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Maastricht paradox. Is there a lesson for Moldova?
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European Monetary Union, represented by the countries that adopted a single European currency — Euro, are nowadays split when it comes to complying with Maastricht criteria. In particular, France and Germany whose budget deficit exceeded 3% of the GDP, are fighting the European Central Bank governor Jean Claude Trichet (until recently the Governor of the Bank of France) and other countries for a more flexible interpretation of the said criteria. Their argument is that in order to comply with the criteria both France and Germany would have pursue tight fiscal policies, i.e. either increasing the taxes or reducing public expenditures. According to them such policies were counterproductive to the economic growth and they might lead to even fewer budget revenues than today. Therefore it would push those countries into a vicious circle: high taxes — economic slowdown; slowdown — low revenues to the state budget; low revenues — higher budget deficit than the current 3%; high deficit — high taxes…?
On the other hand, if allowed to breach the criteria, cutting taxes would boost an economic growth, which in its turn would supply revenues to the state budget and stabilise budget deficit on a mid and long term. The thing is that the countries that today are finding difficult to comply with the criteria, used to advocate the idea in the past so as to protect themselves from the more vulnerable economies of Spain, Portugal, Greece. Ironically the latter register an economic growth with no budget problems to beset them.
That reminds us of the “taboo” put upon the Moldovan budget deficit by the international financial organisations, the “co-authors” of Moldovan economic policies, including the fiscal ones. It is true that in a country where the 1998 crisis and hyperinflation at the dawns of independence still cast a shadow, budget is a rather sensitive issue. The danger here is that, in the eyes of many, budget is associated with a holed sack — no matter how hard you pull, you still get a feeling that there is something there still to come. Unfortunately, once you become addicted to “regular doses of deficit”, sooner or later this “chronic disease” will turn into insolvency. This is not our case yet. Germany or France might regard with envy Republic of Moldova’s budget deficit. Now the question a Moldovan should ask is — whether such a low deficit is of any good?
Tab. 1.1. Evolution of the budget deficit in Moldova over the last 5 years
1998 1999 2000 2001 2002
GDP (million Lei) 9122.1 12321.6 16019.6 19051.5 22040.0
Deficit -305.2 -395.0 -166.4 -1 -109.7
% of GDP 3.3 3.2 1.0 0.01 0.5
To answer this question one may want to analyse fiscal policy from an austerity perspective. In short, fiscal policies consist mainly of manoeuvring tax burden and managing public spending. Lower taxes boost economy (in Moldova another positive secondary effect would be “legalisation” of businesses, as it would encourage those operating on the black market to go legal); public spending boosts a surging demand, consequently production is set to soar. Therefore, is the low deficit policy a luxury that only growth machine countries could afford?
Still, there are good reasons why low budget deficit is “prescribed” to Moldova. Not so long ago, in 1998 Moldova went through a financial crisis that postponed the prospects of economic recovery for several years. Even before the Russian crisis, which hit almost all the countries that had economic ties with the Russian Federation, Moldova showed the first signs of crisis. In particular, foreign investors were getting rid of their T-bills issued by the Government of Moldova and were repatriating their investments, thus wielding a heavy influence on the interest rates, as well as on exchange rate. At that time, the financial pyramid build up on T-bills issued in ever-growing numbers, so as to cover for the interest rate on previously incurred debts, was falling apart thus revealing the fragility of the Moldovan financial system. Due to National Banks’ efforts to avoid an internal default by buying a significant amount of state T-bills, the banking system was flooded with Lei; therefore the financial crisis was headed off from becoming a banking crisis. One lesson Moldova has learned from that folly was that financial pyramid is an extremely dangerous “toy”.
Since 1998 T-bills have been issued in amounts equal to redeemed T-bills, and only a net margin growth in the amount of state T-bills in circulation was allowed. As a result, interest payments are made from budget revenues, while refraining from increasing budget deficit so as to avoid falling twice in the same trap of financial pyramids. Therefore, for Moldova low deficit is more of a constraint inflicted by the vulnerability of a state having a higher public debt than it could handle, than a mere luxury, as it may seem at the first glance.
Still, some would insist that according to economic policies, reducing fiscal burden does not necessarily reduce budget revenues. Low taxes would boost an economic growth, thereby enlarging the fiscal basis. However, some fear that those effects would show off too late and that the budget developed on an annual basis would suffer at start, factor to be avoided in cases of huge public debt. That is why we should give the credit to the international financial institutions and keep this economic lever in reserve for the future (hopefully the near future), when the size of public debt would no longer be a challenge.
Even under current circumstances, it is possible to reconcile on paying back foreign debt on the expense of growing internal debt. For a while now, Republic of Moldova has been on the verge of default, each time heading it off with ingenuity, however not in as much as it may want to, so as to be out of danger. This policy has “costed” the country a credit rating, which otherwise would have been a far better one, and a flow of investments so much needed to boost the economic growth. Therefore, Government may consider issuing more internal debt, converting it into hard currency and using it to decrease the foreign debt. 2003 proved to be quite favourable year for such a strategy. The strong Lei would have allowed to pay back foreign debt at an exchange rate favourable to the Ministry of Finance, whereas excess liquidity occurring once in a while in the banking system would have allowed to enforce the strategy without setting interest rates to soar. Common sense tells that it makes more sense to go for such a strategy, than end up with a budget surplus at the end of the year and still face the risk of insolvency.