Proposal for a COUNCIL DECISION providing macro-financial assistance for Moldova
Date: 1994-03-29
Institutions: European Commission
Subjects: Community loan, International Monetary Fund, USSR, balance of payments, economic support, republic

COMMISSION OF THE EUROPEAN COMMODITIES 

C0M(94)  110 final 

Brussels, 29.03.1994 

94/0101  (CNS) 

Proposal for a 

COUNCIL DECISION 

providing macro-financial  assistance 

for Moldova 

(Presented by the Commission) 

EXPLANATORY  MEMORANDUM 

Moldova's request for Ceffltminity  macro-financial  a p p o rt  ia  1994 

On 23  September  1993,  the  Prime Minister  of Moktov» Mr. Sanghdi  presented  to  the 
Commission  a request  for  Community macro-financial  assistance  to  Moidova for  1994. 
The assistance was requested  in the context  of the economic and reform  programme that 
the authorities were negotiating with the International Monetary Fund. 

Subsequently,  on  26  October  1993,  a  Consultative  Group  meeting  for  Moldova  took 
place under the chairmanship of the World Bank. At the meeting, the IMF indicated  that 
it had  reached  an agreement  in principle with the authorities  on the main parameters  of 
the  programme  for  the  remainder  of  1993  and  1994.  It  also  indicated  that  for  the 
programme  to  be  successful, financial support  of the  order  of US$  155 million  for  the 
programme period  (out  of which, US$  140 million in  1994) would  be  needed  over  and 
above  financing  that  would  be  provided  by  the  IMF  and  the  World  Bank  and  earlier 
bilateral  commitments.  With  a  view  to  meeting  Moldova's  needs  for  complementary 
financing  the Council of Economy and Finance Ministers reached  on  13 December  1993 
an  agreement  in  principle  to  grant  Moldova  Community  assistance  of  ecu 45  million in 
the form of a balance of payments loan-. 

The  decision  in  principle  on  a  Community  loan  to  Moldova,  together  with  assistance 
commitments  by  a  number  of  Consultative  Group  members  (Japan,  the  USA,  the 
Netherlands,  Turkey),  as  well  as  indications  given  by  some  other  countries  (most 
notably,  Russia  and  Romania)  allowed  the  IMF to  conclude,  at  the  Consultative  Group 
pledging  session  held  on  15 December  1993, that  the  authorities  programme  could  be 
adequately  financed.  Accordingly,  on  17  December  1993,  the  IMF  Executive  Board 
approved  the financing  arrangement  with  Moldova.  The IMF  intends  to  make  available 
to  Moldova  for  the  programme  period  (October  1993  to  December  1994)  resources 
amounting  to  more  than  $100  million.  Those  include  the  second  installment  under  the 
Systemic  Transformation  Facility  (SDR 22.5  million  or  some  $32  million),  and  credits 
under  a  stand-by  arrangement  of  SDR 51.75  million  (57.5%  of  Moldova's  quota)  or 
some $72 million. 

The  present  proposal  by  the  Commission  is  made  as  a  follow  up  to  the  decision  in 
principle taken by the ECOFIN Council in December  1993. 

Economic reforms  in Moldova  in  1993 

The authorities of Moldova have initiated  the transition to a market  economy  since  1990 
and  adopted  in  spring  1993  a  more  ambitious  programme  for  the  stabilization  and 
reform.  Since then, the government  has worked  in close coordination with the IMF and 
the World Bank to elaborate the reform  strategy  further. 

The policy dialogue with the IFIs has led to  an agreement  on a stabilization  and  reform 
programme to be supported by the Systemic Transformation Facility of the IMF (the first 
drawing  under  the  STF  of  SDR  22.5  million  or  some  $32  million  was  approved  in 
September  1993) and by a rehabilitation  loan of the World  Bank ($60 million,  approved 
in October  1993). 

The main objectives of the programme were lowering inflation  substantially by means of 
tight  monetary  and  fiscal  policies,  containing  the  decline  in  output  through  an 
acceleration  of  structural  reforms  and  building  up  the  starting  level  of  international 
reserves. Structural measures included promoting market mechanisms and reducing  state 
intervention  in  the  allocation  of  resources,  extensive  prices  and  trade  liberalization, 
phasing  out  consumer  subsidies,  hardening  the budget  constraint  for  public  enterprises 
and  privatization.  The  programme  reflected  the  authorities'  strategy  to  put  in  place  as 
quickly as possible the macro-economic preconditions for the introduction of the national 
currency (the leu) and to speed up decisively the structural change. Since the authorities' 
intention was to move rapidly to an upper  credit tranche arrangement with the IMF, the 
programme was designed to be particularly ambitious and to include policy measures that 
would go a substantial way towards what would be needed for a stand-by arrangement. 

The government's economic programme for  1994 

The key elements of the programme that is being implemented  since late  1993 with IMF 
support  are:  (a) the  introduction  of  the  leu  with  a  single  exchange  rate  and 
implementation  of measures  aimed  at market-based  determination  of the  exchange rate; 
(b) a  further  tightening  of financial policies;  (c) the  continuation  of  liberalization  and 
structural reforms; and (d) the design of a well targeted social safety net. The programme 
is  largely  front-loaded  and  much  of  the  adjustment  is  to  take  place  during  the  first 
months of the implementation period. 

The  central  goal  of monetary  policy that  is being implemented  in  support  of the  formal 
introduction of the national currency (it was completed  on 2 December  1993) is to bring 
inflation  under  control  rapidly  and  sustainably  and  continue  to  promote  market-based 
mechanisms in determination  of interest  rates  and  allocation  of central  bank  credit.  To 
this  end,  the  programme  envisages  strict  control  of  credit  emission  (including 
commitment  not  to  provide  preferential  credits)  and  increased  reliance  on  the  auction 
mechanism for extending credit resources to the banking system. 

The  vigorous  fiscal  adjustment  initiated  in  mid-93  (the  budget  deficit  was  reduced 
dramatically from 26% of GDP in  1992 to  6% in  1993) will be reinforced.  The  overall 
budget deficit is expected to be limited to 3.5% of GDP in  1994, mainly through  revenue 
measures (broadening the tax base through introduction of new taxes and of the scope of 
existing taxes, notably  VAT  and  excise tax). Also, the restructuring  of the  government 
expenditure  will  be  continued,  with  phasing  out  of  consumer  price  subsidies  and  their 
replacement of targeted  cash compensations. As the programme envisages that there will 
be virtually no central  bank financing of the budget, the government  intends to  develop 
non-bank financing instruments. 

The authorities will also continue to follow a restrictive wage policy. Wages in the public 
sector will continue to be monitored  closely and wage increases beyond levels consistent 
with the programme's objectives will be discouraged through tax-based mechanisms. 

The programme is designed to broaden and consolidate price and trade liberalization that 
have  made  substantial  progress  in  1993.  Price  controls  at  all  levels  (production, 
wholesale,  retail)  will  be  eliminated  to  complete  the  liberalization  of  prices  within  the 
programme  period.  In  the  area  of  foreign  trade,  virtually  all  remaining  quantitative 
restrictions  on  exports  will  be  phased  out  and  a  new  system  of  import  tariffs  will  be 
introduced. 

The  ambitious  structural  reform  component  of  the  authorities'  programme  comprises: 
(a) scaling up of the privatization  process (the programme  envisages the privatization  of 
about 35% of state assets by the end of  1994); (b) restructuring of public enterprises and 
of  the  banking  system  (to  ensure  financial  discipline  of  enterprises,  the  programme 
envisages in particular steps to implement the bankruptcy law); and (c) the tax reform. 

Since  progress  in  price  liberalization  and  enterprise  restructuring  is  likely  to  affect 
adversely  the  most  vulnerable  segments  of  population,  the  programme  envisages  also 
specific  social  protection  measures.  Those  include,  in  the  short  run,  targeted  cash 
compensations and the reform  of the present  costly and inefficient  social security system 
(in particular, strengthening of the Pensions Fund and of the Social Assistance Fund). 

External outlook and financing needs 

Owing  largely to  the  structure  of the Moldovan  economy,  largely  based  on  agriculture 
(Moldova is probably closer to  capitalizing  on its comparative  advantage than  a number 
of other former  Soviet republics as it does not bear a heavy burden of large loss-making 
enterprises), it is expected that Moldova can relatively quickly restore growth and export 
capacity  as  reforms  will  take  hold.  In  the  short-run,  however,  the  country's  external 
outlook  is extremely  difficult,  even if "Moldova does not bear the burden  of the  external 
debt of the former  Soviet Union (it signed in October  1993 the "zero-option"  agreement 
with  Russia,  whereby  Russia  takes  over  the  Moldova's  share  of  the  ex-Soviet  debt,  in 
exchange for the ex-Soviet foreign assets). 

It is estimated that Moldova has suffered  one of the largest terms of trade shocks among 
former  Soviet  republics  : the  current  account  deficit  is  likely  to  have  reached  11%  of 
GDP in  1993  (US$ 220  million)  and  it  is projected  to widen  to  13%  of  GDP  in  1994 
(US$ 260  million). Overall,  the  current  account  deficit  during  the  programme  period  is 
estimated  to  be  close  to  US$ 320  million.  Together  with:  (a) net  debt  repayment 
obligations on intra-FSU  credits (amortization  of technical  credit  by Russia  transformed 
into  a government  loan,  minus  amortization  payments  due by Ukraine),  (b) payment  of 
arrears on energy imports from Russia and (c) an initial build up of international  reserves 
of the Central Bank (to some US$ 70 million, or two to three months of convertible area 
imports),  the  overall  financing  requirement  of  Moldova  for  the  programme  period 
exceeds US$ 400 million. 

After  taking into account  available bilateral external financing committed  earlier in  1993 
(mainly  commodity  loans  from  Romania,  the  US  and  China  and  State  credits  from 
Russia),  the  US$ 60  million  World  Bank  import  rehabilitation  loan  and  resources  that 
Moldova  would  be  able  to  draw  under  the  arrangement  with  the  IMF  (over  US$ 90 
million,  including the  second  instalment  under the  STF and  purchases under  the  SBA), 
the  financing  requirement  is  reduced  to  some  US$ 155  million  (US$  140  million  in 
1994). Financial resources the Community is being invited  to  provide would  contribute 
to  meeting  Moldova's  residual financing needs  over  and  above  IMF  and  World  Bank 
financing. 

Main features of the loan 

The  Commission  is proposing  that  the  Community  would  grant  Moldova  a  balance  of 
payments loan of ecu 45 million with a maximum duration of fifteen  years. 

The  assistance  would  be  granted  in complement  to  the  resources  made  available  by  the 
IFIs,  and  in  particular  to  the  IMF  under  the  agreed  stand-by  arrangement.  The  loan 
would  be  disbursed  in  two  tranches.  The  disbursement  of  the  first  tranche  would  take 
place  upon  signature  of  the  loan  agreement;  the  disbursement  of  the  second  tranche 
would  be conditional  upon compliance  with a limited number of conditions  based  on  the 
government's economic programme supported by the IMF. 

The  proposed  duration  of  the  loan  (fifteen  years),  which  is  comparable  to  the  average 
duration  of the  World  Bank  import  rehabilitation  loan  (12-13  years),  is  consistent  with 
the  medium-term  balance  of  payments  outlook  for  Moldova,  which  is  expected  to  face 
substantial financing needs for  the  years  ahead.  Large  and  continuing  external financing 
requirements will  probably  contribute to  a sharp build-up  of  external  debt,  which  raises 
concerns about  steep increases in debt  servicing  obligations  already in the  second  half of 
the decade (with a peak in 1998). 

As in the case of similar operations in favour of Central and Eastern European  countries, 
the Community would  provide the funds through market borrowing  with  a guarantee by 
the  general  budget.  Moldova  would  subsequently  borrow  from  the  Community.  The 
borrowing  and lending operations will be perfectly  matched  and without  any  commercial 
risk for the Community. 

Proposal for a 

COUNCIL DECISION 

providing macro-financial  assistance 

for Moldova 

The COUNCIL OF THE EUROPEAN UNION, 

Having  regard  to  the  Treaty  establishing  the  European  Community,  and  in  particular 
Article 235 thereof, 

Having regard to the proposal of the Commission1 submitted following  consultation with 
the Monetary Committee, 

Having regard to the opinion of the European Parliament2, 

Whereas  Moldova  is undertaking  fundamental  political  and  economic  reforms  and  has 
decided to adopt a market economy model; 

Whereas Moldova  and the European  Union have expressed  their readiness to  enter  into 
negotiations for the conclusion of a Partnership and cooperation  agreement; 

Whereas  the financial  support  of the  reforms  from  the European  Union  will  strengthen 
mutual confidence and will bring Moldova closer to the Community; 

Whereas Moldova has agreed with the International Monetary Fund (IMF) on a stand-by 
arrangement  in  support  of  the  country's  economic  programme  and  whereas  this 
arrangement has been approved by the IMF Board on  17 December  1993; 

Whereas  the  authorities  of  Moldova  have  requested  financial  assistance  from  the 
international  financial  institutions,  the  European  Union  and  other  bilateral  donors,  and 
whereas,  over  and  above the  estimated  financing  which  could  be  provided  by the  IMF 
and  the  World  Bank,  a residual financing gap  of  some  US$  155 million  remains  to  be 
covered  in  1994,  in  order  to  strengthen  Moldova's  reserve  position  and  avoid  an 
additional  degree  of  import  compression  which  could  seriously  jeopardize 
the 
achievement of the policy objectives underlying the government's reform  effort; 

Whereas  the  grant  by the  European  Community  of  a long-term  loan  to  Moldova  is an 
appropriate measure to  support  the balance of payments and to  strengthen  the  country's 
reserve position; 

Whereas the Community loan should be managed by the Commission; 

Whereas the  Treaty  does  not  provide  for  the  adoption  of this Decision,  powers  other 
than those of Article 235, 

HAS DECIDED AS FOLLOWS 

Article 1 

1.  The  Community  shall  grant  to  Moldova  a  long-term  loan  facility  of  a maximum 
amount of ecu 45 million in principal with a maximum duration of fifteen years, with 
a view to ensuring a sustainable balance-of-payments situation and strengthening the 
reserve position. 

2.  To this end the Commission is empowered to  borrow,  on behalf  of the European 
Community, the necessary resources that will be placed at the disposal  of Moldova 
in the form of a loan. 

3.  This  loan  will  be  managed  by  the  Commission  in  close  consultation  with  the 
Monetary  Committee  and  in  a  manner  consistent  with  any  agreement  reached 
between the IMF and Moldova. 

Article 2 

1.  The  Commission  is  empowered  to  negotiate  with the  Moldovan  authorities,  after 
consultation with the Monetary Committee, the economic policy conditions attached 
to the loan. These conditions shall be consistent with the agreements referred to in 
Article 1(3). 

2.  The Commission shall verify at regular intervals, in collaboration with the Monetary 
Committee  and  in  close  coordination  with  the  IMF,  that  the  economic  policy  in 
Moldova is in accordance with the objectives of this loan and that its conditions are 
being fulfilled. 

Article 3 

1.  The  loan  shall  be  made  available  to  Moldova  in  two  instalments.  Subject  to  the 
provisions  of Article  2  (1),  the first instalment  shall be released  on the basis  of a 
successful first programme review under the "stand-by arrangement" with the IMF. 

2.  The  second  instalment  shall  be  released  not  before  the  fourth  quarter  of  1994, 
subject to the provisions of Article 2 (2) and subject to satisfactory  progress being 
recorded in Moldova's application of the "stand-by arrangement". 

3.  The funds shall be paid to the National Bank of Moldova. 

Article 4 

1.  The borrowing  and  lending  operations  referred  to  in  Article  1 shall  be  carried  out 
using the same value date and must not involve the Community in the  transformation 
of maturities, in any exchange or interest rate risk, or in any other commercial risk. 

2.  The Commission  shall take the necessary  steps, if Moldova  so decides, to include in 

the loan conditions, and also to exercise an early repayment clause. 

3.  At the request  of Moldova,  and where circumstances permit  an improvement  in the 
interest  rate  on  the  loans,  the  Commission  may  refinance  all  or  part  of  its  initial 
borrowings  or  restructure  the  corresponding  financial  conditions.  Refinancing  or 
restructuring  operations  shall  be  carried  out  in  accordance  with  the  conditions  set 
out in paragraph  1 and shall not have the effect  of extending the average duration of 
the  borrowing  concerned  or  increasing  the  amount,  expressed  at  the  current 
exchange rate, of capital outstanding at the date of the refinancing  or restructuring. 

4.  All  related  costs  incurred  by  the  Community  in  concluding  and  carrying  out  the 

operation under this Decision shall be borne by Moldova. 

5.  The Monetary Committee shall be kept  informed  of developments in the  operations 

referred  to in paragraphs 2 and 3 at least once a year. 

Article 5 

At least  once a year the Commission  shall  address to  the European  Parliament  and to 
the  Council  a report,  which  will include  an  evaluation,  on the  implementation  of this 
Decision. 

Done at Brussels, 

For the Council 

The President 

FINANCIAL RECORD 

1.  Budget line concerned 

Article  (...)  loan  guarantee  for  aid to  Moldova  (to  be  created  through  an  amending 

and/or supplementary Budget). 

2.  Referencesrtegal base) 

Article 235 of the Treaty 

3.  Classification  of the Expenditure 

Obligatory 

4.  Description and Justification for the action 

a)  Description of the action 

Provision of a guarantee from the Community for a loan to Moldova  in view  of 

ensuring  a  sustainable  balance-of-payments  position  and 

strengthening 

international reserves. 

b)  Justification for the action 

-  The Council  of the EU  has endorsed  the principle  of  providing  assistance  in 

response to a request from Moldova. 

-  The  budget  entry  is  intended  to  provide  a  budgetary  support  for  guarantee 

offered  by the European Community to cover a loan extended to Moldova. 

5.  Nature of the expenditure and method of calculation 

a)  Nature of the expenditure 

A guarantee to a loan to Moldova 

b)  Method of calculation 

-  A token entry is proposed given that the amount and timing of any call  on this 

budget line cannot be calculated in advance and because it is expected that this 

budget guarantee will not be called. 

6.  Effect  of the action on intervention credits 

Only in the case of an effective  call on the guarantee. 

7.  Financing of intervention  expenditure 

9 

-  Endowment  of  the  line  by  transfer,  by  reutilisation  of  reimbursed  amounts 

(Article  27(3)  of  the  Financial  Regulation  of  1977),  or  by  amended  and/or 

supplementary  Budget. 

-  In order to fulfil  its obligations, the Commission  can provisionally  ensure the debt 

service  with  funds  from  its  treasury.  In  that  case,  Article  12  of  the  Council 

Regulation (EEC, Euratom) no.  1522/89  of 29.5.1989 will apply. 

<* 

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