Shock therapy or structural reforms?

The objectives of the National Bank of Moldova (BNM) shouldn't be unilateral and target only deflation/inflation, but also address other key issues like stability and economic growth, or reduction of unemployment. All these objectives must be balanced and it should be avoided pushing harder on a single direction, Financial Brains director PhD Sveatoslav Mihalache told Info-Prim Neo, in commenting on the BNM's goals unveiled on Tuesday, January 19. At a press conference yesterday BNM governor Dorin Dragutanu stated that the main goal of the central government is price stability, meaning a rate of inflation of 5% ±1%. Sveatoslav Mihalache remarks that consumer prices have started rising lately at a worrisome pace. The national bank possesses the necessary instruments to contain prices when they tend to rise abruptly, for example by raising the key rate and increasing the reserve requirements. “During a month now the BNM has been talking about the problem of deflation, but this problem naturally appears in industrialized countries which produce goods on a large scale. Let's not forget that prices on most products in Moldova are higher than in the neighboring countries. What's more, in the last 9 years Moldova's production has mainly consisted of its migrant workforce, its wine, which sells not so good both internally and externally, and toilet paper”, commented Mihalache. Through direct interventions carried out in December 2009 on the internal currency market, consisting of purchases of US dollars for lei, the BNM has achieved its goal. The move benefited the state budget: with a weaker leu, the amount of customs duties, paid in national currency, increased. At the same time, importers paid a higher VAT, expressed in Moldovan lei, compared with November. But because of the devaluation of the national leu, and apparently higher VAT and customs duties, importers decided to lay that burden on the shoulders of the final consumer by raising the prices. And prices rose not only on imported goods, but also on domestic products, observes Mihalache. Today we expect a hike in energy prices, which will trigger a new wave of price increases on basic goods, as Economy Minister Valeriu Lazar anticipated. “What will the central bank do then? Will BNM start increasing the key rate in order to avoid inflation growth, or will it increase reserve requirements?”, asks Sveatoslav Mihalache. He thinks that both methods would have negative effects on the crisis-stricken economy. The first method will make loans more expensive, which will affect the business operations and the consumption levels. The second method will decrease liquidity both on the financial market, which is still in its infancy in Moldova, and the real market. “Both the BNM authorities and the Government should not forget that most people are impoverished in Moldova. Vulnerable people will be the worst affected. To avoid mounting discontent among the populace, BNM and the Government must consolidate their efforts to ensure economic stability not only through monetary instruments, but also through structural reforms”, says the head of the Financial Brains. “BNM and the Government should realize that the positive effect produced by the devaluation of the national currency will not last. In the long run, a vicious circle will form for the state budget – because of chain-reaction price rises and unvarying salaries, the purchase power will considerably decrease, regardless of whether savings are kept in national currency or foreign currency. This will affect sales, which will result in lower incomes to the state budget.” For these reasons, the Financial Brains are recommending the Governmnet to adopt a less liberal yet necessary solution in a period of crisis, which will help to alleviate the general discontent. The solution is to set a fixed mark-up of 25 to 35 percent on all the imported goods. This measure, Sveatoslav Mihalache believes, will have positive effects both in the short and long run. The positive effects for the budget and for the economy in general would be the following: 1.Tax avoidance at the customs will be eliminated. Importers won't resort to minimization of prices anymore; 2.Price stability will help BNM better control inflation and will minimize the necessity of interventions on the monetary markets (changes in the key rate); 3.Purchase power will be maintained; 4.Sales levels will be maintained; 5.The income gap will diminish; 6.This will stimulate the shift from import to domestic production.