How to tame liquidity?
The Moldovan Leu (MDL) has broken through the lower limit of 17 lei - the official exchange rate on July 22 was 16.9884. The previous value below 17 lei was recorded almost three years ago on October 15, 2018 (16.9994). Over these incomplete three years, the 2020 was the year when the peak of the MDL devaluation was registered – on April 7, the exchange rate was 18.6369.
In general, the leu has strengthened by only 1.28% since the beginning of the year (the value as of January 1 was 17.2093). But in January-February, no pandemic was declared yet. Nobody expected such a severe crisis. When the Government declared quarantine and a state of emergency in mid-March, the Leu began to devalue sharply. It is possible that this was due, among other things, to the fact that Moldova, along with other countries, received an urgent loan in the amount of $ 233.9 million from the IMF to fight the COVID-19 pandemic. Funds were transferred to the accounts of the National Bank at the beginning of the third decade of April, when the rate was already “prepared”: at the beginning of the month it reached 18.64, then it dropped slightly (to 17.72), and at the moment when the National Bank had to sell dollars to replenish the budget with lei, it had again exceeded 18: April 27 - 18.3660; then the national currency began to strengthen again. From April 30, the rate did not rise above 18. However, the difference between 17 and 18, for example, on a loan from the IMF, is an additional 200 million lei to the budget.
To understand the reasons for the further systematic depreciation (read - strengthening) of the Moldovan leu, we look at the sources of financing the budget deficit. And the deficit is huge!
The approved in December 2019 budget set a deficit of 7.42 billion lei. In April, due to the pandemic, at the suggestion of the Government, the Parliament adopted amendments to the budget, according to which the deficit increased to 15.98 billion lei. New amendments to the law on the budget, adopted in July, increased the deficit to 17.2 billion lei (with the revenue part of the state budget at 37.85 billion and, accordingly, the expenditure side - 55.06 billion).
One of the traditional sources of covering the budget deficit of the Moldovan government is the sale of government securities (GS) in the primary market.
In general, back in 2019, through the sale of government securities in the primary market, the financing of the deficit was budgeted in the amount of 1.57 billion lei. This is a huge amount! Financing the deficit through the primary sale of government securities only once exceeded one billion MDL in 2009 - 1.595 billion lei. But this happened against the background of the international financial isolation of the last year of Vladimir Voronin's presidency, and amendments were made during the year. And, surely enough, they were not laid down in advance in the original version of the 2009 state budget.
Ultimately, over the past 2019, the Ministry of Finance collected 685.1 million lei (instead of the pledged 1.57 billion). But in the budget for 2020, adopted in December 2019, a figure of 2 billion lei was already included. Despite the last year’ shortage, the Ministry of Finance has included in its plans a substantial reserve. Thus, only in the first two months of 2020, that is, before the beginning of the crisis, 596.53 million lei were allocated to cover the budget deficit through the sale of government securities - that is, more than a quarter of the established limit.
With the onset of the crisis, the need to revise the budget became apparent, turning it into a budget for survival through savings, reduced investment, and increased social support. The changes in the budget, adopted in April, increased the limit for covering the deficit through the primary placement of government securities from 2 billion to 4 billion. But even this was not enough. During the crisis, the Parliament adopted new budget amendments in early July, and now this figure has increased to 6 billion lei. By the way, at the end of the first half of 2020, the Ministry of Finance covered the deficit by selling government securities for 3.007 billion lei - just half of the amount of the new limit.
In other words, out of the deficit of 17.2 billion planned for 2020, the Ministry of Finance plans to borrow 6 billion lei (34.9%) on the domestic market. But this is still not the limit - the budget could be revised further. These 6 billion are part of the existing increased liquidity in the market, and most government securities are purchased by banks in their portfolios.
Coming out of the banking crisis, Moldovan financial institutions, along with the world economy, faced a new pandemic. Lending, which has just approached the indicators of the pre-crisis period (over 40 billion lei), is practically not growing. It has become difficult for many borrowers, and in some cases even impossible for others, to repay current obligations. Few people can afford new loans in these conditions. The already increased liquidity of the Moldovan banking system (which was estimated at 6-7 billion lei last year) is only growing - there is nowhere to invest funds... In such a situation, a commercial bank looks at two main instruments - playing on the foreign exchange market or investing in government securities.
Note that this crisis fell on a period when the prime minister is a financier, who, moreover, headed the Ministry of Finance for several years and is well aware of the internal mechanisms of both the state and the banking sector. He perfectly understands the priorities of the private financial business and, as a "country manager", makes the game in the foreign exchange market "unattractive", thereby directing excess liquidity to the government securities market.
The fact that in the first half of the year it was possible to collect 3 billion MDL speaks of investor confidence in government securities. At the same time, the state “does not treat badly” investors and keeps the rate of return at an interesting level for all. For the first half of the year, the weighted average rate was 5.29% per annum.
The Ministry of Finance recently began to issue longer bonds than before. If earlier the GS circulation period was 91 days, 182 days, 364 days (they remain the most demanded); also sold well securities for 2 and 3 years; now securities with a maturity of 5 years are also in demand.
Speaking of demand. At the auction on July 14, the demand for short securities (up to a year) exceeded the offer by 15% (GS - 364 days); by 20% (GS-182 days) and by 240% (GS-91 days). At the auction on July 15 for GS-2, demand was practically equal to supply; for GS-3 years and GS-4.85 years - almost half the supply. The situation with long-term bonds is quite clear - investors are not yet ready to invest large sums for such a long period.
Interestingly, in a normal situation, with an increased demand for government securities, the rate falls sharply. This year the Ministry of Finance keeps it at a level slightly higher than inflation to keep the interest of investors. In June 2020 the overall inflation rate for 12 months was 4.25% per annum (the weighted average rate on government securities, as we recall, was 5.29% per annum for 6 months). Thus, in the government securities market and for the state, money, in general, is not very expensive, and investment in securities is profitable for business. The foreign exchange market does not provide such profitability today.
A few words about the foreign currencies. The yield of the US dollar is determined by the rate of the Federal Reserve System (FRS), currently being 0-0.25%. During a pandemic, both the United States and Europe are pumping money into their economies. In fact, a printing press for US dollars and Euros was launched. This was the strategy for overcoming the world economic crisis of 2007-2008, they do the same now: the reasons are different, the mechanisms are the same.
Moldova in 2009-2010, it seems, did not pour anything into its economy. The country made do with external loans and internal reserves. By the way, the difference between the amounts injected into the economies of different countries, in comparable terms, affects the exchange rates of these countries.
It should be noted that the low demand for foreign currency in Moldova is also dictated by a sharp decline in imports amid quarantine and a pandemic.
The National Bank is also taking advantage of this situation. It purchases foreign currency, replenishing reserves: since the beginning of the year, reserves have grown by $ 130 million (by 4.25%), reaching $ 3.19 billion. At the same time, only in June, due to the strengthening of MDL, the NBM reserves increased by $ 57.3 million, that is, by 1.7% in just a month.
Summing up, we note the increased liquidity in the banking sector, a sharp decline in lending, the strengthening of the Moldovan Leu and ... created by the Ministry of Finance very attractive conditions in terms of volumes and profitability in the government securities market. Since the securities are being bought, this means that they are trusted. Here, the main issue is not end in default, but there are no prerequisites for this scenario in the foreseeable future.
The Ministry of Finance could have cut rates, given the high demand for securities, but it does not. The reason is that, while supporting the banking sector, the Government has the right to ask it for business support. Everyone is in the same boat.
When it comes to investment, governments are always looking for outside investors. But today the situation is such that Moldova is saving itself - at least by a third. It seems that the increased liquidity still makes it possible to increase the volume of placed government securities from the current 6 billion for a greater reduction of the budget deficit. This largely depends on how much investors will be willing to invest in long-term securities.
In general, Moldova has reserves. Against this background, it is hardly necessary to talk about any possible imminent devaluation of the MDL, the policy of containment does not allow investors (makes the market not interesting) to the foreign exchange market and allows them to replenish the budget deficit. There is, however, a nuance with the upcoming presidential elections, scheduled for November 1, 2020 - after all, elections have always been reflected in the currency market of Moldova. Although everything happening this year is new, and there are no regularities yet. // 23.07.2020 - InfoMarket.