State of the Country Report 2024

The historical developments regarding the Republic of Moldova’s European integration process, which began in 2022-2023, also marked 2024, with the validation of the European integration vector through constitutional referendum, as well as the preparation for the accession negotiations set to begin in 2025. However, the speed of these processes could be jeopardized by a lack of capacity among public institutions, slow progress in bringing about key reforms, and political developments. Obtaining candidate country status in the summer of 2022, and the European Commission’s recommendation to begin accession negotiations in December 2023, marked a new stage for the Republic of Moldova’s European integration process. However, this was determined by geopolitical factors rather than internal structural improvements, and was, de facto, a credit of confidence granted by Brussels to a vulnerable country, in particular in the context of the Russian military aggression in Ukraine, and led by a pro-European government. The major challenge of 2024 was therefore to capitalize on this credit of trust by making a robust start to the preparation procedures for the negotiations, in parallel with pursuing a range of dynamic internal reforms. On the first aspect, the Republic of Moldova did relatively well; on the second, less so. Thus, significant progress was made in terms of bilateral screening before accession negotiations, where the support of civil society was significant. Overall, the preparation processes for the accession negotiations were relatively well coordinated, with the active involvement of the appointed Secretaries of State and the Bureau for European Integration (BEI). On the other side, progress with systemic reforms, especially the most problematic ones, was slow. For example, according to the Shadow Report on the implementation of the European Commission's recommendations regarding the “Fundamentals”  cluster, in terms of progress, only 3.2 points were achieved out of a maximum of 5. The slow pace of reforms influenced to a large extent the lower-then-expected pro-EU vector support at the referendum held on October 20, 2024. Thus, to strengthen the Republic of Moldova’s credibility when it comes to its ambitions to become a member of the European Union (EU), the pace of reforms needs to be boosted, especially in the areas of justice, the fight against corruption, and public administration.

The Moldovan economy is exhausting its potential and should switch its competitiveness model from the one based on cheap labour to a model based on efficiency 

The economic recovery previously projected for 2023 has been postponed to 2024. 2023 was marked by economic stagnation, with gross domestic product (GDP) increasing by only 0.7 per cent despite a favourable agricultural year and the small base of comparison (-4.6 per cent in 2022). For 2024, we estimate an economic recovery of around 2 per cent, supported by dynamic domestic consumption and public investments. The main risks stem from several sectors: agriculture, where we anticipate a recession of around 10‒15 per cent; industrial production, where we anticipate stagnation or insignificant growth; and the external environment, which is expected to affect export activity and private investment. Broadly speaking, over recent years, we have witnessed a continuous slowdown in economic growth rates, with the country's basic problems remaining unresolved, which undermines the country’s investment attractiveness and export potential. Key issues include judicial dysfunctions, political instability, limited access to capital, an almost non-existent capital market, a defective competitive framework, a low level of economic freedom, demographic factors and migration that fuel imbalances in the labour market. 

The deceleration of economic growth over recent years and the erosion of its potential, against a background of worsening labour shortages, reveal that the country is gradually exhausting its current competitiveness model based on inputs/resources (mostly cheap labour), while the transition to another model based on efficiency is slow and uncertain. So far, most exports, investments or agricultural and industrial production implied low levels of technological sophistication and value-added. This explains why the country has one of the lowest levels of labour productivity, wages and exports as a share of GDP in the region. Despite its vulnerabilities, this model has survived thanks to the availability and low cost of labour, which attracted a good part of the foreign direct investment (FDI) in sectors such as automotive and textiles (these sectors generate limited value added as they are based on the import of raw material and a minimum level of processing, after which the products are re-exported for further processing in other countries). Along with increased emigration by the working-age population, as well as the rise in wages faster than labour productivity, the deficit in the labour market has become a significant issue for the business environment and enterprises that have built their business models on low labour costs. Therefore, the Republic of Moldova’s economy has, de facto, exhausted its competitiveness model based on low-cost labour and is entering a period of low economic growth and uncertainty. In this context, there is still no definite answer to the question of when and if it will succeed in transitioning to a new model of competitiveness based on efficiency. Also, the talks regarding the potential liberalization of the labour market for unskilled workers are a step backward, and perpetuate the uncertainty associated with the competitiveness model based on low labour costs. If the goal is to maximize the welfare of the entire economy, and not just that of the companies that benefit from low-cost labour, the government's attention must be focused on channelling policies and resources into supporting the private sector that generates added value, by processing local raw materials, streamlining production processes, and implementing technological innovations. Hence, the focus should be on maximizing added value in the economy and streamlining processes that will create sustainable preconditions for increasing wages, net exports, tax incomes, and economic growth as a whole. 

The real sector is struggling with high uncertainty, security risks, unfavourable market conditions and instability of the legal and policy framework

Amid high uncertainty stemming from domestic and external sources, the aggregate data from company balance sheets for 2023 suggest further growth in risk aversion and limited investment appetite. Companies' equity increased by 9.6 per cent, while the total debt balance decreased by 0.3 per cent. The apathy and wait-and-see attitude displayed by firms in 2023 have partly continued into 2024 among small and medium-sized enterprises (SMEs), while large businesses have more optimistic expectations.

The real dynamics was undermined by unfavourable market conditions in 2024. In agriculture, farmers faced continued pressure of lower prices combined with last year's reduction in harvests by 10‒15 per cent. Industrial production continues to face challenges, and in 2023 its share of GDP fell to historic lows (11.2 per cent), indicating an urgent need for modernization and restructuring. The service sector represents the main source of economic growth for 2024, with the return of retail trade and constructions, along with continued expansion of the information technology (IT) and hotel, restaurants, and cafes (HoReCa) sectors. The new impetus in the residential construction sector, combined with companies’ nascent efforts in terms of refurbishment and automatization, allowed for the positive return of investment in 2024. The banking sector remains stable and resilient, but, despite the relaxation of monetary policy, the level of financial intermediation remains mediocre. Banks are attracting deposits at historically low rates and have recorded the largest spreads between the effective rates on loans and deposits in a decade. 

The analysis of the business environment reveals continuity in terms of the improvement in perceptions regarding the level of corruption in the country, but also in the worsening of the level of economic freedom. In addition to the security risk generated by Russian aggression in Ukraine, the perception of foreign investors towards the Republic of Moldova has also been shaken by some discretionary and poorly reasoned decisions by the government, as well as by the lack of stability of the rules of the game established by legislation. At the same time, notable progress has been made in the digitization of public services and in the development of online commerce. The authors of the report opt for a strategic approach in all economic areas, including those not covered by strategic planning (internal trade, quality infrastructure, and market surveillance, competition). It is recommended that guarantee instruments be created for exporters to mitigate the financial risks and support liquidity flows. Moreover, it is essential to strengthen active employment measures and accelerate the internationalization of universities to respond better to the needs of the labour market. Improving the predictability and stability of regulations to strengthen business confidence should also remain a priority. Applying the “principle of rarity” in granting agricultural subsidies and prioritizing projects with a high economic impact could contribute to a more efficient and impactful use of budgetary resources for farmers.

The high poverty rate, despite a moderate recovery in incomes and consumption, remains the most pressing social problem

From the second half of 2023, the real incomes of the population in the form of wages and pensions recorded a compensatory increase after the inflationary shock of 2022 had subsided. As a result of the increase in real incomes, but also the decrease in interest rates and the revival of consumer credit, a recovery in household final consumption was recorded. The growth rates were still weak, however. Unlike salaries and pensions, real remittances received by the population continued their downward trend in 2023, and did not recover in 2024. The decrease in real remittances was caused by the decline in nominal remittances in foreign currency as a result of the cost-of-living crisis and of decreasing labour demand in host countries. Since remittances represent an important source of income in household budgets, their negative dynamics were one of the factors that diluted the effect of the increase in other types of income on poverty indicators. Thus, in 2023, the absolute poverty rate remained almost unchanged compared to the previous year and even increased slightly, to 31.6 per cent (+0.5 per cent compared to 2022). Groups that were already disadvantaged were the most affected: people whose main source of income is individual agricultural activity, families with children, and people with disabilities. In order to overcome the problem of persistent poverty, it is necessary to continue social assistance programmes targeted at the most vulnerable, as well as to boost economic growth.

Real wage growth led to the population’s more active participation in the labour market, but the labour force continued to decrease, in particular due to emigration. In quarter 2 of 2024 (Q2:2024), the employment rate of the population aged 20‒64 increased by 0.7 percentage points (p.p.) compared to Q2:23, reaching 57.3 per cent. In particular, the number of people employed in public administration, education, health and social assistance, transport and storage, information, and communications increased. At the same time, despite the increase in real wages across all industries, the number of people employed in agriculture, forestry and fishing, manufacturing, trade, and HoReCa decreased. In total, the employed population decreased by 34,400 people compared to Q2:23, the number of unemployed decreased by 600 people, while the population outside the labour force (inactive) aged 15 and over decreased by 25,000 people. This phenomenon was in large part caused by emigration, for economic reasons and because of security risks. After the outbreak of the war in Ukraine in 2022, the number of emigrants of working age from the Republic of Moldova increased to 146,000 people annually, and the number of immigrants of working age reached 99,000 people, which resulted in a net migration of -47,000 people. As a policy response, in order to increase productivity and labour remuneration, it is essential to continue reforming the labour market (reducing the mismatch between workers' qualifications and business needs, increasing women's participation in the labour market by developing child and elderly care services), improving the business environment, and stimulating competition.

The transition to an efficiency-based competitiveness model can be achieved with the financial support from the Government. The main condition is to significantly improve the governance and efficiency of government programs and mechanisms to support the economy

Although, in recent years, the state has increased the level of resources allocated to support the private sector and the economy as a whole, these changes have had a limited impact. With regards to the budgetary programmes designed to support SMEs and agriculture alone, in the period of 2022‒2023  more than four billion Moldovan Lei (MDL) was allocated. However, the respective resources were not managed in the most appropriate way, due to numerous factors including: a lack of coordination between different programmes (e.g. multiple cases of financial support for the same investment project from different programmes), against the background of the lack of a unified register of all support programmes; the allocation of financial support to companies that should not in fact have received preferential financing because they are affiliated to, or de facto part of, large economic groups (the legal framework remains quite permissive in this regard); and, the allocation of financial resources without the establishment of clear priorities for processing activities or activities that bring added value (an eloquent example of this is the subsidies in agriculture, which were also extended to other economic activities such as processing, storage, and the food industry). 

In order to support the transition from a competitiveness model based on the cost of resources to one based on efficiency, the state must review the way it plans and allocates financial resources in the economy. Financial support instruments ‒ above all, agricultural subsidies and the programmes of the Organization for the Development of Entrepreneurship (ODA) ‒ must give clear priority to economic activities that generate added value, such as: processing local raw materials, technologizing production processes, implementing innovations at the firm level, and export orientation. At the same time, it is important to establish a coordination mechanism between various programmes, including by creating a register that integrates them to avoid financial support within different programmes being allocated to the same investment projects. It is also important to focus on making the mechanisms for allocating financial resources more efficient. In this sense, it is crucial to move from an approach based on the mechanical and formalistic evaluation of financing files to an evaluation based on risk, added value generated, and the impact of the business on the sector and the economy as a whole. The Competition Council must play a more active role in detecting and penalizing attempts to benefit from state funding programmes through companies that hide their affiliations. More attention must be paid to how financial support is allocated to the private sector to avoid corrupt or crony arrangements. We are talking about some critical elements of governance here, namely: (i) the separation of evaluation, implementation and monitoring functions; (ii) the independence of financing decisions; and, (iii) the quality of management bodies (boards and executive bodies).

Although Moldova has a well-capitalized banking system and increasingly greater financial resources allocated by the government, the funding deficit reported by companies remains a major problem. Lack of equity capital and intermediation problems translate into businesses that stagnate, and the economy ultimately misses out on opportunities for investment and production, gross value added (GVA) growth, job creation, and GDP growth stimulation. In addition, intermediation problems limit the much-needed structural change of the economy to one with higher added value. Therefore, the analysis of financial factors, which prevent the expansion of private investments and the identification of viable solutions to mitigate them, must remain the government's priority. When the financial market cannot self-correct and cannot identify enough incentives to finance the real economy, state intervention is justified because missing economic opportunities can produce losses that are much harder to recover from over time. Externally, the most common example of state intervention in business financing is that of development banks, which allocate volumes of capital to businesses that show promise, but which, under market conditions, could not achieve their full potential. Thus, given the increasingly frequent crises and the permanent need to support the economy, the government needs to decide which mechanism would result in the most efficient allocation of public funds, whether it is from the state budget, the EU, or other external partners.

Even if the government seems to implement programmes and support measures similar to those of other states, including the countries of the EU, their efficiency is in fact much lower. This is confirmed by the modest economic results achieved. Deficiencies of an institutional nature, along with those in the process of developing and implementing programmes, undermine the potential and expected impact of such programmes and measures. Thus, since we are talking about public resources, which come from the account of taxpayers and companies that generate added value, they must be allocated following the principles of efficiency and the greatest impact on beneficiaries and the economy in general. Clearly, the state must give complete freedom to entrepreneurs, so that they can decide for themselves where to invest. Yet when it comes to state financial aid, it must be targeted, both from the perspective of economic activities and from the perspective of the evaluation criteria of investment projects. As for the criteria used to evaluate projects that are to obtain financial aid from the state, criteria related to the creation of Gross Value Added (GVA) the maintenance and launch of new jobs, or the export of processed products and services with high added value must be followed, rather than only compliance-related criteria. The prioritization of resources based on these criteria could lead to the rapid achievement of economic policy objectives or those expressly established by a certain programme. 

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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.