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External deficits vs. deficit of economic stability
Iurie Gotisan, April 28, 2006
Everybody knows that the Moldovan economy is incapable to fight face to face with European economies. The trade deficit and current account deficit grow in a galloping pace every year, with analysts saying that this rise will continue the next years as well. In addition, consequences of the Moldovan-Russian commercial relations could distort the country's economy much more. But how close is the danger of a crisis?
On the other hand, high external deficits may be absolutely normal for an emergent economy like the one of the Republic of Moldova, whose mechanisms are being defined and bear fruits just now. Under these conditions, the minus between what Moldova exports and what it consumes from imports expressed economically through the trade deficit reached about 171 million dollars in January-March and it was 1.7-fold higher than in January-February 2005.
According to many analysts, nor the certainty that this "hole" will alarmingly grow in continuation is the worst thing to happen to us. However, no matter how explainable and understandable such a deficit could be, but a crisis may occur if it exceeds a certain limit. However, it is not important how high this deficit is, the debt we have to pay for imported goods and services, but if enough funds enter the economy to cover the hole.
The healthy financing of the current account deficit is the key of the problem. Many persons consider that the remittances of Moldovans working abroad would resolve the problem. However, consistent remittances are some short-term sources, which will decline meanwhile. On the other hand, the things are under control as long as there are enough sources to finance the foreign debt. There was financing until now because the Moldovan economy has offered enough comfort to foreign investors, (though it was restricted here and there) and assured revenues for the money invested here. As for example, foreign direct investments (FDI) in Moldova last year accounted for about 260 million dollars, so that the current account deficit (some 285 million dollars) was financed through them 90 percent. Authorities estimate FDI worth about 300 million dollars for this year.
We will face problems only if we are incapable to attract foreign investments. It means that investments in shares of societies rated on capital market, in investment funds, governmental bonds, etc. (portfolio investments) will be outlined since the big privatisations were competed and, on the other hand, the financial market is opening to foreigners. However, investments from portfolio are much more volatile than FDI - these being money looking for good productivity or, according to economists, speculative capitals. That's why they will stay here as long as they will find what they are looking for: high productivity, a healthy economy, economic growth, stability. It is more dangerous when deficits are coupled with a low economic growth.
If the Moldovan economy shows obstacles, and this is possible, the volatile money placed in portfolio investments will be withdrawn. Therefore, this would mean the lack of financing sources for the hole of debt consumption in Moldova. The current account deficit would be truly dangerous. Where the danger is coming from? It is related to the withdrawal of these funds which obstruct the massive currency exchanges on currency market and a massive depreciation of Moldovan leu that may have disastrous consequences on economy. It is also disastrous for the anti-inflation fight of the central bank.
However, the scenario of a crisis generated by a high deficit is improbable. A dangerous scenario could appear if the national currency is depreciating very much - because a strong leu versus dollar or euro hits the exports and reduces their competitiveness. We see a "hole" of the current account of about 9 percent of GDP for 2006, but also investments of 350 million dollars. This scenario with a high enough deficit is not too dangerous and it is natural that the debt of Moldova grows and this is the example of other countries from the region, which have recently joined the European Union and faced the same problems: Poland, Hungary, and the Czech Republic. And this is not "a margin of country" because a big part of consumption comes from companies and turns into investments, which contribute (at least theoretically) to the rise of competitiveness of Moldovan firms.
The individual private consumption - that means of common people - has a lower share in these deficits. The consumption goods represent about 25 percent of imports, while their share was relatively constant in the past years. The rest represents imports of capital goods and raw materials, which will help enhancing the competitiveness of Moldovan firms the next years.
However, the uncontrolled deepening of deficits, of unbalance between capacity to export and need of imported goods and services induces a risk on long term. This is a risk that IMF representatives have also indicated more than once to the Chisinau authorities. The fear of IMF rather envisages a medium and a long term. Because the Moldovan economy is opened and dependent on exterior and everything is happening with the world economy influences us, too. If the world economy is not developing well, the appetite for investments declines. And the possibilities to finance the Moldovan consumption on money of foreigners also decline.