Proposal for a Council Decision On providing further supplementary-financial assistance to Moldova
Date: 2002-10-02
Institutions: European Commission
Subjects: EU aid, International Monetary Fund, Moldova, donation, financial aid, macroeconomics

C 20 E/364

EN

Official Journal of the European Communities

28.1.2003

Proposal

for a Council Decision on providing further supplementary-financial assistance to

Moldova

(2003/C 20 E/31)

COM(2002) 538 final — 2002/0236(CNS)

(Submitted by the Commission on 2 October 2002)

EXPLANATORY MEMORANDUM

INTRODUCTION

In early 1993 Moldova embarked on a comprehensive programme of economic stabilisation and market
reforms, backed by the IMF and the World Bank. By 1995, inflation and the fiscal deficit had been brought
under control, while good progress was also made with structural reform, notably in the areas of taxation,
price liberalisation and privatisation.

During this initial stage of transition to a market economy, the European Community has supported
Moldova 's through various means, including macro-financial assistance. The Community provided two
macro-financial assistance packages worth EUR 45 million and EUR 15 million (Council Decisions
the Community loans were part of an overall package
EC/94/346 and EC/96/242).
mobilised by the international community to complement the resources provided by the IFIs. Moldova
has so far serviced scrupulously its external financial obligations towards the Community and, according to
the agreed scheduling, repaid EUR 18 million in principal between December 2000 and August 2002.

In both cases,

In March 1998, the IMF and the World Bank called a new donor meeting in order to mobilise financing in
support of Moldova's new economic programme supported by the IFIs. In this framework, the Council
approved a new macro-financial assistance loan for Moldova of EUR 15 million, with a maximum
duration of ten years and to be disbursed in two tranches (Council Decision 2000/452/EC of 10 July
2000). By the time the Council Decision was taken, Moldova's arrangement with the IMF under the
Extended Fund Facility (EFF), approved in May 1996, expired (in May 2000).
in
December 2000, by a new three-year arrangement under the Fund's Poverty Reduction and Growth
Facility (PRGF). After the adoption of the arrangement, Moldova was able to draw SDR 18,48 million
(some USD 24 million) under the PRGF at the turn of 2000/2001, but the programme went off track in
the spring of 2001. The IMF resumed its lending to Moldova in July 2002, after the successful completion
of the First Review under the PRGF Programme. At the same time, the World Bank resumed its own
financial support to Moldova with the approval of a new Structural Adjustment Credit (SAC III).

It was replaced,

Meanwhile, the foreign debt situation of the country has seriously deteriorated. In order to address the
issue of Moldova's foreign debt sustainability (as well as that of six other CIS-countries), the World Bank,
the IMF, the ADB and the EBRD prepared a joint study and organised a seminar on ‘Poverty Reduction,
Growth and Debt Sustainability in Low-Income CIS Countries’. The study and the seminar conclude inter
alia that Moldova's financial sustainability requires debt and debt servicing alleviation and urge donors to
help the country with more concessional forms of assistance. As a follow-up to the seminar, a ministerial
meeting on the same issue (so-called ‘CIS-7 Initiative’) was held in Washington on 20 April 2002 and
endorsed a statement calling for ‘more concessional support (such as grants), as well as debt restructuring
or debt relief where needed’.

Moldova's external financing needs for the period covered by the current programme supported by the IMF
and the World Bank comprise a substantial amount of foreign debt, owed to both official and private
creditors. In view of the country's limited financial resources, Moldova will need to either restructure or to
refinance most of its debt servicing obligations. It is also foreseen in the economic programme that
Moldova will refrain from attracting new non-concessional external financing.

Against this background and consistent with the request from the Moldovan Prime Minister Tarlev to
President Prodi of 9 April 2002, the Commission is now proposing that the Community macro-financial
loan to Moldova approved in July 2000 be cancelled and replaced by a straight grant of an equivalent
amount. This new macro-financial assistance will be disbursed in at least two tranches under similar
conditions to those foreseen for the disbursement of the loan and will be complementary to financing
provided by the IFIs.

28.1.2003

EN

Official Journal of the European Communities

C 20 E/365

RECENT ECONOMIC DEVELOPMENTS

Growth

Real GDP grew by 6,1 % year on year in 2001, after a moderate rise in 2000. Despite slow reforms and a
relatively weak external environment, the economy is still expected to grow at an annual rate of around
4,8-5 % in 2002-2003. This reflects an extremely low base period — following years of steep economic
decline — as well as the accumulated effects of a gradual reform process. Moldova's economy will also
benefit from relative macroeconomic stability and generally solid import demand in Russia.

in combination with the halt

The relatively strong performance seen in 2001 is mainly the result of the industrial sector's strong
recovery,
in the agricultural sector's decline. The latter, which still
accounts for about half of total exports, has benefited from the successful farm privatisation and associated
reforms implemented in recent years. However, without strong growth in investments and further liberali-
sation, Moldova's agricultural sector will not be able to diversify into higher value-added commodities or
seek out more lucrative and reliable markets outside the CIS. Even the moderate pace of growth that is
currently expected (on the assumption that the important agricultural sector does not suffer from adverse
weather conditions) would be jeopardised if reforms in the sector were not sustained.

Inflation

Consumer price inflation fell to 6,4 % by the end of 2001, down from 18,5 % in 2000 and 43,8 % in
1999. The significant disinflation recorded in 2001 reflects restrained growth in the money supply, relative
currency stability and an improved agricultural harvest. These factors continued to hold down inflation
over the first part of 2002, with a fall in food and gasoline prices keeping total inflation over the first three
months of the year down to only 1,4 %.

Budget

The tightening of the fiscal policy achieved since the Russian crisis of 1998 continued in 2001: the general
government deficit that still exceeded 8 % of GDP in 1998 was cut to less than 1 % in 2000 and changed
into a surplus of 0,5 % in 2001. However, the 2001 performance reflected insufficient external financing
rather than improved revenue performance. As a result, some new external arrears were accumulated
towards the end of 2001 and severe expenditure cuts had to be made. All in all, the authorities only partly
achieved their goal of maintaining a tight fiscal stance while maintaining and enhancing social expenditure,
in line with the objectives of the I-PRSP (Interim Poverty Reduction Strategy Paper, prepared in coop-
eration with the World Bank and serving as a basis for the Bank's lending programmes).

The budget for 2002 adopted in November last year foresees a consolidated deficit of around 1,4 % of
GDP. However, this budget will be revised in view of, on the negative side, unbudgeted wage increases and
lower than planned VAT collection, and, on the positive side, lower interest payments.

Monetary and exchange rate policy

The easing of inflationary pressures has allowed the National Bank of Moldova (NBM) to gradually loosen
its monetary stance through 2001, through lowering reserve requirements (from 13 % to 10 % in October
2001) and interest rates. Since end-February 2002, the NBM's basic rate stands at 13 %, down from 21 %
in January 2001. The result of this policy has been a rapid growth of deposits and credits to the economy

After almost a year of remarkable stability in 2001, since the start of this year the Moldovan leu (MDL)
showed increased volatility sparked by a seasonal rise in US dollar demand and concerns over political
stability. Between mid-February and mid-March the currency lost more than 3 % of its value, but it has
recovered somewhat since then. Further currency weakening could be seen through mid-2002, reflecting
the political situation and concerns over the government's debt-servicing abilities.

C 20 E/366

EN

Official Journal of the European Communities

28.1.2003

Current account

In 2001, the current account improved considerably. While the size of the current account deficit
remained virtually unchanged compared to 2000 (USD 119 million against 121 million the year
before), it represented only 7,4 % of GDP, down from 8,4 % in 2000. This gradual improvement of the
current account was continuing in the beginning of 2002. The main source of the improvement of
Moldova's external account is the 20 % surge in remittances from Moldovans working abroad (estimated
to equal well over 10 % of GDP annually). At the same time, equally strong growth in exports, resulting
mainly from the improved performance of the agriculture, was not sufficient to narrow the trade deficit in
view of continued high levels of imports.

Privatisation

Privatisation of the wineries, tobacco plants and utilities were earlier conditions set by both the IMF and
the World Bank. The Communist Party consistently opposed the sales when in opposition, but after
coming to power was forced to support them as the restoration of relations with the IFIs grew more
urgent.

Moldova has failed to complete any major privatisation since February 2000, so that the government
earned a meagre MDL 32,6 million (USD 2,5 million) from small-scale privatisations in 2001. It already
abandoned the sales of two of its major wineries at the end of 2001 because the offers, from Russian and
local companies, were too low.

The government has more ambitious plans for 2002, with between 350 and 500 companies up for sale.
This includes plans to sell majority stakes in two of the country's five electricity distributors this year after
two previous failed attempts. Union Fenosa (Spain) bought the other three distributors for USD 25,2
million in 2000 and promised to invest a further USD 67 million.

Foreign debt

Moldova's external debt situation is a major source of concern. Although in 2001 the total external debt
decreased (due to the halt in external financing, notably from the IFIs), it still represented more than 90 %
of GDP. Public and publicly guaranteed debt represents about two-thirds of the total debt stock. The
external debt is expected to rise again in the coming years with the resumption of foreign financing.

The year 2002 is critical for Moldova as regards foreign debt service, which has soared to an annual 250
million dollars. The foreign debt service, if paid entirely, represents almost one-third of export revenue.
Debt service on public and publicly guaranteed debt alone absorbs 18 % of export receipts and more than
50 % of the Central Government revenue.

Already in 2001 Moldova raised the spectre of default on 1997 Eurobonds with late payments on two
occasions. The government is currently negotiating a comprehensive restructuring of outstanding amounts
on the Eurobonds (USD 40 million) and of its debt arrears owed to Russia's Gazprom on natural gas
deliveries.

THE ECONOMIC PROGRAMME AGREED WITH THE IMF AND THE WORLD BANK

The new programme aims at achieving a primary budget surplus of at least 2 % of GDP over the coming
years. The debt burden will be stabilised, and wage and pension arrears will be reduced. Principally better
revenue collection should contribute to the improvement of the fiscal situation. The share of education and
health care in government spending will be increased, while subsidies will be limited. Monetary policy will
aim at keeping annual inflation at less than 8 %, as well as at increasing the level of international reserves
to be equivalent to three months of imports in 2003.

The structural reform agenda of the programme covers a wide range of policies, such as fiscal and financial
sector reform, governance and transparency, privatisation in key sectors of the economy (wineries and
telecommunications),
improving delivery of social services and strengthening the legal and regulatory
framework.

28.1.2003

EN

Official Journal of the European Communities

C 20 E/367

MOLDOVA'S FINANCING NEEDS

Moldova's external financing needs are estimated to be over USD 210 million for the period 2002-2003.
Out of this amount, more than half is expected to be covered by new financing from the IFIs: USD 80
million by the IMF (under the current PRGF arrangement) and USD 30 million by the World Bank (under
the Structural Adjustment Credit III). Under the current financing assumptions, the bulk of residual
financing gap of about USD 100 million (more than USD 80 million) is to be covered by Moldova's
private creditors, through restructuring of Eurobonds and of Gazprom promissory notes. The IMF assumes
that the rest of the financing gap — about USD 18 million (the equivalent of about EUR 20 million, at
the exchange rate at the time the projections were prepared) — would be filled by the EU macro-financial
assistance in the form of grants. Although the Fund does not see at present any urgent need for a Paris
Club treatment of Moldova's debt to official creditors, the possibility of such treatment has been repeatedly
raised by Moldova's government.

THE PROPOSED MACRO-FINANCIAL ASSISTANCE

In view of the deterioration of the foreign debt situation of the country, Moldovan Prime Minister Tarlev
requested in a letter of 9 April 2002 to President Prodi the conversion of the EUR 15 million loan decided
in 2000 into a grant. This request is consistent with the commitment of the authorities to refrain from
new borrowing on non-concessional
the economic programme for
2002-2003 agreed with the IMF.
It is also consistent with the strong consensus within the donor
community that Moldova should receive more concessional support, confirmed at the above-mentioned
ministerial meeting on the CIS-7 Initiative in favour of the poorest countries of the CIS, including Moldova.

terms made in the context of

Against this background, the Commission proposes to cancel the existing decision on macro-financial
assistance to Moldova in the form of a loan of up to EUR 15 million (Council Decision 2000/452/EC) and
to replace it with a straight grant of an equivalent maximum amount. Given that the Guarantee Fund has
already been provisioned with EUR 2,25 million in 2000 as a result of the adoption of the Council
Decision 2000/452/EC, the corresponding deprovisioning will be implemented next year.

to the balance of payments of Moldova. The proposed assistance amount

The Commission considers that the proposed assistance is an appropriate reference amount for the
is
Community's support
consistent with Moldova's residual
the financial outflow
resulting from the settlement of Moldova's debt re-payments to the Community (EUR 46 million
between 2002 and 2006). This support would help the consolidation of the country's official reserves
position and sustain the reform efforts of the authorities. It would also contribute, together with assistance
from IFI's and other bilateral donors to the appropriate coverage of the country's external financing needs.

taking also into account

financing needs,

Without prejudice to the competencies of the budgetary authority, the Commission considers that the new
assistance would have to be implemented in at least two instalments from 2002 to 2004, within the limits
of Category 4 of the financial perspective for the 2000-2006 period.

Accordingly, the Commission requests the Council to adopt the proposed decision and to allow Moldova
to benefit from the new financial assistance package.

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European
Community, and in particular Article 308 thereof,

Having regard to the proposal from the Commission,

Having regard to the opinion of the European Parliament,

Whereas:

(1) The Commission has

consulted the Economic
Financial Committee before submitting the proposal,

and

(2) Moldova

is undertaking

and
economic reforms and is making substantial efforts to
sustain its progress in transition,

fundamental political

(3) Moldova, on the one hand, and the European Community
and its Member States on the other hand, have signed a
Partnership and Cooperation Agreement, which entered
into force 1 July 1998,

(4) The authorities of Moldova have agreed with the IMF on a
macro-economic programme supported by a three-year
PRGF, approved in December 2000, and have expressed
their intention to subsequently continue this programme
in the context of a new appropriate Fund Facility,

C 20 E/368

EN

Official Journal of the European Communities

28.1.2003

(5) By Decision 2000/452/EC of 10 July 2000 (1) the Council
has made available to Moldova macro financial assistance
up to EUR 15 million, in the form of a long-term loan,

(6) Moldova's foreign debt situation has become increasingly
preoccupying and the country is facing very high debt-
to-export and debt-to-central-government-revenue ratios,

(7) The Moldovan authorities have

requested financial
assistance on a concessional basis from the International
Financial Institutions, the Community and other bilateral
donors. Over and above the financing from the IMF and
the World Bank a substantial residual
financing gap
remains to be covered to comfort the country's foreign
reserves
strengthen the
debt
position and support the policy objectives attached to
the authorities' reform efforts,

sustainability,

country's

(8) The IMF, the World Bank, the ADB and the EBRD took
the initiative in convening, on 20 April 2002, a minis-
terial meeting on an Initiative in favour of the low-income
CIS countries, aiming at,
inter alia, providing increased
financial support on a concessional basis to the poorest
countries of the CIS, including Moldova,

loans
(9) Moldova became eligible to highly concessional
from the World Bank and the IMF, and is
facing
particularly critical economic, social and political circum-
stances,

(10) In these circumstances and without prejudice to the
powers of
the Community
the budgetary authority,
macro-financial assistance to Moldova should be made
available in the form of a grant, as an appropriate
measure to help the beneficiary country at this critical
juncture,

(11) This assistance should be managed by the Commission,

(12) The Treaty does not provide, for the adoption of this
decision, powers other than those of Article 308,

Committee and in a manner consistent with any agreement
reached between the IMF and Moldova.

Article 2

1.
The Commission is empowered to agree with the
Moldovan authorities, after consulting the Economic and
Financial Committee, the economic policy conditions attached
to the financial assistance. These conditions shall be consistent
with the agreements referred to in Article 1 (3).

2.
The Commission shall verify at regular intervals, in colla-
boration with the Economic and Financial Committee, and in
coordination with the IMF, that economic policy in Moldova is
in accordance with the objectives of this financial assistance
and that its conditions are being fulfilled.

Article 3

1.
The assistance shall be made available to Moldova in at
least two instalments. Subject to the provisions of Article 2, the
first instalment is to be released on the basis of a satisfactory
track record of Moldova's macro-economic programme agreed
with the IMF in the context of the present Poverty Reduction
and Growth Facility or of any successor upper credit tranche
arrangement.

2.
Subject to the provisions of Article 2, the second and any
further instalments shall be released on the basis of a satis-
factory
macroeconomic
programme and not before three months after the release of
the previous instalment.

continuation

Moldova's

of

3.

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

All

related costs

4.
concluding and carrying out
Decision shall be borne by Moldova, if appropriate.

incurred by

the Community in
this

the operation under

HAS DECIDED AS FOLLOWS:

Article 4

Article 1

The Community shall make available to Moldova macro
1.
financial assistance in the form of a straight grant with a view
to ensure a sustainable balance-of-payments situation and
strengthening the country's reserve position.

The assistance shall amount to a maximum of EUR 15

2.
million.

3.
close

The assistance will be managed by the Commission in
Financial

consultation with

Economic

and

the

At least once a year, and before September, the Commission
shall address a report to the European Parliament and to the
Council which will
include an evaluation of the implemen-
tation of this decision.

Article 5

This Decision shall take effect on the day of its publi-
1.
cation in the Official Journal of the European Communities. It will
expire three years after the date of its publication.

2.

Council Decision 2000/452/EC is hereby repealed.

(1) OJ L 181, 20.7.2000, p. 77.