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International ratings, external deficits, exchange rate…
Iurie Gotisan, March 31, 2009
The Economist Intelligence Unit, part of the well-known British magazine The Economist, has recently published a report on vulnerability of countries of the world to consequences of the world economic crisis. The report ranks the Republic of Moldova, Ukraine and Bosnia-Herzegovina as most politically unstable countries and therefore, very vulnerable to economic developments. In fact, these are very natural explanations, as Ukraine for example has entered a full economic crisis with a divided political class, splitting and internal confrontations. Bosnia and Herzegovina faces a similar situation like Ukraine, while Moldova was introduced as a country with an autocratic rather than democratic regime, with a very discontent population which does not trust much in political institutions. So, all these factors influence directly or indirectly the economic and political stability in a certain country.
According to a rating by the international financial evaluation agency Fitch IBCA, Moldova is rated "B-" for long-term external commitments, "B" for internal commitments and the "stable" forecast for both of them. At the same time, Fitch experts say that the economic situation in Moldova is "very difficult" on background of the increasing external debt and persistence of an appreciated leu. In the context of these evolutions, hereby some comments regarding evaluations of the two ratings, outlining some aspects of the macroeconomic context.
According to the NBM data for the 3rd quarter of 2008, the overall external debt of Moldova accounted for about 4 billion dollars, by about 19 percent more than in late 2007 and more than 66 percent of the GDP (the GDP in 2008 was 6.03 billion dollars, calculated on the basis of an average exchange rate of 10.42 lei/USD). The state-guaranteed debt amounted to about 0.78 billion dollars of the overall external debt or about 13 percent, this being a generally accepted level. The unguaranteed private debt covers most of the overall external debt, about 3.1 percent, increasing by 20 percent compared with 2007, especially after the rise of commercial credits. In addition, the trade deficit reached a record level of over 3.3 billion dollars in 2007, counting for about 55 percent of the GDP, while the current account deficit has likely exceeded 6 percent of the GDP. Accounts above indicate a rising trend of external deficits in the last years with the decisive "contribution" of the private sector. Even more, the growth of external deficits justifies the fear of many economists regarding possible skidding in 2009 on background of the economic crisis’ effects and explains somehow why talks with the IMF are difficult.
In fact, the relation between current account and GDP (CA/GDP) is the key indicator which should be taken into account when the country’s external position is assessed. Therefore, both the trade balance and remittances are part of the current account deficit. For example, the current account deficit of Moldova reached 218 million dollars in the 3rd quarter of 2008. By using a simple extrapolation, one may estimate that the current account deficit will exceed 500 million dollars in 2009 or more than 10 percent of the GDP (IMF estimates 10.6 percent of GDP). Of course, it is hard for any economy to fund a 10 percent, but Moldova is relatively well compared with other countries from the region. The central bank has enough resources to protect itself against eventual speculative assaults, despite a strong use of reserve currency in the recent period. However, Ukraine or Poland faced serious financial crises at such levels in the last ten years, facing devaluations of domestic currency.
One more thing is worth to be mentioned: much of the current account deficit (about 50 percent) is raised on account of the private sector or the private sector borrows more than the Government. There is a very elementary explanation in this regard: the private sector is likely more reasonable than the public sector (as it meets market regulations) and these deficits finally have natural explanations. Statistics for 2008 confirm this assessment: imports of technological equipments, machines and appliances are increasingly larger, so that economic agents invest more in modernization of enterprises and expect larger profits in future.
On the other hand, the announced falls of interest rates on lei, higher wages, expansion of consumer credit, an eventual appreciation of leu will encourage a better dynamic of internal demand than of internal supply. The decline of interest rates would encourage the crediting in lei in an economy caught in the fever of consumption. While the reduction of taxes in 2008 and the duty-free corporate profit did not stimulate enough the budget collections, the expansion of consumption is found in higher external deficits and probably in slower efforts to reduce the inflation. The appreciation of leu versus dollar helped somehow a lower inflation in 2008 compared with 2007, but deepened the external deficits.
The macroeconomic evolution this year will depend much on regional trends as well. However, it is hard to tell Moldova’s possibilities to manage without an external financial help on background of internal and external negative economic evolutions. To recall that the IMF memorandum is almost over, while a new agreement could be negotiated only after the election of a new government. The granting of assistance by other donors is also conditioned with a new agreement with the IMF. If it fails to find alternative funding sources or give up some social and economic programmes, the Government will have to call on assistance of the World Bank. However, the exhaustion of reserves could free the spiral of prices and release new speculative pressures on the leu. An immediate result would be the rise of prices, devaluation of national currency and marking up of strategic imports such as natural gas, electricity, etc. All the more this could happen, as oil prices have suddenly increased on international markets.
We have often been witnesses of accusations brought against NBM with regard to the exchange rate policy, which were justified here and there. An appreciated leu may counteract the inflationist impetuses, but external deficits will deepen and effects will not be late. When the leu is appreciated including nominally, exporters face the consequences first of all, as collections from exports fall down. In addition, a long-term appreciation of the leu with some fluctuations erodes the economic stability if productivity incomes are inappropriate, bringing high deficits at level of enterprises and domestic economy. Staking on the appreciation of leu as a factor capable to reduce the inflation may be a very dangerous solution. Some signal an imminent financial crisis related to an eventual "escape of capital" which would make the leu fall down. But at the same time, Moldova does not run the risk to face the escape of speculative capital. Finally, governmental options should be judged in relations with the National Bank’s dilemmas, while the choices of economic policy faced by Government are very difficult since they imply important compromises and costs. Anyway, a good cooperation between Government and NBM is required, especially when the internal economic conjuncture in 2009 could be influenced inclusively by results of the April 5 parliamentary elections.