MEGA, XVIIIth edition: Economic perspectives in an electoral year

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Publishing date: Tuesday, 24 April 2018
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National economy is approaching an unfavorable equilibrium, marked by low growth rates. In spite of favorable conditions (good agricultural year, re-launch of external assistance, increase in external demand and increase in remittances), the Gross Domestic Product grew by only 4.5% in 2017. This growth is not much higher than the 2016 evolution (+ 4.1%), when the situation was much more difficult, and is similar to the one projected for 2018-2019. These growth rates are below the potential levels and, given the current level of economic development, they are too low to ensure convergence in the western neighboring countries. Therefore, we find that economic growth stabilized around an unfavorable equilibrium, marked by low growth rates. These are due to two fundamental constraints: on the one hand, the population ageing trends diminish the population’s propensity to consume, which affects the main engine of economic growth at present, and on the other hand, the shortage of private capital does not allow for the replacement of consumption with a more sustainable economic growth engine. As a result, the potential GDP over the last few years has seen a steady downward trend, which is expected to continue during the next years, further undermining the growth rates. 

Households’ consumption, which has traditionally been the engine of economic growth, is slowing down, while no alternative sources of growth have been identified. In 2017, the volume of retail trade and services rendered to the population declined, despite the rise in real salaries and remittances. This is explained by both temporary effects (e.g. appreciation of the national currency) and long-term factors related to the population ageing and the increase in the uncertainty level. These phenomena, which will have long-lasting effects, are obviously worrisome, as private investments continued to decline – a process that will most likely last for the next year as well. In order to exit from this equilibrium of low economic growth rates, it is necessary to stimulate private investment activity. Hence, the recent reforms aimed at enhancing the business climate should be complemented with active measures aimed at enhancing the confidence of the private sector in the country and its economic prospects: fostering the protection of investors’ property rights and ensuring a fair market competition are vital conditions in this regard.

The Republic of Moldova is entering a three-year ‘electoral marathon’, not being prepared from an economic and institutional point of view, which feeds a series of long-term economic risks. Electoral periods are always marked by increased budget spending and uncertainty. In the case of the Republic of Moldova, the 2018 parliamentary elections, the 2019 local elections, and the 2020 presidential elections represent major constraints for the national economy, due to the current imbalances in public finances and modest investment activity. In particular, the propensity to engage in election-related public expenditures in the context of a budget deficit of 2.9% of the GDP planned for 2018 is likely to further exacerbate public finances that will fuel domestic Government debt and turn into budget austerity in the years after the elections. At the same time, the weak institutional framework, as well as the high level of politicization of public institutions, lead to increased uncertainty caused by the near elections, which undermines private investment activity: in 2017, despite economic growth, private investments declined, which will most likely remain stagnant in the coming years. 

Besides electoral factors, the public finances will be increasingly affected by the phenomenon of aging population. This, on the one hand, puts pressure on public expenditures on insurance and social assistance and, on the other hand, deprives of important budgetary resources that could be geared towards accelerating the economic growth. Thus, over the past few years, productive expenditures (e.g. public investment in infrastructure, health and education), which lead to quantitative and qualitative increase in human and physical capital, grew more slowly than those for social protection. As a result, the country's public budget is becoming increasingly social, with no major impact on economic development. Thus, the current expenditure structure requires a fundamental rethink in order that the fiscal-budgetary policy be oriented towards stimulating sustainable economic growth.

The high level of tax gap is another major constraint for economic growth that undermines the capacity of the state budget to contribute more actively to development. The tax gap in the Republic of Moldova (the difference between the potential volume of tax revenue and the actual collected revenue) is quite high, being estimated at about 7% of the annual GDP. Although this share stabilized over the last years, the share of tax evasion that determines the tax gap increased substantially. This indicates some risks of increasing the propensity to tax evasion, which could become a major issue for the coming years. Therefore, in 2018 it is crucial to accelerate the efforts to fight tax evasion, without harming the business climate, with an emphasis on promotion of voluntary compliance (e.g. a more active communication with taxpayers and simplification of fiscal management and reporting). 

The slowdown in economic growth takes place in parallel with the slowdown in labor productivity and salaries. Although, on the one hand, the growth rates of productivity and real salaries started to converge, on the other hand, they slowed down considerably. Taking into account that the level of labor productivity in the Republic of Moldova is among the lowest in CEE countries, this phenomenon could denote that indicators stabilized around a negative equilibrium manifested by the low impact of economic growth on population’s wellbeing. This process was influenced by the worsening of the quality of employment and, in particular, by the increase in the informal employment and by the decrease in the share of jobs requiring medium and high skills.

In order to stimulate the long term economic growth up to optimal levels (7-8%) it is instrumental to ensure the quality of structural and institutional reforms. In 2018, virtually, all the ingredients of a qualitative economic growth will be available: tempered inflation, favorable agricultural year, external assistance that will lead to more public investments, increased liquidity in the banking system, more remittances, and a favorable external economic environment. These factors will ensure rapid economic growth only in the context of qualitative reforms that will improve the confidence of investors and public in the Government, and will therefore boost private investment activity. In this respect, the policy priorities for 2018 are as follows:

  • Public administration reform. It must be carried out transparently, predictably and consistently with the Strategy approved in 2016. In order to achieve the expected effects, the reform must be based on functional and impact analyzes and not be limited to institution and staff optimization. The essence of the reform is to improve the quality of public services, and, to achieve this, internal processes at the level of the institutions needs to be improved, public service staff to be better motivated and dependence of public institutions on policy makers to be diminished.
  • Reform of the strategic planning system. A key component of the public administration reform is to increase the effectiveness of the policy planning and budgetary programming system. In this respect, the development of a new National Development Strategy “Moldova 2030” was started, which is to draw the country’s long-term development guidelines in line with the 2030 Agenda for Sustainable Development and the Association Agenda. Once the Strategy is approved, an ample process of optimizing sectoral strategies (e.g. reducing their number by about 10 times) and adjusting the remaining ones is to begin. In essence, there must be a long-term visionary document (NDS “Moldova 2030”), to anchor sectoral strategies which, in turn, to transform into budget programs. This triangle of strategic planning (NDS – sectoral strategies – budget programs) is crucial to ensure efficient management of the limited technical and financial resources available to the Government, ensuring predictability of public policies, and allowing to anchor resources into strategic objectives with sustainable effects, rather than to short-term (e.g. electoral) goals. 
  • Building capacity and ensuring a real independence for integrity and anticorruption institutions. Given that corruption is the main constraint on the business environment (according to the 2017/2018 Global Competitiveness Report) and the country's development, respectively, and the level of confidence of the population and economic agents in government is very low, increasing the effectiveness of the fight against corruption should be a key priority for 2018. In this respect, strengthening the technical capacities and ensuring the full independence of integrity and anticorruption institutions, in particular of the National Integrity Authority and Anticorruption Prosecutor Office, is a must. 
  • Banking sector reforms must be carried out in parallel with the progress of investigations into bank frauds and the recovery of stolen money. Although we appreciate the efforts of the NBM to align the regulatory framework with international banking regulatory standards, their efficiency and credibility is affected by the lack of results in the investigation into bank fraud and recovery of laundered money (except for the income from the execution of assets of bankrupt banks). In this respect, the process and results of the investigations should be more transparent (without damaging the investigation process), coordination between the line institutions (General Prosecutor's Office, National Bank of Moldova, National Commission for Financial Market, Ministry of Finance, etc.) should be more efficient and without any political interference. Failure to ensure the transparency of this process will further affect its credibility, as well as the credibility of other reforms and will further undermine the confidence in the population in the government. 
  • Increasing the level of transparency and governance in the financial and banking sector. Despite some important progress made in this respect over the last period, a number of problems persist and more actions are to be fully implemented so that the progress achieved becomes irreversible. In particular, it is necessary to finalize the process of increasing the transparency of all commercial banks’ shareholders and sell the shares put up for sale to persons complying with integrity and reputation standards.
  • Strengthening institutional capacity in the area of implementation and monitoring of the EU Association Agreement. The public administration reform has further undermined the Government's capacities in this area. Given the strategic importance of this Agreement, improving the inter-institutional coordination on the implementation of the Agreement, strengthening the capacities to renegotiate the Agreement (e.g. negotiating the extension of tariff quotas, which in 2017 were exceeded) and implementing a transparent monitoring and assessment mechanism for implementation of the Agreement, take priority for 2018. 

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