MEGA, the XXIst edition ”Economic growth and public finances during an electoral period: conclusions from 2019 and forecasts for 2020”

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Publishing date: Thursday, 30 January 2020
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After a relatively favorable economic year, 2020 brings more macroeconomic challenges, with major risks for the public finance system. Overall, the economic growth in 2020 will be tempered compared to the result recorded in 2019. Thus, after the economy grew by about 4.5-5% in 2019, in 2020 the GDP will advance by about 3.5-4%. Most economic sectors will show relatively slow growth rates in 2020. The most significant slowdown compared to 2019 will be registered in the construction sector. The sector that was the leader of growth in 2019, with an increase in value added close to 20%, in 2020 will advance by only 2%. On the other hand, domestic trade will remain on a positive track and will ensure the largest contribution to GDP growth in 2020. A first cause of this anticipated economic slowdown for 2020 is the complete dissipation of the effects of the fiscal reform implemented in the last quarter of 2018 (reduction of the social security contribution rate paid employers). Although the relaxation of the monetary policy and the increase of consumption will stimulate the dynamics of private investments, they will no longer benefit from the impulse generated by the mentioned tax reform. Also, the slowing of the economic advance in the EU (the main trading partner of the Republic of Moldova) will lead to the moderation of the rhythms of growth of Moldovan exports, with negative repercussions on economic growth. The expansionary budgetary policy will stimulate the expansion of domestic demand, by increasing public investments and budgetary wages, but this will be mainly covered by imports, further aggravating the current account deficit problem. At the same time, the mechanism of financing the budget deficit could have negative implications on the economic growth if the Government will actively resort to loans from banks, which will undermine the lending of the real sector (crowding out effect).

The year 2019 was a very complicated one for the national budget taking into account the multiple pressures that the public finance system had to face. First, the effects of fiscal reform, although positive in nature, have essentially undermined the balance of the state budget and the social insurance budget. Secondly, as a result of the reform of the pay system in the budget sector, the government had to face financial commitments that far exceeded the limits of fiscal prudence. Only the resumption of the external financial assistance in the fall of 2019, in parallel with the under-execution of the investment expenses, allowed the budget deficit to be framed within the budgetary-fiscal limits established by national legislation. At the same time, the Government has managed to attract only a small part of the grants for direct budget support and financing of capital investments planned for 2019. Thus, the financing of the deficit relied on internal sources, through issuing state securities and lending from commercial banks.

By 2020, public spending will grow faster than budget revenues in the context of a new election year. We forecast that in 2020 the total revenues of the national public budget will increase by about 1% f-a-p, while for the expenses we anticipate an increase of about 4% f-a-p. Although external financing has been resumed, it is partial (segmented) and slow, conditioned by a series of obligations that the Government has not at least formally assumed. In these circumstances, it will inevitably reduce the budgetary expenditures that depend directly on external sources of financing. Thus, the annual budget deficit for 2020 will fall within the range of 2.5 - 3.4% of GDP. At the same time, there are certain signals that the Government will implement a series of measures to mitigate the risks to public finances (eg: social and wage payments will be indexed to a minimum rate, the draft bill being already consulted in this regard with the government). Similarly, given the low rate of investment spending over the past 3 years, they will most likely be reviewed and implemented selectively, depending on their political impact. As a result, we estimate that budget expenditures will decrease by about 5.2% compared to the forecasted level. Overall, we advise the Government to diminish the budgetary deficit to about 1.5% of GDP by properly adjusting the planned budgetary expenditures. Our estimations show that this measure will not undermine the domestic demand and economic growth, but rather will consolidate the resilience and credibility of the fiscal and budgetary policies.

Taking into account the uncertainty regarding the financing of the budget deficit from external sources, the issuance of Eurobonds can serve both an opportunity for the development of the country and a major source of risk - it depends on the way the Government will implement this financing instrument. Eurobond issuance is a tool that could be used by the Government to finance certain infrastructure projects in the context of funding uncertainty from development partners. In this context, it is important for the Government to identify on the basis of a transparent and competitive process a well-established broker with an internationally recognized reputation that will deal with the placement of Eurobonds, following the model of recent emissions by Ukraine and Romania. A potential reliance on brokers with a dubious reputation that do not implement the highest standards in combating money laundering and that will not be able to ensure the creditors' integrity, could cause major image risks for the country and it could lure the country into risky credit schemes for the long-term development of the country. In this sense, it is very important to monitor these processes, and in the case of Eurobond issuance, it will be necessary an active mobilization of the civil society in monitoring of the use and management of these resources. Last, but not least, the issuance of Eurobonds, by no means, should be regarded as a replacement to the financial assistance available from the development partners of Moldova, but rather as a complementary tool to support the sustainable long-term development of the country established broker with an internationally recognized reputation that will deal with the placement of Eurobonds, following the model of recent emissions by Ukraine and Romania. A potential reliance on brokers with a dubious reputation that do not implement the highest standards in combating money laundering and that will not be able to ensure the creditors' integrity, could cause major image risks for the country and it could lure the country into risky credit schemes for the long-term development of the country. In this sense, it is very important to monitor these processes, and in the case of Eurobond issuance, it will be necessary an active mobilization of the civil society in monitoring of the use and management of these resources. Last, but not least, the issuance of Eurobonds, by no means, should be regarded as a replacement to the financial assistance available from the development partners of Moldova, but rather as a complementary tool to support the sustainable long-term development of the country.

In 2020, the need for a more active involvement of civil society in the formation and monitoring of budgetary processes, at central and local level, becomes even more stringent. Given the electoral context, high budget deficit planned for 2020, as well as the Government's temptation to resort to issuing Eurobonds as a financing mechanism for investment projects (and implicitly to cover part of the budget deficit), there are obvious risks regarding sliding the system of public finances into clientelistic arrangements, with negative implications on the efficiency of using public money. In this context, it is important to mobilize civil society and the general population in the formation and monitoring of budgetary processes, at central and local level. This should also become an essential priority of the donor community, in order to increase transparency and open the budgetary framework for citizens, starting with the transparency of budgetary spending at the institution level (including updating the BOOST database), and continuing with real and inclusive consultations on the fiscal and budgetary aspects. It is also important to continue strengthening the civil society capacities for active and constructive participation in the budgetary processes. Streamlining the governance of the public finance system is key to ensuring their efficiency, and the active participation of the population in the budgetary processes is fundamental in achieving this goal.

An important source of risks for economic growth in 2020 derives from the tempering of external economic growth. The economy of the Republic of Moldova has already begun to temper as a result of declining external demand. Thus, total exports are stagnating, while exports to the EU have decreased in the context of an unfavorable situation in the given market, and those to the CIS have registered increases only due to drug re-exports. Exports to Turkey are also on the rise. In addition to these worrying developments, there are also a number of shortcomings related to the concentration of exports both in geographical profile and in terms of the structure of exported products. This is exacerbated by the fact that the majority of exported products have a rather low added value (either primary agricultural products or industrial products processed under the lohn regime), revealing the low level of competitiveness of the domestic producers, which undermines the sustainability of exports. Worldwide uncertainties undermine investment prospects for the coming periods. Moreover, the anticipation of stagnation in food prices internationally, dictated by increased export availability, as well as the tempering of the EU automotive industry will amplify the negative effects on the growth of Moldovan exports to this direction. At the same time, the commercial conditions on the CIS market (in this case the Russian Federation) are still uncertain, and the prospects for their modification for the moment are anchored only in the pre-election promises. It will aggravate the problem of balance of payments, because the foreign investments and foreign assistance will no longer be able to balance the components of the current account deficit, which could put pressure on foreign currency and external debt.

Another source of challenges is related to maintaining the central bank's independence, taking into account the intensification of signals of interference attempts by some political and business interests in its monetary policy. Although there are some inflationary risks, such as expansionary budgetary policy, the dynamics of international oil prices or adverse weather conditions, most likely the inflation dynamics in 2020 will be marked by a moderate disinflationary trend. Still, inflation will not fall below the lower limit of corridor targeted by the NBM (5%, +/- 1.5 pp). At the same time, the NBM has begun to gradually relax its monetary policy, an approach that will most likely continue throughout 2020. However, in the context of the abundance of liquidity in the banking system, its effects on real sector lending will be limited and delayed in time, while the main immediate beneficiary will be the Government due to the decline in the financing costs of the budgetary deficit. Thus, a relaxed monetary policy, amid an expansionary budgetary policy and a relatively stable economic growth (about 3.5%), denotes a potential source of macro-financial risks, as well as risks of political pressures on the NBM. The independence of the monetary authority was also tested in the context of initiatives regarding the reorientation of a part of the foreign exchange reserves for investment purposes. A possible realization of this intention will diminish the functional independence of the NBM and create enormous risks for the security of the national economy. In this respect, it is important to maintain the independence of the monetary authority which is the basis for ensuring macro-financial stability.

Climate shocks are becoming more frequent, which exposes the agricultural sector and the economy as a whole to major risks. Insufficient rainfall in parallel with the abnormally high temperatures this winter are fueling risks of mass freezing in 2020 and / or flooding and other climate anomalies. They risk jeopardizing agricultural production, which could translate into the recession of the agricultural sector, the reduction of employment in this sector, which is also the main employer in the Republic of Moldova, and undermine the production and exports of the agro-industrial sector due to the limited raw materials. As a result, in the event of the aforementioned risks, agriculture could grow much slower than the forecast level, which will also hit the economic growth of 2020. Overall, we point on the increased vulnerability of the agricultural sector and the national economy as a whole to climate change and shocks generated by this phenomenon, which tend to aggravate year-by-year. In this regard, it is necessary to increase the resilience of the agricultural sector to climate anomalies by stimulating investments in the infrastructure and equipment needed by farmers to protect against extreme temperatures or heavy rainfall, to stimulate the development of agricultural insurance, to popularize intensive farming practices and to increase farmers' access to water sources and intelligent irrigation systems.

The economic growth will be challenged by worsening of the demographic situation in parallel with the tightening labor market conditions. The labor market assessment denotes the perpetuation of the seemingly paradoxical situation of having at the same time low employment and low unemployment rates. This is explained by the increase in the share of inactive population, due to the migration (the main factor), population aging (the increasing share of people over 60 years in total population) and increased inactivity in some categories of the population (mainly women). At the same time, these trends have put increasing pressures on the labor market. Tightening labor market conditions is due to the continuous reduction in the supply of labor force, which cannot compensate the increased demand from firms. A relevant indicator highlighting the widening gaps between labor supply and demand is the number of job vacancies. During 2016 - 2019, their number practically doubled. The migration of the working age population causes the shortage of not only skilled labor force, but also the unqualified one, which poses constraints for the private sector. In this sense, it is necessary to streamline the systems of forecasting the needs for labor force from the companies and increase the flexibility of the educational system in order to make it better anchored into the firms’ needs. In general, it is necessary to ensure a closer collaboration between the education system and employers, both at the level of schools / universities and companies, and at the level of public institutions (Ministry of Economy and Infrastructure and Ministry of Education, Culture and Research).

Last, but not least, an important source of risks also derives from the eventual hasty and non-transparent privatization of some important state assets expected for 2020. Already, there have been some signals about the Government's interest to privatize some important state-owned enterprises, which could serve as a source of financing the budgetary deficit in 2020. Although, in principle, we welcome the intentions of selling the state assets to private investors, we draw attention to the fact that any privatization must be operated in accordance with the highest standards of transparency, fair competition and good governance. These processes should not be carried out in a hurry, but in an open, consultative and well-calculated approach. Nor should they be viewed as a source of financing the budget deficit, but rather an opportunity to attract private investments, modernize the companies and increase the competitiveness of the national economy. In this regard, it is important the active participation of the civil society and the donor community in monitoring the privatization processes of the state's assets in order to ensure their credibility, as well as their efficiency.

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This document is published by the Independent Think-Tank Expert-Grup within the project “Inform, Empower, Act! Civil Society for good budgetary governance in Moldova” funded by the European Union and Konrad Adenauer Stiftung e.V.

Tags: Natalia Chitii

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