Commentary | 17 December 2015

Why Moldova is Failing and What can be Done

The European continent is beset by challenges. Political and economic turmoil in Moldova, a state of some three million people on the continent’s eastern periphery, may seem inconsequential by comparison, but in the current climate Europe can ill afford yet another state-failure in its neighbourhood.

At face value Moldova has a lot in its favour. It borders the EU (one can drive from Chisinau to EU-member Romania in 1.5 hours), it has maintained steady economic growth since 2009, and has, at $300 per month, a low average wage that should be attractive to investors. Moldova should be, as highlighted by World Bank representative to Moldova Alex Kramer, the ‘tiger’ economy of Europe. But this is not the case. Moldova is predicted to have entered recession in the second half of 2015, with foreign direct investment and government expenditure tumbling.

At the heart of Moldova’s travails is endemic corruption, a virus that has thoroughly infected politics and business (although the distinction between the two is often vague). The most spectacular example of this is the theft of $1 billion from three Moldovan banks, the details of which have yet to be fully understood. The uncovering of this scandal brought thousands of protestors onto the streets of Chisinau and the arrest of former Moldovan Prime Minister Vlad Filat in the chamber of the Moldovan parliament. This forms only a part of the political turmoil engulfing the country, with the ruling coalition beset by resignations and infighting. It is not surprising that the popularity of political groups advocating for Moldova’s membership of the Eurasian Economic Union rather than the European Union has risen significantly. All whilst a motion to modify the constitution to allow the direct election of the President passes through parliament.

This bank heist, warning signs about which were registered by the World Bank as far back as 2013, has had a deep and far-reaching impact on the economy. The initial reaction by the Moldovan Central Bank was to print money, eventually leading to a collapse of the leu’s value in early 2015 accompanied by a rise in interest rates.

In turn this led to a decrease in VAT receipts and foreign direct investment (FDI) and an increase in government borrowing costs. As confidence in Moldova falls, this has led to a decrease in government revenue and expenditure. In practical terms this has resulted in the freezing or cancelation of infrastructure developments that the economy desperately needs. Furthermore, the FDI that does make its way into the country is predominantly being invested in the unstable and clearly insecure financial sector, rather than in agriculture, the only productive portion of the economy.

This lack of investment is set to have serious consequences for Moldova in the medium term as its Association Agreement (AA) and accompanying Deep and Comprehensive Free Trade Agreement (DCFTA) with the EU comes into full force. If Moldovan products cannot be made more competitive in the interim this trade liberalisation may prove an existential challenge for many industries rather than a boost.

Moldova has also fallen victim to adverse economic influences outside of its control, in particular the recession underway in Russia. Moldova relies on remittances from nationals working abroad to cover a large part of its current account deficit, with Russia and Ukraine as primary destinations. The downturn in the Russian economy has resulted in a 27% decrease in Moldovan remittances. On a structural level the way this remittance capital is spent is also of concern, as rather than being invested in domestic sectors it is overwhelmingly spent on imports.

The politically motivated sanctions on Moldovan agricultural exports to Russia in the aftermath of the signing of Moldova’s AA are also a considerable contributor to this downturn.  To make matters worse the Moldovan agricultural sector has produced notably low yields in recent months due to drought.

Short-term support was set to be provided by Moldova’s neighbour and close partner Romania in the form of a $161 million loan (although recent developments in Romania suggest this may be cancelled) as well as a number of projects aimed at diversifying the Moldovan energy sector away from complete reliance on Russian exporters. These projects include the import of Romanian natural gas from off-shore deposits in the Black Sea and the direct import of Romanian electricity. Should investment capital be available the Moldovan government also hopes to develop renewable sources.

Taken at face value few would criticise Moldovan efforts to provide for its energy security through diversification. However, this has the potential to severely damage the economy of Transnistria, Moldova’s break-away region and the source of much of Moldova’s natural gas and electricity. The Transnistrian economy already faces significant structural challenges, and a loss of the revenue generated from electricity exports to metropolitan Moldova would significantly add to the possibility of an economic collapse. Moldova is ill-equipped deal with the security challenge that this would represent.

Why does all this matter? Until recently Moldova was the star performer in the EU’s Eastern Partnership programme, but now faces the real possibility of its EU orientation being overturned. Moldova, alongside Ukraine, is the frontline in a contest between two political-economic projects. The increasingly German-dominated EU and the Russian-dominated Eurasian Economic Union (EEU) are very visibly represented by opposing protest camps dotted throughout central Chisinau, as well as between the ever shifting parliamentary and extra-parliamentary representatives of the country. This division, fuelled by the frustration of the Moldovan people at the inadequacies of governments past and present, has remained a largely peaceful one. However, as was made clear in Kiev during the Maidan protests such tensions can escalate suddenly and with terrible effect.

The onus for addressing Moldova’s problems rests first and foremost with the political and business class’ efforts to combat corruption. Yet, a valuable supporting role can be provided by western institutions.

Whilst Moldovan cooperation with NATO is often viewed exclusively through the prism of military capacity building, the aid NATO can provide in terms of improving democratic control of the armed forces is arguably much more important. This helps ensure a key area of government expenditure is properly accounted for, and sets standards for other parts of the administration. Assistance in more specialist areas such as cyber-security is also invaluable.

The World Bank has also made some excellent suggestions for restructuring state support to the agricultural sector. This revolves around defunding unproductive areas and refocusing subsidies towards sustainable projects that make use of modern technology in an effort to increase competitiveness. Investment in relevant education programmes is a vital supporting element of this.

Whilst the signing of the Association Agreement with the EU is a great leap forward for EU-Moldova cooperation, there is still much to be done with regard to implementation. This agreement follows a visa facilitation agreement and Moldovan accession to the Energy Community Treaty, all designed to improve the resilience of the Moldovan economy and facilitate greater economic diversity. Furthermore, on 27th November 2015 the EU, at the request of the Moldovan Government, launched an assessment of all Moldovan legal institutions, a crucial and timely intervention. Moldova’s need for EU support specific to its particular attributes is desperate.

Time is not on the side of these initiatives. The collapse of the edifice of the Moldovan state is a plausible scenario, and one which Europe simply cannot afford.

 

The opinions articulated above represent the views of the author(s), and do not necessarily reflect the position of the European Leadership Network or any of its members. The ELN’s aim is to encourage debates that will help develop Europe’s capacity to address the pressing foreign, defence, and security policy challenges of our time.