Economic Policies on July 1–16, 2006

Prices and inflation

Estimates for inflation: chain price rises…

The Consumer Price Index (CPI or inflation rate) rose by 0.2% in June, while the cumulated inflation rate for the first half of this year was 7.4%. Moldova may face some factors of risk which halts the anti-inflation fight — adjustments of administrated prices and modifications of tax policy in the next period — after the natural gas price has grown up to 160 dollars per 1,000 cubic metres. According to our estimates, some adjustments of regulated prices, especially of electricity, heating and gas may occur, as the regulation authorities have revised the price rise schedule for these utilities. The effects of these chain price rises will be observed in house maintenance and, implicitly, in CPI.

Prices of natural gas for Moldova may be at European level by 2008…

In this regard, the scenario that the prices of natural gas for Moldova will be at European level by 2008 may be materialised, as the Government has failed to sign a long-term agreement with Gazprom. As regards the electricity, a full liberalisation of this market may be observed in early 2008, concomitantly with the partial liberalisation of heating price and withdrawal of the national reference tariff (about 230 lei/1GK). It is not a surprise that the Government has already asked the Ministry of Finance to present the draft budget law for 2007 by late August.

We could presume that excises for main groups of products covered by this regime may also grow, a measure which will affect the inflation. The adequate budgetary policy could to support the anti-inflation fight, which could direct to balanced deficits and contribute to a better productivity of work and economic growth through paces of expenses (directed especially to productive objectives). On the other hand, the growth over expectations of international prices of crude oil and natural gas and of some food products may also slow down or even stop the inflation.

Food products, alcohol and non-alcohol drinks cover over 40% of consumption basket…

Food products, alcohol and non-alcohol drinks hold a large share, representing more than 40% of the consumption basket, almost double compared with their share in some member states of the European Union, notably the Czech Republic (20%), Slovakia (17%) and Hungary (21%). As regards the prices for house maintenance in consumption basket rank the second place after food products, though their share is relatively lower than in other countries. On the other hand, the costs of maintaining a house (water, electricity, has and other fuels) are estimated as much higher after the rise of the gas price. The rise of prices for some products with administrated process starting July, 2006 may lead to the growth of monthly average inflation rates, as expected. The 10% forecast for 2006 is impossible without substantial adjustments of administrated prices.

Tax policy

We have budgetary surplus…

According to statistics, over 4 billion lei (about 235 million euros) was raised to the state budget in basic revenues in the first half of this year, by 17.5% more than in January-June 2005. At the same time, about 3.73 billion lei was spent from the state budget or by 30.6% more than in the first half of last year. Data show a clear budgetary surplus of over 200 million lei or 0.5% of GDP.

…but we do not know to use it

Perhaps it is hard to understand why? A wrong criticism could say that Moldova is incapable to spend some additional money efficiently because the amounts directed to development, infrastructure or healthcare and education reforms have been used for consumption (salary rises, subsidies, social programmes, etc.) every time until now. Following this logic, it would mean that Moldova is condemned a priori. In reality, this is not a fatality, but a need of prudence from at least two reasons.

On one hand, the economic structure makes a large budgetary deficit threaten more the payment balance (which is much adverse nevertheless) and inflation. On the other hand, the inexistence of a tax strategy for more years produces curious jumps in executing the budget and incoherence of planning: a budgetary surplus was also registered in 2005 and like now the budget had a surplus because of the shortage of investment projects or incapacity to implement them. This also explains the incapacity of efficient spending mentioned above: the financial statistics show that the expenses for investments in fixed capital grew slowly in the first five months of this year, even much slower than in pessimistic scenarios launched in early 2006 — by only 9%, compared with 27% in the first trimester of the precedent year and 15% in 2004.

Currency and currency market

Leu is sensitive to international shocks…

Foreign funds (speculative or hedge funds) have started withdrawing from emerging countries, challenging the depreciation of their currencies, due to increasing geopolitical tensions, Iranian nuclear programme, tests of North-Korean rockets or the conflict between Israel and Lebanon plus the rise of the world price of crude oil up to about 77 dollars per barrel. Nor the Moldovan leu has got rid of these developments, with the euro reaching 16.36 lei in May and 16.85 in July. The U.S. dollar had a similar evolution: it rose from 13 lei per dollar in May up to 13.3 lei per dollar in July. We estimate a fluctuating exchange rate for euro by the end of this year — minimum 16.5 lei and maximum 16.8–17 lei per euro, while the exchange rate of the U.S. dollar could be between 13.3 and 13.5 lei per dollar.

Potential dangers of depreciation: private foreign debt and regional markets…

But what could happen further on? If this negative evolution of international financial markets continues this way, after increasing the gold ounce up to maximum of the past 26 years — over 740 dollars and we may face a situation of crisis similar to the autumn 1998 one. The emerging economic areas may be the main “targets” this time, which have profited of massive inflows of speculative capitals in the past years. Turkey is a good example, which had to increase the reference interest up to 22% in order to protect its lira, while the Hungarian forint, for example, registered the lowest quotations in the past years.

BNM officials have recently assured that we have why to be calm, as the fluctuations of exchange rates are part of the rule of game. BNM is not concerned with speculative funds (funds which did not invade us indeed), while an eventual sterilisation will be easily achieved, given the currency reserve of about 640 million dollars of the central bank. Problems may occur due to the boom of private foreign debt, which has exceeded the public debt. However, as regards the leu/dollar relation, it seems that the current geological situation is favourable for the U.S. currency, as shown by evolution of euro/leu parity, and this creates premises for its comeback to the level of 12.8 lei per dollar, which was not reached since late 2005.

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