October 2, 2017
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Recent Economic Developments
In the first half of 2017, real GDP increased by 2.8 percent, mainly driven by private consumption. The recovery in remittances, strong growth in wages and the indexation of pensions in 2016 drove consumption growth (+3.6%, y/y). Despite robust exports (+14.6%, y/y), supported by the good harvest of 2016 and a weaker Leu, imports increased 13.9%, resulting in a negative contribution from net exports to growth.
Fixed investment rebounded from its sharp decline in 2016, and grew 4.8%, y/y. The build-up in inventories added another 2.3 percentage points to overall growth. On the production side, with stagnating industry, the main growth impulse came from retail and wholesale trade, while agriculture contracted in the first half of 2017 by 4.1%, y/y.
Consumer inflation has been above target since April. Despite the reduction in the policy rate by 150 basis points to 7.5%, financial intermediation remains subdued. The latter, combined with a recovery in deposits, is contributing to persistent excess liquidity. Thus, the reserve requirement ratio increased to a record high of 40%. The increase in administrative prices kept inflation above the target corridor for the fifth consecutive month in August. Favorable exchange rate developments allowed the increase of foreign reserves, which now exceed 5.5 months of imports.
In the first half of 2017, the current account deficit increased to 9.3 percent of GDP from 5.9 percent a year earlier, driven by stronger imports growth than export performance. On account of reinvested revenues, net direct investments reached 2.2% of GDP, from 1.6% at end-2016. After decline in 2016, remittances increased 10.5%. External debt remained the main source of current account deficit financing. Due to Leu appreciation, external debt decreased by 0.6 percentage points to almost 92 percent of GDP.
In January-August 2017, government fiscal revenues and expenditures registered a double-digit nominal y/y increase, resulting in a 0.4 percent of GDP fiscal deficit. Compensating for the underspending in 2016 (due to late disbursement of the external budget support), current expenditures in the first eight months of 2017 rose rapidly. The largest increases were marked in subsidies to agriculture and procurement in goods and services. Spending on fixed assets increased by 14.5%, y/y, while capital investments marginally decreased. In the first half of 2017, on account of stronger growth, public debt and guarantees decreased by 4 p.p. of GDP, as compared to end-2016, reaching 40.1% of GDP.
Medium Term Outlook
The economy is expected to grow 3.5 percent during 2017, supported by a good harvest and strong private consumption on the back of higher remittances and private and public wage growth. Despite favorable exports developments, the contribution of net trade to GDP growth is likely to remain negative as imports are rapidly expanding. In 2017, with lower external assistance from the EU, the fiscal deficit is forecasted to remain below the planned 3 percent of GDP.
Strong revenue performance is expected to offset higher public spending. Should additional international support materialize, public investments will increase further. The revitalization of foreign inflows, and improvements in the financial sector and in the business environment are expected to encourage further private investments.
Real growth in public transfers and the ongoing rebound in remittances will help support growth in the medium term. Real GDP is projected to reach 3.8 percent and 3.7 percent in 2018 and 2019, respectively. With declining financial support from the international community, fiscal deficit is expected to widen but to remain below 2.5 percent of GDP.
As consumption and imports strengthen, the current account deficit is expected to gradually increase, but to remain below its historical average thanks to revitalization of foreign inflows. The inflation rate is expected to remain on average in the targeted corridor. Against this background, the poverty rate measured at the Upper Middle Income line of PPP US$5.5/day is projected to decrease by 3.2 percentage points in 2016-2019, supported by continuous real wage growth, remittances and public transfers.
Key downside risks to the baseline outlook include a slowdown in the implementation of key growth-enhancing reforms, including those related to the restructuring of the financial and energy sector and to the efficiency of public finances. Weak rule of law and vested interests could further halt the reform process. Parliamentary elections, scheduled in 2018, may also affect the pace of the implementation of the reform agenda. Weaker than expected growth in Moldova’s main trading partners (European Union and Commonwealth of Independent States) could further dampen growth.
Strengthening public finances by increasing the efficiency of public spending, including elimination of unproductive tax exemptions, and improved revenue mobilization would allow Moldova to create the necessary fiscal space for key social and capital expenditures and boost growth.
Improved economic governance in the financial and real sector would help Moldova increase its socio-economic outcomes (in particular in education, health, and vital infrastructure) and build a stronger foundation for growth. The elimination of tax exemptions that do not a have a clear rationale remain among the key reforms in the area of public finances. A forthcoming Special Topic argues that tax exemptions, including on VAT, represent a key source of last revenue.