World Bank: Moldova’s Fiscal Policy has been Generally Expansionary in Recent Years, Supporting Economic Growth

A new study by the World Bank titled “Analysis of Public Finances: Sustainable and Growth-Oriented Fiscal Policies” was presented on Tuesday at the Economic Press Club. The study asserts that the cyclically adjusted primary balance is an important indicator for assessing the structural orientation of fiscal policy by differentiating cyclical changes. Fiscal impulses have often been positive when the economy was already recovering and negative when the economy was in recession, with some notable exceptions (2007, 2016, 2017, and 2020). This indicates a procyclical behavior of fiscal policy.

World Bank experts state that automatic stabilizers should respond to the economic cycle, with revenues declining and some expenditures increasing during crisis periods, which is largely the case in Moldova. In Moldova, the fiscal impulse, which measures the discretionary actions of the government, has prevailed over the automatic stabilizers of the fiscal system. World Bank analysts emphasize that the persistence of procyclicality, although to a relatively lesser extent than in comparable countries, has partially hindered the sustainability of fiscal policy. The correlation between the cyclical components of public expenditures and GDP growth is about half compared to the average of comparable countries (0.3% compared to 0.6%).

Structural features of Moldova, typical of a small economy including a modest production base, excessive dependence on imports, and vulnerability to exogenous shocks, require a much stronger countercyclical orientation and increased fiscal resilience to mitigate the socioeconomic impact of different crises when they occur. As mentioned, starting from the year 2000, the Republic of Moldova has faced a major natural disaster on average every three years, with the droughts in 2020 and 2022 being just the most recent in a long and increasingly frequent series of weather events exacerbated by climate change. The energy crisis and the Russian invasion of Ukraine have highlighted Moldova’s instability and lack of energy source diversification through imports from a single source and supplier.

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The World Bank study underlines that a positive characteristic of Moldova’s fiscal situation is the low level of fiscal inflexibility, although fiscal rigidity has recently increased significantly. The low level of fiscal rigidity facilitates short-term budget reallocation in case of new priorities and/or the materialization of shocks. In the case of the Republic of Moldova, fiscal rigidity increases considerably when considering the budgets of social and health insurance funds as well as transfers to local administrations, which represent the main source of financing at the local level. Compared to structurally similar and aspiring countries, Moldova’s expenditures are more flexible, with rigid elements – salaries, interest payments, and social benefits (mainly related to social insurance but also including social assistance programs) – accounting for approximately 60% of total public administration expenditures.

Fiscal rigidity increases in countries with higher social and wage costs, so recent decisions to increase the minimum wage and pensions in 2022 have heightened fiscal rigidity in Moldova but remain relatively low compared to other countries. As emphasized by World Bank experts, when income sharing is added to the analysis, fiscal flexibility decreases to 12% of total expenditures. When including social benefits, the health fund, and transfers to local administrations, estimated fiscal rigidity reaches nearly 74% of total expenditures. This is largely due to capital expenditures, which are financed from allocated sources. In addition, some budget positions cannot be changed in the short term. These medium-term constraints related to subsidies to state-owned enterprises, the Road Fund, and the private sector account for another 3.4% of total expenditures, further reducing the ability to reallocate funds in response to shocks, and resulting fiscal space is reduced to 12%.

World Bank experts highlight that at the same time, intergovernmental transfers, which represent about 20% of total expenditures, are an important category that affects not only overall fiscal rigidity but also fiscal sustainability. Local expenditures affect global expenditures and are not supported by adequate local revenues. Local administrations in Moldova spend 8.1% of GDP, equivalent to a quarter of total expenditures, which is much higher than in structurally similar countries but in line with the average of target countries. The vertical fiscal imbalance, i.e., the share of local expenditures financed through transfers from the central government, is particularly high, at 75%, considering the high dependence of local administrations on these transfers. Moldova’s vertical fiscal imbalance is nearly twice as high as the average of all comparable countries, with only Estonia and Lithuania having a higher share.

As emphasized by World Bank experts, this is particularly important in terms of efficiency, given that the current administrative and territorial structure of Moldova is suboptimal compared to the country’s size and population. Except for Chisinau and the Gagauzia ATU, most municipal administrations rely heavily on transfers from the central government, with limited revenue collection capacity compared to their needs. This contributes to horizontal fiscal imbalance as most transfers go to the capital city of Chisinau, which represents approximately 60% of Moldova’s GDP and has a greater revenue collection capacity.