Note #5 – May 2005                                                               

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•   View from Outside: Prospects for Descending Interim Growth

•   Financial Markets as a Development Component

View from Outside: Prospects for Descending Interim Growth
by Karsten N. Pedersen, The Netherlands

Highlighted by value added growth in her farm sector rising by 20 percent last year, Moldavian economy appears to start reaping the benefits from structural reform. As real economic change commences to dominate shorter term activity effect from economic liberalization, GDP growth continue hover at her 6-7 percent level from beginning of decade – sustaining sustainability as the economic recovery transforms from monetary stabilization and ownership reform into a medium term phase of industrial recovery.

Number of obstacles, predominantly in finance, nevertheless continues to impede a well-balanced recovery. Hereto, years of economic recovery incurred at the expense of undernourished foreign currency reserves at National Bank of Moldova. These endure at less than three months of import financing despite reversal of external financial inflows during the last two years.

At present, currency stabilization and rising price pressure emerge as symptoms of a liquidity boom in a fixed foreign currency regime as growing net inflows of foreign currency assets arrive from increasing confidence in Moldavian currency - and contributes to rise the country's foreign currency reserves. In this vein, inflows of foreign currency assets contributed to a 45 percent rise in broad money supply as measured by M2 in 2004 – while consumer price inflation ascended to twelve percent despite diminishing growth in consumer retail sales.

In this fashion, effects from accommodative policy responses increasingly highlight profound trade offs between real and monetary stabilization as price pressure begin erode achievements already made in improving Moldavian business climate. As National Bank of Moldova's use of secondary policy instruments including growing issue of domestic debt papers is beginning to strain domestic credit costs, efforts to couple monetary and fiscal policy with the objective to contain ongoing liquidity expansion may contribute to facilitate government's longer-term goal of sustaining recurrent economic recovery. More important, as recovery in domestic credit markets remains driven by reduction to risk premia on lei currency assets - rather than
explicit internal rates adjustment - incrementally raising domestic financial rates leaves modest anticipated effect on foreign financial flows. On this background, further financial reform with the aim to deepen domestic markets for debt security should serve as an inroad to viable liquidity growth as foreign currency reserves are rebuilding while leaving favorable effect on internal price pressure.

In an effort to contain credit expansion - domestic interest rates rose last year following many years of decline while issue of domestic debt securities by government and monetary authorities expanded at vivid pace. While such response comes as an obvious reaction to growing domestic price pressure from expanding liquidity - further curtailing liquidity growth with the purpose to reduce internal price pressure could leave an uncomfortable rate of activity reduction at present.

The achievement of and sustaining medium term financial surpluses need to remain National Bank of Moldova primary working objective as holdings of foreign reserve recuperate from 2.7 month of import finance in 2004. Rebuilding of foreign currency buffers at National Bank of Moldova may recover at increasing pace in the near future - adding further strains in domestic finance as vivid reaction from improving monetary condition emphasize as short term unaccounted financial inflows rose to US$ 38 mill first three quarters of 2003 and further US$ 78 mill first three quarters of 2004 equivalent to 1.9 and 3 percent of GDP respectively.

Further contributing to stress in financial intermediation as the expansion of liquidity extends is financial deepening by financial intermediaries as demonstrated by Moldavian money multiplier (i.e. ratio of broad money to cash and reserves held by financial intermediaries) rising to 1.5 in 2004 from 1.2 end of past decade.

Largely resulting from migration of labor - remittances from Moldavian nationals residing abroad are steepening. It is estimated foreign currency inflows from labor income of Moldavians living abroad rose from about a 6-8 percent share of GDP end of past decade to an excess of twenty percent in 2003. These flows are estimated to have grown further in 2004 despite currency stabilization and rising inflationary pressure as workers’ transfer of labor income climbed to almost US$ 1/2 billion first three
quarters of 2004 equivalent to 63 percent of merchandise export receipts. Obvious concerns to balance of payments viability arise from exceptional large transfers of labor income as durability of these flows varies from merchandise trade income. As such risks relate to income differentials between at domestic jobs and opportunities abroad - sustaining high income growth create incentives to repatriate.

GDP growth is expected to soften this year as the economy recovers from windfall gains in agriculture last year. But policy demands to achieve further recovery to net exports is expected to remain a primary concern with requirement for monetary adjustment other than currency revaluation. As reduction to activity growth this year should arrive with lower import demand, recurrent liquidity expansion could nevertheless extend at high pace adding to price pressure in the event domestic financial market reform further delays.
 

Financial Markets as a Development Component
by Vadim Matsui, CISR/ASE

According to the Constitution of the Republic of Moldova (clause 126), its economy is market and socially oriented, 
based on private and public property and free competition. These characteristics have been mainly achieved over the 
transition period:

·        Major part of the country’s GDP is formed in private sector rather than state sector;

·        Prices in general realistically reflect alternative costs of resources’ utilization, thus affecting decisions made;

·        Private persons can freely, at will, engage in entrepreneurial activity;

·        Tax system has been modernized and tax burden has been cut, which resulted in increased tax collection rate.

It is a paradox, but at the background of these fundamental changes situation in financial and banking sector looks contradictory. Given that most banks are quite well-off and render services in accordance with European standards, the stock market itself has not passed the stage of embryonic growth yet.  In the meantime, in a sense, it is stock market is a very peculiar superstructure and an indicator of the country’s market maturity. Now, the main problem of Moldova, with conversion to the economy’s modernization under the Government Activity Programme for 2005-2009, is “fight” for investment resources. And it is very difficult to provide for competitiveness of the country, of its goods and services (2^nd Copenhagen criteria of EU) without attracting direct foreign investments, state budget funds or savings of the population (and financing development at the expense of owned means of enterprises). 

Financial market, being a proving ground for taking and realizing the most efficient investment decisions can ensure mobilization of savings, including citizens’ remittances from abroad and their transformation into investments. Creation of advanced national financial institutions that would enjoy trust of economic agents and the population is a prerequisite for both growth of internal savings and their efficient utilization in the interests of the country’s economy.

    Source: National Commission for Securities

Moldova’s Stock Exchange (MSE), by the highest standards, does not function duly, simply being a formal mediator in transactions of securities purchase rather than a place where market value of stock is determined (and changed at every single moment of time) under influence of demand and supply. At MSE, there are mainly arranged dealings whose contractors already know each other before the beginning of auction, and stock of privatized enterprises is sold. Thus, in 2004 there were registered 1855 transactions of 281,9 mil MDL at MSE, which makes 0.88% of GDP. This number of dealings is registered during several minutes at large exchanges (see Table 1). Among positive trends, one could note decreasing share of SWAP transactions at MSE: they made up 70% of the total in 1998, while only 2.24% in 2003. 

Two ways of stock market development are possible: evolutionary and revolutionary. The second, faster variant of stock market development presupposes stimulating through various financial instruments (tax remissions, in peculiar) of emission of stock and/or loan securities of Moldovan enterprises. 

Table 1

  The Role of Stock Exchange in National Economies in 2003

  Source: International Federation of Stock Exchanges, 2005

However, once at least several new joint-stock companies of “MMM” or “Intercapital” type appear in the market, one can forget about its development for another 3-5 years. If it was Ministry of Finance of RM that, in its time, issued loan securities with 100% dividend yield and then extended term of their circulation, our entrepreneurs can devise even more original methods to concurrently obtain facility and income. Therefore, the evolutionary way of stock market development seems to be more preferable.  

First, it is necessary to realize why it is very profitable for enterprises and households of the whole world to use the stock market services, which holds an important position in national economies, and why it is not the case in our country. In our opinion, main problems of Moldovan stock market are high costs related to emission of securities and high mistrust of economic agents towards transparency and efficiency of the stock market. Large enterprises that can issue loan securities to expand or modernize their production are the most realistic actors in stock market, but they are VIP clients of banks. And it is profitable for banks to render credits to these enterprises (than work with hundreds of small clients), so such enterprises have no need to look for alternative sources of financing. 

Public mistrust towards stock market is not groundless either. Protection of investors’ rights is covered by the last chapter of the Law on Market of Securities, which is close by its contents to the chapter “Informational Provision of Market of Securities” of the similar law of Russian Federation. While there is no separate law that would be dedicated to protection of rights and legitimate interests of investors in Moldova. Besides such a law, it is necessary to create Center for Protection of Investors’ Rights (holders of stock, loan securities, depositors), which would work with troubled enterprises that do not wish to pay on their own, and thereby decrease their number and restore the public trust towards the stock market.