State of the Country Report 2022

The political alignment of the different branches of power in Moldova has created both advantages and disadvantages as regards governance. On the one hand, it ensures stability, continuity, and predictability. On the other, it generates risks of non-compliance with the principle of separation of powers. The takeover of the government by a single party with reformist and pro-European intentions has partially improved the decision-making process. However, in the attempt to increase the speed of reforms, governance has sometimes overlooked the principles of transparency and inclusiveness, with reforms in some sectors (e.g. justice system reform, local public administration reform) being highly politicized, subordinated to the political calendar of the ruling party, and communicated to stakeholders in an inconsistent way. The government has also tried to surround itself with a protective circle of people in what is still an unreformed system. The recruitment policy chosen by the ruling party has sought to attract those who are compatible with its (geo-) political aspirations, and who have the necessary training and integrity to carry out the planned reforms in the manner proposed by the current leadership of the country. 

Moldova’s candidate country status in regard to membership of the EU gives an entirely new strategic and practical significance to the European integration process for the country. From now on, the national reform agenda must be combined with European integration priorities in order to produce effects in both directions. Moldova’s EU candidate country status maximizes the requirements of the EU and, at the same time increases Moldova's political commitment in a policy context that is no longer reduced to the technical implementation of the Association Agreement. Thus, progress in the pre-accession process will depend on the authorities' ability to integrate the EU's political requirements into the national reform agenda.

Overcoming structural difficulties on the way to progress in (pre-) accession negotiations depends not only on the political will of the authorities, but also on the capacity of the government apparatus in terms of European integration. The relatively limited knowledge of EU policies among figures in the Moldovan government was not a problem due to the constrained ambitions of both parties (Moldova and the EU) during the previous implementation of the Association Agreement. Moldova’s EU candidate country status implies a need for radical change in approach. Moldova must identify and employ human capital with knowledge and practical experience in the field. This means, on the one hand, training existing staff, and, on the other, attracting individuals from the diaspora.

In the period analysed in this report it became very clear that the main factor that can, even in the face of the system's resistance, ensure the effective promotion of reforms – especially unpopular ones – is external pressure. On the one hand, this can take the form of negative pressure, such as exogenous crises/shocks that dictate urgent structural changes internally, along the lines of the energy crisis which has been induced by external factors. Indeed, the reality now confronting the country has determined, for the first time in the last 30 years, a true security, diversification, and energy efficiency agenda. On the other hand, it can take the form of positive pressure exerted by development partners, by establishing conditionalities for providing their support. The most recent case of such pressure is the list of reforms that the European Commission highlighted when it granted Moldova EU candidate country status. 

Exogenous crises have, on the one hand, exposed the state's vulnerabilities, and, on the other, tested the government's capabilities. Since taking power in August 2021, the Action and Solidarity Party (PAS) has had to respond to a series of crises, which were amplified by the aggression by the Russian Federation against Ukraine, launched in February 2022. Two of these crises – the COVID-19 pandemic and the energy crisis – continued from 2021. The other crises – the refugee crisis and the security crisis – arose due to Russia’s war and the secondary implications of Western sanctions against Russia. Moldova’s ability to manage these crises, and to mitigate their negative consequences, has largely been due to the external assistance it has received from the EU, other Western partners, and international organizations. Nevertheless, Moldova remains vulnerable to exogenous crises, both as a result of its interdependence in relation to external factors (energy, trade, transport, etc.), and because of the country’s weak institutions, which are further undermined by kleptocratic groups of Moldovans that have obtained refuge abroad (e.g. in Israel and the United Kingdom, etc.).

In addition to the slow pace of reforms, coupled with the rapid increase in prices, the national economy is also expected to be affected by other shocks going forward. The Moldovan economy will go through a phase of stagflation in 2022, followed by a slow recovery in 2023. The biggest challenge for the economy is the escalation of security risks in the region, due to the Russian invasion of Ukraine. In addition to the fact that trade with the Russian Federation, Belarus, and Ukraine has been compromised, uncertainty has also increased, which has significantly reduced the investment appetite of economic agents both inside and outside of Moldova. At the same time, the tightening of monetary policy has increased the cost of finance for business, while unfavourable weather conditions have affected agricultural production. In this context, the economic outlook for 2022 is pessimistic: in addition to an average annual inflation rate close to 30 percent, mainly determined by the increase in import prices, economic stagnation is also anticipated. 

The perpetuation of the various shocks facing the country reduces the growth potential of the national economy. This will constrain gross domestic product (GDP) growth and will impact   household incomes in coming years. While GDP grew at an average annual rate of 4–5 percent between 2016 and 2019, and while in 2021 Moldova recorded its highest economic growth in its history (13.9 percent), the long-term economic dynamics are now slowing. Thus, potential GDP growth rates have decreased from 3.5 percent in 2016 to 2.2 percent in 2022. This trend will continue in the coming years and will impose constant constraints on both household income and the State Budget. In this context, one of the main preconditions for boosting economic growth is the promotion of reforms and the establishment of good governance in public institutions and state-owned companies/enterprises.

Ensuring the rule of law and the effective implementation of the regulatory framework remain the main ways of ensuring a favourable business climate. In the 2022 edition of the Economic Freedom Index, produced by the Heritage Foundation, the Republic of Moldova  scored 61.3, ranking 78 at the international level and coming 39th out of the 45 states in the European region. Over the past five years, economic freedom has continued to expand slowly, so that Moldova remains in the “moderately free” category for the third consecutive year.  Of the 12 indicators that make up the Economic Freedom Index, Moldova’s worst performance is on judicial effectiveness and government integrity. It also has a lot of room for improvement on the indicators related to investment freedom, financial freedom and property rights. At the same time, Moldova is in a favourable competitive position in terms of the indicators relating to fiscal burden and fiscal resilience, as well as monetary and trade freedom. 

In the same context, the latest assessment of the investment climate carried out by the US State Department is relevant.  Although this assessment finds that during the activity of the current government, which is perceived as pro-reform, Moldova is making progress in terms of economic reforms and strengthening democratic institutions, it also identifies challenges to the business climate in the country. These relate to the lack of effective and fair implementation of laws and regulations, as well as arbitrary and non-transparent decisions by government officials, which give domestic producers in certain fields an advantage over foreign competitors. Another aspect highlighted is that the government is free to invoke, in a relatively discretionary way, public security or the general social welfare as reasons for intervening in the economy, a fact that often contravenes the principles of the free market.

The business environment remains resilient against the backdrop of the current crises. Despite the numerous crises facing the country, important structural changes in the field of entrepreneurship have been observed: while in the period 2017–2020 the number of established businesses was constantly lower than the number of closed ones, in the period 2021–2022 a reversal of the situation is observed, with registered companies beginning to outnumber closed ones. In the context of economic, inflationary, energy and security crises, such a structural change means an improvement of the business environment and creates a solid basis for economic recovery. This trend may be the result of the new support programmes in the field of entrepreneurship, launched by the Organization for Development of Entrepreneurship, but it may also be a result of a qualitative change of perception on the part of the business world regarding the business environment in the country. 

In addition to its dramatic social implications, the pronounced inflation of 2022 has highlighted some fundamental shortcomings of the Moldovan economy, especially those related to reduced competitiveness and the poor quality of the competitive framework. It is certainly true that the main inflationary factors are external, being mainly determined by the increase in global prices, especially for energy and food resources. These phenomena have led either to a direct increase in the prices of consumer products, or to an increase in production costs. However, the increase in prices is also the result of a number of internal shortages. Compared to previous years, a new phenomenon has emerged: according to data from the first seven months of the current year, there is a major discrepancy between industrial prices for the local market (+32 percent) and those for export, which increased at a rate more than three times lower (+9). This phenomenon has several explanations: i) the existence of a series of industrial products that are sold only on the local market; ii) the need for exporters to honour previously concluded contracts; iii) the pressure of competitiveness, in order to keep customers even at the limit of the break-even point; or, iv) the possibility of operating with lower margins due to the higher volumes sold. At the same time, it reveals the shortcomings of the competitive framework in Moldova.

The numerous crises in the 2020–2022 period have revealed, in addition to the limited presence of business support resources, the fact that the tools available for intervention are extremely rudimentary. These crises, which started with the COVID-19 pandemic, have also brought to the fore the fact that the insufficiency of financial resources is not the only challenge in regard to the state providing support to the business environment. The lack of support mechanisms for systemic interventions has led to a situation where even the somewhat modest amounts provided, planned in the Budget, could not be assimilated, against a background of institutional and administrative barriers, and the establishment of some types of ad hoc support. In this context, the effort made in the last year by the government to develop forms of support that have a sustainable character and that can be used by the state in the future, whenever the need arises, is welcome. Several such measures can be mentioned: i) allowances amounting to 50 percent of their basic salary for employees who are technically unemployed, if the activities of the economic agent are suspended; ii) the reduced activity regime (of the “Kurzarbeit” type), which provides for granting an allowance of a maximum of 50 percent of the amount of the average salary for the economy forecasted for employees with a reduced activity regime; iii) the reorganization of ODIMM within the Organization for Development of Entrepreneurship, facilitating small and medium-sized enterprises’ access to the programmes of support; and, iv) the establishment of the Fund for Entrepreneurship and Economic Growth of Moldova (FACEM), which is a low-cost state financing tool for investment projects initiated by entrepreneurs. 

Against the backdrop of difficult economic and social realities, the stability of public finances has been maintained mainly thanks to external financial support. According to the latest budget correction, the Republic of Moldova will have an estimated State Budget deficit for this year of 6.2 percent of GDP or MDL 17.2 billion. Most of the expansion of public spending has been directed towards the social sectors, largely to protect the incomes of the most vulnerable groups, which have been severely eroded by inflation. For this year, the budget deficit has been covered exclusively from external resources. Given the large deficits accumulated in 2020–2022, and the likelihood of an equally significant budget deficit for 2023, to mitigate the effects of the concurrent crises, there is uncertainty and fear among the business community about the prospects for an increase in the fiscal burden in the next period. However, it is obvious that, in the medium and long-term, the Republic of Moldova cannot afford to sustain enormous deficits without adjusting its tax rates.

Based on the above-mentioned constraints, the report formulates the following strategic priorities for the coming years:

• Promoting public administration reform. The success of other reforms depends on this and it must aim to promote an attractive, competitive and performance-based wage policy in the public sector. There is also a need for flexibility in regard to firing inefficient officials, and for new hires, in parallel with the depoliticization and professionalization of the public administration, as well as flexibility in the procedures for reorganizing public institutions, in addition to their full digitization. 
• Increasing capacity to assimilate foreign assistance. In the context of increasing external financial and technical support, the issue of the capacity to absorb this support has become even more relevant. Accordingly, the public administration reform must also aim to strengthen the institutional capacities of the public authorities, especially the State Chancellery and the Ministry of Finance, in order to be able to coordinate external assistance. It is also necessary to implement donor requirements regarding public procurement, to improve policy and budget planning, and to strengthen inter-institutional cooperation. 
• Reviewing the legal and institutional constraints that prevent reforms from moving forward. It is necessary to evaluate the appropriateness of establishing effective sanctions for cases of sabotage within public institutions. It is also necessary to review the procedures by which legal bodies can open criminal cases against high-level public officials, including reducing discretion, which carries a risk of abuse, as well as to ensure legal protection for public officials, modelled on the principles of independence applied to central banks. 
• Making public communication on the reform agenda more efficient. Communication must be frequent, well-targeted and relevant, to explain to the population/electorate the need for reforms, the rationale for certain actions/policies, and to prevent/combat populism and misinformation. 
• Increasing the level of accountability of parliamentarians. The presidency, civil society, parliamentary and extra-parliamentary political parties, as well as the development partner community, must draw more attention to the decision-making process within parliament. This is necessary because it perpetuates some old deficiencies related to transparency, inclusiveness, and even risks of lobbying by various obscure interests. At the same time, there still exist cases of draft laws being promoted without tangible evidence, or of the legislature skipping certain important steps in the decision-making process, especially when it comes to analysing the impact of regulations. There is thus a need for permanent and thorough monitoring of the parliamentary agenda, and the way decisions are made in the supreme legislative forum. 
• Strengthening energy security. The Republic of Moldova must fully capitalize on the unique historical opportunity currently available to restructure its energy complex. This can be achieved through external pressure, coupled with full support, from development partners, by reducing energy dependence on the Russian Federation, increasing energy efficiency, and developing renewable energy sources. 
• Anchoring and aligning promoted public policies to the strategic framework. With the approval of the “European Moldova 2030” national development strategy, whose priority directions are clearly assigned to the expenditure programmes of the Medium-Term Budget Framework, it is important that this exercise be extended to all strategic planning documents. The adoption of strategies and programmes whose targets, from the start, are not feasible in relation to the actual possibilities undermines the effective implementation of public policies. 
• Ensuring a transparent, inclusive and dynamic European integration process. The implementation of the pre-accession and EU accession agendas must be well-communicated internally and must involve all interested parties as fully as possible. Only in this way will it be possible to consolidate, at both the national and local levels, a sense of ownership over the respective agenda – the main element in ensuring its sustainability and irreversibility. Both the particularities of the European integration process and the benefits for the population must be part of a clear and evidence-based communication strategy.

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This publication is produced by the independent think-tank Expert-Grup, in partnership with the Friedrich-Ebert-Stiftung (FES). The views and opinions expressed in this document are those of the authors and are not necessarily shared by the FES and by Expert-Grup.

Expert-Grup does not express collective opinions. FES’s publications cannot be sold without FES’s written consent. This version of the report is a translation of the original, which was written in Romanian. Every effort has been made to ensure that the translation is a faithful reflection of the original. However, in all matters relating to the interpretation of specific terms and information the original language version of the report shall prevail over this translation.