For debate in the Standing Committee — see Rule 15 of the Rules of Procedure

Doc. 9797

25 April 2003

Economic development of Moldova: challenges and prospects

Report

Committee on Economic Affairs and Development

Rapporteur: Mrs Sigita Burbiene, Lithuania, Socialist Group

Summary 

Economic reform in Moldova has over the last decade proceeded more hesitantly than in most other transition countries. As a result, living standards have eroded while the economy developed slowly or even contracted, with the level of investment being insufficient to sustain growth. More recently the country has achieved a degree of political stability and economic prospects are now improving. However, widespread poverty, a heavy external debt burden and an extensive shadow economy are sources of continued concern.

Moldova’s key development challenges include the need to integrate its Transnistria region into the country’s economic and political structure, to ensure a prudent management of the national budget and the external debt, to accelerate structural reforms and to build a business environment conducive to greater competitiveness, investment and economic growth. This calls for a more efficient dialogue between political parties, the business sector and NGOs, a system of checks and balances leading to greater transparency in the state and regional administration and active co-operation with international financial institutions.

I.        Draft Recommendation

1.       After over a decade since the beginning of the economic transition process to market economy in central and eastern Europe, the achievements reached by individual countries vary considerably. Moldova’s current economic and social weakness places it among the least successful in this regard. Although the country has achieved relative political stability and macroeconomic indicators are improving, the levels of poverty, external debt and the size of the shadow economy are of continuous and serious concern.

2.       The Parliamentary Assembly welcomes the fact that, in spite of continued economic hardship, Moldova has remained overall committed to the economic reform programme supported by the European Bank for Reconstruction and Development (EBRD), the European Union, the World Bank and the International Monetary Fund (IMF) and others. This assistance remains necessary and should be expanded further.

3.       The Moldovan economy has suffered greatly from the uncertainty surrounding the status of the Transnistria region. Beyond the political consequences related to the emergence of this auto-proclaimed entity in 1992 – not recognised by the international community – the economic effects are substantial, as Moldova’s budget has been deprived of tax inflows from Transnistria for over a decade, economic ties between Transnistria and the rest of the country have been disrupted, investor confidence has been undermined and tensions have occurred in trade links with certain neighbouring countries due to extensive unaccounted-for economic activities in the region and cross-border smuggling. A peaceful and rapid solution to this problem is essential for the country’s economic development.

4.       In order for current economic growth to be consolidated, accelerated and sustained, Moldova has to improve the business and investment climate. Genuine support to small and medium-size businesses for the creation of employment would constitute a major step forward. Moreover, as the restructuring and privatisation of state enterprises continues, the Parliament of Moldova holds a special responsibility to improve legislation regarding enterprises, banks and customs, including through a close dialogue involving representatives of all political parties, business associations and NGOs, and to establish a system of checks and balances capable of ensuring greater transparency in the state administration.

5.       To alleviate poverty, bold measures are called for. The agreement on a national Economic Growth and Poverty Reduction Strategy, must lead to a channelling of limited resources available to the poorest and the most vulnerable population groups. The Assembly believes that close co-operation between the Moldovan authorities and the international aid institutions is vital to allow a speedier reform of the social protection system, notably in healthcare, education and the pension system.

6.       The external debt service places a heavy burden on an already weak economy and impedes much-needed public investment. External debt restructuring, especially through the Paris Club of bilateral creditors, and efforts to boost and diversify exports are necessary to make more funds available for priority activities under the Economic Growth and Poverty Reduction Strategy.

7.       The Assembly welcomes Moldova’s recent accession to the Stability Pact for South-Eastern Europe and the World Trade Organisation (WTO). It notes Moldova’s active involvement in many Stability Pact initiatives, especially those concerning trade liberalisation and facilitation in line with WTO and European Union principles. The Assembly in this context :

8.       In the light of the foregoing, the Assembly recommends that the Committee of Ministers urge:

      i. the member states of the Council of Europe:

      iii. the authorities of Moldova:

9.       Given the fact that Moldova is so far the only recent member state of the Council of Europe Development Bank (CEB) that has not yet received any funding from it, the Assembly calls on the Moldovan authorities and CEB to step up their co-operation with a view to resolving the outstanding issue of Moldova’s contribution due following accession to the Bank and the subsequent speedy identification of projects for financing in priority fields, which could benefit from subsidies of the CEB Selective Trust Account, notably facilities for the return of victims of trafficking in human beings and measures to prevent such trafficking.

10.       The Assembly recalls its Resolutions 1303 (2002) and 1280 (2002), in which it asked the Moldovan authorities to pursue co-operation with and to apply Recommendation 110 (2002) made by the Congress of Local and Regional Authorities of Europe on local and regional democracy in Moldova. It reaffirms these earlier calls and draws attention to the need to ensure attribution of real competences to the local and regional authorities in Moldova, notably as concerns the management of local budgets.

11.       Finally, the Assembly hopes that more constructive negotiations will lead to an early political settlement of the Transnistrian issue and the speedy and full reintegration of the region into Moldova, also economically. It calls on the international institutions concerned to stand ready to enhance their support to this process.

II.        Explanatory Memorandum by the Rapporteur

1. INTRODUCTION

1.       On 9 April 2001, Mrs Pozza Tasca and other members of the Assembly presented a motion for a recommendation (Doc. 9019) on the need to assist in the economic development of Moldova. While pointing to the country’s poor economic and social conditions, the motion calls for support to job creation and measures against social exclusion, poverty and economic crime in order to narrow the development gap between Moldova and other member states of the Council of Europe. The motion also specifically asks the Council of Europe Development Bank to consider allocating funds and endorsing projects towards assisting the country to overcome its economic problems.

2. In response to the motion, which was referred to the Committee on Economic Affairs and Development, this report aims to examine Moldova’s current economic and social situation. It starts with an overview of key economic and social indicators and continues with a presentation of challenges and prospects for future development. In conclusion, the report seeks to identify options for concrete action to help Moldova ensure for its citizens an economically viable future.

3. The report makes use of national data from Moldova’s Department of Statistics and Sociology, the Ministry of Economy, the Ministry of Finance and the National Bank of Moldova. It also draws on reports and surveys prepared by the Moldovan Economic Trends (an EU-funded project providing quarterly reviews of the Moldovan economy and analyses of the country’s main macro-economic indicators), as well as the work of international institutions such as the EBRD, the IMF, the World Trade Organisation, the UNDP (United Nations Development Programme), the World Bank and the Council of Europe itself. The Rapporteur would like to thank the Moldovan parliamentary and government authorities for information and assistance provided during her fact-finding visit to Chisinau (12-16 March 2003), following which she was able to complete her report and to formulate a number of recommendations for action.

4. Prior to analysing the state of the Moldovan economy, the Rapporteur wishes to pay tribute to the commitment of Moldova (a Council of Europe member since 1995) to the consolidation of democracy, structural reforms, the rule of law and political pluralism even during the most difficult times of transition and periods of adverse external and internal conditions. This is not to say that problems of corruption, economic crime and insufficient economic management have all been successfully overcome, but rather to acknowledge that many Moldovans are doing their utmost to improve their country’s performance.

2.       ECONOMIC OVERVIEW

2.1.       Background

5. Moldova is a relatively small country of around 3.6 million inhabitants (over 600 000 Moldovans have left the country since the 1990s), its population being composed of various ethnic groups: about 64% Moldovans/Romanians, 14% Ukrainians, 13% Russians, 3% Gagauzians and the remainder consisting of other smaller ethnic groups. It is situated between Romania on the west and Ukraine, on the north, east and south. Moldova gained independence in 1991 and like many former Soviet republics it suffered hard from the disruption and disintegration of its traditional economic and trade relations. The country was also adversely affected by the abrupt increase in external prices, especially for energy resources, on the imports of which it depends almost completely. It was particularly hard hit by a series of natural disasters and the turmoil that followed the 1998 financial troubles in Russia, its main trading partner. As a consequence, Moldova has experienced a substantial economic downturn in both agriculture and industry, accompanied by increased unemployment, worsening social conditions and a mass emigration of workers.

6. Upon independence, Moldova embarked on ambitious structural reforms aimed at the transition towards a market-driven economy. Notwithstanding continuous economic hardship, Moldova has, with few exceptions, been committed to the economic reform programme supported by international institutions such as the European Union, the EBRD, the World Bank and the IMF. Reform policies have been aimed essentially at macro-economic stabilisation, liberalisation and privatisation. However, despite numerous efforts and some more recent signs of a modest recovery, the Moldovan economy has failed to gain significant momentum. Moldova is now the poorest country in Europe and, next to Tajikistan, the second poorest of the former Soviet republics.

7. In addition to its economic plight, Moldova has been involved in a conflict with the separatist region of Transnistria - mainly inhabited by ethnic Russians and Ukrainians (about 250 000) - which proclaimed its independence in 1992. Beyond the political consequences related to the emergence of this auto-proclaimed entity – not recognised by any sovereign state – the economic effects are substantial, as Moldova’s budget has been deprived of tax inflows from Transnistria for over a decade. Economic ties between Transnistria and the rest of the country have been disrupted, investor confidence has been undermined and tensions have occurred in trade links with certain neighbouring countries due to extensive, unaccounted-for economic activities in the region and to cross-border smuggling. While there has been little fighting since the civil war in 1992, the conflict is far from resolved. The bid for reconciliation seems to be making some progress with the current President (an ethnic Russian) bringing Moldova and Transnistria closer to an agreement and with Russia having agreed to pull out its troops. There is, however, little real advance and the Russian troops have not left the region in due time.

8. The European Union and the OSCE have closely followed negotiations between the Moldovan authorities and the Transistrian leadership. The European Union in particular considers that the failure so far to resolve the Transnistrian problem is the largest impediment to Moldova’s political and economic development and one of the root causes of its current poverty. Deeming what it saw as obstructionism by the Transnistrian leadership unacceptable, the EU together with the United States introduced a travel ban against Transnistria’s main representatives in February 2003. The OSCE, for its part, blames the Transnistrian administration for delaying the withdrawal of Russian troops from the region, for which the deadline had to be extended for another year, until the end of 2003.

9. It is important in this context to note that the macroeconomic indicators available to the Rapporteur from the various sources do not cover the economic performance of Transnistria, nor do they take into account a substantial decrease in Moldova’s population due to the vast, but officially underestimated, emigration over the past decade. Moreover, varying ‘guesstimates’ as to the size of the shadow economy make any more precise evaluation of the true economic situation and the country’s development potential more difficult.

2.2.       Macro-economic Indicators

10. Since the early 1990s, Moldova has experienced a continued decline in its gross domestic product (GDP) with negative real GDP growth rates almost every year of the decade (see Figure 1 below). In 2001, with a GDP of USD 1.38 billion1, the IMF estimated that the country’s economy had shrunk by 60% since 1991. Similarly, the GDP per capita annual growth rate between 1990 and 1999 averaged a negative 10.8 %2. In 2001, GDP per capita was estimated at only USD 4003 or well below the average for the countries in transition. Although in 2002, the fourth consecutive year of rising per capita GDP, this indicator amounted to USD 449, it still had not reached the level of 1997, the year before the economy suffered from the effects of the 1998 Russian financial crisis.

11. Nevertheless, with a positive real GDP growth resumed in 2000 (up by 2.1%), the outlook now looks somewhat brighter. Real GDP grew by 6.1% in 2001, not least due to various positive trends in the economy (such as greater economic, political and social stability, further privatisations and restructuring, increased domestic demand, as well as strong export growth and improved relations with international financial institutions)4. This development continued in 2002, with real GDP growth of 7.2%. Official sources forecast that the Moldovan economy will register about 7% growth in 2003. This estimate is based on the expected impact of structural reforms (including a stronger legislative framework), increased investment, household consumption and export gains.

12. Following the 1992 hyper-inflation rate of 1209% (mainly caused by monetary emission in order to finance the budget deficit, but also a result of the liberalisation of domestic prices), the primary objective of the National Bank of Moldova has been price stabilisation. As depicted in Figure 2 below, inflation rates were consistently brought down between 1995 and 1998 under a tight monetary policy. In the wake of the Russian financial crisis that year, inflation peaked again at 39% in 1999, but then came down to 18.5% in 2000, 6.5% in 2001 and 4.4% in 20025.

13. The government balance, while still in deficit, has been brought to the fairly sustainable level of –2.9% of GDP in 2000 from –9.7% of GDP in 19966. The subsequent tightening of fiscal policy reduced the deficit and even generated a surplus of 0.5% of GDP in 2001. According to the IMF, the 2002 fiscal programme was weaker than expected, but the Moldovan authorities managed to limit the deficit to about 1% of GDP while still having room for additional social expenditures and clearance of arrears in the range of 0.5% of GDP. The 2003 budget foresees a deficit of about 0.8% of GDP and provides for its coverage with earnings from privatisation and the sale of government securities. Many experts believe, however, that the expected proceeds from privatisation are largely overestimated. Moreover, the recent tensions in relations between the Moldovan authorities and the IMF could lead to a halt in financing not only from the IMF but also the World Bank and the European Union, as well as to further complications in Moldova’s plans to restructure some of its external debt via the Paris Club of bilateral creditors.

Figure 2. Inflation (Consumer Price Index)

1995-2002

Figure 3. Nominal Lei/USD Exchange Rate

1994-2002



Source: National Bank of Moldova

14.       From the introduction of the Moldovan Lei at a flexible exchange rate in 1993 up until 1998, the nominal Lei/USD exchange rate depreciated relatively slowly (see Figure 3 above). The negative impact of the 1998 Russian financial crisis and the subsequent deterioration of the current account (see further Section 2.4. on trade) put strong pressure on the currency thereafter. In 1999 alone, the Lei depreciated by 37.7% against the US Dollar. The exchange rate has stabilised recently (Lei 14.5 against the USD in mid-March 2003) thanks to stronger demand for the Lei linked to a growth in exports, tax revenue and foreign investment, but also due to foreign currency inflows from Moldovans abroad. The Lei/Euro exchange rate (about 15.5 in mid-March 2003) has generally followed the trend of the Lei/USD rate, but the depreciation of Lei versus Euro was generally less pronounced. In terms of competitiveness, the real effective exchange rate7 appreciated constantly until 1998, leading to a loss in the competitiveness of Moldovan products. It fluctuated up until 2000, but is now fairly stable and broadly adequate for maintaining competitiveness.

15.        Privatisation has advanced significantly since independence, particularly as regards small-scale enterprises. The growth of private enterprises (totalling 195 000 registered companies) has resulted in a situation where the public sector accounted for less than 50% of GDP in 20018. The privatisation of larger public enterprises (in power generation and supply, public utilities, telecommunication, and transport sectors) has, however, been less successful. The privatisation of, for example, the state wine and tobacco industries was stopped in late 1999 as the coalition government at the time (with a strong reform platform) faced strong opposition in parliament. This led to a suspension of World Bank and IMF funding, which resumed only in late 2000 after the parliament had accepted privatisation in the wine and tobacco sectors.

16.       Despite such occasional slowdowns, privatisation and restructuring is moving forward. Thus, the restructuring and privatisation of the energy sector (power distribution companies) is well underway, land privatisation is nearly complete and farm restructuring covers 80% of agricultural land. What the agricultural sector now seems to need most is the consolidation of land holdings and the development of cooperatives. This process has to be stimulated by legislation and financial measures. For the privatisation of state enterprises to bring more benefit to the society, there need to be well functioning anti-trust laws and related provisions, as well as stronger consumer protection laws.

2.3.       Economic Sectors

17.       Moldova, a traditional agrarian economy and with agricultural land making up three-quarters of the total land area, depends heavily on agriculture which accounts for about a fifth of the country’s GDP and employs a quarter of the country’s workforce. Favourable climate and soil conditions enable the country to produce a wide range of crops, including fruit, vegetables, grain, sugar beet, sunflower seeds, tobacco, as well as wine (many of which are recognised as among the finest in the market), beef and milk. While the industrial sector has relied primarily on agriculture-related activities such as food processing (including the production of canned juice, fruits and vegetables, as well as sugar and vegetable oils) and the manufacturing of agricultural machinery, Moldova’s industries also include shoe-making, textiles, wood processing, foundry equipment, and some consumer goods (namely refrigerators, freezers and washing machines). Today, manufacturing accounts for around 80% of total industrial output.

18.       Both agricultural and industrial production has been in decline since independence. In the 1990s, average annual growth rates in agriculture and industry were negative at –13.7% and –15.7% respectively9 (Figure 4). As a result (Figure 5), the shares of both agriculture and industry in GDP declined, while that of services increased considerably. The latter’s growth is explained largely by the steady expansion in transport and communications services, trade and construction. In 2002, the shares of agriculture, industry and services in GDP amounted, respectively, to 21%, 18.6% and 47.5%10. The shadow economy measured as a share of GDP is estimated at about 31%.

Figure 4. Agricultural and Industrial Output 1995-2002

Figure 5. GDP by Sector 1995 & 2000


(Note: The difference between the sum and the total of 100 % is made of net taxes on goods and imports)

Source: Moldovan Department of Statistics and Sociology

19.       Two components of the overall economic reform programme have been land privatisation and farm restructuring. The break-up of large agricultural farms and the distribution of land titles to farmers transferred most agricultural production into private hands. In 2000, private agricultural output accounted for 74% of total production (compared to 38.6% in 1993)11. Despite the privatisation efforts, agricultural production has continued to fall, primarily due to lower productivity and harvesting levels (yields have fallen because many small farmers cannot afford equipment, fertilisers, seeds or irrigation, but also due to adverse weather conditions). A recent move towards the private land consolidation and the creation of voluntary cooperative associations is therefore a welcome trend. The recovery in industrial output was noticeable as from 2000 and continued in 2001 and 2002, as the year-on-year growth rates amounted to 8%, 14.2% and 10.6% respectively12; the agricultural output continued to grow steadily, by 4.4% in 2001 and 8.8% in 2002. However, further efforts are needed to steadily implement structural reforms in order to consolidate economic growth.

2.4.       Trade

20.       As part of its overall economic reform programme, Moldova has pursued a policy of trade liberalisation since early on in its transition process, for instance by removing the state monopoly over foreign trade in 1992 and gradually eliminating restrictions on imports and exports. As a small country, Moldova cannot afford to be self-sufficient in more than a few industries and therefore relies greatly on foreign trade. Just as it needs to import a wide range of goods and raw materials, greater export diversification and promotion must be key priorities.

21.       Primarily due to the collapse of domestic output and the need to import certain commodities (especially energy), major trade imbalances have led to a gradual but substantial deterioration of the current account deficit. The annual growth in imports of goods and services averaged 4.6% between 1990 and 2000, while the annual average growth of exports was only 1%13. As Figure 6 below shows, the current account deficit averaged 10.6% of GDP between 1995 and 2000, peaking at 19.3% in 1998 following the Russian financial crisis. It is largely attributed to a widening of the trade deficit. Export earnings fell from 60% to 52% of GDP, while import expenditure rose from 70% to 72.5% of GDP during the same time period (see Figure 7 below). At the same time, Moldova’s terms of trade14 deteriorated by 26% (from an index rating of 100 to 74) between 1995 and 2000. Although Moldova’s volume of foreign trade increased considerably in 2001 and 2002, the trade imbalance persisted.

Figure 6. Current Account Deficit 1995-2002

Figure 7. Export & Imports 1995 & 2000


    Source: National Bank of Moldova, Moldovan Economic Trends

Source: Department of Statistics and Sociology of Moldova

22.       Such current account imbalances are exceptionally high by industrial country standards and far exceed those experienced by emerging market economies. As a result, Moldova’s external position has worsened substantially over time and, between 1995 and 2002, average foreign reserves were valued at only 2.6 months of imports. However, the IMF expects the current account deficit to improve, as exports rise and energy losses decrease following further privatisation and restructuring in the energy sector, thus reducing the trade deficit. For the first time since the 1998 Russia crisis, the year-on-year growth rate of exports exceeded that of imports in the second quarter of 200115 but the volume of exports still did not reach the level of 1997 and a balance of trade remained negative in 2001 and 2002.

23.       Tables 1 and 2 below list Moldova’s principal export and import products. While some progress in export diversification away from agricultural products (most notably wine and tobacco) has been made in recent years, foodstuffs, beverages and tobacco still accounted for 38% of total export earnings in 2002. The second most important export commodity (textiles and textile products) has increased its share significantly since 1997 when it accounted for only 6.7% of total export earnings. Nevertheless manufactured goods made up only 27% of exports, with primary exports accounting for the remaining 73%. Imports of mineral products account for a fifth of all import expenses, as Moldova depends on foreign supplies of oil, coal and natural gas for power generation. Moldova’s total export earnings stood at USD 878 million in 2002 while its imports totalled USD 1279 million16.

Table 1. Main Export Commodities

Table 2. Main Import Commodities

Commodities

% of Total in 2000

% of Total in 2002

Food, beverages, tobacco

41.9%

37.8%

Textiles

17.7%

16.7%

Vegetable products

14.0%

15.0%

Machinery & equipment

5.2%

4.2%

Livestock & animal products

4.8%

2.2%

Leather & fur

2.8%

Metal & metal products

2.5%

1.1%

Chemicals

1.7%

Mineral products

0.6%

1.6%

Other

8.8%

21.5%

Commodities

% of Total in 2000

% of Total in 2002

Mineral products

33.0%

21.7%

Machinery & equipment

12.7%

14.0%

Textiles

10.0%

10.0%

Chemicals

9.6%

10.7%

Food, beverages, tobacco

9.2%

Metal & metal products

4.1%

4.6%

Vegetable products

3.3%

4.0%

Livestock & animal products

1.4%

Leather & fur

0.3%

Other

16.4%

35.2%

Source: Moldovan Department for Statistics and Sociology; Ministry of Economy and Reforms

24.       Moldova is still largely dependent on Russia for its trade (tables 3 and 4 below), especially as regards exports. While the share of exports to Russia and other CIS countries has declined somewhat since 1995, it still accounted for 58.6% of total exports in 2000 (52% in 2002). However, the share of total imports from the CIS countries has decreased substantially from 67.7% in 1995 to 32.5% in 2000 and 39.4% in 2002. The importance of central and eastern European countries has declined as regards exports, while their share of total imports increased from 14.3% in 1995 to 26.4% in 2000 and 23.2% in 2002. The importance of EU countries as trading partners has been growing, both in terms of exports and imports. Exports to EU countries accounted for 21.9% of the total in 2000 (as opposed to 11.6% in 1995) and 24.3% in 2002, while 26.4% (in 2000 and in 2002) of total imports came from EU countries (compared to 13.7% in 1995). There is also a growing share of imports (15.8% in 2000) from other countries (including the USA).

Table 3. Main Export Partners

Table 4. Main Import Partners

Countries

% of Total 2002

% of Total 2000

% of Total 1995

Russia

35.4%

44.5%

48.3%

Romania

8.4%

8.2%

13.9%

Italy

9.1%

7.7%

2.1%

Ukraine

9.1%

7.6%

7.9%

Germany

7.4%

7.6%

6.1%

Other EU countries

7.9%

6.4%

3.4%

Other countries

10.2%

6.1%

4.5%

Belarus

5.6%

4.6%

3.6%

Other CEE countries

3.3%

3.8%

3.7%

Other CIS countries

1.8%

1.9%

2.9%

Hungary

1.3%

1.0%

0.8%

Bulgaria

0.5%

0.7%

2.9%

Countries

% of Total 2002

% of Total 2000

% of Total 1995

Romania

11.4%

16.3%

6.7%

Other countries

11.0%

15.8%

4.3%

Ukraine

20.4%

14.2%

27.2%

Russia

15.3%

13.2%

33.1%

Germany

9.2%

10.8%

5.4%

Other EU countries

9.7%

9.9%

6.0%

Other CEE countries

7.1%

5.8%

2.9%

Italy

7.5%

5.7%

2.3%

Belarus

3.5%

4.1%

6.0%

Hungary

2.0%

1.9%

1.0%

Bulgaria

2.6%

1.8%

3.8%

Other CIS countries

0.2%

0.4%

1.4%

Source: Moldovan Ministry of Economy and Reforms, Moldovan Economic Trends calculations

25.       Moldova is party to a number of multilateral trade agreements, the most important being Moldova’s accession to the World Trade Organisation in July 2001. Its WTO membership should facilitate the promotion of Moldovan products abroad, the expansion and diversification of its trade relations, and the protection from discriminatory trade measures. In 1994, Moldova signed the Partnership and Co-operation Agreement (PCA) with the EU. It became effective in 1998 and aims, among other things, to create a favourable environment for mutually beneficial trade, investment and economic relations and could eventually lead to the establishment of a bilateral free trade area. Furthermore, in June 2001 Moldova joined the Stability Pact for South-Eastern Europe, which envisages free trade agreements between all the parties. Finally, in order to maintain and expand its traditional trade links, Moldova has concluded bilateral free trade agreements with all CIS countries (except Tajikistan) and Romania.

2.5.       External Debt

26.       Moldova began its transition in 1991 with virtually no external debt, since Russia took over the country’s outstanding obligations when the Soviet Union collapsed. Since then, as illustrated below, the external debt in comparison with GDP and exports has grown enormously. A number of factors help to explain this, such as the accumulation of large current account deficits in the late 1990s, the rise in external energy prices, a sharp depreciation of the Moldovan Lei in 1999 and poor economic growth, exacerbated by the 1998 financial crisis in Russia. By the end of 2000, total external debt (including estimated USD 300 million debt for energy resources) amounted to USD 1.55 billion, equalling 108% of GDP and 243% of export earnings. It contracted to USD 1.5 billion in 2001 but grew to USD 1.64 billion in 2002.

27.       Since the accumulation of debt has coincided with a fall in export earnings (especially since the 1998 Russian financial crisis), Moldova has had increasing difficulty in making payments on its debt. Toward this end, like many poor countries, Moldova has resorted to new borrowing simply to service its debt obligations – creating a vicious circle of more debt and more borrowing. In 2000, the external debt service (principal plus interest) amounted to 21% of exports (having gone down from its peak of 31.6% in 1999) and 23.7% of budget expenditures. However, in 2002, the debt service shrank to only 10.4% of exports and 9.2% of budget expenditures, partly due to much stronger economic growth, but also owing to a rescheduling of an outstanding payment of USD 39.6 million on a Eurobond emission.

28.       While the share of public debt (i.e., that of the government and the National Bank of Moldova) of total external debt has fallen from 80% in 1995 to 58% in 2001, public debt service expenditure still averaged a quarter of total budget expenditures in a 1999-2001 period. Of the total external debt outstanding and disbursed by the end of 2001, 60% was owed the World Bank, the IMF and other multilateral institutions; 22% was owed bilateral creditors, and 18% private lenders. According to World Bank classifications, Moldova is still considered a moderately indebted country in terms of external debt per capita. Its debt indicators are, however, very close to those of severely indebted countries. External debt is a particularly heavy burden on Moldova in terms of debt to GDP (estimated at 107.8% in 2002) and a major impediment to much-needed public investment. If the external environment becomes less favourable and growth stagnates, the debt situation may become unsustainable. Although, in mid-2002, the IMF evaluation of the Moldova’s debt situation was positive, the major credit rating agencies, including Standard & Poor’s and Fitch, saw Moldova on the brink of default on its debt payments due in 2002 and downgraded the country’s rating. However, the outlook for 2003 looks more positive.

2.6.       Foreign Direct Investment and Overseas Development Assistance

29.       Flows of Foreign Direct Investment (FDI) into Moldova were practically non-existent at the beginning of the transition. Since 1995, however, FDI has picked up (as shown in Figure 8 below). FDI was particularly low in 1999 as a result of the 1998 Russian financial crisis, political uncertainties and delays in privatisation. In 2000 it peaked with USD 127.5 million (equalling 9.8 % of GDP) before lowering to a mere USD 37 million in 2002. In terms of total investment stock, Russia is by far the largest investing country (USD 150.8 million by the end of 2002 or 36.4% of the total) in Moldova. It is followed by the United States (USD 42.2 million), Spain (USD 39.3 million), France (USD 15.3 million) and Germany (USD 13 million). To date, total investment into the authorised capital of joint ventures in Moldova amounts to USD 671.2 million, of which USD 414 million, or 62%, are from abroad. The main investment inflows have so far benefited enterprises in energy, gas and water supply (44%), processing (23%), trade (12%), transport and communications (10.6%).

30.       Moldova offers a liberal and non-discriminatory foreign investment regime. FDI is allowed in all sectors, but is particularly encouraged (through, for example, tax concessions) in energy, agriculture, construction and telecommunications. In addition, Moldova is a member of the MIGA (Multilateral Investment Guarantees Agency), which offers political risk insurance to investors and lenders and assists countries in attracting and retaining private investment. Notwithstanding the institutional and legal framework favouring FDI, Moldova has lagged behind other transition countries in terms of total FDI since independence. In 2000, however, Moldova fared well in terms of FDI per capita of USD 23.8, ranking 13th of all transition countries17. The rising trend is likely to continue if the government privatisation strategy goes ahead as planned.

31.       However, many foreign companies find it difficult to do business in the country, due to what they feel is excessive state regulation. A World Bank study in 2002 on the cost of doing business in Moldova reported relatively high bribes paid to public officers, excessive licensing requirements, lengthy and costly customs clearance, complex company registration procedures and far too frequent inspections. Furthermore, domestic entrepreneurs complain about unclear business-related legislation, a lack of business support services (in particular for the small and medium size enterprises), corruption and export restrictions (especially as regards grains). In March 2003, the World Bank reported what it considered to be a worrying harassment by the state authorities of the Spanish Company Union Fenosa, a strategic investor owning three Power Distribution Networks in Moldova.

32.       With regard to Overseas Development Assistance (ODA)18, Moldova has benefited from the support of many multilateral organisations as well as from several bilateral assistance programmes. Between 1997 and 1999, annual ODA inflows averaged 7.6 % of GDP. Since Moldova joined the World Bank in 1992 and IDA (International Development Agency) in 1994, the World Bank Group cumulative commitments to Moldova as of March 2003 totalled USD 505 million for 14 projects. While initial lending focused on adjustment support, building a private sector in both agriculture and manufacturing, and improving the management of the energy sector, current support targets macroeconomic sustainability, private sector development and public sector reform. The IMF has advanced around USD 241 million to Moldova since 1992 essentially in support of financial policy targets and structural reforms.

33.       Moldova’s relations with its biggest multilateral creditors – the World Bank and the IMF – have been rather complex. Disagreements over macro-economic policies and certain laws led to a halt in financing for 18 months as from July 1997 and for shorter periods between 1999 and 2002. There is renewed strain as these lines are being written (March 2003), as the institutions are considering to suspend financing unless, in the next few months, a Law on Pre-shipment Inspection is passed in the version previously agreed with the IMF; the 2003 Budget is tightened; all export restrictions and state interference with the activities of private enterprises are removed; and the Poverty Reduction and Growth Strategy is finalised. International experts are also concerned about additional expenditure for an administrative-territorial reform considered less of a priority. The Congress of Local and Regional Authorities of Europe has deemed the proposed reform as not being in line with the European Charter of Local Self-Government and has issued a number of recommendations19 meant to rectify various shortcomings.

34.       The EBRD support to Moldova (€ 203.8 million as of June 2001) centred on the co-financing of projects in the financial, agricultural, private corporate, and infrastructure (including telecommunications) sectors. Other large-scale multilateral support includes funding from the European Union’s TACIS Programme (about € 95 million for the 1991-2002 period) and the UNDP. The largest bilateral donor remains USAID, which has committed a total of USD 190.5 million since it began its operations in Moldova in 1993. In consideration of the fact that Moldova is the only CIS member state to have joined the Stability Pact for South-Eastern Europe, more flexibility on the part of the EU is needed to allow for a more coherent use and co-ordination of aid funds made available for regional co-operation in south-eastern Europe via the CARDS, PHARE, SAPARD, ISPA and TACIS programmes and also occasionally European Investment Bank credit lines. The Rapporteur hopes that the proposed new framework20 for relations with the EU’s eastern and southern neighbours following the enlargement of the EU will open up prospects for enhancing EU-Moldova trade links and overall co-operation.

2.7.       Social Indicators

35.       As a result of their country’s economic decline, Moldovans have seen their living standards erode since 1991. In 2000, 40.5% of all Moldovan households lived below the poverty line (set at 30% of the minimum subsistence wage). The situation is even worse in rural areas (54% of the total population), where over half of the population lived below the poverty line in 200021. With a Human Development Index (HDI)22 of 0.699 in 1999 (0.700 in 2000), Moldova ranked 98th of 162 countries. Only Uzbekistan and Tajikistan of the former Soviet republics ranked lower in 1999. By comparison, the Soviet Republic of Moldova had an HDI of 0.758 in 1990.

36.       The official unemployment rate in 2002 was measured at a mere 2% of the economically active population23. This rate, however, includes only those officially registered as unemployed. The ILO (International Labour Organisation) estimation of the unemployment rate is 7.3% (with youth unemployment rate being close to 16%), but even this may not reflect the true situation. Moreover, apart from the hidden unemployment, the figures may also be revealing low productivity, low mobility of the work force, ill-functioning bankruptcy mechanisms and little real competition on the job market that would otherwise stimulate vocational training and the acquisition of new skills.

37.       While the per capita monthly disposable income24 increased from Lei 135 in 1997 to Lei 186 in 2000 in nominal terms, the real monthly disposable income per capita in 2000 did not even reach 80% of the 1997 level. Today, about 90% of the population live on less than USD 1 per day. Wage arrears, real income decline and rising prices for basic goods and housing have left most Moldovans in dire straits. Thus the so-called ‘Gini coefficient’25 for income distribution was estimated at 0,406 in 1999, while the richest 20% of the population earn 11 times more than the poorest 20%. In 2001, the situation improved slightly, as average wages picked up, rising to USD 40 per month from USD 30 per month in 2000 and to USD 54 per month in early 2003.

38.       Given the poor condition of the state budget, public spending on education, health and social security dropped from 26.9% in 1997 to 17.6% in 2000. Similarly, education spending as part of total public expenditure decreased from 24.4% in 1995 to 16.7% in 2000, while public spending on health fell from 15.8% to 11%26. Over the 2001-2002 period, however, budgetary allocations for healthcare, education and social security increased, reaching, respectively, 25%, 14.2% and 14% total expenditure in the 2003 budget. Because of the tough socio-economic situation in their home country, a substantial proportion of Moldova’s economically active population has chosen to live abroad. Around 600 000 Moldovans are estimated to have left, temporarily or permanently, to work in Russia and western Europe. In 2002, these migrant workers are estimated to have transferred at least USD 275 million by official channels and about USD 150 million by other means in support of their families in Moldova.

39.       In July 2002, the Moldovan government approved a comprehensive interim Poverty Reduction Strategy in coordination with the World Bank and the European Union and is expected to finalise a more comprehensive Economic Growth and Poverty Reduction Strategy in early 2003. Furthermore, the government has increased pensions by 20% and reduced arrears in wage bills (pension arrears were successfully eliminated already in the first quarter of 2001)27 drawing on an unused budgetary surplus from 2001 that was carried forward. The IMF commended Moldova’s prudent fiscal and monetary policies as applied over the past year and the country’s further consolidation of its institutional framework. In consequence, the IMF resumed its loan disbursements under its Poverty and Growth Facility in July 2002.

3.       CHALLENGES AND PROSPECTS FOR THE FUTURE

40.       Reforms and policies of the past few years have yielded positive results as regards macro-economic stabilisation, privatisation and economic restructuring, and have led to a modest economic recovery. However, Moldova remains vulnerable to changes in the economic situation of its major trading partners, notably Russia. The country also faces serious external debt repayment problems, as debt service absorbs a significant share of government revenue, thereby reducing the scope for vitally needed public investment and worsening the budget deficit. While future economic and export growth may alleviate the debt burden in the long-term, the only short- to medium-term option is debt rescheduling. Sustaining growth, alleviating poverty and reducing the debt burden will therefore remain Moldova’s main policy objectives in the years to come. Towards this end, the government will have to continue growth-oriented structural measures, while keeping financial policies under control and pursuing active co-operation with the multilateral financial institutions.

41.       Key reform challenges also include trade diversification – both in terms of products and partners; further restructuring and privatisation of large public enterprises and turning towards the consolidation of private land ownership; and the improvement of the business environment through legal and institutional adjustment, investment protection and support networks, especially for SMEs which should be a central source of employment, innovation, entrepreneurship, and productivity growth. Bold measures are also needed to strengthen country’s social security system, tax collection system (especially via customs) and the domestic energy sector.

42.       Unlike many other transition countries, Moldova has avoided any ‘shock therapy’ to its economy, but its more gentle way of carrying reforms forward has yielded less tangible results so far. Living standards have eroded continuously, while economic activity has shrunk or stagnated, with the volume of investment being far too modest to sustain growth. Persuading foreign and local investors to expand their activities in Moldova will not be easy, unless the authorities invest themselves with good governance and continued reforms. The ‘two-steps-forward-one-step-back’ approach to reform has already cost much resources and time. The territorial-administrative reorganisation undertaken by the present government is an example of a costly exercise in what must be considered a matter of lower priority given the country’s many other urgent problems. The reform in question not only largely undoes the work of the previous government and strains the budget, but is also in contradiction to the European Charter of Local Self-Government. There is therefore every reason why it should be reconsidered.

43.       The Moldovan economy has suffered greatly from the uncertainty surrounding the status of the breakaway Transnistria region, as Moldova’s budget has been deprived of tax inflows from that region for over a decade, economic ties between Transnistria and the rest of the country have been disrupted, investor confidence has been undermined and tensions have arisen in trade links with certain neighbouring countries due to extensive unaccounted-for economic activities in the region and cross-border smuggling, especially on the border with Ukraine. More constructive negotiations should lead to an early political settlement of the Transnistrian issue and the speedy and full reintegration of the region into Moldova, also economically. The international institutions and countries concerned should to stand ready to enhance their support for this process.

44.       Finally, given the fact that Moldova is so far the only recent member state of the Council of Europe Development Bank (CEB) that has not yet received any funding from it, co-operation between the Moldovan authorities and CEB should be stepped up, with a view to resolving the outstanding issue of Moldova’s contribution due following accession to the Bank and the subsequent speedy identification of projects for financing in priority fields, which latter could benefit from subsidies via the CEB Selective Trust Account, notably facilities for the return of victims of trafficking in human beings and measures to prevent such trafficking.

Reporting committee: Committee on Economic Affairs and Development

Reference to committee: Doc. 9019, Ref. 2601 of 27.4.2001.

Draft recommendation unanimously adopted by the committee on 1 April 2003.

Members of the committee: Mrs Zapfl-Helbling (Chairperson), Mr Kirilov, Mrs Burbiene, Mrs Pericleous-Papadopoulos (Vice-chairpersons), Mr Ašikg÷z, Mr Adam, Mr Agius, Mr Agramunt, Mr I. Aliyev, Mr Anacoreta Correia, Mr Andov, Mr Arnau, Mr Assis Miranda, Mr Ates, Mr Berceanu, Mr Braun, Mr Brunhart, Mr Budin, Mr ăavusoglu, Mr Cosarciuc (Alternate: Mr Neguta) , Mr Crema, Mr Djupedal, Mr Duivesteijn, Mr Elo, Mr Eyskens, Mr Figel, Mr Floros, Mr Galchenko (Alternate: Ms Yarygina), Mr Galoyan, Ms Griffiths, Mr Grignon, Mr Gusenbauer (Alternate: Mr Grissemann), Ms Hakl, Mr Haupert, Mr H÷gmark, Mr Jonas, Mr Kacin, Mrs Kestelijn-Sierens, Mr Klympush, Mr Korobeynikov, Mr Kraus, Mr Lachnit, Mr Le Guen, Mr Leibrecht, Mr Liapis, Mr Makhachev (Alternate: Mr Slutsky), Mr Masseret, Mr Melcak, Mr Mikkelsen, Ms Milicevic, Mr Naumov (Alternate: Mr Umakhanov), Mr Íhman, Mr O’Keeffe, Mrs Patarkalishvili, Mrs Pintat Rossell, Mr Podgorski, Mr Popa, Mr Puche, Mrs Ragnarsdottir, Mr Ramponi, Mr Reimann, Mr Riccardi, Mr Rivolta, Lord Russell-Johnston (Alternate: Mr Banks), Mr Rybak, Mr Schreiner, Mr Severin, Mr Seyidov, Mr Slakteris, Ms Smith, Mr Stefanov, Mr Tepshi, Mr Torbar, Mrs Vadai, Mr Voog, Mr Walter (Alternate: Baroness Hooper), Mr Wielowieyski, Mr Wikinski, Mr Zhevago, Mr Zvonar.

N.B. The names of those members present at the meeting are printed in italics

Head of Secretariat: Mr Torbi÷rn

Co-Secretaries to the committee: M. Bertozzi, Ms Ramanauskaite and Ms Kopaši-Di Michele


1 World Bank: World Development Indicators

2 UNDP: Human Development Report 2000

3 Department of Statistics and Sociology of Moldova

4 IMF Country Report No. 190 of August 2002

5 Moldovan Economic Trends

6 Ministry of Economy

7 The real effective exchange rate measures international competitiveness by relating domestic and foreign price levels taking into account the main trading partners. It is influenced by the nominal exchange rate, inflation in Moldova and other countries and trade flows between them.

8 EBRD Transition Report 2002

9 World Bank: Country Assistance Strategy 1999-2001, Moldova at a Glance

10 Moldovan Economic Trends

11 Moldovan Department of Statistics and Sociology

12 Moldovan Economic Trends

13 World Bank: Country Assistance Strategy 1999-2001, Moldova at a Glance

14 Measured as the number of units of imports that can be exchanged for a unit of exports.

15 Ministry of Economy and Reforms, Moldovan Economic Trends

16 Ministry of Economy and Reforms

17 Freedom House: Nations in Transition

18 Bilateral or multilateral grants, loans and technical assistance on relatively concessionary financial terms.

19 Recommendation 110 (2002) on local and regional democracy in Moldova

20 Communication on “Wider Europe – Neighbourhood: A New Framework for Relation with our Eastern and Southern Neighbours”, issued by the European Commission on 11 March 2003

21 Moldovan Economic Trends: 2000 Household Budget Survey

22 The HDI (with a maximum of 1) is built upon composite indexes of life expectancy, education and GDP (UNDP: Human Development Report 2001).

23 Department of Statistics and Sociology, Moldovan Economic Trends

24 Apart from employment income, disposable income also includes capital income, income from non-salaried activities (mainly agricultural) and social security benefits.

25 The Gini coefficient measures the extent to which the distribution of income deviates from a perfectly equal distribution and varies from 0 (perfect equality) to 1 (perfect inequality). ( UNDP: Human Development Report 2000)

26 Ministry of Finance

27 EBRD Transition Report 2002