The country’s investment climate shows signs of improvement but capitalizing on opportunities will be difficult

Introduction

Moldovan parliamentary elections are scheduled for February 24th. Publicly, the contest is being billed as a battle for the country’s future geopolitical orientation, with the Democratic Party of Moldova (PDM) backing closer integration with the EU and the the Moldovan Party of Socialists (PSRM) favoring a closer economic and military relationship with Moscow. In reality, however, their politics are more similar than it might appear. In 2017, both sides worked together to secure a 2017 electoral reform that will undermine other parties’ prospects while strongly benefitting PDM. While the victor in these parliamentary elections could affect a degree of geopolitical change, it will be primarily cosmetic. Both the EU and Russia are important trading partners for Moldova, and a rupture with either party would be both economically and politically painful. Rather, expected victory by PDM or PSRM is likely to lead to a little-changed foreign policy, and a continuing role for corruption at the heart of the country’s political system.

In this piece, SSU will paint a picture of Moldova’s political, geopolitical, and economic background before diving into investment possibilities. It will then examine potential windows of opportunity, notably how Moldova’s improving economic environment is underappreciated by foreign investors, while also elaborating on the very clear risks. Sandwiched between the EU (Romania) and Ukraine, Moldova currently has free trade agreements with both the EU and the Russia-led EAEU*, making it temporarily a strategic middleman to Russia and the EU and a beneficiary of both. But Moldova is also Europe’s poorest country. A murky private sector shrouded in ‘insider clientelism’ makes many investment opportunities almost comically difficult to realize. Despite recent improvements, capital allocation in Moldova for either short or long-term opportunities remains deeply problematic.

Political Background

Moldova’s transition to democracy in the 1990s was relatively successful compared to some CIS countries, but deeply flawed on the whole. Although today the country boasts semi-democratic elections and a robust civil society, rampant corruption remains at the heart of the political system.

Moldova’s political outlook has fluctuated in the past decade. In 2013 the country signed an association agreement with the EU, which committed it to economic, judicial, and financial reforms. While initial government progress appeared hopeful, in April 2018, the EU announced that 100M ($114M) in future loans and grants would be blocked until greater efforts were made to tackle corruption. Right now, Moldova’s electoral laws leave parties vulnerable to capture by vested interests, and are regularly exploited by Vlad Plahotniuc—the country’s richest man. In a report published last month, the Venice Commission, an advisory body of the Council of Europe that consults on issues of constitutional law, reiterated its warnings that the law left room for “undue influence and manipulation” of the political process.

Vlad Plahotniuc (Photo by Bani.Md)

Two recent examples encapsulate the brazen nature of corruption under the Plahotniuc regime. In 2014, the ‘Great Moldova Bank Fraud’ saw $1 billion—13% of the country’s GDP—lifted from banks overnight and siphoned into offshore accounts. While many experts have alleged that Plahotniuc was behind the scheme, the country’s politicized authorities ultimately blamed his coalition partner – Moldovan Prime Minister Vlad Filat – who was jailed for facilitating the transaction. In any event, this huge theft of national wealth that occurred under Plahotniuc’s watch caused outrage among the citizens of Europe’s poorest country.

The second example of corruption was the outcome of this year’s mayoral elections in Chisinau—Moldova’s capital. Pro-Russian candidate Ion Ceban faced off in the second round against Andrei Nastase, a young anti-corruption campaigner. Nastase’s lack of financial and administrative resources put him at a disadvantage, but his message of European integration combined with a clarion call to eliminate the influence of vested interests in Moldovan politics struck a chord with many voters. Nastase went on to beat Ceban in the the second round, and should have become the city’s next mayor. But hopes of reformism at City Hall were abruptly dashed when Moldova’s constitutional court ruled the election void on an obscure technicality, and announced the city’s pro-Plahotniuc mayor would remain in his place after all. Outraged, tens of thousands of pro-Russian and pro-EU Moldovans took to the streets of Chisinau, and protested the corruption of the incumbent regime. Surprisingly however, some governance improvements have been observed in Moldova over the last year, according to the 2018–19 EBRD transition report.  

2019 will be a year of challenges for Moldova’s political development. In June 2018, 46% of Moldovans wanted their country to join the EU, while another 38% preferred to join the Eurasian Economic Union. Only 21% of Moldovans expressed support for joining NATO. This divide can also be found in the upper echelons of government. Moldova’s prime minister, Pavel Filip, seeks closer integration with the EU, while President Igor Dodon aspires for closer ties to the Russia-led EAEU.

In late January, Dodon announced that he was prepared to call another election within three or four months if February’s poll produces a hung parliament. There are high concerns around the world that Russia seeks to interfere in the republic’s elections. On January 16, the US State Department warned the Moldovan authorities to “take all necessary measures” in the run-up to the February 24 elections and “guarantee transparent results that reflect the legitimate will of Moldovan voters.”

This all paints a precarious picture for 2019. Before 2015, the country had never experienced any organized and large-scale protests. However in 2015, 2016, 2017, and 2018 Moldovans took part in mass protests but were unable to change the direction, let alone the regime, of the country. These failed protests have only created further disenchantment, which has indirectly allowed Plahotniuc to take increasingly greater control of the system. In July 2017, Plahotniuc’s party pushed electoral reforms that significantly encourage gerrymandering and favor candidates who are backed by wealthy donors. On top of the prospects for greater political corruption, President Dodon has said that if his party wins elections in February, he will cancel the association agreement signed with the EU, which is similar to the action which caused President Yanukovych ‘s 2013 ouster in neighboring Ukraine. Recent polling suggests Dodon’s Socialists will become the largest parliamentary after the elections, though they may need support from opposition parties to pass legislation.

Igor Dodon (Photo by Ulyanovsk.sm-news.ru)

Geopolitical Background

In the past 15 years, countries outside the EU and the EAEU (like Moldova and Ukraine), have represented real and ideological battlegrounds for Moscow and Brussels. This is key to understanding what drives Moldova to take certain postures in the international arena, and indirectly impacts investment opportunities in the region.

Relations with Russia

Moldova has historically had hot and cold relations with Russia. It is currently an observer of the EAEU, which gives Moldova certain privileges —namely being able to trade freely with Armenia, Belarus, Kazakhstan, Kyrgyzstan, and Russia, but does not allow it to take part in decision making. However, its flirtations with the West have also led to Russia sanctioning certain Moldovan products, negatively impacting the small Moldovan economy. In 2014, for example, Russia banned all fruit imports from Moldova. By 2019 however, Russia had not only un-banned them, but also removed tariffs from the import of Moldovan fruits, vegetables, and wine. Moldova has done well to diversify its trade volumes away from Moscow’s orbit recently, but still about 20% of Moldova’s exports still go to Russia. This trade relationship gives Moscow indirect sway over Moldovan politics. To guarantee even greater influence, Moscow has time and again interfered in Moldovan elections (to varying degrees of success) and are set to try again this upcoming election.

Map of Moldova in Europe (left); Map of Moldova with Transnistria and Gagauzia highlighted (right) (both from DW.com)

Relations with the EU

Moldovan relations with Romania are its gateway to the west and keep it in the discussion for eventual EU accession. In the past, some Romanian politicians have called for Moldova to unite with Romania, but currently Prime Minister Pavel Filip is strongly opposed to the idea. Romania, acting as a sort of big brother, has defended Moldova in the face of criticism from Brussels. Most recently, in December 2018, Romania blocked the EU foreign ministers from adopting the conclusions provided by the EU’s Foreign Affairs Council that said the republic had become “a state captured by oligarchic interests.” Bucharest’s motivation for rejecting these conclusions is to keep the door open for possible future reunification.

Moldova’s relations with the wider EU, are sub-optimal. Brussels views the country as a corrupt oligopoly that serves as a conduit for Russian interests. However, as recent as 2012, the Head of the EU Delegation to Chisinau, Dirk Schuebel said “I do believe that Moldova has a real chance [to join the EU]; some others do believe, as well.” Nevertheless, Moldova accession remains a long way off. Unlike Serbia or Macedonia, Moldova is not a candidate member. In fact, it is not even an official potential candidate like Bosnia and Herzegovina. It is simply part of the association agreement, signed in November 2017, which established free trade and visa-free travel.

Currently, the EU is Moldova’s most important trading partner. In 2017, trade amounted to €4B, an 18 percent increase compared to 2016.

Economic Picture

Moldova’s economic performance over the next year will remain dependent on remittances from workers abroad (which accounts for 25% of its economy – the highest figure in the world), industrial production, as well as demand in its leading export markets. Real GDP increased by 4.8% during the first half of 2018, driven by strong private consumption and capital formation. Similarly, real GDP grew 4.5% in both 2016 and 2017 on the back of strong foreign demand, new investments in machinery and equipment, and low inflation. The World Bank expects improved business and consumer confidence to continue to drive a strong GDP growth of 3.5% in 2019 and 2020.

The National Bank of Moldova has proved both transparent and accommodating. Following the uptick in inflation experienced in 2016, the NBM lowered its basic rate on short term monetary policy operations from 19.00 (2/25/2016) to the present level of 6.50 (5/12/2017). Currently, inflation has fallen well below the NBM’s target rate of 5% due to the MDL’s appreciation, weaker external inflationary pressures and low administered prices. However, the World Bank expects inflation to return to 2017 / early 2018 levels behind strong domestic demand and changes in regulated prices.

Moldova Annual Inflation

Insulated wire, sunflower seeds, wheat, and wine account for nearly 30% of Moldovan exports. Its goods-dependent economy leaves it heavily exposed to potential export bans or sanctions by Russia and Belarus – Moldova’s two largest trading partners.  In the past, Russia has sanctioned Moldovan fruit, wine and vegetables to punish the country for its interest in joining the EU. Other important Moldovan trading partners include Romania, Italy and Turkey.

Moody’s gives Moldova debt a junk grade rating—B3 credit. While Moldova has recently demonstrated strong economic growth, the country still faces deep, structural economic challenges. On the positive side, the government has a moderate debt burden and strong debt affordability coupled with improved institutional capacity. In 2018, Moldova’s current account deficit decreased to 62.1% of GDP, while net FDI climbed to a respectable 2.5% of GDP from 1.6% in 2017. Moldova’s private sector, once characterized by an incapable and corrupt banking industry, is now reaping the benefits of a revitalization of foreign inflows. But at the same time, Moldova’s domestic policies are difficult to predict in advance of a crucial election. The risks of political instability in the country’s breakaway Transnistria region are also not insignificant, given the ongoing and unsanctioned presence of Russian peacekeepers.

The agreements with the EIB and IMF are likely to provide enough carrot and stick motivation for the reforms to continue. In November 2016, the IMF approved nearly $180M worth of loans to Moldova as a reward for its progress with reform, and on proviso that reforms would continue. Progress in 2018 led the World Bank, IMF, and EIB to provide an additional $15.2M and 28.9M in loans to support Chisinau’s budget. Advances in the banking sector are also evident. After years of barely being profitable, Moldova’s banking sector recorded a net profit of 1.6B MDL last year, a 7% increase compared to 2017. If financial reform continues and the country’s governance becomes increasingly transparent, that rating will likely improve further. However, if the government moves in an anti-EU direction that would hinder reforms, or if the frozen conflict in Transnistria were to reignite, the country’s rating could also be expected to sink.

Moldova is protected against any forthcoming global economic crisis. According to the Banker Magazine, it has the fifth lowest exposure to any future financial crisis, sitting only behind Norway, Russia, Kuwait, and Singapore. Its security is rooted in its banks’ high capital-to-asset ratio and low levels of lending. Similarly, the NBM’s reserve requirement ratio currently sits at a record high of 42.5%. Furthermore, the appreciation of the MDL has supported a large accumulation of foreign reserves, which now exceed 6 months of exports.

Moldova’s biggest challenge moving forward will be modernizing its economy. By most metrics, it lags far behind its neighbors. For example, Moldova has fewer than 2 robots for every 10,000 workers—the worst among all European countries. Additionally, early 20th century industries—agriculture, mining, and utilities—still account for 35% of national employment.

Investment Activity

Moldova’s investment environment has become increasingly attractive in recent years. For one, the Association Agreement with the EU became fully enacted on July 1, 2016. And also, low operating and payroll costs, low tax rates, and free trade with EU and CIS markets make Moldova a uniquely situated country in a time when commerce between the two blocs has been in decline.

The European Bank for Reconstruction and Development (EBRD) has taken note of Moldova’s positive development and in October of this past year (2018) bought a stake in Moldova’s largest commercial bank—Moldova Agroindbank (MAIB). In exchange for €23M, the EBRD acquired a 41.09% stake in MAIB, hoping that its purchase will encourage other investors. In the aftermath of the purchase announcement, Francis Malige, the EBRD’s managing director for financial institutions said Moldova’s “government showed strong political will and resolve to clean up the banking sector…It took a brave decision to support the sale process of MAIB, which…will contribute to better banking services and stronger investments to the Moldovan economy as a whole.” Malige is arguing that the EBRD’s involvement reflects the progress Moldova has already made in reforming its financial institutions and will also spur along more foreign money flows. Interestingly, the purchase came only months after the EBRD brokered a deal for Banca Transilvania, Romania’s 9th largest bank, to acquire a majority stake in Victoriabank, which was at the time, Moldova’s third largest bank.

The EBRD is not the only group allocating capital to the region. On January 22, 2019 Moldova’s central bank announced that it had given permission to Doverie-United Holding, a Bulgarian company, to take over 33.9% of the country’s second-largest bank Moldindconbank (MICB). The central bank’s asking price is €38.2M, a sum that surpasses the total of Doverie’s assets. So it is possible that the deal falls through. This is notably Doverie’e third attempt to enter Moldova’s banking sector. It previously failed to secure permission to take over Tokuda bank in 2015. It is clear, however, that there is some appetite for Moldovan equity, although for now it’s a secret kept with neighbors.

The final notable development, announced in mid January 2019, is Moldova’s plan to build a 62 mile (100km) $140M gas pipeline to improve gas connections with Romania. This projects comes amid projections from Bucharest that Romania intends to double natural gas production by 2025. Romania’s Transgaz is currently building a pipeline with an annual capacity of 1.5 billion cubic meters, more than Moldova’s annual consumption.

Current Investment Opportunities

The Moldovan investment universe is characterized by asset illiquidity, scarcity of instruments, and overall obscurity. In Moldova, transactions in secondary security markets take place through the Moldova Stock Exchange (MSE) and the over-the-counter market (OTC). The MSE was founded in 1994, and is of negligible size. Although there are close to 1,000 companies registered for trading, the amount of listed companies is only 17. Trading volumes are extremely thin: in 2013, the average daily volume in the MSE was $0.2M, the total amount of transactions performed was 1258, and the total value of transactions was $48M**. As of 2013, the market capitalization of the MSE was ~$70M.

The MSE is inexplicably complex. Legal ownership of publicly traded stocks, for example, is underpinned by 14 registrars as opposed to a central registry of ownership. Despite using the National Securities Depository (NSD)*** for all clearing, settlement, and custody functions, this entity is not classified as a registry and does not keep a register of corporate securities. Therefore, the MSE is a dematerialized exchange not supported by a traditional central securities depository—a structure unlike other emerging market systems. The lack of a central securities depository poses a risk to domestic financial stability. High reliance on smaller FMI’s could prove disastrous for other institutions if they are unable to settle obligations or perform other key operational activities.

Over-the-counter transactions are those that occur directly between a buyer and a seller either with or without a broker’s participation. In Moldova, the OTC market is larger than the MSE in terms of number and value of transactions, however these amounts are still miniscule in comparison to its EM counterparts. In 2013, the total amount of transactions performed was 2,846, and the total value of transactions was $52M. As of February 2016, the market capitalization of it OTC market was ~405M.

Non-banking financial markets, which include the securities market, are regulated and supervised by the National Commission of Financial Market (NCFM). The NCFM has been able to implement a vast array of European directives and other modern capital market practices, and has thus proved itself as a commanding authority in Moldova.

Chisinau has recently passed laws governing the domestic stock exchange, JSCs, public offers on secondary markets, dealers’ and brokerages’ activity, and many other market-related functions. However, the extensive regulation passed has served to suffocate investment opportunity as opposed to regulate it, leading to a limited development of domestic capital markets. As such, collective investment institutions are simply not present, and low trading volumes have restrained the creation of financial instruments. The existing structure is not sufficient to support substantial domestic or foreign investment appetite.

Outside of equities, the only other financial instrument present in the Moldovan securities market are bonds. Similarly to the equities market, the bond market is highly illiquid and characterized by low issuances and a very limited secondary market.

There is negligible activity in the corporate bond market. In the sovereign bond market, there are several multi-year bond issuances, however these are issued in very low quantities, have little secondary market activity, and are only issued in the local currency, MDL. The lack of secondary activity limits visibility into price fluctuations and bond yields.

The main securities available are money market instruments in the form of two week National Bank of Moldova (NBM) certificates and Treasury Bills of up to one year. Both of these securities are issued regularly; certificates follow an outlined 2-week issuance schedule, while TBills are issued twice a month and volumes fluctuate based on the tenors of each tranche.

NBM TBill issuance on February 5th 2019

Although short term TBills currently offer attractive nominal yields (weighted average of 4.71%) and real yields (>3.7%), we do not believe that these securities present an attractive risk-adjusted return. On the one hand, we emphasize that despite current subdued inflation rates, (currently at 0.9%, well below the NBM target rate of 5%), the CPI is expected to rise in the short term (NBM expects annual inflation to be in 3.5 – 4% at EOY 2019). Although the NBM goes to great lengths to provide transparency to its open market operations, inflation has been able to climb quickly—in the first six months of 2017 inflation jumped from 2.5% to the target rate of 5%. Furthermore, the notes are extremely illiquid: on February 5th 2019, only $3M 91 day notes were issued. The low volume drives a dry secondary market, which can prove deadly in an event in which one must exit their position.

Moldova 3Month TBill Yield (white) vs. Annual Domestic Inflation (CPI) (yellow)

What if the Moldovan securities market was in fact not created with the intention of raising, deploying, and selling capital, but as a mere byproduct of post-Soviet privatization reforms? The unnecessarily complicated infrastructure of the secondary securities market, paired with overbearing laws stemming from multiple regulatory agencies makes for a convoluted and unappealing system. For example, a good indicator of capital market activity lies in the number of new joint-stock-companies in the region, as these imply interest in capital allocation and investment projects. In 2014, only 2 new companies were registered, totaling $28,700. Similarly, investment funds, trust management companies, and virtually all institutional ownership is considered inexistent in the region. It is not surprising that stocks and bonds are the only instruments traded in Moldova, as many of the investment institutions required to provide other assets are missing. Lack of agency transparency, non-market-friendly regulation, and low public trust in the country’s financial institutions will likely continue to plague the Moldovan securities market over the medium term.

Risks

The four main risks facing Moldova are: 1) labor flight, 2) instability in Transnistria, 3) Russian aggression, and 4) corruption.

  1. Moldova’s 2004 national census listed 3.4 million people living in the country. The 2014 one listed 2.9 million. Currently, almost 1 million Moldovans currently live abroad, and the Moldovan government claims it would be unable to take in even half of those people, due to poor infrastructure, limited employment opportunity, and an unsustainable pension system. Labor flight has been good for Moldova up until now. Remittances fuel the economy, and the poor standard of life in Moldova is eased greatly by fewer mouths that need feeding. However, there may come a day when this equilibrium ceases to work.
  2. Transnistria is a frozen conflict state that acts autonomously of Moldova despite being universally recognized as part of the country. For the most part, it aligns with Moscow. After a brief war in the early 1990s, Transnistria has remained stable for over 25 years and is unlikely to erupt, but the possibility is never beyond question as long as Russian peacekeeping troops remain there. Transnistria is a de facto mafia state with close ties to the Russian and Ukrainian business elites. For example, the largest employer in Transnistria, Moldova Steel Works, is owned by Alisher Usmanov’s Metalloinvest. Despite this, some progress is being made to open up the country. In April 2018, Chisinau and Tiraspol (Transnistria’s capital) signed the “package of eight” agreements, giving Transnistrians the right to leave the unrecognized republic. A deal like this may seem inconsequential, but would never have happened 15 years ago, and is thus an encouraging sign of thawing relations.
  3. Russian aggression may come through the channels that exist in Transnistria or through the autonomous republic of Gagauzia. The most likely option is a repeat of what happened in 2013-14 in Ukraine. If Dodon’s Party of Socialists jettisons the EU association agreement, many Moldovans may protest, which ultimately lead to Russian military aggression in the event of regime instability. Russian troops could be deployed through Transnistria.
  4. Finally corruption continues to hold the country back. Vlad Plahotniuc has so many politicians under his control that eliminating corruption from the country appears to be an impossible task, at least for now.

Conclusion

Moldova’s outlook is uncertain. Blatant and widespread corruption, poor infrastructure, and a weak and inconsistent political sphere all overshadow the potential rewards of allocating capital there. The promise of reforms is only worth so much. After five years the economy is still sclerotic, the country’s infrastructure cannot handle its minuscule population, and corruption in the banking and political spheres (arguably the two most important areas when considered investing) is widespread. However, Western investors have recently taken part in large transactions in the country, which points to the fact that investor sentiment may be shifting. Improved consumer confidence, greater exports, and a transparent Central Bank policies have contributed to recent economic growth and growing foreign direct investment. Although nominal returns may appear enticing, waiting for the results of the February 24 elections and their aftermath is likely to prove the more prudent choice.

*Through its observer status in the Eurasian Economic Union, otherwise known as the EAEU

**The MSE has been unresponsive to requests for updated exchange data. The last available trade figures are from 2013.

***The NSD is jointly owned by its participants, including the MSE, domestic commercial banks, and broker dealers.