Proposal for a Council Decision providing further macro-financial assistance for Moldova
Date: 1995-11-10
Institutions: European Commission
Subjects: Community loan, International Monetary Fund, Moldova, balance of payments, economic support, financial aid

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 8.11.1995 
COM(95) 533 fina 

95/0275  (CNS) 

Proposal  for  a 

COUNCIL  DECISION 

providing further macro-financial assistance 

for Moldova 

(presented  by the  Commission) 

1 

EXPLANATORY  MEMORANDUM 

Economic situation and progress with stabilisation and reform in 1994 

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

Following the introduction, in November  1993, of its national currency - the Moldovan 
leu-,  Moldova has taken decisive  steps towards financial stability in the context  of the 
economic  programme  supported  by  an  IMF  stand-by  arrangement  (approved  in 
December  1993)  and  complementary  assistance  from  the  international  community, 
including EU macro-financial assistance of up to ECU 45 million. 

The programme was implemented in a very difficult  environment. Real GDP is estimated 
to have fallen by about 22 percent in  1994,  compared with an anticipated  decline  of 3 
percent.  This is  in part  attributable  to  the  continuing  disruptions  to  output  and trade 
associated with the collapse  of  central planning.  Industrial production fell  by about 30 
percent in the first half of 1994, before stabilising in the second half of the year. A severe 
drought,  followed  by flooding and  hail  storms,  devastated  key  crops  in  this .mostly 
agricultural country in the third quarter of 1994. 

the  Moldovan  authorities 

this  unfavourable  economic  environment, 

Despite 
demonstrated  considerable  resolve  and  consistency  in  the  pursuit  of  financial^ 
stabilisation. Reviews under the IMF stand-by arrangement were successfully  completed 
in June and December  1994, and all performance  criteria for end-December  1994 were 
met. The key objective of the programme was a rapid and sustained reduction in the rate 
of inflation based on the introduction of the leu, and a stabilisation of the exchange rate. 
As a result of the firm implementation of the programme, inflation decelerated sharply in 
1994. The monthly rate of inflation fell from an average rate of about 20 percent in the 
fourth  quarter of  1993  to  an average rate  of  about  3 percent  in the fourth  quarter  of 
1994. As inflation subsided, the exchange rate stabilised and the credibility of the leu was 
enhanced  as  reflected  by  the  reversal  of  currency  substitution,  allowing  a  decline  in 
nominal and real interest rates. 

Fiscal  deficit  for  1994  was  contained  to  8  percent  of  GDP,  despite  the greater-than-
expected  decline  in  real  output  and  inflation.  However,  liquidity  problems  in  the 
enterprise  sector  impeded  tax  collection  and  resulted  in  the  assumption  by  the 
Government  of  guaranteed  loans  to  enterprises  in  default.  Furthermore,  expenditure 
arrears rose by some 1 1/2 percent of GDP, including arrears on wages, as a result of the 
application of a strict cash management system. 

The balance of payments remained under severe pressure throughout  1994 primarily as a 
result of higher prices for  imported  energy and the effects  of natural disasters. Based on 
preliminary  data,  the  current  account  deficit  was  equivalent  to  10  percent  of  GDP. 
Moldova was highly dependent  on  foreign  assistance,  the  disbursement  of which  (US$ 
370 million)  covered  some  50  percent  of  total  imports.  The IMF  and  the World  Bank 
contributed  some  38  percent  of  total  foreign  assistance,  Russia  some  36  percent 

(primarily in the form of arrears by Moldovan enterprises for energy imports), and other 
bilaterals some 26 percent, including the EU (ECU 25 million corresponding to the first 
tranche  of  the  macro-financial  assistance),  Japan  (US$  30  million),  the  US  (US$  20 
million)  and  Romania  (US$  10  million).  With  the  pace  of  disbursements  in  foreign 
assistance  increasing  late  last  year,  gross  reserves  of  the  central  bank  reached  the 
equivalent of 3 months of imports at end-1994. 

The progress  made in terms  of  structural  reform  in  1994 was mixed.  State  enterprises 
remained largely unresponsive to market forces (which resulted, inter alia, in the increase 
in arrears to the budget and to external suppliers of energy as indicated above), owing in 
part  to  the  weakness  of  the  bankruptcy  and  liquidation  process,  and  delays  in 
privatisation. However, towards the end of the year, there was a substantial  acceleration 
of  reform  efforts,  as  the  authorities  recognized  that  further  delays  in  implementing 
structural  reforms  threatened  to  undermine  the  stabilisation  gains.  A  new  streamlined 
auction  procedure  was  introduced,  that  facilitated  the  implementation  of  an  ambitious 
schedule for  the  auction  of  state  enterprises.  The  Government  also  decided  to  identify 
and  initiate  liquidation  proceedings  against  seven  of  the  most  problematic  state 
enterprises. 

Economic programme for 1995/96 

At this critical juncture of the reform process, the Moldovan authorities have formulated 
an  ambitious  strategy  for  1995  with  the  objective  of  consolidating  the  progress  in 
stabilisation  and  intensifying  structural  reforms.  The programme  that  is supported  by a 
new IMF stand-by arrangement approved in March  1995 requires further  complementary 
financing from the international community. 

The  programme  aims  at  economic  growth  of  1  1/2  percent,  led  by  a  recovery  in  the" 
agricultural  sector  with  the  return  of  normal  weather  conditions,  a  reduction  in" the 
annual  rate  of  inflation  to  about  10 percent  and  the  containment  of  the  deficit  in  the 
current  account  of  the  balance  of payments.  To  meet  these  objectives, fiscal policy  is 
centered on sharply reducing the budgetary deficit  to the equivalent of 3  1/2 percent and 
monetary policy is to remain tight. The acceleration of structural reforms  in late  1994 is 
to  be  sustained  in  1995  through  an  accelerated  privatisation  programme,  the 
establishment  of  the  legal  basis  for  bankruptcy  proceedings,  the  strengthening  of  the 
capital  base  of  the  banking  system  and  the  development  of  indirect,  market-based 
monetary controls. 

The  programme  entails  considerable  risks,  both  domestic  and  external.  The  task  of 
implementing  a  systemic  change  is inherently  difficult;  it  is further  complicated  by  the 
conditions of trade and payments disruptions. Furthermore, key elements for the success 
of the programme,  such as improvements  in tax administration  and  the  enforcement  of 
enterprise financial discipline  can  only  be  implemented  gradually,  and  will  require  the 
maintenance  of  a large  consensus  among  a population  that  has  suffered  from  a  severe 
erosion of its purchasing power. 

The external position of Moldova will remain under severe pressure in  1995. The  effects 
of the  terms-of-trade  shock  caused  by the  increase  in imported  energy  prices  to world 
market  level  will  continue,  and  although  the  programme  does  not  target  a  further 
increase  in  the  gross  international  reserve  position  of  the  central  bank,  Moldova  will 
remain  highly  dependent  on  foreign  assistance.  In  Î994,  Moldovan  enterprises  had 

largely  resorted  to  external  arrears to  their Russian  suppliers  of  natural  gas.  By  end-94, 
cumulated  arrears  amounted  to  about  US$  120  million,  of  which  US$  52  million  have 
been  cleared  through  a  debt-equity  swap  operation  in the  course  of  1995.  Moldova  is 
now  expected  to  begin  reducing  the  outstanding  arrears,  and  further  amortisation 
payments are due in  1995 to the Russian Federation and to the EU  (ECU  27  million). In 
the  circumstances,  anticipated  foreign  loan  disbursements  of  some  US$  200  million 
under  existing  commitments  (including  US$  144  million from the  IMF  and  the  World 
Bank,  US$  24  million  from  the  EU  -  corresponding  to  the  ECU  20  million  second 
tranche  of  macro-financial  assistance  -,  and  a  similar  amount  from  other  bilaterals  -
mostly  the  US  and Japan) will  leave  a financing gap  of  about  US$  50  million.  Further 
commitments  from  creditors  and  donors  that  participated  in  providing  exceptional 
financing  to  Moldova  in  1994,  including  the  EU,  Japan  and  the  US  have  been 
contemplated  in the Consultative  Group meeting held in March.  Actual  disbursement  of 
this  external  assistance  will  be  critical  to  sustain  the  policy  efforts  required  from  the 
Moldovan authorities in the framework of the programme for  1995. 

In  the  first  quarter  of  1995,  the  Moldovan  authorities  have  strictly  implemented  the 
financial  policies  contemplated  in  their  programme.  Based  on  preliminary  data,  all 
performance  criteria  for  end-March  have  been  met,  including  a  better-than-expected 
foreign exchange position of the central bank. This has resulted in a stable exchange rate 
and a containment of inflationary pressures. 

The acceleration of the reform efforts  that started in the last quarter of  1994 is expected  -
to  continue  in  1995.  In  particular,  a  new  ambitious  privatisation  programme  covering 
1995  and  1996  has  been  approved  by  the  Parliament  on  15  March,  that  covers  a 
substantial  portion  of  the  remaining  state  assets,  and  introduces  along  the  existing 
voucher  system,  privatisation  for  cash  (in  order  to  provide  new  liquidity  to  enterprises 
for  post-privatisation  restructuring  and  to  open  privatisation  to  the  participation  of  \ 
foreign investors). A  "wait and see" attitude of enterprise managers in anticipation of the 
adoption  by  Parliament  of  this  new  privatisation  programme  was  however  partly 
responsible for the slowing down of the privatisation process in the first quarter of  1995. 
The  pilot  liquidation  of  seven  enterprises  is  now  well  under  way;  the  Liquidation 
Committee,  that  performs  asset  sales  and  the  payments  of  creditors,  has  been  formed, 
and  three  of  these  enterprises  have  been  liquidated,  while  two  others  found  sufficient 
resources  to  clear  their  outstanding  liabilities.  A  bankruptcy  law  has  been  drafted  with 
the  assistance  of  the  IMF.  Import  tariffs  have  been  reduced  to  30  percent  since  end-
March. With respect  to  the banking  sector,  the  central bank  has  started  auctioning  State 
certificates  in  March.  And  the  Government  is  preparing  iv--  new  laws:  the  lav/  on  the 
central bank, which  sets out the responsibilities  of the N7?.?  .  md the criteria which  should 
guide  the  conduct  of  the  monetary  policy,  nd  the  lav  •,..  financial  institutions,  which 
provides the  framework  for  the NBM  supervision  of co.  . : ;:cid banks. 

Previous  ramcro-financiai  assistance  to  MoEdovc 

On  13 June  1994  the  Council  of  the  European  Union  decided  to  grant  the  Republic  of 
Moldova  a  loan  of  ECU  45  million  witîi  a  maximum  duration  often  years  (Council 
Decision  94/346/EC)  to  assist  the  country  in  its  transition  efforts  and  to  strengthen  the 
reserve position of the central bank.  The Community lo  n was part  of an overall  package 
mobilised by the international  donor  community in favour  of Moldova  to  complement  the 
resources provided by the IMF and the World  Bank. 

The  Community  loan  was  to  be  disbursed  in  two  tranches,  upon  the  fulfillment  of 
conditions  specified  in the Memorandum  of Understanding  (MOU) attached  to the loan 
agreement.  The first tranche,  of ECU 25 million, was disbursed  in December  1994, on 
the  basis  of  the  successful  completion  of  the  first  programme  review  under  the  IMF 
stand-by arrangement. The disbursement  of the second tranche, of ECU 20 million, was 
conditional upon a successful  track record  of the IMF stand-by arrangement  and  subject 
to a positive evaluation by the Commission of performance criteria and of progress made 
with  respect  to  structural  reform.  These  conditions  have  been  fulfilled  and  the 
Commission disbursed the second tranche on 7 August 1995. 

Financing meeds for 1995 and proposed further macro-financial  assistance 

On 20 March  1995,  a  Consultative  Group  meeting  for  Moldova  took  place  under  the 
auspices  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 
1995. The Fund also indicated  that for the programme to be successful,  complementary 
financial  support  of  some  US$ 50  million  for  the  programme  period  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  residual  financing 
needs,  the  ECOFIN  Council  reached  on  the  same  day  an  understanding  on  the 
opportunity to grant Moldova Community assistance of ECU  15 million in the form  of a 
balance of payments loan facility. 

The  prospect  of  a  further  Community  loan  to  Moldova,  together  with, assistance 
commitments by a number of other bilaterals (the USA, Japan, the Netherlands),  as well 
as indications given by Russia  on rescheduling  of arrears on gas payments,  allowed, the 
IMF  to  conclude  that  the  authorities  programme  could  be  adequately  financed^ 
Accordingly,  on  22  March  1995,  the  IMF  Executive  Board  approved  the financing 
arrangement  with  Moldova.  The  IMF  intends  to  make  available  to  Moldova  for  the 
programme  period  (April  1995 to  March  1996) resources  amounting  to  about  US$  90 
million in the form of a stand-by arrangement. 

The present  proposal  by the  Commission  is made  as a follow  up  to  the  understanding 
reached by the ECOFIN Council in March 1995. 

Main features of the loan 

The Commission  is proposing  that  the  Community  would  grant  Moldova  a  balance  of 
payments loan of up to ECU  15 million with a maximum duration often years. 

The assistance would  be granted  in complement  to the resources  made  available by the 
ÏFÏ's,  and  in  particular  by  the  IMF  under  the  agreed  stand-by  arrangement.  The  loan 
would  be  disbursed  in  a  single  tranche,  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 (ten years), which is shorter than the duration  of the 
World Bank Structural  Adjustment  Loan (20 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. 

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  would  be  perfectly  matched  and  without  any 
commercial risk for the Community. 

In  accordance  with  the  Guarantee  Fund  mechanism,  the  budgetary  implications  of  a 
decision to make available assistance of up to ECU  15 million to  Moldova would  be a 
ECU 2.25 million provisioning of the Fund. 

(i 

Proposal for a 

COUNCIL DECISION 

providing further 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  after  consulting  the 
Monetary Committee, 

Having regard to the opinion of the European Parliament2, 

Whereas  Moldova  is  undertaking  fundamental  political  and  economic  reforms  and  is 
making substantial efforts  to implement a market economy model; 

Whereas  Moldova  on the  one hand  and  the European  Communities  and  their  Member 
States on the other hand,  have signed  a Partnership and Cooperation  Agreement  which 
will help the development of a full cooperation relationship; 

x. ~ . 

from,the 
Whereas  the  authorities  of  Moldova  have  requested  financial  assistance 
international financial institutions,  the European  Community  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$ 50 million remains to be 
covered in  1995, in order to  support the policy objectives  attached  to the  government's 
reform  effort; 

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 22 March 1995; 

Whereas, by Decision 94/346/EC 3, the Council approved macro-financial  assistance  for 
Moldova of up to ECU 45 million; whereas, however, further  official  support is required 
in order to support the balance of payments, consolidate the reserve position and comfort 
the necessary structural reforms in this country; 

Whereas an additional Community loan facility to Moldova is an appropriate measure to 
help easing the country's external financial constraints; 

OJ N° Ll 55,22.6.94, p.27 

Whereas the Community loan facility 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  make  available  to  Moldova  a  long-term  loan  facility  of  a 
maximum  principal  amount  of  ECU  15  million  with  a  maximum  duration  of  ten 
years,  with  a  view  to  ensuring  a  sustainable  balance-of-payments  situation, 
strengthening  the  country's  reserve  position  and  comforting  the  implementation  of 
the necessary structural reforms. 

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 

, 

' 

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

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  facility  and  that  its 
conditions are being  fulfilled. 

Article 3 

1.  The  loan  shall  be  made  available  to  Moldova  in  a  single  tranche,  which  shall  be 
released  subject  to  the  provisions  of Article  2  and  subject  to  satisfactory  progress 
being  recorded  in Moldova's  application  of  the  stand-by  arrangement  agreed  with 
the IMF. 

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

8 

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  requests,  to  ensure 
that an early repayment clause is included in the loan terms and conditions, and that 
it may be exercised. 

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 maturity 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 

n 

FINANCIAL RECORD 

1.  Budget line concerned 

Article  (...)  reflecting  the  budget  guarantee  for  the  Community  loan  facility  to 

Moldova (to be created through an amending and/or supplementary Budget). 

2.  Referencesflegal  base) 

Article 235 of the Treaty 

3.  Classification of the Expenditure . 

Obligatory 

4.  Description and Justification for the action 

a)  Description of the action 

The  budget  entry  reflects  the  commitment  of  the  budget  guarantee  associated 

with  the  Community's  borrowing  and  corresponding  lending  operations  to 

Moldova. 

b)  Justification for the action 

' . ' * *' 

\ 

The  viability  of  Moldova's  external  accounts  heavily  depends  on  external 

financial  assistance from official  sources. 

, 

r 

5.  Nature of the expenditure and method of calculation 

a)  Nature of the expenditure 

Potential activation of budget guarantee for the Community borrowing aimed to 

fund the 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 

Recourse  to  the  Guarantee  Fund  established  by  Council  Regulation  (EC, 
EURATOM) n° 2728 of 31 October 1994. 
In  case  the  Guarantee  Fund  did  not  contain  sufficient  resources,  additional 
payments  would  be  called  up from the  budget  by  transfer,  by  reutilisation  of 
reimbursed  amounts (Article 27(3) of the Financial Regulation  of  1977), or by 
amending and/or supplementary Budget. 
In order  to  fulfill  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.  1552/89 of 29.5.1989 will apply. 

Il 
ANNEX 

BUDGETARY RESOURCES NECESSARY FOR THE PROVISIONING OF 
THE GUARANTEE FUND IN 1995 AND MARGIN UNDER THE RESERVE 
FOR GUARANTEES 
(IN ECU MILLION) 

Operations 

Basis of the 
Calculation 

Provisioning of 
the Fund1 

Reserve 
Margin 

Project related assistance 
EIB/CEEC 
EIB/MED 
EIB/PVDLA 
EE5/SOUTHAFR 
EURATOM 

Macro-financial  assistance 
Bulgaria 
Belarus 
Ukraine-n 
Moldova-II 

1121 
52.5 
139 
125 
50 

403 
754 
2005 
155 

157 
7.3 
19.5 
18.7 
7 

6 
11.25 
30 
2.25 

323< 

166 
158.7 
139.2 
120.5 
113.5 

107.5 
96.2 
66.2 
64 

1  According  to  the  provisioning  rules  provided  in  the  Council  regulation  (EC,  EURATOM)  n° 
2728/94 of 31 October  1994. After  a first drawing  of the  Guarantee Fund,  and in compliance with 
Article 5 of the Regulation, the rate of provisioning for new operations is being increased from  14 % 
to  15% in  1995. For  1995, all  EIB  and  EURATOM  operations  approved  in  1993  and  1994  have 
been provisioned with a  14% rate. New macro-financial  assistance operations have been provisioned 
with a  15% rate. 

2  Reserve amount in  1995 under the financial perspective. 

3  Commission  proposal  (COM(94)118  of  21.11.1994,  94/0103(CNS))  to  increase  the  maximum 

amount of the existing loan facility to Bulgaria from ECU  110 million to ECU  150 million. 

4  Council decision of 10 April  1995. 
5  Commission proposa!. 

ISSN 0254-1475 

COM(95) 533 final 

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