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The floating of the Moldovan Leu — free or managed?
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The exchange rate of the Moldovan Leu (MDL) has floated significantly. The issue of currency exchange rate may be approached in a number of ways. Most directly, the currency exchange rate affects the contents of one’s pockets, which is more or less depending on the period of time when one looks at it: in December 1997 it amounts to US$215, and in April to only US$68. In both instances these amounts can be changed into a few notes of 200 Moldova Leu (MDL). This approach is the closest to us. Even when we cautiously save in US dollars or (ever more often) in Euro, usually we get our wages in MDL, and so the value of our national currency concerns us in any case.
Another approach is the one of the authorities — the macroeconomic level. Here things seem a bit paradoxical. A “weak” MDL would advantage exporters, experts would surpass imports, the commercial balance would produce a currency increment, and so the MDL would become “strong” again. On the other hand, a “strong” MDL is good for a budget burdened by foreign debt. Budget incomes are in MDL, and if this one becomes “stronger”, fewer MDL would be needed to buy currency and pay off the foreign debt. A “weak” MDL advantages those who have a long-lasting position in currency (meaning currency liquidities overpass currency bonds), and the devaluation of the MDL generates profits for them.
The Central bank takes a special role in this system. This role is described in Article 4 of the Law on the National Bank of Moldova: “the main objective of the National Bank is to achieve and maintain the stability of the national currency. For this purpose, the National Bank sets and upholds the conditions in the monetary, credit and currency markets, which ensure sustained economic development, in particular of the financial and currency systems based on the laws of the market.” This objective was proposed two years after the introduction of the national currency, although the behaviour of the central bank on the currency market has been through a number of radical changes since then.
The currency regime before the 1998 regional crisis could have been characterised as a regime of managed floating. The participants in the currency market can still remember the “fixing” meetings at the Currency Exchange. Back then, the National Bank had to interfere almost on a daily basis. The year 1998 was special in a number of ways. Signs of the crisis that took place in August that year could have already been felt in early 1998. Until September 1998 sales mounted to over US$ 50 million. In September-October the National Bank had to interfere with about US$ 70 million. Under these circumstances, the depreciation of the currency reserves was as important as the shrink in foreign competitiveness for deciding to let the MDL float freely depending on the demand and offer of currency in the market. As a consequence, the MDL lost half of its value in December. At the same time, the currency offer started to outnumber the demand.
Since late 1998 the National Bank has interfered with the currency market in an asymmetrical way. Namely, when there is an opportunity, the National Bank buys currency and increases its currency reserves, yet, when things turn the other way round, the bank refrains from interfering to support the MDL. Such behaviour is characteristic of the free floating currency regime, and the argument is exactly this — the lack of interference to support the national currency, and as such it offers a number of advantages. First, asymmetric interference prevents the MDL from adding on value, which fact would be completely unjustified under circumstances of a negative commercial balance. Secondly, buying currency when foreign funding is absent is practically the only source of increasing currency reserves. Thirdly, a consequent policy of refraining from supporting the MDL helps avoid the risk of speculative attacks, as when the central bank is known as being neutral, speculations are a priori destined to fail.
As long as the MDL determines independently its level in relation to other currency, we should have a closer look at the subjective and objective factors that influence evolution of its exchange rate.
The subjective factors are the currency demand or offer determined by the economic outlook. Depending on the latter, the participants in the currency market take a position in the market. In the event that the MDL is expected to devaluate — be it for seasonal reasons or certain economic indicators such as inflation or GDP — the currency position will be on rise, and currency will be bought or at least kept. When the MDL is expected to add value, everyone will tend to get rid of currency. In some way, such tactics almost always yields the expected outcome when everyone buys currency, the demand increases (although artificially at times), the MDL loses value and the forecasts come true.
The objective factors are the ones determined by the currency flow. The import of goods and services, money transfers abroad as payments for the foreign debt, other capital transfers are all currency refluxes, which are normally balanced through a corresponding currency influx at the account of exports of goods and services, foreign investments, withdrawals from credits, as well as (importantly for Moldova!) currency transfers by the numerous Moldovan citizens working abroad. The net flow is ultimately a currency offer or demand, which forms objectively.
Another series of factors to be taken into account when analysing the currency exchange rate are the seasonal factors. Either objective or subjective, they manifest periodically, but not always regularly. For example, some of them are related to the agriculture-driven nature of the Moldovan economy. The start of the agricultural season is always associated with massive purchases of seeds, fertilisers etc. and the ensuing increase in imports prompts a higher demand for currency and so the MDL devaluates in March-April. On the other hand, the end of farming season is accompanied with an increase in exports and in currency offer, and so the MDL adds value. Another seasonal factor is related to the payments for power consumption. This is fully imported and payments for consumption increase as the weather gets colder. Thus, a slight devaluation of the MDL in November could be due to this. By December though the MDL gets back to normal due to the increase in expenses on the eve of winter holidays, which are normally incurred in MDL and sometimes involves foreign currency being exchanged into MDL.
The following can be concluded from the above:
- The passage from the regime of managed floating to the one of free floating was prompted by the need to preserve the currency reserves and the competitively of Moldovan exports on foreign markets. This has allowed not only for later “saving” the currency reserves, but also filling them up to a satisfactory level. We believe that this policy of the National Bank will continue at least as long as the level of currency reserves does not reach the critical threshold worth three of months imports.
- The so-called dolarisation persists in Moldova as a phenomenon and is a real impediment for the monetary policy. It is necessary to fight it in order to enhance the trustworthiness of the national currency. Otherwise, we would have to face the galloping inflation that we have experienced in early 1990s.
- As long as there are no real prospects of us joining the EU, I would not recommend that the MDL exchange rate be tied up to the Euro. It is to be noted that the trade with the EU is relatively small, and so there are more disadvantages than advantages to it, such as, for example, losing competitiveness on the CIS market. In the event that the prospect of membership becomes clear, things would look differently. Tying the MDL up to the Euro would then reduce the cost of transactions related to the currency exchange and eliminate the currency risks.
- The currency reflux generated by the negative trade balance is made up for by the income sent home by the Moldovans who work abroad. While this in itself results in a certain stability of the currency market, in the long term this phenomenon prompts, indirectly, the devaluation of the currency. This happens due to the fact that the money sent home from abroad produces inflation as most of it is used for current consumption. The price increase, according to the law of parity of purchase power, finally causes the national currency to devaluate. One can only hope that in the future Moldova will be less sensitive to these fluxes.
During the past few years the amplitude of the currency rate exchange floating has considerably reduced. We look at this as primarily an obvious result of the enhanced efficiency of the currency market. We believe that in future this enhancement will grow and the risks associated with the devaluation will diminish. In a certain way this phenomenon will run in parallel with the stabilisation of prices, i.e. the fall in the inflation rates in the coming years.