deposits compared to credits, leading to a shrinking interest margin. However, it did not undermine the profitability indicators of banks because, while the average interest rate on deposits increased, the share of long-term deposits in total bank deposits, which bear the highest interest rates, decreased. It complicated the historical structural issue of maturity mismatch of liquidities of Moldovan banks, because of high uncertainty around the economic and security situation of the country that the owners of deposits to increase their liquidity by switching to shorter-term deposits. Another important factor was the increase in interest rates on state securities and NBM certificates after the monetary policy tightening that supported the profitability of banks. 

The high liquidity and capitalization of the banking sector, along with monetary policy easing and improving inflationary dynamics will lay the ground for a robust economic recovery in 2023-2024. Assuming that in 2023 the security situation in the region will marginally stabilize, the inflation will continue decelerating with continued monetary policy easing, the agricultural year will be better than in 2022 and the economic situation in the region will also marginally improve, the banks’ balance sheets will continue expanding at a high pace. Namely, the volume of new loans is forecasted to increase by 28% and 18% in 2023 and 2024 respectively. The growth rate will be much higher in the case of consumer loans (+51% and +21% for 2023-2024) compared to firms (+22% and 17% for 2023-2024), especially taking into account the low comparison basis: in 2022, the volume of new loans to population decreased by 35%, while in the case of firms they grew by 26%. As a result, the total stock of loans will expand by +24% in 2023 and 14% in 2024, which will stabilize around 13%-14% during 2025-2027.

Overall, the central bank promotes a conservative and cautious monetary policy, responding adequately to the inflationary dynamics and the balance of risks, but promoting a more forward-looking monetary policy should be considered in the future. During 2022, given the second-round effects of external inflation shocks (mainly, the inflationary expectations and the second-round effects of energy price hikes), the central bank significantly tightened its monetary policy, both by raising the policy rate and mandatory reserves rate. The main reasons for this monetary policy tightening were to address the second-round inflationary effects of the cost-push inflation shocks of 2022, by mitigating the raising inflationary expectations, limiting lending and withdrawing idle liquidity from the banking sector. As long as it became clear that the inflation upward trend reversed, the central bank started to gradually ease the monetary policy by cutting the policy rate, but being more cautious in cutting its mandatory reserves rate. The reason is that, on the one hand, the central bank intends to stimulate lending in national currency, by cutting the mandatory reserves rate in MDL and keeping unchanged the rate in foreign currency; on the other hand, the high level of idle liquidities in the banking sector does not allow the NBM to cut the mandatory reserves rates further. 

Despite the major shocks of 2022, the central bank managed to maintain a relative stability of the national currency and overall resiliency of the macro-financial situation. The national currency remained stable despite the multiple shocks and difficult economic conditions. It was possible due to the central bank’s timely interventions on the domestic currency market. Namely, in order to avoid excessive depreciation of the Moldovan leu during the harshest times of the crisis (e.g. after the war in Ukraine started or when the import prices for energy increased), the NBM sold from its international reserves sufficient foreign currency in order to contain the increased demand for foreign currency and mitigate the pressure on MDL. However, during the following months, the level of reserves consolidated thanks to the international financial support from development partners.

2023-2024 will mark a period of “return to normality” of the inflationary dynamics. The inflation shocks started to dissipate at the end of 2022 and the beginning of 2023, with the annual CPI posting a downward trend. The deceleration of inflation will last throughout the entire 2023-2024 period, on the grounds of a high comparison base, better agricultural year, stabilization of inflationary trends in the region, and limited demand-side inflationary pressures at the domestic level. Hence, assuming that there will not be any major cost-push inflationary shocks, the CPI will continue declining down to 13-14% average for 2023 and 5.5% in 2024. The inflationary deceleration will allow the central bank to ease its monetary policy further during 2023-2024. 

Fears of capital flight from Moldova and depletion of reserve assets, which were circulating at the beginning of the war in Ukraine, did not materialize. In fact, net capital inflows recorded in the balance of payments financial account were 37% higher than in 2021. Non-residents have not withdrawn their deposits from the Moldovan banking system, on the contrary, foreigners’ deposits have increased and foreign investors have significantly expanded their direct investments in Moldova. The NBM intervened in the foreign exchange market at the beginning of the year to meet the sudden surge in demand for foreign currency, but this situation did not last long. During 2022, on the background of large inflows of foreign capital, the state's reserve assets increased and reached a record level.

However, action is needed to correct the exaggerated current account deficit, caused by the persistence of competitiveness issues of Moldovan exports as well as by the price dynamics of imported energy resources. Chronic deficits lead to the accumulation of external debt over time which, although not currently exceeding sustainability limits, may result in a debt crisis in the future. In this respect, it is crucial that Moldova seizes the opportunities offered by its status as a candidate country for EU membership by implementing the necessary reforms and promoting structural policies to boost supply.

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About MEGA

MEGA is an English acronym standing for Moldova Economic Growth Analysis. MEGA is a biannual review published by EXPERT-GRUP since 2009 with the purpose of explaining the fundamentals of the recent economic trends in Moldova, analysing economic policies and proposing solutions for the economic development strategies of the country.