Economy of Moldova - Macroeconomic Situation

Macroeconomic Situation

As a whole, Moldova is doing well, despite a series of consecutive shocks, which included the doubling of the price of imported natural gas and Russia's ban on imports of Moldovan wine in 2006, and a severe drought in 2007. Growth is estimated at 5 percent in 2007 and is projected to increase to 7 percent in 2008. Investment is picking up, and is beginning to replace remittances as the main source of growth—an encouraging sign that the earlier model of consumption-driven growth is changing.

Moldova increasingly faces the challenges experienced by other transition economies. Improved growth prospects have come with strong appreciation pressures from foreign exchange inflows, and a widening trade deficit. Foreign direct investment (FDI) has picked up and is estimated to have reached 12 percent of GDP in 2007, compared with 7 percent in 2006.

The main macroeconomic concern is inflation, which at 13 percent remains high for the region.

A deterioration in the merchandise trade balance due to strong import growth has been offset by improvements in net income and transfers, with a small improvement in the current account deficit to 12 percent of GDP. A resumption of wine exports to Russia in October was a major positive development, although volumes are likely to recover slowly.

Fiscal policy remained tight, ending 2007 with a modest deficit of 0.3 percent of GDP. Strong revenue performance was driven by robust VAT on imports, while expenditure was kept in line with the budget. However, the tax cuts introduced in 2008 may undermine the favorable fiscal position.

Monetary tightening in 2007 was complicated by the strong inflow of foreign exchange. The National Bank of Moldova increased reserve requirements from 10 to 15 percent, and raised policy interest rates by 2.5 percentage points. Nevertheless, the possibility of second-round effects from the drought, liquidity pressures from growing remittances and FDI, and the continued strong growth in credit and broad money suggest that upside risks to inflation are not yet fully contained.

In spite of some favorable background, the Republic of Moldova remains Europe's poorest nation, resisting pursuing the types of reforms that have vastly improved the economies of some of its Eastern European neighbors. The Communist Party retained political control after winning the March 2005 parliamentary elections and re-elected its leader, Vladimir Voronin, as president in collaboration with the opposition. Although the government maintains a pro-Western stance, it has had trouble pursuing structural reforms and has made little progress on the International Monetary Fund's program to attract external financial resources. The parliament approved the government's economic growth and strategy paper in December 2004, but international financial institutions and Western investors will not be satisfied until the government begins to address fiscal adjustment, wage restraint, and payment of debt arrears. Despite the fact that the pace of privatization and industrial output has slowed, GDP growth was 7.3 percent in 2004, consumption continues to grow, and the currency continues to appreciate. The impasse in the pro-Russian Transnistria enclave, plagued by corruption and the smuggling of arms and contraband, continues despite international attempts at mediation.