State of the Country Report 2019

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Publishing date: Monday, 04 November 2019
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The political transition following the parliamentary elections in 2019 produced a major change of power that created preconditions for boosting the reforms’ agenda, but the fundamental weaknesses of the state of the country were not resolved yet.

The takeover of power by the multi-geopolitical opposition, which entered into a temporary coalition based on joint pro-reform commitments, put an end to the oligarchic governance under the umbrella of the Democratic Party of Moldova (PDM). Most of the reforms were initiated by the parliamentary majority formed of the Party of Socialists of the Republic of Moldova (PSRM) and the ACUM bloc aimed at reviewing and remedying the governance shortcomings of the previous governments, focusing primarily on policies initiated by the PDM. The depoliticization of institutions, judicial reform, and better use of public money and property are the major reform landmarks, equally appreciated by public and external partners (International Monetary Fund (IMF), World Bank, European Union). However, the PSRM-ACUM government, has hesitated repeatedly to carry out real depoliticization, and the initiated de-oligarchizing is strongly focused on the  system previously led by Vladimir Plahotniuc, rather than on establishing a mechanism to prevent and fight the phenomenon of the ‘captured state’ by de-oligarchizing political power in a systemic and permanent manner.

The revival of the internal democratic process has resuscitated, as a ‘chain reaction’, foreign policy with both the West and the East. The rapid unfreezing of European Union (EU) budget support has considerably fostered the dialogue with the EU institutions. Thanks to the return to a proportional voting system, more rigorous investigation of the “billion dollar theft” from the banking system, the prioritization of judicial reform and the fight against political corruption etc., the PSRM-ACUM coalition has quickly gained robust credibility among external partners. At the same time, there is a firm stance towards the importance of restoring the relationship with Russia, mainly in commerce, the energy sector, and in relation to the settlement of the Transnistrian conflict. The Socialists insist on the idea of a ‘balanced foreign policy’, while the ACUM bloc shows no resistance to this. Intelligent, i.e. flexible, conditionality needs to be strictly applied to the governing parties, to discourage deviation from their commitments. At the same time, rebuilding the relationship with Russia must be free of any elements that might reduce Moldovan security, in particular by encouraging ‘hybrid’ activities in the informational space or with regard to the Transnistrian conflict resolution, carried out by the Russian authorities in the region.

On the economic side, Gross domestic product (GDP) annual growth rates have stabilized at around 4 per cent, without any significant structural changes in the national economy. Although volatility has decreased, this growth plateauing presents some significant risks. First, this level of GDP growth is insufficient to achieve convergence with Central and Eastern Europe. Moreover, such a rate will push back convergence with these countries in terms of GDP per capita by several decades. At the same time, such a slow rate of growth does not allow for a qualitative leap towards a new model of economic development. Thus, the growth paradigm remains the same: household consumption accounts for over 80 per cent of GDP and depends strongly on remittances. Such a model can hardly survive in the long-run, and the inability to accelerate and diversify the economy means that the population will continue to suffer low standards of living. The economic growth above 5% in 2019 is likely to be temporary, being fuelled by the low comparison base and the effects of the tax cuts from 2018 that will rapidly fade aways. 

Some marginal improvements in personal income and welfare have been recorded. Real disposable personal income is on an upward trend. Over the past decade, although with periods of stagnation and decline, the personal income grew by about 3 times in nominal terms, representing a 30% growth in real terms. This growth was also reflected in people’s perceptions of their standard of living. The share of those reporting a ‘bad or very bad’ standard of living has fallen to an historical low – 10 per cent of all households. The majority (75 per cent) believe they have a ‘satisfactory’ standard of living. Despite these positive trends, per capita income and consumption in the Republic of Moldova remain at only 40 per cent of the average in Central and Eastern Europe, without showing signs of rapid convergence. Further income growth, or accelerating the convergence with such countries, is restricted by the income structure in the Republic of Moldova. An increasing number of Moldovan households receive their main income from activities that are not linked directly to the performance of the national economy and labour productivity. In 2017, over 60 per cent of households were receiving either pensions or remittances from abroad as their income. Thus, the demographic and migration limitations create significant challenges for the sustainable and rapid growth of income for a large part of the population.

At the same time, there is a worring level of income inequality, given the sizeable informal economy and narrow tax base that undermine the capacity of the social protection system to address this problem. About 40 per cent of total disposable income is held by quintile V (the richest category) of the population, with the Gini coefficient being estimated at a worrying level of 0.35 points. People working in agricultural are the most vulnerable: more than half of them are part of quintiles I and II (the lowest income), revealing issues with income inequality. These trends indicate that farming households are marginalized from the income growth and convergence process. Only those who have given up farming have joined this process and managed to exit the ‘poverty trap’. However, over the last few years, the level of inequality has been decreasing. More active involvement of low-income groups in migration is a factor that has narrowed inequalities. The share of remittances in the income of these households is now the same as in the high-income groups. The structural change in the social and economic status of households has been another factor that has contributed to income convergence. The number of farmers and agricultural employees has decreased, where the concentration of the poor is higher than 50 per cent of households with this status. Despite this dynamic, the level of inequality remains a major concern, poses risks to the state of the country, and calls for economic and tax policies adapted to this challenge. While the level of inequality compares well with other countries in the region, the low capacity of the social protection system to address inequality is an issue going forward. The reasons are mainly related to high fiscal imbalances, coupled with profligate fiscal and budgetary policy before the Parliamentary elections in 2018, which limits the policy space for Government in fighting inequalities with fiscal and budgetary tools. In addition, the demographic aging process could further hinder inequality narrowing efforts, while in the medium and long-term, these processes could further aggravate inequalities due to the diminishing share of the economically active population and the increasing share of pensioners.

A major challenge for the state of the country and the economic development is related to the deprivation of the main factors that have until recently underpinned economic growth and attracted investments – remittances and cheap labour. Remittances are becoming more volatile and uncertain, and tend to shrink in the long-run, and the main factor that has attracted (the low level of) investment so far – cheap labour – is undermined by emigration, an  inefficient education system, and wage growth outstripping productivity. As a result, the country’s ability to generate added value is diminishing, as revealed by the slowdown in economic growth in recent years, which is expected to worsen in the future. The seriousness of the situation is also revealed by decreasing labour productivity and the stagnation of the employment rate (both being the lowest in Europe), with increasing informal employment. Thus, if Moldova does not identify sustainable sources of value added investment and exports in the coming years, the economy will deplete its ability to create jobs, income for the population and revenue for the public budget, with economic growth tending to become lower and less certain.

The slowdown in economic growth becomes even more problematic against the backdrop of a broadening current account deficit, which reveals structural weaknesses in competitiveness. This imbalance is mainly caused by the increasing gap between exports and imports, which ultimately points on competitiveness issues in the Moldovan economy and fuels risks for the long-term macroeconomic stability. It is not the deficit per se that is problematic, but rather the fact that it is determined by imports of energy products, consumption and industrial inputs, and not by machinery, equipment and know-how, which would boost exports in the long-run and balance the current account. In addition, with stagnating foreign investment and the expected decline in remittances, financing the current account deficit will become an increasingly acute problem, putting pressure on the national currency and foreign debt. In this context, enhancing the competitiveness of the national economy must be the fundamental priority for Government.

Competitiveness enhancement should be ensured on three interdependent areas: (i) the labour market; (ii) capital and investment markets; and, (iii) foreign markets for exports. Labour-force competitiveness must be enhanced by improving its quality and relevance, rather than by decreasing labour costs. In this regard, the educational system needs to be reformed so that, on the one hand, it is more flexible and able to respond to the economy’s needs, and, on the other hand, instils a spirit of entrepreneurship, initiative and innovation. These efforts should be also encouraged by tax and economic policy. This will allow the harnessing of people’s potential, especially of the younger generation, and will make Moldova more attractive for talent – a fundamental condition for strengthening the state of the country and its long-term competitiveness. At the same time, this should be the main sustainable factor in terms of increasing the country’s competitiveness at the level of the capital and investment market. Fostering a high-skilled labour force, initiative, and openness to innovation and know-how should be the main factors behind the country’s investment attractiveness and must be supported by pro-business regulation, a free market economy, transparent and non-corrupt institutions, and a rule of law that protects private property rights. This will boost competitiveness at the level of foreign markets for exports, by augmenting the technological sophistication of exports, diversifying them in terms of products/services and sales markets, and adding more value for the economy and the country as a whole.

While policies aimed at competitiveness enhancement should be intense and active, these should not compromise on sustainable development objectives related to environment protection, the integrity of investments (transparency), employees’ security and human rights in general. Given scarce investment, Moldovan governments have traditionally prioritized pro-business policies and marginalized other important objectives related to sustainable development. As a result of this narrow approach to economic policies, Moldova is still lacking investment, while having weak frameworks and institutions dealing with environment protection, employees’ rights and money laundering. The government should not attract investment at all costs (e.g. by granting citizenship to investors without proper screening, by capital and tax amnesties, by weakening the environment and labour protection institutions of control and enforcement). Instead, Moldova needs a balanced economic policy that would stimulate through all possible means (e.g. fiscal, regulatory, financial tools) investments that contribute to the sustainable long-term development of the country. Such investments would meet the following 5 criteria: (i) generate high-value added; (ii) are export-oriented; (iii) create decent jobs; (iv) implement green technologies and contribute to decoupling of economic activity from the use of natural resources; and, (v) comply with the highest standards of transparency and integrity of ownership. The government should deploy  a wide range of investment attraction tools for investments meeting all of the above-mentioned criteria. 

All in all, the state of the country can be fostered by empowering three key elements: (i) government; (ii) private sector; and (iii) households. In a nutshell, the current state of Moldova is undermined by highly corrupt, inefficient and weak public institutions, which in turn represent the main barriers for doing business and, hence, lead to a fragile private sector, undermining the tax base, employment and the wellbeing of the population. It forms a vicious circle, because weak private sector and high poverty undermine further the public institutions by narrowing the tax base and fueling corruption. In order to turn this vicious circle into a virtuous one, Moldova needs a complex and well-coordinated set of reforms that should be anchored in a well-defined national development strategy for the next 10 years. Policies should target the mentioned three elements that define the state of the country: (i) the government has to become more accountable and efficient, by increasing the transparency of public institutions, fostering the integrity framework, reforming the justice system and making the public sector attractive for talented professionals; (ii) the private sector should be supported by implementing balanced pro-business fiscal and economic policies (without undermining the sustainable development objectives mentioned above), providing loan guarantees for SMEs and start-ups that implement innovations, generate added value and jobs, developing business infrastructure for start-ups and easing the bureaucratic procedures (e.g. digitalization, tacit approval mechanisms, one stop shops etc.); (iii) households should be empowered by reforming the educational and health systems – top sectors of systemic and strategic importance where reforms stagnated over the last years and which determine the long-term development of the country. Hence, the structure of this edition of the state of the country report is centred around these three key elements.

Read also: State of the Country Report 2019: social and economic inequalities are decreasing, but there are major risks that in the long term they may diminish

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Tags: Natalia Chitii

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