What has gone wrong in Moldova? Last year the government failed to complete a number of key reforms, such as the planned privatization of the tobacco sector, and its budget deficit began to run out of control. As a result, the IMF decided in February to suspend a $185 million extended fund facility (EFF) for the country – the second time it has halted disbursements since the facility was first agreed in 1996. Meanwhile, Moldova is finding it hard to borrow internationally and foreign investors are deserting its domestic debt market.
This sequence of events may be commonplace in some parts of the former Soviet Union. Not in Moldova, however. For much of the mid-1990s, investment bankers fêted the former Soviet republic as a classic case of triumph in the face of adversity. Soon after the break-up of the USSR that led to Moldovan independence, it seemed that Moldova too would break into two pieces as ethnic Russians in the Transdniestr region to the east of the country pressed for autonomy and a bitter civil war broke out.
The separatists would have taken with them most of Moldovan manufacturing industry, leaving a rump country dependent on agriculture. Moscow played a cautious game, reluctant to provide support to the rebels but equally aware that Moldova’s dependence on it for oil and gas meant that it had tremendous leverage.
Despite uncertainty about whether the country was even going to survive, the Moldovan government pressed ahead with reform and management to steer a clever path between Moscow and the rebels in Transdniestr. Under Mircea Snegur, president until December 1996, Moldova eased itself out of the rouble zone and introduced its own currency, the leu.
Moldova was also one of the first former Soviet republics to achieve monetary stabilization. From 2,000% in 1993 and 115% in 1994, the inflation rate had fallen to 15.1% by the end of 1996 and may even reach single digits in 1998. There were even the first signs of economic growth, with a 9% increase of industrial production in the first half of 1996. In addition, the conflict between the Moldovan government and the rebels has calmed down.
These reforms were recognized by the IMF, which granted the country its medium-term EFF in 1996 – a year when the fund was extending only short-term standby facilities to most CIS countries. The ratings agencies were also quick to acknowledge the pace of change. Moody’s awarded Moldova a Ba2 long-term debt rating in January 1997. It’s a speculative-grade rating but impressive given that it is the same level as Russia and one notch higher than neighbouring Romania, a much larger and arguably more politically stable country.
With the benefit of its rating Moldova issued a public Eurobond in June 1997, raising $75 million of five-year fixed-rate funding through Merrill Lynch. “The deal was four times subscribed,” recalls one banker. “They could easily have doubled the deal and got as good execution, but the Moldovans decided it was wiser to keep the deal at $75 million in the expectation that they would get even better terms in the future.” As subsequent events showed, that was a mistake.
In late 1996, before the rating was awarded, Merrill Lynch also arranged a $30 million three-year private placement for Moldova, which was callable after two years and carried a coupon of 250 basis points over Libor.
In retrospect, late 1996 was the turning point for Moldova. Snegur lost the presidential election in December 1996 to Peter Lucinschi, bringing about a subtle change in approach. “In theory Lucinschi is a reformer, but he does not have the same clout as Snegur,” says a political analyst.
Whereas Snegur was capable of pushing through reforms, Lucinschi’s initiatives have been held up by a parliament that is dominated by pro-Communists – like so many in the CIS. Parliamentary elections were due in late March and western political analysts are holding out little hope that they will produce a parliament that is more in favour of reform than the previous one. The result of all this has been that Moldova has failed in 1997 to maintain the breakneck pace of reform in the last two years of the Snegur presidency.
The evidence of economic growth also disappeared as quickly as it had appeared. As a result of the flood in the summer of 1997, agricultural production fell short of expectations and the economy is estimated to have contracted by 2% in 1997, although economists are predicting growth of 3% to 5% this year.
The IMF started to sound the warning bells in November 1997. It said it was dissatisfied with Moldova’s progress at reform and listed a set of measures that needed to be carried out:
* parliament should lift its ban on raising energy prices;
* privatization of the power-engineering sector needed to begin straightaway;
* there should be a ban on making tax payments in kind rather than in cash;
* government spending needed to be reduced by $70 million, with cuts in healthcare, science, education and social welfare;
* the government should begin bankruptcy proceedings at 10 large enterprises that have not made full tax payments;
* the government should decide privatization plans for three major enterprises operating in the energy sector: Moldgaz, Moldenergo and Tirex-Petrol;
* the government should also complete the privatization of two other assets that were already on the block: the tobacco industry and Moldtelecom, the country’s telecoms operator.
Apart from the political change, Moldova was hit hard by the worldwide crisis in the emerging markets, triggered by events in Asia, in the last quarter of 1997. “[The country] has been one of the biggest east European victims of the Asian crisis,” says a debt trader in London.
In 1996 and 1997 the Moldova government financed much of its budget deficit by issuing treasury bills, and yields tumbled as the rate of inflation declined. They fell further to the 20% to 25% range as foreign investors piled into the market in the first half of 1997. Then the market retraced as foreign investors moved out and since a large proportion of the market comprises three-month paper, the government found itself refinancing its debt at higher and higher rates.
Worse still, Moldova’s foreign debt surged during 1997, rising over a quarter to $1.3 billion – the equivalent of over 60% of GDP. Much of this reflected energy debts, which Moldova has had difficulty paying. “Since the collapse in the emerging markets makes it unrealistic for Moldova to return to the Eurobond market and the IMF facility has been frozen, it could be very hard for them to get any external finance,” says the debt trader. He notes that funding from international institutions accounts for a large proportion of Moldova’s foreign exchange reserves. These stood at around $400 million at the end of 1997.
Unlike some east European countries, Moldova has not been bailed out either by portfolio investment in its equity market. This is despite the fact that it has one of eastern Europe’s best-structured stock exchanges. The Moldova Stock Exchange (MSE), based in the capital, Chisinau, opened for trading in June 1995. Over 500 companies are traded on the exchange, though most of them are small and medium size.
Like the Warsaw exchange, the MSE has an automated, order-based system and 56 brokers trade on it. “It is one of the best regulated markets in eastern Europe,” says an analyst in London. The trouble is that there are no stocks with substantial liquidity and no shares traded internationally in depositary receipt form.
The full depth of Moldova’s problems became clear in late February when the government settled its debts with Gazprom, the Russian gas monopoly, through a debt-for-equity swap. The Moldova government gave Gazprom 50% of the shares in the natural-gas pipeline running through Moldova in return for which the Russian utility wrote off Moldova’s $650 million debt.
Analysts viewed this as an act of desperation since it meant Moldova was giving up future toll revenues from the pipeline, an important source of invisible earnings, as well as partial control over a strategic asset: the pipeline is the only route through which Russia can supply gas to the Balkans.
Spurred on by the IMF, Moldova pressed ahead with privatization in the latter half of 1997. Foreign observers are watching particularly closely the results of the privatization of Moldtelecom, which is due to be sold in the first half of this year. Last summer, the Moldovan parliament approved a law on the telecoms sector, which implicitly laid down procedures for privatization.
The government then appointed UK merchant bank NM Rothschild and international accountancy firm KPMG to advise on the deal. It decided that only 40% of the company would be put up for sale to the strategic investors, with the balance remaining in state hands in the short term at least.
The final round of bids were submitted in late December. According to an investment banker close to the deal, offers have been received from Greek telecoms operator OTE and a consortium of France Télécom and GN Store Nord of Denmark. France Télécom already has a cellular licence in Moldova.
The minimum bid was set at $18 million for a seven-year licence and $102 million investment in the company, making this potentially the largest foreign investment in Moldova since independence. The licence will give the winning bidder a monopoly in Moldova until the monopoly on fixed-line telecoms expires in 2005.
However, in mid-March it was still not clear whether the deal would go ahead, amid rumours that parliament was trying to block it and that the bids had fallen short of the government’s expectations.
Although the sale of the telecoms operator, if it goes ahead, may encourage foreign strategic investors in other industries, Moldova is still recovering from the damage to its reputation springing from its failure to sell its tobacco industry in 1996. This is one of the most important industries in a country that derives much of its export earnings from agriculture.
Several other east European countries have found cigarettes a good way to kick-start their privatization programmes: there are a number of cash-rich multinationals looking to invest their capital in countries with high cigarette consumption rates and lax health standards. In the event, Moldova received bids from two producers: BAT of the UK and German company Reemstma, which have both invested heavily in cigarette factories in the rest of eastern Europe.
Even though the bids were around the $70 million mark – which at the time would have made this the largest foreign investment in the country – no transaction resulted from the tender when the government could not decide which bid to accept and withdrew the tender. In early 1998, bankers were saying that Moldova might sell its cigarette factories one by one – the approach taken by most east European countries. However, it lost considerable face through the failure of its first attempt to privatize the sector.
With the IMF’s decision to suspend its facility putting massive pressure on the Moldovan government, investment bankers are looking forward to a string of major utility sales out of the country in the wake of Moldtelecom. Moldgaz is regarded as a less interesting asset after the transfer of part of the gas pipeline to Gazprom. One utility that the government is likely to attempt to sell over the next 12 months is Moldenergo, the country’s principal electricity provider.
Although the government has increased electricity prices, they are not yet up to free-market levels because of parliamentary opposition. In addition, bankers say that Moldenergo is heavily indebted and will require substantial investment for it to reach a sustainable level of profitability.
