Major Economic Evolutions in 2018
In 2018 the Moldovan economy generally developed as forecast, but new risks emerged. Our estimates show that GDP increased by 4.2% - 4.6%, on a broad basis which included almost all key sectors. The domestic supply was mainly driven by gross fixed capital formation (but there are major issues regarding growth quality and sustainability) and by increase in household final consumption. Households benefited from increase in salary income and social benefits and more tempered growth of prices. The foreign sector, however, had a much bigger impact on domestic economic dynamics.
Concerning macroeconomic indicators as a whole, worsening of the current account is the most worrying evolution. Its dynamics is persistently negative: from -4.2% of GDP in Q1-Q2:16 to -8.7% in Q1-Q2:17 and -10.6% of GDP in Q1-Q2:18. In the first half of the year, exports of goods and services increased by about 23.5%, but imports grew even more dynamically (24.5%), and from a much higher initial level than exports. The higher deficit of the trade in goods as accompanied by a better balance of services. The defining structural and geographic trends consolidated by augmenting the role of EU and the share of automotive industry exports. Remittances from emigrants, expressed in USD, increased more slowly. It is worthwhile noting that in 2018 the EU area exceeded for the first time the CIS states in the geographical structure of the personal transfers made by emigrants living abroad (40% compared to 33%). Altogether, in 2018 the current account was financed less from foreign direct investments and mostly through reducing external assets and contracting new commercial loans.
As a reflection of the current account dynamics, the domestic demand components developed robustly in the first half of 2018. The main component of the demand - households’ consumption - increased by about 4.2%, financed by higher incomes from almost all sources. In particular, the income from the salaries increased by about 3.8% in real terms. The higher salary income is explained to a certain extent by the increase in men employment (+2.6% of the employed population) and, especially, women’s employment (9.2%), as well as by the recession of the unemployment rate to historical lows (3.0% for women and 3.9% for men, both seasonally adjusted). But the level of employment continued to increase especially through the informal employment in agriculture. Generally, the agricultural employment has grown steadily over the recent 5 years, which is a phenomenon with dual economic implications. The involution of remittances expressed in Moldovan lei is equally notable and worrying, which decreased by about 3% in real terms of the domestic currency. Revenues from social protection programs increased by 10%. This administrative increase in revenue - both welcome and necessary - is something to be expected in the current political context making the Government to offer more generous electoral alms. In the long run, however, it makes households more vulnerable to potential problems affecting the revenue side of the public budget.
After a stagnation period of several years, in 2018 we also saw a more tepid investment process. Gross Fixed Capital Formation (GFCF) increased substantially by about 9%, but, in terms of quality, this increase is not unequivocal. On the one hand, there is a feeble increase in private investments (+1.5%), mainly to replace some of the depreciated productive capacities. On the other hand, the GFCF growth is determined mainly by public investment programs. Some of them, such as ‘Good Roads for Moldova’ Program, were implemented without proper preparation and gave the impression that the Government is more interested in the process rather than in the outcome. Without questioning the need for good roads at local level, more and more field evidences reveal big problems with the relevance of the rehabilitated sections and quality of the performed works. In other words, a large part of the public investments program implemented in 2018 could eventually turn out to be nothing more than a waste of resources. It will not increase productive capacity of the economy and, in the medium run, will put even greater pressure on public finances and, ultimately, on taxpayers.
The domestic production capacity covered less than a half of the aggregate demand growth. The 4.5% GDP growth in the first half of the year consisted of the real increase in gross value added (4.1 p.p.) and of net taxes on products amounting to 0.4 p.p. The market services generated the largest share of total gross added value. In particular, there has been an increase in retail sales (+4% in Q1-Q3:18) and if services provided to population (+12%). The dynamics of the transport services provided to enterprises (+9%) coincided with the evolution of domestic and foreign trade. The industry has shown impressive growth rates (+6% in the first nine months), the most dynamic were the automotive, construction, packaging, and shoe production sectors. The volume of agricultural production did not increase significantly, albeit without negative impact on incomes of the rural population. The exceptions are farms which were directly affected by the overproduction of fruits and related price reduction. Construction sector has also shown certain revitalization (+6%), possibly due to mortgage lending.
The banking sector continued to reduce its presence on the credit market, while the non-banking lending companies advanced impressively. Their aggressive marketing strategies in the last three years allowed them double their share on the lending market, even if the terms of loans are draconian (effective interest rates exceed 25% in most cases). Total financial intermediation reached historical lows. The Government is still the preferred customer of the commercial banks. Despite very low interest rates, private companies do not hurry to finance their investments through bank loans. On the contrary, there is evidence that companies instead of investing, increase their medium-term bank deposits - a symptom of the investment skepticism before the elections. Thus, loan resources increasingly migrate to finance spending priorities with a modest impact on the economy’s productive capacity - including mortgage or consumer loans - and escalate the risk of growth in the indebtedness level of some households, and, in the mid-term, the risk of a possible negative adjustment of the final consumption.
The developments in the agricultural sector led to minor increases in prices or even to decline in prices of some foodstuffs. At the same time, the political context and the appreciation of the national currency resulted in downward revision of tariffs and prices for some regulated goods and services. As a result, the annualised consumer price index decelerated, from 4.7% in March to 1.2% in October 2018. Reduction of inflationary pressures, coupled with growing supply of foreign currency, allowed the NBM to increase its official reserve assets to more than USD 3 billion, thus ensuring comfortable financing of more than 5 months of imports and exceeding the short-term foreign debt by 60%. The NBM base rate remained at 6.5% over the whole year. In Aug:18 the NBM increased the rate of minimum reserve requirements. After a steady decrease over the recent period, the yield curve of government T-bills increased slightly in Q2-Q3:18, on the background of increased volume of issued T-bills and growing domestic debt. This is due also to the increased level of creditors’ skepticism regarding the budget revenues in 2019, given that EU cancelled macro-financial assistance, while the fiscal reform will probably produce positive results with a certain delay. At the same time, these changes could also reveal slightly worsening inflationary expectations in the banking community.
In 2018, the Government had strong fiscal positions which were weakened for next year due to changes in tax policy and new budgetary commitments. Total NPB revenues increased by 11.0% y-o-y in the first 9 months of 2018, and full year revenues are expected to exceed by 2.3% those approved in the initial version of the budget. The foregone foreign grants and loans were offset by the higher tax and non-tax revenues. However, revenues to the budgets of administrative-territorial units evolved at a much slower pace, reflecting poor economic and demographic situation at level of territorial communities, especially of the small rural ones. Expenditures in the first three quarters were executed at 65% of the planned level, but we expect that situation will change significantly in the last quarter of the year, both for technical reasons (traditionally, many public procurements are made closer to the end of the year, when there is higher certainty about the execution of revenues) and political ones, determined by the elections calendar. Overall, expenditures estimated for the whole 2018 will exceed the approved amount by about 1%, resulting in budget deficit lower than previously expected. Corroborated with the change in calculation methodology for GDP, co-evolution of budget revenues and expenditures may result in a small budget deficit (below 1% of GDP, according to our estimations). In 2018, the Government adopted a package of tax and institutional reforms with a negative impact on short-term revenues (even if net impact is positive in the medium and long term), undertaking new financial commitments with immediate effect. They will not have a major negative impact in 2018, but the situation could be different in 2019. Increasing fiscal disequilibrium, combined with a reduction in foreign assistance, could lead to surge in government debt level. Evidence in this sense represents the increase in Government’s forecasts regarding internal debt: at the end of 2017, authorities were expecting total internal debt not to exceed MDL 27 billion towards the end of 2020; only one year later, the expected level was raised by MDL 1.5 billion to a total balance of MDL 28.5 billion at the end of 2020.