Economic Policies on May 1–15, 2011

Prices and inflation

Inflation is expanding…

According to NBS data, the Consumer Price Index (CPI) in April 2011 was 101.0 percent compared with March 2011 and 106.5 percent compared with April 2010. Prices have grown by 4.3 percent since the beginning of this year (in April 2011 compared with December 2010). According to the NBM officials, prices will grow more than expected this year. The National Bank has increased the inflation growth forecast. A new report on average inflation rate states that prices will increase by about 8.5 percent this year, compared with 7.9 percent expected in February. Prices will grow more than expected in 2012, too. Thus, the inflation rate forecast for 2012 was increased from 4.5 percent up to about 6 percent. Prices will grow in connection with dearer fuel on international markets. This rise will be reflected in domestic prices by higher fuel prices and dearer production costs. At the same time, the depreciation of US dollar versus Euro will increase prices of imported products.

Economy or economic system is not something static. That’s why the fact that the central bank updated the forecasts made half a year ago is something normal. The country is facing so far a very uncertain period and working on various scenarios is normal. But even the 8.5-percent rate updated by National Bank for this year seems to be more than less unrealistic. Despite the economic growth in 2010, the country could easily enter a negative phase, given such shocks, as the recovery of Moldovan economy is pretty thin. For example, the direct export was relatively good in 2010, but it depends on developments in Europe, which absorbs half of trade exchanges. Or, the situation in this area is not excellent and some countries even face economic recessions, sovereign debts, rise of inflation and prices. These factors affect the domestic market of Moldova at a smaller or larger extent.

In addition, international financial institutions such as IMF will update forecasts on Moldova for sure, particularly because it forecasted a 7.5-pervent rate, which is better than of NBM. The Moldovan economy is very exposed to exterior and the share of foreign trade in GDP is heavy. Or, a high inflation could be recorded since Moldova imports very much. Some price rises for gas, energy agents, etc., will fuel inflation in general and will hit consumers in particular. As the previous issues of this publication have already said, the inflation will be the No.1 challenge for authorities and the evolution of other macroeconomic indicators which have an impact on people will depend on inflation.

Eventual forecasts…

According to official statistics, the inflation rate is close to 5 percent after four months of this year. Given this dynamic, the inflation rate could exceed 10 percent in 2011. A usual deflation recorded on summer would fail to improve the situation. There are eight months left until the end of the year. The National Bank could intervene on market (but laws allow it to do so just in emergency situations) and introduce a more or less directed currency regime in a move to maintain a reasonable inflation rate, and such a situation could be already observed on currency market — appreciation of leu versus dollar. But the dynamic of currency rate will also depend on evolutions on regional and international markets, speed of countries from the Euro zone to get rid of the current crisis, which will influence the situation in Moldova for sure.

Currency market

Exchange rate gives “headaches”…

Following a gradual fall of the official leu-dollar exchange rate, a gradual sustained rise is now observed. As for the leu-euro exchange rate, the trend is changing after a sudden fall two weeks ago. The last price rise accompanied by appreciation of the leu-euro exchange rate, has an impact both on economy and people. On one hand, the devaluation of leu versus euro and inflation growth advantage producers and businesses, since their production is more expensive, inclusively when exported, as the final cost includes a series of utilities, raw material sources, which have become pretty expensive. Thus, producers and exporters earn more from devaluation of leu, too. On the other hand, final consumers are disadvantaged. Therefore, people will have to pay more for products, services, etc. But how to afford higher prices since no rises are planned to help them. No salary, pension rises were forecasted. Even worse, authorities would probably try to reduce expenses in order to prevent financial holes which are hard to cover. At the same time, one may say that the stability of leu versus dollar, on which our leu is anchored, is beneficial to control inflation.

Macroeconomy

Results of negotiations with IMF…

The results of negotiations with the International Monetary Fund mission may be described as useful and proposals by the latter are relevant in general. Fiscal measures such as introducing a 4-percent single tax for small and medium-sized businesses, as well as reintroducing the corporate profit tax, a single tax for enterprises but now of 12 percent instead of 18 percent as effective until 2007, seem to compensate income deficit in state treasury. In fact, these are some normal measures, as the IMF and authorities attest an economic redress and estimate growths in several sectors of economy, as for statistics. Thus, these measures are welcome. On the other hand, despite optimistic data (particularly on industry) provided by official statistics, one should not forget that the productive sector is off the scent so far, and many enterprises are hardly redressing after crisis. Even more, the industry covers more than 12 percent of GDP, but it employs just more than 10 percent of labour force, while some sectors reported a fall in the first trimester. How should one understand the updating of economic indicators by Government first and then by IMF, son that to increase forecasts? First, Moldova is up serious difficulties to attenuate shocks (particularly those coming from exterior as effects of crises, etc.). But in most of cases these difficulties have origins in development level, structural and institutional features which are incompatible with current market rules. Second, the high share of foodstuffs in consumer basket (around 35 percent) explains why the depreciation of leu fuels inflation quickly. The relatively high share of foreign trade in GDP (+/- 100%) was a trump for domestic economy to resist to impact of international financial crisis. Therefore, the production development accompanied by larger budgetary collections made the Government and IMF to increase the economic growth forecast. However, there are serious vulnerabilities when the country has a growth model based on consumption (fuelled by remittances and imports) and increasing crediting, foreign loans and often speculative investments.

IMF recommends limits for internal modification of expenses…

In fact, IMF officials rely on reducing expenses in some sectors, especially after crisis, being concerned but notifying Government in connection with eventual problems related to budgetary-fiscal adjustment. A relatively high speed growth was recorded the last years, but fiscal consolidation has some serious steps to do so far. One should not forget the low budgetary collections of about 38–40 percent in Moldova. State-run enterprises are very inefficient. The situation summoned the Government to reduce expenses in several fields. For example, it reduced subsidies for agriculture; the budget is poor but what about the huge fiscal evasion officially estimated at 15 percent of GDP, funds which could go to various sectors including agriculture, if collected at least half of them. This is a proof that state-run institutions fail their mission or are very corrupt. What about regional development, Moldovan villages which face a lamentable condition? The Moldovan economic policy does not control these factors, but seriously hardens the structural and institutional reformation, so that it would be very hard to achieve the desired results without radical actions. These measures are bitter on a short term and have undesired social effects, but they could bring amazing results on a medium and long term.

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