This is the 3rd issue of the Regional Economic Review: Transnistrian region, which analyses the economic evolution of the region from Dniester’s left bank, explains the key macroeconomic and sector-level trends in the region and provides forecasts for key economic indicators for 2016.
Key messages of this issue
- The Transnistrian region is facing an unprecedented economic crisis. By the end of the current year, the region's GDP could contract by about 10-12%, due to an accumulation of negative external and internal shocks. The unfavourable context on external markets (instability in Ukraine, economic downturn in Russia and on the right-bank Moldova, falling demand in the EU, devaluation of national currencies in the region) have led to a decline in demand for the region's exports by almost a quarter. This resulted in a lower rate of industrial production, which in the first 9 months of the current year decreased by about 10%.
- The economic crisis is likely to turn into a major social crisis. Households’ incomes shrank by about 30% following the decline in all sources of revenue (remittances, wages, income from entrepreneurial activity, social payments and pensions). Overall, the estimated real revenues for 2015 are lower than in 2007. As a result, the final consumption decreased by about 21-22%, i.e. slower than the revenues. This gap between current income and consumer spending adjustments shows that the population is intensely spending previously accumulated savings, which could generate a faster slowdown in consumption in the near future if the economic situation does not recover.
- Social risks are fuelled by labour market issues, as well as by budgetary constraints. The capacity of the economy to generate new jobs is turning down, some jobs are closed and in the remaining ones wages are being cut. Moreover, wage arrears in the public and private sectors increased by nearly 4.5 times. Due to economic difficulties, the budget spending decreased and the public debt increased. In the context of a growing budget deficit and a narrow fiscal space (caused by receding economic activity and growth of the informal economy), the authorities have very limited room for manoeuvre, which could lead to further budget austerity measures.
- The Transnistrian region turned to be unprepared for such an economic and social shock. In particular, with a high budget deficit and public debt, the public finance system was already highly unbalanced before the crisis. The situation got worse due to an ineffective tax system (featured by a lack of VAT and prevalent focus on direct taxation of the private sector), to worsening demographic crisis and growing pressures on the pension system (in 2015 the number of retirees exceeded the number of employed population).
- Amid the budgetary constraints, the regional authorities have increased pressures on the private sector. Large arrears in the payment of public contracts have been accumulated and a part of public spending was effectively transferred on private business. A telling example is the recent opening by the Rabnita Metallurgical Plant of a network of social stores. Another example is the case of large agricultural farms financing community and social development investment (repairs of the culture houses, museums, gasification projects, rehabilitation of administrative buildings). Most likely these practices will continue, further weakening the economic and financial situation of the enterprises.
For the upcoming 2-3 years, we foresee at least three major economic risks affecting the region: (i) acceleration of the decline in export; (ii) a faster decrease in consumption; and (iii) a severe increase in inflation and poverty rate.
- Acceleration of the decline in exports could be caused by Tiraspol authorities’ rejection on the implementation of the provisions of the Moldova-EU Association Agreement. This will make the EU replace the autonomous trade preferences that anyway are going to expire in 2015, with the import tariffs on products from the region. This could increase the prices of Transnistrian exporters on the EU market, on average, by about 15%. Besides the appreciation of the "Transnistrian ruble" against the Euro, this will serve as an additional factor undermining the competitiveness of the region.
- A faster decrease in consumption might be caused by the depletion of household savings that people in the region have recently started consuming to counterbalance the current income reduction. If the aforementioned risk materializes because of rejection of the Association Agreement, a sharp fall in consumption and a further worsening of the economic situation in the region will be unavoidable.
- The risk of a sharp increase in inflation is fuelled by two main factors. First, the regional authorities cover the budget deficit by increasing public debt and by financing it at a preferential rate through the "Transnistrian Republican Bank". This results in increasing the monetary base that is not covered by the production of additional goods and services and thus generates imminent inflationary risks. Second, fixing the exchange rate and ignoring the economic realities cannot last forever, especially given that currency reserves of the "Transnistrian Republican Bank" are already low, and the gap between the demand and supply of currency is substantial. Further maintenance of the fixed exchange rate of the "Transnistrian ruble" against the US dollar could, at some point, force the monetary authority to rapidly devaluate the currency, with obvious inflationary and social consequences. The materialization of this risk will have major effects on poverty in the region, particularly by worsening the living standards of those who are already below the poverty line and have limited opportunities to emigrate or to specialize in other fields of activity.
Given the economic and social trends and risks, we call on the authorities from the region to take the following urgent measures:
- Implementing the minimum requirements of the Association Agreement concerning region’s external trade. It is of primary importance to focus on the technical cooperation between the authorities from Chisinau and Tiraspol on issues related to certificates of origin, customs duties, sanitary and phytosanitary standards, competition policy, public procurement and fiscal policy.
- Giving up the practice of transposing the social protection commitments on the private sector, especially amid extremely austere economic circumstances. The continuation of such practices can lead to the degradation of the productive capital (companies will not have sufficient resources to invest) and can even generate a capital flight from the region. At the same time, it is also obvious that public expenditure policy should be reviewed and rationalized.
- Reforming the tax system in the region. Currently, tax revenues are excessively concentrated on direct taxation, without applying VAT. This creates major pressures on the private sector and undermines the competitiveness of exporters, since most of the region’s trading partners apply VAT whereas the region lacks a VAT refund mechanism. Tax reform could be based on two key elements: (i) implementation of a transparent and simple VAT system; and (ii) ensuring compatibility between the tax systems on both banks of Nistru river and aligning them to international standards. The focus should be transposed from taxing profits and investments towards taxing
This document is published within the Program “Support to Confidence Building Measures”, financed by the EU Delegation in Moldova and implemented by United Nations Development Programme in Moldova. Opinions expressed in this document belong to the authors and are not necessarily the opinions of the donors. Also, the authors are aware of potential risks related to quality of the statistical data and have used the data with due precaution.