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Inflation reduction from 23.8% in 1995 to 4.4% in 2002, though many analysts still doubt those figures, was in fact a big step towards the stability of the Moldovan Lei. However, the 15.7% inflation rate registered last year has handily outstripped NBM's forecasts. Noteworthy, periodical drops in the inflation rate were preceded by some hard fluctuations, even some sharp ones, as was the case in 1998-1999, when inflation rate teetered between 18.3% and 43.3%. This sharp drop was largely due to Russian financial crisis. Republic of Moldova was hit by that crisis as at the time Russia accounted for more than 70% of its foreign trade. Still many economy-watchers express lingering concerns with regard to National Bank's forecasts on the inflation rate, for them even 8-10% is a quite optimistic forecast.

Here are some of my thoughts on the high inflation rate as well as some ideas on how to keep it under 10% in 2004. Monetization, common to all transition countries at least during their first years of transformation, was the system's response to the huge "structural strain" a result of the inefficiency of many companies when it came to the new liberalised prices. On the other hand, such factors as arrears and debts, price formation by companies, and a certain exchange rate regime have brought new structural dimensions to the inflation and made them chronic. In turn chronicity has boosted even further the inflationist expectations. The latter are also related to the low credibility of the stabilisation measures undertaken throughout the years.

Still, throughout 1995-2003 National Bank undertook some major quasi-fiscal operations (subsidisation of certain types of economic activity), either through foreign exchange policy, or credits under preferential terms. In 2002 the lowest inflation rate, i.e. 4.4%, in the 11 years of transition was registered, that achievement was largely due to administrative control over major prices (including appreciation of the official exchange rate, energy price, etc) and sharp monetization of economy. Monetisation (which stands for surging monetary assets in GDP) was largely due to positive interests for the first time ever, which in its turn have made long-term deposits more attractive. Monetisation also explains how was it possible that huge currency issuing (M0) and implicitly soaring liquidity (M2) in economy brought among others by subventions (other than from state budget) to agriculture and other sectors have not ensued in immediate surge of inflation.

As for the monetary source of inflation, it is worth mentioning that inflation kept high regardless of GDP, when being high and when being low. In other words, the economic cycle (of business) has had more of a saying in shaping the inflation, at least in the last 11 years of transition. Throughout that time, National Bank issuing, i.e. currency and bank deposits (either as a countermeasure to surging net foreign assets, or additional net credit granted to commercial banks) was quite high. Those years were characterised by monetary bodies practising quasi-fiscal operations, so as to monetize deficits in economy. Quasi-fiscal operations were the primary cause of soaring issuing, which made the control over liquidity a more challenging task. They indicate a still insufficient level of restructuring in the Moldovan economy, as well as the fact that National Bank took over some funds care, that should have gone to the public budget. In the recent years quasi-fiscal operations resumed to National Bank buying state securities issued to aid struggling banks.

While state securities operations are targeted at shaping monetary market (such as the level of interest rates), in Moldova such operations were employed to indirectly finance budget deficit. To put liquidity under control, National Bank had to issue certificates of deposit and raise the level of obligatory reserves of the commercial banks held at the National Bank. To preserve the stability of the national currency and reduce inflation, last year National Bank Administration Council raised the obligatory reserves from 10% to 12%. The move deprived monetary market of an estimated 400 million MDL, which as a result eased the speculative pressure on USD. However, the move felt short of those expectations. Commercial Banks did not redirect their foreign currency placements, but rather had to decrease the amount of credits offered to the real economy sector. Reduction of the stock of money, and implicitly of the credit, may lead to a considerable increase in interests, that is to damage the bank portfolio due to the impact of the credit cost on the real economy.

Moreover, shortage of Lei determined some commercial banks to resort either to interbank credits or to the sale of securities, thus increasing the interest rates on those financial instruments in the future. At the same time, high interest rates would eventually affect budget equilibrium and businesses' crediting, as well as overall economic stability. Confronted with high interest rates, economy would end with short-term capital inflows, that might eventually lead to a sharp appreciation of Moldovan Lei and as a result drop in export revenues and growing commercial deficit.

Armed with formulae and tables of data economists would probably argue that soaring interest rates would attract foreign capital, that would in turn increase the volume of foreign net assets and bring the monetary market back to normal. Unfortunately, Moldovan realities have proved totally opposite, especially given the state's deficient position when it comes to investments. The capital likely to be attracted by the skyrocketed interest rates would be a speculative one, ready to flee the country upon the first signs of danger. That is exactly why IMF's traditional set of economic policy recommendations are built from the perspective of descending evolution of the interest rates, rather than ascending one.

It is all-too-clear that measures undertaken by the National Bank have more of analgesic than therapeutic effect. A similar thing happened in 1998 when in two weeks NBM raised the obligatory reserves from 8 to 15%, and than gradually decreased it throughout 2000-2001. NBM monetary policy for 2004 provides for a gradual decrease of obligatory reserves up to 8%, however it seems it would be impossible to achieve. It is not clear for how long NBM would be able to support the financial pyramid that is more and more inclined to collapse. Still, we would like to think that what we experienced in 1998 was the worst thing we had to go through. That is why, Government together with National Bank should find the most appropriate measures for recovery. And this because the former is largely responsible for the inflationist expectations and depreciation of the national currency, as it increased budgetary expenditures while failing to secure funds to cover for them, and missed foreign crediting.

Structural causes of inflation are related to insufficient restructuring of the economy. Slow reallocation of funds and low level of foreign direct investments (less than 3% of the GDP, that are in a way creating workplaces) have kept a strong pressure on the public finances and NBN when it was not free of quasi-fiscal operations. Noteworthy, those operations were undertaken also due to the system risk, that is the need to prevent the collapse of the entire banking system, in this respect a close link could be found between inflation and arrears. In my previous writings I sought to prove that arrears reflect economy's incapacity to quickly adjust to various shocks and that they may be viewed as temporary quasi-inside money, in other words "antibody" to shocks. High areas (35-40% of the GDP in the recent years) point to the insufficiently restructured economy (such as the appetite of many companies for state subventions in order to survive) on the one hand, and on the other the temptation of many businesses, even profitable ones, to evade taxes. Sharp surge in arrears coupled with the impossibility of current payments would block the economic system and result in a wide-scale crisis.

As is the case of many economies in transition, an ongoing competition between the state enterprises and private ones in failing to pay for the debts and perpetration of actions towards inflation. To put it differently, fighting inflation should be accompanied by imposing tough budgetary constraints, so that companies (especially the state-run ones) would pay taxes to the state budget. From this perspective, last year Government ordinance on freezing the debts worth 500 million Lei was doomed right from the beginning, as it did not address the major causes that led to huge arrears in the first place. It comes as no surprise than, that the names of the companies who benefited of the said ordinance were never disclosed, nor were the details of operation; however one may easily guess which particular companies enjoyed Government's mercy. Indeed, the said ordinance proved quite handy to moguls in Government or Parliament who stay behind those particular companies and who are jostling for influence. When the law turns into business it does no longer serve its purpose, whereas in business money factor undermine the decision-making.

Without a better financial discipline, it would be difficult to reduce sharply inflation and it would also create some problems to the banking system with many companies facing an increased financial blocking. Freezing debts involves a number of risks. And these are threefold. Firstly, the move induces a harmful fiscal treatment in economy. Huge debtors, state owned companies, might be led to believe that sooner or later they would benefit again of such fiscal charity. Thus, they would be encouraged not to pay the debt in line with a quite simple reasoning: the state forgave me once it will forgive me once again. However, small business would never indulge in such a reasoning. They know far-too-well that fiscal bodies are not are as forgiving when it comes to small-to-middling business, whereas fiscal control bodies are merciless when it comes to them paying arrears to state budget. And here we come to the second risk: the move runs counter to the very principle of fair competition. It comes down to discrimination, i.e. there are those who enjoy a preferential treatment and those who don't.

And finally, unless freezing of debts is backed up by payment of current debts, in a year or so Moldovan economy would be on the verge of a crisis. Financial blockage would be so huge that the state budget as well as private economy would run the risk of being suffocated. These huge debts are nothing but a ticking bomb ready to explode anytime, thus triggering a major financial collapse. The explosion wave would reach us regardless of whether we are shielded by a relatively balanced budget or not. Under the current circumstances, it would be smart to weight all the implications of such economic measures, so as not to run for some bubble benefits in the future, instead of some solid gains today.

It we are to look at maintaining a stable general price index, the raft of measures and mechanisms employed firstly by the NBM and later on by Governments that succeeded each other, were aimed primarily at keeping inflation under control. Inflation rate throughout 2000-2002 was the lowest ever. In 2000 it was estimated at 18.4%, in 2001 - 6.3%, whereas in 2002 - only 4.4% (!), the lowest in the former soviet area. Also, it is quite interesting that the monetary stock in circulation grew in 2002 by 36%(!) reaching 6,511 thousand Lei, as compared to only 4,787 thousand Lei in 2001, whereas GDP grew by only 6.3%. And here's a paradox: how was it possible to have such a low inflation rate, when the economy grew by nearly 6%, while the monetary stock grew by 30% (!). Monetary stock growth exceeded even the prices' growth, which rose on average by 5.2% per month on consumer goods, whereas the monetary stock rose by 7.8% per month.

In this respect, the limitations of monetary policy in influencing the real sector of economy were quite obvious. NBM's consistent restrictive policy has only partially achieved its goals, it managed to head off hyperinflation that was imminent at that time. However, we may not help wondering: how was it possible to reduce inflation to a one digit figure (below 10%) in 2001 - 2002, at the time there were no signs of wide scale restructuring. One answer is related to the durability of the low inflation rate, which is still questionable in many situations. The second explanation stems from the inflation impact on the amount of debt in real terms. That is exactly what determined the suspension of salary payments throughout 1996-1998. At the same time, arrears to the salary payments to state employees reached in 2003 almost 200 million Lei, whereas the need to pay suppliers of paramount goods, such as Russia delivering natural gas, made inflation exercise a even harder pressure on economy. Thirdly, such factors as large scale barter in domestic trade and high unemployment rate (around 20%) require an urgent wide-scale restructuring, and return to higher inflation rates. In Bulgaria there is a Monetary Council (establishing fixed rate of the national currency to a reserve currency, whereas the monetary policy is null) the dynamics of monetary offers rests only on the inflows and outflows of Central Bank's international reserves (the great majority of countries that undergone financial crisis in the last decade - Argentina, Estonia, Lithuania, Mexico, Indonesia, had a fixed exchange rate that triggered the financial crisis in the first place). In Albania also, low inflation was brought by financial crisis that had a disastrous effect on the people's savings and generated huge public debts (which is quite relevant for Moldova as well).

This once again proves that liberalisation and stabilisation of the macroeconomic factor does not in itself produce institutional and macroeconomic basics necessary to boost economy. Moreover, by breaching Central Bank's independence, the Government once again used it for its own good (making it cover the state financial holes from its foreign currency reserves or cover budget deficit), thus tarnishing its credibility. Another example in this respect is the artificial maintenance of low Lei/ USD rate, albeit it points, as does the trade balance deficit that reached 600 million USD in 2003, to the fact that Moldovan economy is feeble. Artificial strengthening of national currency and thwarting liberalisation of exchange rate have considerably affected economy by making imports cheaper and exports costly.

For instance, on average in 2003 the real exchange rate of MDL against Russian Rubble (prices in Moldova as compared to those in Russia) was almost 23% higher than prior to the financial crisis. However, if compared to economic conditions in Belarus and Ukraine, the prices rose by more than 17%. If we are to refer to 1998, than the gap between the prices is even wider: compared to Russian economic environment Moldovan prices rose by 30%, compared to Belarus by 40%. Skyrocketed prices were the result of discrepancies in the real exchange rate and inflation. For instance, average level of prices in 1998 rose by 40% as compared to 1997, whereas exchange rate of USD against MDL rose by only 3%. It is all-too-clear that between 1998-1999 the exchange rate rose at a faster pace than prices, a similar situation was registered in 2000-2001. As a result, in 2001 average price level rose by 43% as compared to 1999, whereas the exchange rate by only 23%.

It may well happen that in 2004 inflation rate would rose at its fastest speed. And this due to increased prices on imported energy, as well as on energy delivered to industry and housing. Another factor that might perpetrate inflation is commercial banks providing credits under preferential terms to businesses, which eventually prove to be inefficient. Albeit commercial banks' non-operational credit portfolio has reduced, banking system is still weak and divided. Chaotic turbulence in financial system only fostered inflationist expectations among the population. Although Republic of Moldova headed off default and its foreign currency reserves rose by 310 million USD, according to sources in NBM, country rating remains low, which means that the cost of loans on the international capital market is still quite high.

Consequently, anti-inflation program should not simply resume to NBM reducing issuing (M0). It should also include measures to be undertaken in the monetary and foreign currency fields, public finances, imposing financial discipline, revenue policy, overseeing financial and banking system, anti-monopoly legislation and competition policy.