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Domestic Implications of the Economic Policy in the Foreign Sector of Moldovan Economy
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Recently National Bank of the Republic of Moldova released some figures, in fact rather surprising ones, on the growing trade deficit that has reached 400 million USD in the last nine months as compared to only 240 million in the same period last year. What are the reasons behind the said figures and why do they come as a surprise?
One may cite arguments forecasting changes in the trade balance for this year. Given that other conditions did not change, such as slow economic recovery, that is not exclusively based on exports, the double drop in foreign investments has lead to a growth of trade deficit albeit the boosting exports. Both arguments make sense if considered based on the figures showing the evolution of economy (industry production, labour force employment, etc) for the relevant period of the year.
If the trend continues it might well happen that by the end of the year the trade deficit would reach 500 million, i.e. 25% of the GDP. Moreover, this indicator might as well grow by 100 million as compared to the previous year, that in itself runs counter to the provisions of the Memorandum signed with IMF on the economic and financial policy of the Government and National Bank of the Republic of Moldova for year 2003. The said institutions predicted a trade deficit not exceeding 300 million USD for this year.
Let us go back to why the growing trade deficit has come as a surprise. There are several reasons for the people responsible for the economic policy, including National Bank, to worry about. Firstly, the 6% economic growth the Government forecasted for this year might not by itself account for the growing trade deficit, except when domestic real economic growth would have been far more emphasised than what the figures are really telling. Nevertheless the discrepancy is reflected in the trade balance.
Secondly, the foreign exchange policy declared and applied by the central bank has allowed for a real appreciation of the Lei, which in its turn affected the trade balance. The fact that the said policy is not making the struggle for reducing inflation much easier is another story and I would not dwell on it here. A great risk especially in the countries under tremendous pressure from outside is the appreciation of the real exchange rate. Even in the countries where inflation is reduced to a reasonable one-digit figure, appreciation may destabilise trade balance if not backed up by a considerable raise of productivity. National Bank has always clearly stated its top objective, i.e. to reduce inflation at any price. Besides this, stabilising national currency has been and will be another priority.
Exchange rate should reflect the real situation in economy and should have a positive impact on it, which is not exactly the case in the Republic of Moldova. Irrespective of this, National Bank has been promoting an overstated exchange rate for the national currency. And this in the context of unbalanced trade. It has used appreciating foreign currency to cover the imports. Given that the degree of inflating depreciation of the Moldovan Lei has never been reflected to a full extend in the exchange rate, what monetary institutions really did was to apply the practice of strong currency rather than free floating one. Still, monetary appreciation discourages exports, and on the contrary encourages imports, which in the long run affect trade balance.
Due to the understated US dollar exchange rate, Moldovan exporters have incurred huge loses for several years now. This “stability” policy not justified from the theory of transition point of view was promoted irresponsibly and as a result has had some severe repercussions. If National Bank had refrained from interfering by uselessly maintaining an overstated exchange rate of Lei, then most likely the favorable exchange rate would have been a strong insensitive to the exports, thereby inhibiting unproductive imports in favor of domestic initiatives. The only counter-argument I could bring myself is the fact that, we have nothing to export after all, and even if something is produced the raw materials are also imported, therefore the profit margin is very low.
The experience of macroeconomic stabilisation programs throughout the world indicates that appreciation of the real exchange rate is a source of vulnerability if not backed up by a relevant increase of the productivity. Both in Latin America in 80’ and 90’s, in South-Eastern Asia during the wide-scale financial crisis, and turmoil in Argentina back in 2000 — the appreciation of the real exchange rate impaired credibility and boosted trade deficits to a level of unsustainability resulting in a financial collapse. This is why careful administration of the trade balance is a very important objective and in great many cases governments conceive the economic strategy with an eye towards securing foreign trade balance.
Thirdly, this year’s imports constantly exceeding those of 2002 point to the fact that what we are dealing with is probably not a simple “accident”. Even if we take into account the impact economic recovery has on the foreign trade, the discrepancies mentioned above still hold true. At the same time, transfers from the current account are far from considerably reducing the trade deficit. To put it differently, despite the considerable amount, transactions are impaired by the more considerable growth of imports as compared to exports. In the end, one may not speak yet of a flow of direct foreign investments, which accounted for just 65 million USD in 2002 as compared to 114 million in 2001, and 128 million in 2000. According to the report of the United Nations Conference on Trade and Development for 2002 on the global investments, the share of foreign direct investment in GDP in Moldova is the lowest in Europe. It is believed that the volume of foreign investments in Moldova in the last couple of years is even smaller than the volume of international drug smuggling through our country. Lack of foreign investments is determined equally by economic crisis and by political instability and ambiguous legal framework.
How could one explain the growing deficit of the trade balance and current account? One explanation would be the growing Euro against US dollar, as well as structural and geographic changes in Moldovan trade, though there are no reliable data to back up this assumption. One might also consider possible adverse evolution of the prices on products and services (raising prices on oil and energy) which account for a great proportion of Moldovan trade, although this year boost in Moldovan exports seem to invalidate this assumption as well. Sluggish economic activity throughout Europe, which accounts for 30% of Moldovan trade, while eastern market accounts for another 60%, meaningful might be considered as another explanation. Trade policy applied by the Government is another reason. For instance facilities granted by Government on certain imports is nothing but an appreciation in real terms of the national currency, which in its turn boosts imports. Moreover, when Moldovan Lei registered a nominal appreciation against US dollar it also appreciated against Euro, which again boosted imports. This requires for the foreign exchange policy to take into account foreign unbalance. We could also cite the lack of financial discipline (such phenomena as “money laundering”, fiscal evasions, etc), which indicates that certain available funds could have been used for additional imports.
Given the deteriorating international economic situation, the challenges lying ahead of the Republic of Moldova’s economic recovery are far more. It would be more difficult to export, whereas external funding of our deficits would be more complicated. And this is not it. Besides good news, year 2003 brought some bad news as well: growth of financial indiscipline (arrears of up to 40% of GDP) as well as doubled deficit of the trade balance and current account. Those deficits are not sustainable and therefore require a raft of correction measures especially given the ever more uncertain international financial environment. The Government has already announced some measures that are also featured in the letter of intention on the new agreement with IMF. Those measures, most likely restrictive ones, would influence the pace of economic activity in the year to come.
A string of factors such as — a budget surplus of 0.8% of the GDP provided for in the draft budget for year 2004, a decrease in the non-governmental sector deficit by 3% of GDP in the next year (from the 6% forecasted for this year), annulment of some fiscal and trade facilities, a restrictive monetary policy (aimed at reducing inflation), strictness in granting funding to state enterprises -make the 5% GDP growth forecasted for the next year totally unrealistic. Under the given circumstances even 4% seem a too ambitious task! The Government may want to revise its forecasts on the next year economic growth given the recession of the western economies, raising oil prices, negative trends in agriculture, and problems in the domestic energetic sector. To count on an unachievable economic growth is to forecast budget revenues that would be never secured, which would jeopardise the budget even further, would skyrocket interest rates and inflation, and as a result would perpetrate foreign trade unbalance.
Having said that, and considering the evolution of the trade balance we are inclined to believe that National Bank should not venture in appreciating substantially the national currency in its efforts to reduce inflation. This is especially true since Government should be aware of the risks involved in “overheating” an unstructured economy. We don’t think it’s a good idea to rely exclusively on budgetary and trade policy when trying to keep trade balance deficit under control. In other words, National Bank should not refrain from pursuing two goals, namely keep inflation and interest rates under control.
At the same time Government may want to be more willing to fight debtors by imposing tighter budgetary constraints, to oversee budgetary spending, privatisation, revenues policy, oversee monopoly practices, and through various means shape the commitment of certain companies doing excessive imports by taking advantage of the favourable conditions.
If an efficient approach towards trade balance deficit is imposed, then it would require an adjustment of the elements to the economic policy mix, including privatisation, as well as a good co-operation between the decision-makers responsible for economic policy. So far, everything was more or less quite; the governor didn’t came up with any spectacular actions, whereas Central Bank had an average performance. The way trade balance deficit is handled would test Government and National Bank’s ability to reach the most advantageous compromises.
It is difficult to choose the right economic policy as it inevitably involves compromises at the time it is necessary to boost economic growth simultaneously with reducing inflation expectations. However, neglecting the threat posed by the trade balance deficit may well result in problems surfacing in 2004, as well as in a return to the so-called boom and bust cycle. There are no reasons to panic yet, however one may want to keep a close eye on the evolution of the trade balance deficit.