Report No. 30998-MD The Republic of Moldova Trade Diagnostic Study December 23, 2004 Poverty Reduction and Economic Management Group Europe and Central Asia Region Document of the World Bank CURRENCYEQUIVALENTS CurrencyUnit =Leu US$l.OO = 12,5Leu (November2004) WEIGHTSAND MEASURES Metric System GOVERNMENTFISCALYEAR January 1-December31 ABBREVIATIONSAND ACRONYMS ACP African, Caribbean and Pacific countries GSM Global System for Mobile Communications ACV Agreement on Customs Values GSP Generalized System of Preferences AITA International Association of Road Haulers HACCP Hazard and Critical Control Points Moldovan Agency for International Road ICT Information and Communication Technology/ AMTAI Transportation Moldova's Telecommunication National Agency for Regulation in IF1 International Financial Institution ANRTI Telecommunication and Information Scienices IMF International Monetary Fund Business Environment and Enterprise IRU International Road Transport Union BEEPS Performance Survey IS0 International Organization for Standardization CAP Common Agricultural Policy LCS Letters of Credits CEECs Central and East European Countries MEPO Moldovan Export Promotion Organization CEN European Committee for Standardization MFN Most Favored Nation European Committee for Electrotechnical MRL Minimum Residue Levels CENELEC Standardization MT Metric Tonnes CFM Moldovan Railways CIS Commonwealth of Independent States MTC Moldtelecom CM Contract Manufacturing NBM National Bank of Moldova Organization for Economic Cooperation and CMEA Council of Mutual Economic Assistance OECD Development Contract for the International Carriage of PCA Partnership and Cooperation Agreement CMR Goods by Road PPP Purchasing Power Parity CPTA Cargo and Passenger Transport Authority PSI Pre-Shipment Inspection system European Bank for Reconstruction and EBRD Development SAD Single Administrative Document European Conference of Ministers of SEE South East European ECMT Transport SPS Sanitary and Phytosanitary EU European Union Technical Assistance for Commonwealth of FDI Foreign Direct Investment TACIS Independent States FSU Former Soviet Union TBT Technical Barriers to Trade FTAs Free Trade AgreementsBree Trade Areas Trade and Transport Facilitation in Southeast TTFSE GAP Good Agricultural Practice Europe Program WTO World Trade Organization GATS General Agreement on Trade in Services VOIP Voice over Internet Protocol GATT General Agreement on Tariffs and Trade GOM Government of Moldova Standardization institute from the Soviet GOST Union Vice President ShigeoKatsu (ECAVP) Country Director Paul Bermingham (ECC07) Sector Director Cheryl Gray (ECSPE) Sector Manager Asad Alam (ECSPE) Task Team Leader Lawrence Bouton (ECSPE) Acknowledgements The report was preparedby a World Bank team ledby Lawrence Bouton. Backgroundpaperswere prepared by Carolina Revenco (Trade and Foreign Investment Performance), Guido Port0 (Trade and Poverty), Evgeny Polyakov (Domestic Trade Policies and Regional Agreements), Paul Brenton (Market Access to the EU), Miroslova Zervoudakis and Eugene Hristev(Standards and Conformity Assessment), Michel Zamowieclu (Customs Administration), Lauri Ojala and IonLupan (Transportation and Logistics), David Satola (Telecommunications), DanMozes and Negruta Veaceslav (Financial Services) and a team from the Center for Strategic Studies and Reforms ledby Anatol Gudim(Transnistria). The case studies were prepared byBuddhika Samarasingheand Victor Moroz (Winery Sector), John Gray and Victor Moroz (FreshFruitandVegetable Sector) and Heikki Matilla andMariaGheorghita (Textiles and Apparel). Additional comments and inputswere providedby Anca Dumitrescu, and Maya Sandu. The team would like to acknowledge helpful comments fiom the peer reviewers, Harry Broadman and MonaHaddadMaya. Sandu, and Viorica Strah were instrumentalincoordinating the consultation process and linkingwith EGPRSP working Groups and local stakeholders. DoreenDuffprovided able support with the production of the report. Last butnot the least, the World Bank team i s extremely grateful to all the local stakeholders and donors inMoldova who participatedinthe various discussions and workshops. We would particularly like to thank the members of the Trade Study's Consultative Group for their review and inputto the study. This volume is aproduct o fthe staff ofthe International Bank for Reconstruction and Development/ The World Bank. The findings, interpretations, and conclusions expressed inthis paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy o f the data included inthis work. The boundaries, colors, denominations, and other information shown on any map inthis work do not imply any judgement on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptanceof such boundaries. PART I:MAIN TEXT EXECUTIVE SUMMARY ........................................................................................................... i INTRODUCTION .......................................................................................................................... 1 CHAPTER 1 MACROECONOMICSETTING: WEAK BUSINESSENVIRONMENT . UNDERMINESSUSTAINABLEGROWTH ............................................................................. 3 INTRODUCTION ....................................................................................................................... 3 RECENT GROWTH PERFORMANCE ........................................................................................... 4 INTERNATIONAL PRICE COMPETITIVENESS ............................................................................. 6 MOLDOVA'S BUSINESS ENVIRONMENT ................................................................................... 8 CHAPTER2 TRADE AND POVERTY: EFFECTIVEACTIONS INMOLDOVA CAN . BRINGLARGEREDUCTIONS ................................................................................................ 10 INTRODUCTION ..................................................................................................................... 10 POVERTY MOLDOVA ......................................................................................................... 11 THEPOVERTY EFFECTSINTERNATIONALTRADE............................................................. IN CONCLUSIONS....................................................................................................................... OF 14 18 CHAPTER3 TRADE AND FOREIGNINVESTMENTPERFORMANCEAND . STRUCTURE: LIMITEDDIVERSIFICATIONCONSTRAINSFUTUREPROSPECTS19 INTRODUCTION ..................................................................................................................... 19 ...................................................................... 20 DIRECTION TRADE........................................................................................................... OVERALL TRADEPERFORMANCE SINCE 1995 OF 21 COMPOSITION OF TRADE ...................................................................................................... 23 FOREIGNDIRECT INVESTMENT ............................................................................................. 24 CHAPTER4 DOMESTICTRADE POLICIESAND REGIONALAGREEMENTS: . FORMAL STRUCTURESUNDERMINEDBYWEAK IMPLEMENTATION .................27 INTRODUCTION ..................................................................................................................... 27 THEMOLDOVAN REGIME.......................................................................................... TRADE 27 IMPORTS AND TAXREVENUES .............................................................................................. 30 EXPORT REGIME ................................................................................................................... 31 REGIONAL FREETRADEAGREEMENTS (FTAs) .................................................................... 32 The CISfree trade area............................................................................................... 32 ROMANIA-MOLDOVA TRADEAGREEMENT THEINSTITUTIONALFRAMEWORK FORTRADE POLICY FORMULATION.................................. FREE .................................................................. 34 35 GOVERNMENT EXPORT 36 CONCLUSIONS....................................................................................................................... PROMOTIONSTRATEGY ................................................................... 36 CHAPTER5 MARKET ACCESS TO THE EUROPEANUNION: EUCOULDDOMORE . BUT DOMESTICBARRIERSDOMINATE ........................................................................... 38 INTRODUCTION ..................................................................................................................... 38 TARIFFBARRIERS THE Eu-AN OVERVIEW OF GENERALIZED IN SYSTEM OF PREFERENCES (GSP) PREFERENCES ............................................................................................................. THEIMPACTOF GSPPREFERENCESONMOLDOVA - TRADECOVERAGE AND UTILIZATION 39 .38 TARIFFBARRIERS THE EU-MEASURES IN OF AVERAGE PROTECTION ................................. 41 THEIMPACTOFEUTARIFFPREFERENCESONKEY SECTORS ............................................... 43 THEIMPACTOFENHANCED TRADEPREFERENCES.......................................................... EU 44 THEIMPACTOFEUSUsSIDIES ONMOLDOVAN AGRICULTURAL EXPORTS ........................... 46 THEIMPACT ...................................................................................... OF EUENLARGEMENT 47 CONCLUSIONS....................................................................................................................... 50 CHAPTER6 STANDARDS,CONFORMITY ASSESSMENTAND TRADE: . MODERNIZATIONTO FACILITATE MARKETACCESS ............................................... 52 INTRODUCTION- STANDARDS AND TRADE ........................................................................... 52 THEWTO AGREEMENTSTECHNICALBARRIERS TRADEAND SANITARY AND ON TO PHYTOSANITARYSTANDARDS .............................................................................................. 54 STANDARDS AND CONFORMITY ASSESSMENT INMOLDOVA ................................................. CONCLUSIONS....................................................................................................................... 57 63 CHAPTER7 CUSTOMSADMINISTRATION: HIGHBORDERRELATED COSTS . UNDERMINECOMPETITIVENESS ....................................................................................... 65 INTRODUCTION 65 CORRUPTION......................................................................................................................... ..................................................................................................................... 65 THEEFFICIENCY CUSTOMSREVENUE MOBILIZATION OF ..................................................... 66 REVENUEMOBILIZATION TRADEFACILITATION AND ........................................................... 67 AN OVERVIEW OF MOLDOVA'S CUSTOMS PROCEDURES ...................................................... 67 Registration ................................................................................................................. 67 ConJirmation ............................................................................................................... 68 Border procedures ...................................................................................................... 68 Transit......................................................................................................................... 68 THEBURDEN CUSTOMS PROCEDURES.............................................................................. Inland clearance ......................................................................................................... 69 OF 70 Delays in Clearing Customs....................................................................................... 70 TheEffectiveness of CustomsProcedures in CombatingFraud ................................ 70 ExcessiveDocumentation and Repetitive Verijkations.............................................. 71 Risk Analysis ............................................................................................................... 72 VALUATION OF IMPORTS ....................................................................................................... 73 Invoice checking.......................................................................................................... 73 CHAPTER 8 TRANSPORTATIONAND LOGISTICS: HIGHCOST IMPEDESACCESS . TO KEY MARKETS ................................................................................................................... 75 INTRODUCTION ..................................................................................................................... 75 AN OVERVIEW OF MOLDOVA'S TRANSPORT INFRASTRUCTURE ............................................ 75 THEIMPACTOFPOOR QUALITY TRANSPORT INFRASTRUCTURE ........................................... 76 MOLDOVA'S UNDERDEVELOPED TRANSPORTATION AND LOGISTICS SECTOR ...................... 78 VEHICLE QUALITY AND PERMITS .......................................................................................... ESTIMATINGTRANSPORT LOGISTICS INMOLDOVA ................................ 80 AND COSTS TRADE 83 CHAPTER 9 FINANCIAL SERVICES: LIMITEDACCESS AND HIGHCOSTS . ...........88 INTRODUCTION ..................................................................................................................... 88 REGULATORY IMPEDIMENTS ................................................................................................. 89 BANKINGSERVICESFORINTERNATIONALTRADEAND EXPORT PRODUCTION ...................... 90 Letters of Credit.......................................................................................................... 90 Leasing........................................................................................................................ 91 Insurance..................................................................................................................... 91 CONCLUSIONS....................................................................................................................... 92 Foreign TradeReceivables Insurance........................................................................ 92 Table 1.1 Moldova: Contributions to Real GDP Growth. 2000-2003 ....................................................... 4 Table 1.2 Real and NominalWages. 1995-2002 ....................................................................................... 8 Table 2.1 ConsumptionBudget Shares in2002....................................................................................... 12 Table 2.2 13 Dynamics of Movements into Poverty inMoldova 1997-1999............................................... Sources of Income inMoldovan Households in2002............................................................. Table 2.3 14 Table 2.4 Trade inGoods and Services................................................................................................... Dynamics o f Movementsout o f Poverty inMoldova 1999-2002 ........................................... 14 Table 3.1 19 Table 3.2 Predicted and Realized Shares of Intra-CIS Exports............................................................... 21 Table 3.3 Geographical Composition o f Trade........................................................................................ 22 Table 3.4 Export concentration................................................................................................................ 23 Exports to EU.......................................................................................................................... 22 Table 3.5 Table 3.6 FDI,average 1995-2002.......................................................................................................... 24 Table 3.7 Geographical Composition of FDI.......................................................................................... 25 Table 3.8 25 MoldovaMarket Share on Major Export Markets................................................................... Sectoral Breakdownof FDI..................................................................................................... Table 3.9 26 Table 4.1 28 Moldova's Exports to the EUUnder the GSP in2002 ............................................................ Moldova: Taxation o f Imports, 1999-2002 ............................................................................. Comparison of Average AppliedTariff Rates......................................................................... Table 4.2 31 Table 5.1 40 Table 5.2 Average Tariffs on MoldovaExports to the EU...................................................................... 41 Table 5.3 Key Sectors inMoldovan Exports to the EUand Tariff Preferences...................................... 43 Table 5.4 The Impact ofDeeper GSP Preferenceson Average EUTariffs............................................. 45 Table 5.5 Average EUTariffs as Appliedto MoldovanExports to Russia............................................. 45 Table 5.6 EUAgricultural Subsidiesand Moldovan Exports.................................................................. 46 Table 6.1 Companies with I S 0 9000 Certification................................................................................. -54 Table 7.1 Rail, Roadand Motor Vehicle Densities inSelected Countries .............................................. Productivity of SelectedRegional Customs Administrations, 2003........................................ 66 Table 8.1 76 Table 8.2 Distribution of Cargo Traffic by Rail ...................................................................................... EstimatedVehicle Operating Costs inMoldova...................................................................... 77 Table 8.3 78 Table 8.4 Annual Cost of Operating a 20 Ton Truck inInternationalTraffic for 200,000 kmPer Year ............................................................................................................... 80 Table 8.5 Comparison of the Compliance of Moldovan and LatvianTruck Fleets................................. 81 Table 8.6 Sensitivity of Trade to Transport Cost and Time ..................................................................... 83 Table 8.7 A Typology of Total Direct andIndirect Logistics Costs........................................................ EstimatedFreight Revenue inForeignTrade .......................................................................... 84 Table 8.8 84 Table 8.9 EstimatedLogistics Costs inMoldovanForeignTrade........................................................... 86 Figure 1.1 Real andNominalEffective Exchange Rate.............................................................................. .......................................................................................... 6 9 Figure 2.1 Poverty and GDP Trends inMoldova, 1997-2002 .................................................................... Figure 1.2 Perceptions ofthe Business Climate 9 Figure 2.3 Impact on Poverty o f ReducingBarriers to Exports................................................................ Figure 2.2 Impact on Poverty o f an Improvement inImport Procedures.................................................. 11 16 Figure3.1 Exports, Imports & Trade Balance, 1995-2003....................................................................... 18 Figure5.1 Distributionof Moldova's Exportsto the EUAccording to Tariff Bands, With and Without Preferences................................................................................................. 42 Figure 5.2 Distributionof Moldova's Exports to the EUby TariffBand with Fulland Actual Utilization of Preferences............................................................................................. 43 Figure 7.I Payment o f Bribes at Border Crossings................................................................................... 66 Box 1.1 Workers' Remittances ............................................................................................................... 5 Box 1.2 Moldovan Market Share .......................................................................................................... 26 Transnistria ................................................................................................................................ 7 Box 3.1 Box 5.1 Rules of Origin ........................................................................................................................ 40 Box 5.2 GSP Preferences and EUOutward Processingo f Textile and Apparel................................... 41 Box 5.3 EUSubsidies to the Fruitand Vegetables Sector .................................................................... 47 Box 5.4 EUSubsidies to the Wine Sector............................................................................................. 48 Box 6.1 Opportunities under the TBT/SPS Agreements....................................................................... 58 Box 6.2 61 National Quality Plans: Experiences of Other DevelopingCountries .................................... The Independence o f the Accreditation Body: Experiences From Europe............................ Peruvian Asparagus Industry................................................................................................... Govemment and Business Collaboration on Standards: and Example from the Box 6.3 62 Box 6.4 63 Box 7.1 Documentary Requirements as Specified by Order 384.......................................................... 69 Box 7.2 Best Practices inRisk Management......................................................................................... 72 Box 7.3 MinimumPrice List ................................................................................................................. 74 Box 8.1 Logistics Considerations inApparel and Textile Industry...................................................... 79 Box 8.2 Logistics and Moldova's Future inElectronics Assembly ...................................................... 82 PART 11: CASE STUDIES Fruit andVegetable Sector Case Study Textiles andApparelCaseStudy Wine Sector Case Study EXECUTIVESUMMARY INTRODUCTION 1. The Moldovaneconomy was hithardby the disintegrationofthe Soviet Union. Not only did Moldovalose direct and indirect subsides from the all-Union funds, it experienced a severe terms of trade shock which was compounded by the de facto separation of the Transnistrian region, the breakdown o f traditional trade links and distribution channels, arelative reduction inthe demand for Moldovan products due to higher quality Western substitutes andreducedincomes o fits mainCommonwealthof the Independent States (CIS) trading partners. Inthe thirteen years since independence,Moldovahas seen per capita income fall bymore than 60 percent. Moldova is now the poorest country inEurope with an Atlas GNP per capita in2003 of around US$550. 2. Starting in2000, however, the economy has rebounded and Moldovahas enjoyed cumulative growth o f more than 20 percent. Growthhas relied primarily on domestic consumptionfueledby large inflows of workers' remittances and sizable increases inwages. Investment remains a relatively small share o f GDP and has not contributed greatly to the recent growth performance. While exports have grown strongly, rebounding from the collapse experienced followingthe 1998regional financial crisis, importshave grown even faster with the results that the contributionof net exports to growth i s still very negative. It i s unlikelythat the factors that have ledto the resurgence of the Moldovan economy will persist over the medium term. While workers' remittances will continue to play an important role inthe Moldovaneconomy, it will be difficult to sustain the current growth rate o f these flows. The growth impetus from past structural reform efforts has not beenreinforced and future growth will be compromisedby the poor business and investment climate. As a small open economy, closer integration into the world economy and a rapidgrowth innet exports must serve as the engine of growth inMoldova. 3. Across the transition economies, there appears to be a strong and positive association between export market growth and economic growth. Export market growth, for its part, has beenclosely linked to the larger order trade reorientationtowards the EuropeanUnion (EU). Thisreorientation, inturn, has been associatedwith product upgrading and investment, commonly undertaken by foreign investors. Given its proximity to the EU, the performance of Moldova's exports to the EuropeanUnion (EU)has been disappointing. Moldova's exports are still concentrated ina few commodities and are still primarily destinedfor the CIS market. While macroeconomic stability hasbeen largely achieved, formal and informal trade and investment barriers, including a highbribe tax, have limitedmuchneeded restructuring, domestic and foreign investment and quality upgrading. As this study suggests, the achievement o f more sustainable export-led growth andpoverty reductionwill require policies that go beyond formal trade policies. Indeed, a more open trade regime must go hand-in-hand with a good business and investment climate. Trade, Growthand Poverty Trade canplay an important role in alleviatingpoverty in Moldova by stimulatinggrowth, increasing employment and reducing theprice of consumedproducts; Thefull impact of trade onpoverty will only be realized if the range of informal barriers to both imports and exports in Moldova, such as cumbersome and restrictive tradeprocedures, corruption, burdensome and inappropriate regulations and high transport costs, are significantly reduced. 4. Trade will affect poverty through its impact on the rate o f economic growth. Economic policies that promote trade and growth are therefore likely to have a substantial impact onpoverty reduction. However, vulnerability to changes inexternal conditions, as shown by the impact of the Russia crisis on i poverty rates, suggests that factors constraining the diversification of trade inMoldovaneedto be alleviated. 5. Trade will also affect poverty through changes inprices, which affect consumption, and by affecting employment, wages and incomes. It i s important to note that the trade-poverty links are influenced not only by formal trade policies, such as tariffs, but also by a range of informal barriers in Moldova. Cumbersome and restrictive customsprocedures, corruption, burdensome and inappropriate regulations, such as those relating to product standards, and hightransport costs all act to raise the prices of traded goods and have implications for poverty. 6. A number of simulations undertaken for this study show howpolicy initiativeswhich reduce the cost o f importing and exporting inMoldova, and which make it easier to access overseasmarkets, could have substantial impacts on poverty -reducingpoverty by more than 10percentagepoints. Trade Policy and Regional Free Trade Agreements Thetariff schedule is growing more complicated. A simpler, more uniform tariffstructure should be adopted, allowing tariff revenues to be collected more efficiently; . Severe constraints on transit through Ukraineand lack of effective dispute settlement to deal with this issue greatly undermines the value of the CISfree trade agreementfor Moldova; Thecurrent exportpromotion strategy should be reworked to achieve a balance between offshore and onshore objectives, and toprovide an effective mechanism of implementation. An increasing focus on quality should be at theforefront of export promotion activities in Moldova. 7. While Moldovahas drastically liberalized its trade regimeinthe decade since independence, and now has a very liberal statutory trade policyregime, the way trade and other policies are being implementedi s creatingsubstantial barriers to imports and exports. The current tariff schedule has become more complex, increasing the administrative burdeninapplying trade policy and collecting tariff revenue. A more uniformtariff structure with a small number o f tariff bands that is subject to less frequent changes will reduce uncertaintyand allow tariff revenues to be collectedina more efficient manner. A further reason for maintainingfairly uniformtariffs i s to avoid an escalating tariff structure. While highertariffs on finishedproducts than on importedinputsprovides higher levels o f effective protection for producers of final goods, inMoldovait appearsthat incertain instancestariff differentiation has actually ledto de-escalating tariffs with higher duties onraw materials and unprocessedproducts than on finished goods. This suggests that producers of some final products in Moldova will find it more difficult to compete with foreign producers inthe domestic market since they will bepayingmore than the world price for their inputs. 8. Moldova has become increasingly dependent on the taxation of imports. Customs duties, however, play a rather minor role inimport taxation. Fromthe taxation viewpoint, the small collection of customs duties does notjustify the administrative complexity of ahighly detailed and variable import tariff schedule.Revenues from import duties would be collectedmore efficiently with a simpler and more uniformtariff structure. 9. Exporters inMoldova are confronted with the burdensome requirementto repatriate export earnings within a given time period. Late repatriation leads to the levyingof heavy fines. This requirement, even ifthe timefi-ame i s extended, i s unnecessaryand shouldberemoved. The timely reimbursementofVAT paid onbothdomestic and importedinputsis also problematic. The Moldovan Export Promotion Organization(MEPO) asserts that no more than 45 percent of export VAT refund requests are beingsatisfied on a regular basis andthese are typically inthe form of offsets against other tax liabilities. The existing VAT refundmechanism, therefore, creates considerable hurdles for exporters, at least interms o f the highcost of delays, and shouldbereformed. 11 .. 10. Moldova is aparticipant ina number of free trade areas: the plurilateral CIS free trade area, consistingof 12 former Soviet republics, the bilateral Romania-Moldova free trade area and free trade agreements (FTAs) with six stability pact countries of South EasternEurope. The CIS free trade area i s playing an extremely important role inMoldova's external trade, absorbing over half of the country's exports. The FTAswith CIS countries, however, have a number of important shortcomings: (i) the web of bilateral and multilateral agreements undermines transparency and hampers the efficiency o f the free trade area; (ii) exclusions from the free trade regime can be imposed unilaterally; (iii) agreements lack the permanency; and (iv) inthe absence o f a plurilateraldispute resolutionmechanism, all disputes have to be resolvedpolitically at the bilateral level. These features are particularly disadvantageous for a small country such as Moldova. 11. Despitea free transit provision includedinthe FTAs,Moldova experiences serious problems with the transit of its trade through Ukraine. The transit environment remains chaotic and a regimeo f free transit has never been achieved. While Moldova sits on the Working Party for the accession of Ukraine to the World Trade Organization(WTO) and could potentially exert pressure on Ukraine by making requests on free transit issues, transit issues through Ukraine do not appear to be on the agenda o f Ukrainian accessionto the WTO. Hence, on this issue, Moldova could exploit the benefits of its membership of the WTO further. 12. Moldova adopted an export promotion strategy inearly 2002. International experience suggests that a good export promotion strategy should strike a balance between offshore objectives (information gathering, market research, trade representation, and trade fairs) and onshore objectives (issues of competitiveness: quality standards, pricing, supportive services, domestic input supply, development of new business models and practices). The current strategy, while addressing some o f the former issues, i s weaker on the later. Inthis regard, it i s unlikely that progress inprovision o f information will have a substantial export promoting impact without significant efforts to improve the domestic business environment. Market Access to the European Union Through lobbying of the EU on the extension of the Generalized System of Preferences (GSP) scheme,Moldova should seek to have a larger number ofprocessed agricultural products class$ed as non-sensitive under the GSP, thereby making them eligiblefor zero duties, and to include as eligiblefor preferences for the$rst timeproducts such as wine; Internally, strong efforts should be made to identifi and alleviate constraints on the take-up of GSPpreferences and to ensure that Moldovanproducers are aware that new opportunitiesfor exports may arise in the new member countries in central and eastern Europe; Addressing the domestic constraints on trade and investment would not only stimulate trade but also bring Moldovan institutions andpolicies on apath whereby afree trade agreement with the EU could become a reality. 13. Givenits economic size and proximity, economic analysis suggests that the principaltrading partner of Moldova shouldbe the EU. Instead, Moldovan trade i s dominated by exchange with other CIS countries -principally Russia -and the share of the EUinMoldovan exports remains very low relative to what would be expected under "normal" trade relations. EUtrade protection and agricultural subsidies can only explain a small part of the gap between the current share o f the EU-15 inMoldova's exports (around 23 per cent in2003) and the share that could be expectedunder "normal" trade relations(between 40 and 50 per cent). Indeed, Moldova is one of the most preferred partners of the EUunder the GSP with significantly better market access than other CIS countries, the maincompetitors to Moldova. However, there i s still roomfor further enhancement o f these preferences, particularly with respect to Moldovan wine exports, whichare currently excluded frompreferences. Access to the EUmarket, particularly for agricultural goods, will be substantially altered bythe recent enlargement, raising competitive challenges ... 111 for Moldovanproducers but also providingnew opportunities as dutieson some of the key products exported by Moldova fall inthe new EUmembers. 14. While reducingEUtariff barriers can contribute to reorientationof Moldovan exports to the EU, effective market access i s determined by much more than tariffs inthe overseas market. A number of policies applied inthe home market can influence the ability of exporters to penetrate overseas markets. Having to contend with, for example, the costly and time consuming clearance of exports, the difficulties and costs o f obtaining funds for working capital and for investmentand the difficulties causedby the current system o f product regulations and conformity assessmentare equally important factors limiting the ability o f Moldovanexporters to penetrate the EUmarket. Indeed, inmany cases, removal of these domestic barriers will be a pre-requisite for the successfulexpansion of exports to the EU.Ifthese barriers are, ineffect, prohibitive, thenthere canbeno impact from the reductionof EUtariffs untilthey are alleviated. For example, ifMoldovan products cannot satisfy the minimumrequirements necessaryto beplacedonthe EUmarket, thenchangesinthe EUtariffwill have no immediate effect and will only be exploited inthe longer-term if constraints on the ability of firms to investto raise quality are removed. Addressing these barriers would also putMoldova on a pathtowards a free trade agreementwith the EU and a clear track towards more comprehensive integrationwith the EUunder the `new neighbors' policy currentlybeingdeveloped. StandardsandConformityAssessment Thegovernment should aim to move rapidly to the so-called "voluntary" system of standards based on the adoption of international and, where relevant, EUstandards. I t should establish clear targetsfor thisprocess; Thegovernment should consider drawing up a national quality plan, integral elements of which would be raising awareness of standards issues in thepublic institutions andprivate sector, a shift to a more modern and business oriented approach to conformity assessment, greater participation of theprivate sector in the standards process and enhancing the reputation of testing, inspection and accreditation bodiesfor independenceand competence. 15. Standards have come to be crucial elements facilitating transactions and trade bothwithin countries and ininternationalexchangebetween countries. The ability to comply with the standardsin overseas markets i s a major factor determining access to those markets and the capacity to export. In addition to the writingo f standards, an essential element of the systemo f standardization i s conformity assessment, the technical procedures such as testing, verification, inspection and certification, which confirm that products hlfillthe requirements, laiddown inregulations and standards. 16. As part ofits accessionto WTO, Moldova has a commitment to implement a systemofvoluntary standardization. Despitethe ambitious programset upby the Government conceming the transition towards this systemby 2005, there has been inadequate financial or technical support for this program. As aresult, Moldova's institutional structure inthe area o f standardization, metrology, certification and accreditation still resemblesmany o f the features of the former system o f centralized control, which results in a highdegree o f government control and influence over the placing o fproducts on the market. 17. The slow pace inadoptinga modemstandards system contributes to a negative business environment. The current system i s overly complicatedwith no clear rules regarding application, which leaves too muchroom for discretion. Functions, relationships and responsibilities of different state bodies comprisingthe systemare not clearly definedand very often are overlapping. Information i s not readily available and the rationalebehindsome o f the requirementsi s not made clear to those that have to apply them. Inaddition, the needto certify goods andproductionprocessesis daunting, bothfor exporters and importers, because of the highdirect and indirect costs. iv 18. The slow adoption o f internationalstandards, and the excessive use of mandatory standards, i s an important factor affecting the access of Moldovan exporters to the EUmarket. Moldova's current system o f standards also acts to discourage foreign direct investment and constrains innovation and strategies towards product differentiation. Adequate and appropriate conformity assessment infiastructure and transparent, non-arbitrary regulations and procedures are key factors affecting the location decisions o f multinational firms. Countries meetingworld standardstend to attract more investors. This constraint on foreign direct investment (FDI) limitsthe transfer of technological knowledge to Moldova, especially of processesand procedures that would raise quality inMoldova. 19. A key issue for Moldovais to encourageand facilitate more companies to focus on, andtake responsibility for, the quality of the goods or services they produce. Without this fundamental change of attitude, the prospects for generating higher value added activities and of long-run increasesin competitiveness will bepoor. An increasing focus on quality, therefore, should be at the forefront o f export promotion activities inMoldova. Customs Administration Review all documentary requirements with the objective of increasing tradefacilitation by streamlining Customsprocedures. I nparticular, review the necessityfor the conJirmation procedure and ensure that the application of currentprocedures are consistent with the Kyoto Convention; Develop aproper valuation system by (i) reinforcing the valuation unit and developing a transactionprice data base, (ii) establishing communications with industry and importers to assess realistic valuesfor major commodities, and (iii) developing an initial valuation investigation process; Over the longer-term, Customs should aim to substantially reduce the number ofphysical examinations by introducing a basicform of risk management which could be supported in the earlier phases by random selection of declarations. Based onpreliminary results, Customs should startpreparing a more sophisticated risk management system. 20. Reductions intariff barriers around the globe andchanges insupply chain management practices, such as a greater reliance onjust-in-time deliveries, have resulted ina relative increase inthe importance of border procedure-related trade transaction costs. Inefficient and costly border procedures exact significant cost on boththe businessesthat have to use them as well as the authorities that have to administer them. Similarly, inefficient border procedures are also likely to lead to poor export competitiveness, make a country less attractive to foreign investment andreduce the ability of domestic firms to participate in global productionnetworks. 21, Moldovahas achieved some success inimproving the services of the Customs Administration and reducing the associatedtrade and transport impediments. Unfortunately, surveys o f Moldovan businesses revealthat, despite recent improvements, customs regulations are still perceivedas cumbersome and costly, acting as an impedimentto foreign trade operations. These perceptions are the result of (i) complicated, non-transparent, and frequently changing Customs procedures, (ii) delays long for clearing goods or proceedingthrough the border, including fiequent physical inspection of goods and, (iii)difficulties inapplying modem Customs standards, such as the WTO Agreement on Customs Valuation. 22. Many of the control mechanisms imposedby Customs are designed to control fraud and increase revenue collection on existingtransactions. While revenue collection has increased, the efficiency o f Moldovan Customs lags behindother countries inSoutheasternEurope. Further, the objective o f Customs to control fraud is not being effectively achieved. The detection of irregularities i s rare -only 2.3 percent of all import declarations, a figure usually encountered only inhighlycompliant countries. Instead, V complex procedures impose an unnecessary and costly burdenon legitimate businesses. Riskanalysis, which allows for some selectivity inchecks, i s still very limited and more attention needs to bepaidto the negative impact of these controls on trade facilitation. The direct and indirect cost o f these control mechanisms to society can be very high.Customs should review all current documentary requirements and procedures to ensure that they are consistent with the Kyoto Convention and the objective of improving trade facilitation. Among the benefits of simplifiedCustoms procedures would be the increased competitiveness of local firms and the increasedefficiency of Customs. Transportation and Logistics Improve road management andJinancing systems, including the establishment of a road maintenancefund and the development ofperformance-based road maintenance contracts; 23. The cost andquality of transport and logistic servicesmatter for trade competitiveness. Evenif tariff and non-tariffbarriers to trade are substantially liberalized, the penalty of hightransportation costs has a negative impact on growth rates and income of countries with poor internationaltransport links. Countries with highertransport costs are also less likely to attract FDI. Since FDIi s often a key channel of international knowledge and technology diffusion, these higher costs may lead an economy to be further removedfrom the world technology frontier and impede its rate o fproductivity growth. Moldovanexporters, confrontedwithhighfreight andlogistic costs, must pay lower wages to its workers, accept lower profits or increaseproductivity. 24. Moldova's existing transport infrastructure, albeit extensive, hasbeenpoorly maintainedandno infrastructure has beenaddedto address the needs associatedwith changing trade pattems. The generally poor condition of Moldovan roads imposes a substantial cost on the economy. Estimates suggest that reducingvehicle-operating costs byupgradingroad quality would generate savings on the order of US$20 to 25 million annually. To achieve these savings, there i s a needfor better road management and financing systems with a particular emphasis on roadmaintenance. This requires: (i) the State RoadAdministration to strengthen its procedures for planning and budgetingroad expenditures and assessing priorities for road maintenance; (ii) a transparent road fund, for bothnational andlocal networks, be established to provide a stable source of funds for road maintenance; and, (iii) development of multi-annualperformance-based maintenance contracts. 25. Moldovan trucking firms have the lowest operational costs inEurope. The shift to higher standard vehicles inother countries, however, reduces this cost advantage. With its aging truck fleet, only a small number o f multilateraltransport permits are available to Moldovan trucking firms. Unless Moldova upgrades its trucking fleets, its ability to compete inthe EUmarket will be hindered. Unfortunately, fleet renewal to meet higher EURO-standards has been modest becauseof the highcost of loans and the VAT tax bias against leasing arrangements. 26. It is estimated that over US$70 million couldbe savedannually throughmore business friendly government policies and more efficient logistics. If,for example, the Govemmentbringstrade documentation and administrationto the level found inmost EUaccessioncountries, logistics costs of firms could be reducedby about US$35 million. A more predictable trade environment would lower inventory-carrying costs by over US$lO million, even when inventory-handling costs remain unchanged. Reducingaverageborder crossing time would save at least U S 2 0 million inwaiting time costs alone. Finally, more efficient operations and increasedcompetition inrail androad transport could lower the total transport costs by 20 percent, equivalent to US$25 million. Reducedlogistics costs would dramatically improve the competitiveness of Moldovanfirms and contribute to their ability to participate inglobalproductionnetworks. Vi Financial Services Therestrictions limitingforeign exchangelending to exporters should be removed; . Thefiscal agent responsibilities imposed on the banking sector, such as the monitoring of repatriations of export proceeds, should be lifted. Tofacilitate leasing, the VATstatus of lessors should be adjusted to be the same asfor banh. The 5percent of eachpayment to the leasing company that the lessee is required to deduct as a tax advance should be eliminated. 27. Financial services are essential for the functioning of amodem economy. Such services are especially important for the facilitation of internationaltrade, where there i s a need for various services and instruments to increase speed and certainty inpayments across internationalborders and indifferent currencies. Insofar as these financial services have limitedavailability and are costly, they become important constraints for the development of internationaltrade. 28. A highlydollarized banlungsector dominates the financial sector. Capitalmarkets, contractual savings and specialized financial institutions are non-existent, inactive or very small. Almost all business surveys carried out for Moldova show that access to finance i s a considerable impediment to business development. The capacity o f banks to appraisethe creditworthiness of clients is still developing and, as a result, banks are generally credit risk adverse. The dearth of mediumto long term credit i s not only due to the highfundingrisk,but also because such credits effectively reduce the capacity o f banks to restructure their balance sheets when circumstances change. A legal framework that clearly establishes the rights,responsibilitiesand liabilities of the parties to financial transactions andwhich provides a means to enforce legal obligations and claims efficiently i s a key ingredient to a more stable and robust financial system. 29. The bankingsector i s fairly concentrated, withthe sizable number of small andvery small banks suggesting large inefficiencies and highcosts. Encouraging the reductioninthe number of smaller banks will be animportant part o f creating a banking sector that i s healthier and more capable ofproviding efficient, better and cheaper financial services. The introductionof foreign banks into the Moldovan banking sector would be highly desirable as they would exert competitive pressure on local banks and bringnew financial products to the market. 30. Several government and National Bank of Moldova (NBM)restrictions andregulations further affect the performance o f the banking sector. With very limitedexceptions, and contrary to the reality o f lendingrisks, banks are authorizedto lendinforeign currency only to importers. Exporterscannot borrow in foreign currency to finance local expenditures. Since local currency interest rates are considerably higher than foreign currency rates, this restriction makes credit much more expensive to exporters, reducing their international competitiveness. 31. Banks are also charged with a number of fiscal agent responsibilitiesthat are incompatible with bankingbusiness. Among these are the controls over repatriation o f export earnings. These regulations are a costly burdenfor the banks that are required to monitor all transactions and report indetail to the authorities. Eliminating these regulationswill not only save exporters a lot of administrativehassle, it will save the commercial banks andNBMthe significant cost of monitoring, recordingandreporting the related data. vii 5 b 0 .z%!i a m m m 3 % % 4 4 4 u u E E Z % % E E E E % % 3E 9 9 \o 00 \o F I- 9 \o 00 0 0 0 0 0 0 0 0 0 0 3 3 0 0 0 0 c;' c;' c;' c;' c;' 9 VI c;' c;' 0 VI VI VI 0 m v, VI 0 VI 0 0 0 0 0 0 0 N 0 N N 0 N 0 N 0 N 0 N 0 N Y Y m m a cd FI m m a \o \o \ o \ o \o DQ 3 0 0 0 0 0 0 3 0 0 0 0 0 0 9 q c;] T C ; ' q 9 IC, v , v r v, In 0vr v, 3 0 0 0 0 0 3 0 0 0 0 0 0 N N N N N N N X .i m . .-r .rc C C c 7 E Q E .L C c c. Ee m . - INTRODUCTION 1. Rapid economic growth i s a preconditionfor sustainedpoverty alleviation. Since 2000, when Moldova's economic recovery finally commenced, poverty rates have dropped significantly - from a high of 71percent in2000 to less than 40 percent in2003. Withthe current economic recovery drivenlargely by consumption, there is concern that the current growthperformance will not be sustainedover the mediumterm. Internationalevidence suggests that broad-basedand sustainedgrowth depends, inpart, on an open and transparent trade regime. InMoldova, however, the efficient allocation of resourcesthat openness brings i s being undermined by poor governanceand domestic policies that raise the cost of doing business. Improving the business environment andreducing the cost of doing business will not only promote more sustainable growth, it will also have a direct impact on the economic welfare ofMoldova's population. Reform of policies that affect internationaltrade, therefore, has an important role inpoverty alleviation. 2. Confrontedwith higher costs of doing business, Moldovanproducers must either accept lower profits, undertake investmentsto increaseproductivity or pay lower wages to its workers. The current investment climate, however, has discouraged the domestic investment neededto increaseproductivity and has made it difficult to attract foreign direct investment. Since foreign investment i s often a key channel of internationalknowledge and technology diffusion, these higher costs have leadthe Moldovan economy to be further removed from the world technology frontier and has diminishedMoldovan future growth prospects. Apart from the obvious anddirect impact on poverty, lower wages have been a key factor contributing to the massive internationalmovement of labor out of Moldova. Reducingcorruption and lowering the cost of doing business inMoldovaare, therefore, key elements of any strategy to sustain economic growth andreduce poverty. 3. While a good business environment has many important dimensions, this study focuses on those areas that have direct implications for internationaltrade. The key topics chosen for this study were identifiedby stakeholders inthe private and public sectors as beingmajor barriersto internationaltrade. To set the stage for the study, Chapter 1reviews the Macroeconomic setting. As i s now well recognized, growth inMoldova has been drivenprimarily by final consumption with the contribution of net exports beingnegative. As a small open economy, sustained growthwill requireimprovedexport and investment performance. The chapter notes that inorder to stimulate exports and overcome the impact ofremittances on the real exchangerates and the poor overall business environment, Moldovawill needto address the major impediments to trade identified inthis study. The key findingof this study, that measures to reduce trade-related impediments has a significant impact on poverty, is presented inChapter 2. Drawingonthe findingspresentedinthe rest o fthe study, simulations undertaken for this chapter demonstrate the potentially large impact that the removal of these impediments can have on poverty. 4. Unlikemanytransition countries, Moldovahasbeenslower inredirectingtrade away from its CIS trading partners towards the EU. Inaddition, Moldova's exports continue to be focused on anarrow range ofproducts. Moldova's recent trade and investment performance is described inChapter 3. As the Chapter notes, the narrow country andproduct focus of Moldovan exports has potentially negative implications for future export growth performance and exposesMoldovato further regional external trade shocks. The inability of Moldovato attract muchneededforeign investment is also reviewed inthe chapter . 5. The extent to whichtrade performance hasbeeninfluencedby Moldova's own formal trade policies and regional trade agreements i s examinedinChapter 4. The value o f the regionaltrade arrangements to Moldova i s also explored. The chapter examines the way inwhich trade and other policies are implementedinMoldova and how they create a substantial barrier to imports and exports, Some commentators have expressedthe view that Moldova faces crippling external trade restrictions, 1 such as those inthe EU, that prevent them from exploiting their sources of comparative advantage. The trade barriers inhibitingMoldova's market access to the European Union are explored inChapter 5. 6. While reducing EUtariff barriers can contribute to the reorientation o fMoldova exports to the EU, the rest ofthe study highlightsthe importantpoint that effectivemarket access is determined by muchmore than tariffs inoverseas markets. A number o f policies applied inthe home market can also influence the ability of Moldovanexporters to penetrateoverseasmarkets. InChapter 6, the difficulties causedby Moldova's current system ofproduct regulations and conformity assessment i s highlighted. The chapter notes that ability to comply with the standardsinoverseasmarkets i s amajor factor determining access to those markets and the capacity to export. Having to contend with the costly and time-consuming clearance o f exports and imports also limitsthe ability of Moldovanexports to penetrate newmarkets. Chapter 7 examines Moldova's inefficient and costly border procedures andnotes that these procedures exact a significant cost onboththe businesses that have to comply with them as well as the border authorities that have to administer them. 7. Inadditiontoborder-relatedtradetransactioncosts, Chapter 8analyzestheextenttowhichthe cost and quality o f Moldova's transportation and logistics services matter for trade competitiveness. The chapter also addressesthe barriers that inhibitMoldova trucking firms from taking advantage o f their low operating costs. Finally, Chapter 9 examines the difficulties and costs of obtaining funds for working capital and investment that confront Moldovan firms. Insofar as financial services have limited availability and are costly, they become important constraints for the further development of international trade. The extent to which government restrictions andregulations affect the performance o f the banking sector, and hence trade competitiveness, i s explored. 8. While Moldova's recent strong export growth performance i s encouraging, exports have only just recovered to levels achieved before the advent of the regional financial crisis in 1998. The continuation ofthis growth performance i s not a foregone conclusion. However, given its proximity to the large European market, Moldovahas many opportunities that, ifexploited, will sustain the growth inexports and, hence, economic growth and poverty reduction. To realize these opportunities, however, Moldova must address the barriers that impede Moldova's efforts to diversifyexports, attract foreign investment and integrate into global production networks. The study presents an action planthat highlightsthe main constraints to trade and presents policy recommendations to overcome these barriers. The analysis inthe study confirms that alleviatingthesebarriers to trade wouldhave a substantial impact on poverty. 2 CHAPTER 1. MACROECONOMICSETTING: WEAK BUSINESSENVIRONMENT UNDERMINESSUSTAINABLE GROWTH INTRODUCTION Trade canplay a key 1.1 Inthe thirteen years since independence, Moldovahas seenper capita incomefall role in reducing bymore than 60 percent. Moldovaisnowthe poorest country inEurope with anAtlas poverty, especially GNP per-capita in2003 o f around $550. There are severalreasons for Moldova's difficult in small open transition performance. Inthe Soviet system, Moldova's role was mainly to supply economies such as agricultural products while beingentirely dependent on imported energy inputs. Moldova, but trade Consequently, Moldova was among the hardesthit by the collapse of theSoviet Union. can also bring new Not only didMoldova lose direct and indirect subsides from the all-Union funds - risks and lower subsidies that amounted to 25 percent of its GDP -it also experienced the worst terms of welfare for some. trade deterioration o f all CIS countries, approximately 40-50 percent. This shock was compoundedby the breakdown of traditional trade links and distribution channels, relative reduction inthe demand for Moldovan products due to higherquality Western substitutes and the reducedincomes of its mainCommonwealthof the Independent States (CIS) trading partners. Further, the civil war and de facto separation of the Transnistrian region eroded the industrial base of the republic since most industrywas located primarily inthe breakaway region.' 1.2 Duringthe early 1990s, Moldovawas considered a leadingreformer among the CIS countries. A new currency was introducedin 1993 that, combinedwith a tightening o f monetary and fiscal policy, contributedto early success at macroeconomic stabilization. These efforts were complemented by a series of first generation reforms, including trade and price liberalization, mass privatizationand financial sector reforms. Bythe mid-1990s, however, macroeconomic stabilizationand early liberalizationefforts hadproved insufficient to attract foreign investors or generate growth from internal sources. Inpart, the productive sector failed to sufficiently adjust to the post- independenceenergy price shock and household consumption didnot fully adjust to the fall inreal incomes. The absenceofpolitical consensus behind further economic reforms, frequent changes ingovernment and weak institutional capacity combined to produce a stop-go pattern inthe implementation of structural reforms. Moldova was one of 1.3 Moldovawas one o f the CIS countries hardest hitby the regional financial crisis the CIS countries in1998.The depreciation ofthe leuagainstwestern currencies andits simultaneous hardest hit by the appreciation against the RussianrubbleresultedinMoldova's seconddramatic terms o f regionaljnancial trade shock. Exports halved andreal household incomes were reduced to less than 60 crisis in 1998. percent ofthe pre-crisislevels. Followingthe crisis, the sources of fiscal deficit financing diminishedconsiderably as the T-bill market and foreign financing dried up. As aresult, fiscal policy hadto tighten considerably, boththrough increasedrevenue collection incash and expenditure reduction. A number of important structuralreforms also took place. Among the most important were: a) significant steps towards rationalization inthe energy sector, including the privatization o f three electricity distributioncompanies; b) imposition of hard budget constraints through energy sector reform and collection ofbudget revenues incash; and, c) launching of pensionreform and clearance o fpensionarrears. These reforms, combined with the economic recovery Transnistria accounted for more than a third of the total industrial output but only about 17 percent o f the population before independence. Nearly all the cotton textiles, power transformers and electrical machines were produced there, as well as 90 percent of the electricity generation. 3 inneighboring countries andthe sizableinflow ofworkers' remittance, contributedto Moldova's growth turnaround in2000. RECENTGROWTHPERFORMANCE Since 2000, 1.4 Since 2000, Moldovahas enjoyed cumulative growth o f more than 20 percent. Moldova has Inthelastthreeyears, growthhasaveragedmorethan6.7percent. AsshowninTable enjoyed cumulative 1.1, the turnaroundinMoldova's growthperformancehasbeendrivenprimarily by growth of more than domestic consumption* Private Table 1.1. Moldova: Contributions to Real 20percent. The consumptionhas beenfueled by GDP growth, 2000~2003 turnaround in large inflows o f workers' (percent) Moldova growth 'S remittances and sizable increasesin 2000 2001 2002 2003 performance has wages and pensions. A large Real GDP growth 2.1 6.1 7.8 6.3 been driven increase intax revenues, principally primarily by taxes on imported goods, has Final Consumption 15.4 4.5 9.8 17.9 domestic consumption. contributedto an increase inpublic GrossInvestment Consumption. While investment has Net Exports -14.8 -0.3 -2.3 -13.5 grown Over the last three years, it still representsonly a relatively small share of GDP and, hence, has not figuredpredominately as a contributing demand factor incurrent growth performance. Over the last three years, exports have There is a strong rebound sharply from the steep drop experienced inthe aftermath of the regional andpositive financial crisis. Export growth duringthis period has averagednearly 19percent association between annually. Imports, however, have grown even faster, averaging nearly 20 percent per export market annum over the same period. With the value of imports amounting to more than one and growth and halftimes that o f exports, the contribution o fnet exports to Moldova's growth hasbeen economic growth. negative. Export market growth has been 1.5 All the transition countries startedwith common ownership andcontrol regimes, closely linked to administered prices and trade organized on the basis of the requirements dictated by trade reorientation centralized planning. While trade patterns among these economies may have mimicked towards the some view o f comparative advantage, almost all trade was conducted intra-Council of European Union. Mutual Economic Assistance (CMEA). While, trade barriers inmost of these countries have come tumblingdown, albeit with different degrees across countries, growth performance has varied widely across countries. Empirically, there appearsto be a strong and positive association between export market growth and economic growth.' Export market growth, for its part, has beenclosely linked to the larger order trade reorientation towards the European Union (EU). Intum, excluding trade innatural resources, export Formal and informal growth has been associatedwith product upgradingand investment, commonly trade and investment barriers limit the undertaken by foreign investors. By contrast, formal and informal trade and investment much needed barriers, including a highbribetax, limit the much neededrestructuring, domestic and restructuring, foreign investment and quality upgrading. As a result, productivity improvementsremain domestic andforeign small or absent as do export opportunities. As the rest o f this study suggests, any solution investment and to this problem needs to embrace a great deal more thanjust formal trade policy. Indeed, quality upgrading. a more open trade regime must go hand-in-hand with a good investment climate and other virtuous features andvice versa. 1.6 The "Non-observed economy. The non-observed economy inMoldova, which includes the informal sector, household production for own final use, and hidden activity of the formal sector, i s estimated at 31.6 percent o f GDP. Of this, 6.6 percent i s the See, for example, Christoffersonand Doyle (1998), "From inflation to Growth: Eight Years of Transition", IMF Working Paper, WP98/100, Washington DC 4 hidden economy inthe formal sector and 9.2 percent represents the informal sector and the rest is comprised of household production for own use. With regards to hidden activity inthe formal sector, the major part is concentrated inindustry and trade, those areas o f the economy subject to a higher fiscal burden and, hence, with a greater incentive to evade taxes. Reforms that improve the business climate, including the removal of the various impediments to trade, would launch a virtuous cycle such that the activities of the informal and hidden economy are encouraged to migrate to the "observed" economy thereby reducing the need for the burdensome control mechanisms designed to detect these informal and hidden activities. This shift ineconomic activity would also have the associated benefit ofbroadeningthe tax base, allowing for a reduction inmarginal tax rates while at the same time increasing overall tax revenues. Box 1.1-Workers' Remittances Traditional trade theory, anchored onthe assumed international immobility o f factors o fproduction, focuses on the exchange o f goods across international borders as a result o f the differences intechnologies and factor endowments. According to this theory, unfettered international trade ingoods will leadto the equalization o f factor returns across countries. Inpractice, however, factors o fproduction, including labor, are not immobile. Any constraints ontrade ingoods, therefore, may leadto the international movement o fthe factors o fproduction to seek out higher returns abroad. That is, rather than exporting the services o f domestic factors embodiedinthe form o f goods, those services are provided directly to market overseas through physical movement o f factors. Temporary migration is a relatively newphenomenonfor Moldova. Itbegan in earnest after the 1998 regional financial crisis and has expanded significantly inthe last three years. As a result, Moldova's single largest export has beenits labor force and workers' remittances havebecome the single largest source of foreign exchange inflows. In2003, recordedremittancesamountedto $393million(20percentofGDPand49 percent o f merchandise exports). Although transactions are secure, associatedcosts are high. Ifthe money is converted into Moldovanlei, bank fees for conversionand remitting funds can amount to upto 25 percent ofthe amounttransferred. As aresult, a large portion o f remittances is sent home via unofficial channels (estimated at about 40 percent). Recordedremittances, therefore, substantially undervalued actual flows. It is quite likely that the total inflow o f workers' remittances is more inthe neighborhood o f $650 million a year (33 percent o f GDP or 80 percent o f exports). The absence o f a recent population census makes i t difficult to estimate the precise number o fMoldova working abroad. Various studies put the number o fmigrants at between 200,000 and 700,000 Moldovans. (By comparison, employment inMoldova is 1.5 million and the population is 3.6 million). About half o fMoldova's migrant population is working inCIS countries, primarily Russia. The rest are distributedmainly between Western Europe, Southeastern Europe and the Middle East. Those migrants inthe CIS are predominately men working inseasonal jobs, tend to have lower education levels an( Host Country NumberofMigrants earn less compared with migrant workers in Europe. Despite the relative small share o f RussianFederation 240.000-270.000 the total migrant population, nearly 60 Italv 150.000 percent o f remittances come from workers livinginWestern Europe-predominately Portugal 80,000 educated females working as caretakers or Greece 30.000 baby-sitters. Czech Reoublic 40.000 Insofar as Remittances augment the recipient individuals' incomes and increase Turkev 20.000-50.000 the recipient country's foreign exchange Spain, France, Israel 20,000 reserves, the economic effects canbe positive. Ifremittances are invested, they Source: IMFArticle IV StaffReport, 2004 5 contribute to output growth, and ifconsumed, they canhave positive multipliereffects, lifting some families out o fpoverty. While most remittances inMoldova appear to support increased consumption, some 16percent o frecipients use the funds to support some sort o f business investment. Contrary to local concerns, Labor migration does not appear to have precipitated a brain drain. Indeed, the local labor force i s more likely to have a university education than expatriates. One emerging area o fconcern, however, is the so-called "Dutch disease" effects that can take place as a result o f the large inflows o f remittances. The corresponding increase inforeign reserves cancause the real exchangerate to appreciate - an increase inthe relative price o fnon-traded goods - resultinginthe contraction o fthe manufacturing sector or de-industrialization. INTERNATIONALPRICECOMPETITIVENESS The Government can 1.7 TheReal Effective ExchangeRate. The internationalprice competitiveness of a contribute to country can bebroadly measuredby the evolution o f its real effective exchange rate imvroved (REER).3 Moldovaintroducedanew currency, the leu, inNovember 1993 to replace the competitiveness by Russian ruble.The currency addressing costly was backed by foreign- Figure 1.1: Real and Nominal Effective Exchange Rate - policy and "behind- (lode= ZOO2 100) exchange reservesand some the-border barriers 160 " US$250 million in 150 ?. Nominal Effectlve Exchange Rate to trade. International Monetary 140 1 Fund(IMF) loans. Until 8 ' 130 A` November 1998, the leu 120 I\. Real Effective Exchange Rate ~ A was stable against major 1I O 100 3 currencies, appreciating in 90 V real effective terms between 80 b--' I 1994 and 1997. After the 70 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 devaluation of the Russian SOYIE~ NmonaI Bankof Moldova and IMP data rubleinAugust 1998, the leu's relative stability came to an end inthe face o f intense speculative pressure and the outflow of capital. InNovember 1998, the centralbank stopped supportingthe currency and the leu depreciated rapidly throughout the remainder o f 1998 and into 1999, losing almost 20 percent of its value inreal effective terms. Since the beginning of 2001, the leu has experienced a gradual depreciating trend, reflecting largely the real depreciation against the Russianruble. Inmid-2003, the central bank tightened monetary policy, moderatingits foreign exchangepurchases, inorder to slow the rapid growth indomestic credit and inflation. With the continuedinflows of workers' remittances, this change in policy will likely leadto the further appreciation of the nominal andreal exchangerate. To offset the negative impact on overall macroeconomic competitiveness, domestic firms will need to reduce costs andundertake productivity-enhancing measures. The Government can contribute to improved competitiveness by addressing costly policy and "behind-the-border'' barriers to trade. The real exchange rate measures acountry's competitivenessposition resultingfrom changes inthe nominal exchange rate and domestic costdprices relative to its tradingpartners. Generally, the comparisonof relativeprices canbebasedon consumer prices, producerprices, GDP deflators or unit labor costs. Many studieson competitivenessfavor the use of unit labor costs because it reflectsboth changesinproductivity and wages. Unfortunately,a consistenttime-series of aggregate unit labor costs is unavailable inMoldova. As a substitute, the consumerprice index is usedsince it allows for easy comparabilitywith other countries. 6 Box 1.2. Transnistria The economyofTransnistriahas registeredaspectaculardecline since the early 1990swith living standards deterioratingevenmorethan that experiencedonthe right bank ofthe Nistruriver. The economicpoliciespromotedinTransnistriahavebeenvery different from those inthe restof the country. While Moldova was pursuingeconomic liberalization, albeit ina somewhat stop andgo fashion, the separatistregime inTransnistriahas vigorouslyresistedeconomic reforms. With its long porousborder with Moldova, Transnistriahas hadamajor impacton bothforeign anddomestictrade of the RepublicofMoldova. It is the commonperceptionthat Transnistriahas become a`big trans-shipmentcamp'for cigarettes,oil products, liquor, andother smuggledproducts. This illegal trade i s believedto not only benefitthe Transnistriaregime, but also businessesfrom Moldova andneighboringcountriesthat use Transnistriaas ameans of avoidingMoldova's Customs andTax authorities. Indeed,the existenceof such trade, andthe perceived lossto the Moldovan budget, has beenanimportantelement ofthe Moldovanauthoritiesreluctance to ease administrative controlsover trade. Thoughit is difficult to give an exact estimationofthe size of the smugglingphenomenonand its impacton the budget, its order ofmagnitude is suggestedby Transnistria'strade indicators. Over the last three years the Transnistrianeconomyhas beenregisteringan extremelyhigh degree of openness - 4 times higher than inMoldova. For some keyproducts, Transnistrianimportsvastly exceed internalneeds. Solutionsadoptedto prevent illegal activitiesthroughtheboundaryhaverelied on the cooperationofMoldova's neighbors. Upuntil2001, MoldovanauthoritiesallowedTransnistriato use Moldovan customsstamps andissue Moldovancertificatesof origin for the Transnistria's exports. With Moldova's accessionto the WTO in2001, however, new customsstamps were introducedand, two years later, an agreementwas reachedwith Ukraine, accordingto which goods from Transnistria couldbe only be importedifthey usedofficial Moldovandocuments(which also impliedthe registrationofTransnistrianexporters with the MoldovanRegistrationChamber). This had a serious impact on Transnistria'sextemaltrade andresultedinsignificanteconomic losesfor the region. In reaction, the separatist regimeintroducedacustomfee of 100percent for all importsfrom the right bank. Resolutionofthe Transnistriaissue would eliminateamajor sourceofpolicy distractionand Formal and informal permitgreater investmentandpolitical stability. While the government of Moldovahasplacedthe impediments to resolutionofthe Transnistriaconflict at the top of its political agenda, the integrationof the two business and trade economiesremains adistantprospect. Economic reformsinMoldovathatresultedinstronger make Moldova less economicgrowth andpovertyreduction,however, would providean impetusto furtherpushthe attractive toforeign political processtowards resolution. investment and Source: "Research Paper on Transnistria", Center for Strategic Studies and Reforms, November 2003. reduces the ability of firms to take 1.8 Average Wages. The cost and productivity of labor also plays an important role advantage of low indetermining acountry's competitiveposition, particular withrespectto foreign wages and investors interested inlabor-intensive industries. Average wages for bothskilled and participatein global unskilledlaborhave increased considerably since 1995, albeit from avery lowbase. In production networks. U S dollar terms, the average monthly wage paidto skilled workers increased from $55 dollars in 1995, rising to $92 dollars in 1998. The impact of the large devaluation against the dollar drove down wages indollar terms andby 2002 average wages had only risen backto $87. The trend inwages paidto unskilledworkers follows a very similar pattern. Low wages, an educatedpopulationandproximately to Europe could make Moldova an attractive location for firms seeking to take advantage of these resources. Formal and informalimpediments to business and trade, however, make a country less attractive to foreign investment andreducesthe ability o f firms to take advantage of Moldova's low wage rates inorder to participate inglobal production networks. 7 Table 1.2 Real and NominalWages, 1995-2002 1995 1996 1997 1998 1999 2000 2001 2002 RealMonthlyWages (Index) Skilled Worker; 100.0 107.8 118.3 132.9 123.0 124.4 131.6 150.9 Unskilledand Semi-skilled Workers 100.0 98.6 97.8 100.9 84.7 81.9 97.1 116.0 NominalMonthly Wages (in US$) Skilled Workers 55 72 88 92 60 68 76 87 UnskilledandSemi-skilledWorkers 30 36 40 38 23 24 31 37 Source: Moldova DepartmentofStatisticsand author`scalculations Creating a good MOLDOVA'S BUSINESSENVIRONMENT4 business environment is a key 1.9 Creating a good business environment i s a key aspect of the transition to a market aspect of the economy. A good business environment encourages entrepreneurial activity, job transition to a creation, and economic growth with positive implications for poverty alleviation. market economy. Similarly, a good quality businessenvironment fosters domestic investment and, all else equal, makes a country more attractive to foreign investors. A good business 1.10 A goodbusiness environment has many dimensions. Iti s linkedto the quality of environment has a country's public and private institutions, government policies and legal andregulatory many dimensions. frameworks that protect property rights, enforce contracts, and provide other public goods that are needed inamarket economy. A sound business environment depends on the integrity o f public and private agents and the control of crime and corruption. It requires political and economic stability, a level playing field among marketparticipants and a tax systemthat i s universally applied and not undulydistortionary. Effective infrastructure and a well functioning financial sector are also important considerations. 1.11 A number o f surveyshave been undertakenrecently to assessthe quality ofthe Moldova business environment. The Business Environment and Enterprise Performance Survey consistently ranks (BEEPS) asks enterprises to evaluate economic governance and state institutions and to behind other countries on several assess how the functioning o f the state, physical infrastructureand financial institutions critical aspects affect their business operations. As the BEEPS survey indicates, shown inFigure 1.2, related to a Moldova consistently ranks behindother countries inthe CIS, and considerably behind conducive the Central and EasternEurope and SoutheasternEurope, on several critical aspects investment climate. related to a conducive investment climate. Policy uncertainty clearly leadsthe concerns o f Moldovanenterprise managers. More than 80 percent of managers are concerned with macroeconomic and microeconomic (regulatory) policy uncertainty. Tax rates, tax administration andthe access to and cost o f financing also rank among major constraints. Nearly 60 percent o f firms identified corruption as a major or moderate constraint and, related to this, 58 percent of managers identified business licensing and operating permits as an important constraint to doing business. Moldova's business environmentis reviewed extensivelyin the InvestmentClimate Assessmentfor Moldova, World Bank, March2004. 8 Much more remains 1.12 Lookingat the perceptions of entrepreneurs inmore detail, it becomes clear that to be done before administrative barriers are the number one constraint. While there have beenrecent Moldova can match improvements inthis area, registering a new business is still cumbersome, and licensing the standards of the remains one o f the most restrictive among transition economies. Similarly, while the advanced transition duration and cost o f inspections have come down, the frequency o f inspections has countries - increased. While the BEEPSand complementary "Cost o f Doing Business surveys Moldova 's suggest that the business environment has shown some recent improvements, muchmore competitors in the global production remains to be done before Moldova can match the standards o f the advanced transition networks. countries -Moldova's competitors inthe global production networks. The remainder o f this study explores a number o f trade specific areas-customs administration, standards and conformity assessment, financial services, transportation and logistics and telecommunications - and makes specific recommendations for changes inthose areas that would positively improve the business environment. Figure1.2. Perceptionsof the BusinessClimate Financing Corruption Source: Business Environmentand EnterprisePerformance Survey, 2002 9 CHAPTER2. TRADE AND POVERTY: EFFECTIVE ACTIONS INMOLDOVA CANBRINGLARGEREDUCTIONS INTRODUCTION Tradecanplay a key 2.1 The linkages between trade andpoverty indevelopingcountries have been role in reducing extensively investigated and a consensus has emergedthat trade can bebeneficial for poverty, especially some individuals while at the same time beingharmful for others. Whereas integration in small open into world markets providesnew opportunities for growth and higher welfare, trade economiessuch as liberalizationmay also bringabout new risks and increasedpoverty for some. It i s Moldova, but trade therefore important to identify the winners and losers from trade liberalizationand to can also bring new quantify these gains and losses. This i s particularly relevant inMoldova, a small open risks and lower economy vulnerable to changes inexternal conditions. welfarefor some. 2.2 There are a number of channelsthrough which trade can have an impact on poverty. Trade causes prices to change, thereby generating changes inthe welfare (real income) o f the household by affecting: Consumption expenditures. Trade liberalizationmay bringdown tariffs on products, such as food, causing prices and, consequently, poverty to decline. Trade liberalizationtypically leads to differentprice changes for different goods and varying impact for households who consume diverse bundles o f goods and services. To study these effects, the chapter looks at the different consumption Tradeaffects patterns o f Moldovan households at different levels o f income. households through The value of goods and sewices produced within the household. These own- changes inprices, which affect production effects of trade refer to the changes inhouseholdincome that are consumption brought about by changes inproducer prices. Highertrade-induced prices for expenditures,and by some goods (for example, agricultural inputs) cause welfare gains for households affecting wages and that are net producers o f these goods, and losses for households that are net incomes. consumers. To deal with these impacts, the present chapter examines the importance of own production as a source o f income o f Moldovanhouseholds and investigates how the value of own-production is affectedby trade. Incomesfrom employment outside of the home. Trade liberalization causes some sectors to expand and others to contract. Expanding sectors will demand factors o f production (skilled labor, unskilledlabor, land) indifferent proportions from those usedinthe contracting sectors. Factor prices, particularly wages, will therefore adjust. As a result, the income o f Moldovanhouseholds will change depending upon their different factor endowments. This study examines the impact o f trade on labor income and on cash agricultural income. Transfers eitherfrom government orfrom private sources. Trade can affect both the capacity o f the government to provide transfer within the economy and flows betweenprivate individuals, bothwithinthe country and from outside. 2.3 Trade liberalization will also affect householdsifit has an impact on the rate of economic growth. The expansion o f those sectors benefiting from trade will require labor (and other factors) and, as a result, sectoral employment will increase. This provides new opportunities for substantial welfare gains. There i s a substantial, although contested, body o f work that suggeststhat trade plays a major role ineconomic growth. While this chapter highlightsthe importance of economic growth to poverty alleviation inMoldova, simulations o f the impact of trade on poverty concentrate on the static effects on consumption and incomes. 10 Trade liberalization also has an effect on 2.4 Itis important to note that the trade-poverty linksare influencednot only by poverty by allowing formal trade policies, such as tariffs. While, as shown inChapter 4, formal trade policies for a higher rate of are fairly liberal, with relatively low tariffs and formal export barriers, trade is economic arowth. constrained by arange of informalbarriers inMoldova. Cumbersome and restrictive customs procedures, corruption, burdensome and inappropriate regulations, such as those V'hileformal trade relating to product standards, and hightransport costs all act to raise the prices of traded policies in Moldova goods and have implications for poverty. This chapter seeks to assess how areduction in arefairly liberal) it these constraints upon trade may influencepoverty inMoldova. Many of these factors is likely that the wide array of constrain exports as well as imports. However, since exports are also affected by the informal barriers to policies implementedinoverseas markets, it i s necessaryto consider how improvements trade have important inoverseasmarketaccesswill impactthepoorinMoldova. implicationsfor 2.5 The analysis is basedon simulationexerciseswhichlinkestimated changesin poverty. prices, predictedexpansion of particular sectors and other relevant changes, brought about by the integrationofMoldova into world markets, with changesinconsumption and income for households. The basic data input for this exercise was information obtained on the structure of consumption and the sources o f income for different household groups inMoldova.Beforediscussing the poverty simulations, the maincharacteristics ofthis data on poverty inMoldova are briefly presentedhere. POVERTY INMOLDOVA5 Poverty in Moldova 2.6 There are two distinctive features of poverty inMoldova: it is widespread, deep is widespread and and closely relatedto growth inmean consumption. Figure 10.1 shows the trends in deep, Despite a poverty and the rate o f growth of per capita GDP from 1997 to 2002. Froma poverty rate significantfall in the (head count ratio) of : number ofthe poor 47.4 percent in 1997, Figure 2.1 Poverty and GDP Trends 1997-2002 since thepeak poverty reached apeak 2o during the Russian o f 71.1percent in 1999. 80 crisis almost half of Thisdramatic increase 5 -- 70 Moldovans still live in occurredat poverty .- 515 -I in poverty. the same time as the Russian crisis andthe -- 6o 2 10 severerecession that -- 504 &B -a: -- P period. During2001 characterized the s 5 - - 40 3 a h and2002, theeconomy $ o - -- 30 inMoldovagrew at 6.1 ~ 1997 2000 2001 2002 and 7.2 percent, -- 20 il 8 respectively, with -- -- 10 poverty declining to 3 -5 62.3 percent in2001 -10 ' ' 0 and 48.3 percent in Source. Beegle(2004) 2002 as a result. This recent experience suggests that growth and poverty are closely linked inMoldova. Hence, economic policies that promote growth are likely to have a substantial impact on poverty reduction. On the other hand, beinga small open economy also leadsto a degree The datacomes from the MoldovaHouseholdBudgetSurvey (MHBS), conducted monthly since 1997, and i s designedto berepresentativeof the populationof the country (excludingTransnistria). Using a slightly different methodology, the authorities estimatethat the povertyratehas continuedto fall in 2003 to about 37 percent of the population. 11 o f vulnerability to changes inexternal conditions, as shown by the impact of the Russian crisis onpoverty rates from 1997 to 1999.This suggests that factors constraining the diversification of trade to a broader range of markets should be alleviated. 2.7 The geographical division of Moldova inthe HouseholdSurvey comprises large Poverty is highest incities, small other towns, andrural areas. Duringthe whole period, poverty inlarge cities small towns and was much lower than insmall towns andrural areas, with the highestpoverty rate then areas and observed insmall towns. In2001, for example, the head count ratio was 80 percent in lowest in large small towns, 64 percent inrural areas and 44 percent inlarge cities. In2002, after strong cities. Subsistence growth, the head count ratio was 28.1 percent inlarge cities, 62.2 percent insmall towns agriculture is an and 51.6percent inrural areas. The lower poverty rate recorded inrural areas, relative to important that in small towns, reflectsthe contribution of subsistence agriculture for food characteristic of consumption and employment opportunities. rural households. 2.8 Poverty inall regions increased from 1997 to 1999. Although the poverty rate in large cities was the lowest, it increased faster than inany other region. Inaddition, even though the country grew by 2 percent in2000, poverty insmall towns, as opposedto poverty inlarge cities and rural areas, continued to increaseduringthis year. 2001and 2002 finally brought about substantial poverty declines inall regions. 2.9 A key aspect ofthe analysis ofthe impact oftrade liberalizationonpoverty is the initial structure of household expenditures and sources of household incomes. Since different households have different consumptionbundles, a change inrelative prices will impact more on some households than others. Indeed, increases inprices of products that comprise a large proportion of consumptionexpenditure will tend to have a negative impact on household welfare, whereas households will benefit from decliningprices of Household the mainproducts intheir Table 2.1 ConsumptionandBudgetShares in 2002 expenditures in all consumptionbundle. Deciles regions are Lowest Middle Highest dominated byfood and beverages. 2.10 Table 2.1 summarizes the information on the structure of ~ , a ~ ~ ~ f ~ ~ e v e r a g e s 72.6 63.4 38.6 Ofwhich cash 65.7 55.7 32.7 householdexpenditures in2002 2. Alc beverages, tobacco 2.1 2.3 accordingto large cities, other 4. Housing 3. Clothing and footwear 2.61 2.3 12.7 9.2 15.4 15.8 towns and rural areas. Bv far. the 5. Transoortation 5.2 4 6 d 1 most important category of 6. Other'goods and services 9.5 12.8 24.5 expenditure, inall regions and for OtherTowns all deciles. i s food and beverages. 1, Food & Beverages 78.4 69.7 47 " Of which cash - 60.3 48.7 38.8 Households inthe lowest four 2. Alc beverages, tobacco 3 3.9 2.2 deciles inlarge cities spendmore 3, Clothing and footwear 1.5 4.3 10.1 4. Healthcare 1.2 2.8 8.9 than 65 percent of their budget on 5. Transportation 0.2 0.8 3.3 food. Insmall towns the averages 6. Other goods and services 7.5 9.6 21.7 are higher than 70 percent, and in 1.Food&Beverages Rural Areas 81.6 75.4 52.1 Of which cash 17.5 20.5 19.6 Tradewill areas, they are higher than75 2, AIc beverages,tobacco 4.6 5.7 3.3 primarily afect percent. Thus, trade Will primarily 3. Clothing and footwear 1.4 3.7 10.1 household affect household welfare in :;gits&d 4. Housing 6.4 6.9 17 0.6 1.2 2.8 we2fare in Moldovathrough its influence on, 5.4 7 14.6 Moldova consumption of food. Source: Household Budget Survey through its influence on 2.11 The table also shows the amount o f total outlays on food andbeveragesthat consumption of households report as beingpaid for incash, with the difference referringto in-kindfood food. expenditures. Most o f the expenditure on food andbeveragesinurban areas (Large Cities and Small Towns) i s incash, but a significant fraction comprises in-kindexpenses. 12 Incontrast,mostoftheexpenditure onfoodinruralareasisinkind,indicatingthatown- producedand bartered food items dominate consumption inthese areas. 2.12 Inpoor households,the only other importantcategory ofexpenditure is housing, a non-traded good that includes utilities and energy. Inthe bottom o f the distribution, There are significant average budget shares spent on housingrange from 9 percent to roughly 15 percent in differences large cities. Insmall towns, these shares are smaller, ranging from 9 percent to 12 between cities, percent, while inrural areas the averages are more stable at around 6 to 7 percent. towns and rural Expenditures on other categories, including alcoholic beverages and clothing and areas in the main footwear, are a small fraction of total outlays. source of income. 2.13 Table 2.2 reports the Table2.2 Sourcesof Incomein MoldovaHouseholds, The effects of average share of different sources 2002 international o f income o f Moldovan Deciles Lowest Middle Highest trade onpoverty households in2002, again Large Cities will be transmitted distinguishinglarge cities, small Non-agricultural production 0 2.6 2.2 mostly through towns and rural areas. The table Agricultural production 1.3 0.4 0.6 wages and the shows that there are substantial Income from employment 46.9 43.1 58.8 Pensionsand retirement 31 32.7 7.7 value of differences inthe main source of Other social security income 1 0.7 1.1 agricultural income indifferentregions. In Gifts 10.8 16.9 26 production. large cities, income from Other 9 3.7 3.7 Other Towns employmenti s the main source of Non-agricultural production 0 2.2 1.9 income o f the poor, while inrural Agricultural production 11.2 16 8.4 O fwhich: cash 1.9 2.9 2.6 areas the crucial source o f income Income from employment 46.4 42.6 48.5 i s agricultural production. In Pensionsand retirement 24.5 21.8 5.4 small towns, the poorest region, Other social security income 1.1 0.1 0.1 Gifts 13.1 14 26.5 income from employment i s the Other 3.7 3.3 9.2 most important income source. In RuralAreas all regions, income from pensions Non-agricultural production 0.1 0.4 0.8 Agricultural production 67.9 61.2 57.1 and gifts are important. This O f which cash 4.3 7.8 15.3 impliesthat the effects of Income from employment 8.8 7.8 12.3 Pensionsand retirement 14.5 22.4 9.6 internationaltrade on poverty will Other social security income 1.1 0.4 0.8 betransmitted mostly through Gifts 5.2 4.8 12.3 wages and the value o f Other 2.4 3 7.1 Source: Household Budget Survey agriculturalproduction. 2.14 Giventhe importance of income from employment as a source of income, it i s also important to look at differences inwages across sectors of economic activity. Ifthe adjustments following the liberalization of trade leadto a shift from higher-wage to lower-wage sectors then there will tend to be anegative impact onhousehold incomes. On the other handthere will tend to be a positive effect iftrade leads to an increase inthe number ofrelatively highlypaidjobs. 2.15 Exploitingthe panel structure o fthe HouseholdBudget Survey will reveal, in more detail, the reallocation o f resources from contracting sectors to expanding sectors for the main features o f the socioeconomic dynamics inMoldova. The survey i s a rotating panel, which means that some households are interviewed for several years (some for two consecutive years, others for four consecutive years). The approach i s to first look inmore detail at those households that moved into poverty between 1997 and 1999 and then to look at the fraction that changed socioeconomic groups. 2.16 The main conclusion drawn from Table 2.3 is that there are only mildtransitions across socioeconomic groups among those families that moved into poverty from 1997 to 13 1999. Perhapsthe most important dynamics are observed among the farmers in 1997 that tended to become workers inthe agriculture sector in 1999. There are also some wage- workers (inagriculture and non-agriculture) that became farmers, indicatingmovements towards subsistenceagriculture. Table 2.3 Dynamics of Movements into Poverty inMoldova 1997 - 1999 Socioeconomic group in 1999 Socioeconomic Farmers Employed in Employedin Self Pensioners Others group in 1997 Agriculture Non-Agriculture Employed Farmers 10 8 4 0 3 0 EmployedinAgriculture 12 54 4 0 7 0 EmployedinNon-Agriculture 8 2 72 1 5 1 Self Employed 0 0 6 2 1 0 Pensioners 2 5 5 0 90 0 Others 1 0 1 0 3 0 Source: Household BudgetSurveys 2.17 The second, look is at the dynamics ofthose households that movedout of poverty from 1999 to 2002. Table 2.4 shows that again there are only minor movements of households from one socioeconomic group to others. Indeed, most families tended to remain inthe same socioeconomic group in 1999 andin2002. However, there are some important movements of those that were employed inagriculture in 1999 towards farming activities in2002. It i s also interesting to note that the net effect o f movements towards employment innon-agriculturei s positive, indicating that there was a tendency among those escaping poverty to move to employment activities not relatedto agriculture. The lack o f significant changes insocio-economic groups as households bothenter and leave poverty suggestthat such movements may be very costly inMoldova and may take much longer than the short periodwhich has beenthe focus here. Table 2.4 Dynamicsof Movementsout of Poverty inMoldova 1999--2002 Socioeconomicgroup in2002 Socioeconomic Farmers Employed in Employedin Self Pensioners Others group in 1999 Agriculture Non-Agriculture Employed Farmers 26 3 6 0 2 1 Employedin Agriculture 31 23 9 0 I O 1 EmployedinNon-Agriculture 6 7 73 1 6 3 Self Employed 0 0 3 0 0 0 Pensioners 5 2 7 0 112 1 Others 1 0 7 0 1 2 Source: Household Budget Surveys The lack of THE POVERTY EFFECTS OFINTERNATIONAL TRADE significant changes 2.18 A number ofpolicy exercisesis now presented withthe aimof assessing the role in socio-economic of trade as apoverty reducing mechanism inMoldova.6 Since formal trade policies are group as households both enter and leave fairly liberal, the exercises start by consideringthe elimination of informal barriers to poverty suggest that trade inMoldova, such as, hightransport costs, cumbersome customs practices, such movements inappropriateregulations and corruption. What follows are estimates of the poverty maybe very costly in effects of each of these factors, a look at the poverty impacts o f improved custom Moldova. A more detailed discussionof the modelingapproachis providedinPorto, G (2004) "Informal ExportBarriers and Poverty" forthcoming Working Paper, World Bank. 14 practices on the import side, and then, an analysis of the poverty effects of reducing such costs associatedwith exports. 2.19 Imported Goods: Improved Customs Practice. This section covers the investigation of the effects of improving custompractices on the prices of imported goods and on poverty. Import procedures inMoldova are cumbersome and complicated and they impose a cost on importing firms. As a result, prices are higher for imported goods and poverty may be affected. Moldovan imports comprise mostly chemicals, fertilizers, machinery, energy and manufactures. A simulation exercise was performed whichinvestigated the consumption effects ofimproving customspractices on importsof consumer goods and energy. 2.20 For modelingpurposes, all goods were aggregatedinto a single import commodity with price pi. The domestic price o f this aggregate commodity i s givenby where pi i s the internationalprice of the goods, ~is the import tariff levied on these * i goods and ni i s a measure o f the transaction cost associatedwith import procedures. Accordingly, it i s assumedthat areduction inthe cost of importing can be modelledas a reduction inthe price of imports. 2.21 The first order effects on household welfare (real income) of improving import practices can be measuredby the product o f the budget shares spent on different importable goods and the inducedchange intheir prices. It i s assumedthat the prices o f the following goods are affected by the cumbersome custompractices: Clothing and footwear, energy, household operations and leisure related goods (entertainment goods such as TV's radio, etc.). Some food prices will also change andit i s assumedthat 10 percent (the food import share) of the total food expenditures i s affected by import prices. 2.22 The Cost of DoingBusiness Surveys were used, supplementedby a recent survey o f exporters and importers and importersto get an estimate of the cost of informal import barriers to trade inMoldova. This analysis suggests that the average transaction cost relatedto imports was equivalent to around9 percent o f the value of a shipment. This i s a large number. The most costly regulations are relatedto customs procedures, standards verification, tax administration issues, and ecological controls. Of lesser importance are the costs associatedwith bordertroops, the roadauthority, the border police, and sanitary and veterinary controls. 2.23 For the purpose o f the simulation, it i s assumedthat these costs are reduced ina way that the prices of imported goods decline, on average, by 4.5 percent. The poverty impacts of such a change inimport prices are inFigures 2.2. The curve representsthe average change inthe real income o f the household (measured as the product of budget shares and a price change of 4.5 percent) at different levels of per capita expenditure. Usually, averages by deciles are computed, as inTables 2.1 and 2.2. Here the averages are computed for the fullrange of income levels. By doing this, the poverty effects can be visualized across the entire income distribution. The averagesrepresent the changes in real expenditure, as a share o f initial expenditure, so that a welfare effect of 1means that household real income (expenditure) increasesby an amount equal to 1percent o f its initial outlays. InFigure 2.2, the vertical line representsthe poverty line, so that all 15 households to the left are considered poor and all households to the right are considered rich(or not poor). Improving customs 2.24 Figure2.2 suggests that improving import proceduresbenefits all households and tax procedures, across the income distribution. For poor families, the average gains are equivalent to less and other administrative than 1percent of initialhousehold expenditures. The curve i s upward sloping, especially factors that raise theafter crossing the poverty line, indicatingthat these impacts are relatively pro-rich. price of imports in Indeed, for the richest Moldovanhouseholds, the average gains amount to up to 2 percent MoId0vu would o f expenditure. Thisreflects that all families face the same price levels, butricher benefit all families spendahigher share o f their expenditure on the consumer goods beingconsidered households. There here. There are some positive effects due to lower prices on imported food (which tend would be a decline to benefit the poor more than the rich). However, imported food comprises a small in thepoverty rate fraction of total household food expenditures. Our estimates indicate that, fkom an initial from 48.3 to 47.6 poverty rate of 48.3 percent in2002, poverty would decline to 47.6. This impliesthat 0.7 percent. percent of the population, or slightly over 25,000 individuals, would leave poverty due to better import practices. Figure 2.2. Impact on Poverty o f an Improvement in Import Procedures 2 .-2 E - E .- C 01 m 1.5 cm cm m $n 1 3.5 4! 4.5 ! Source: Author's calculations log5I per capita expenditure 5.5 I 6I 6.5 I 7I 7.5 I 2.25 TheImpact on Poverty of Alleviating Export Constraints.Corruption, inefficient customs procedures, hightransport costs and inappropriate regulations, such as standards and requirements relating to repatriation of export proceeds, tend to raise the costs o f exporting, which inturn may influence prices, employment and wages, with a consequent impact on poverty. The investigation o f the impacts o fbarriers to exports on the income that households earn is presentedhere. Specifically, it i s assumedthat households supply inputsto exporting firms. Labor or raw agricultural goods usedinthe productionprocess (such as grapes suppliedto the wineries or apples suppliedto thejuice producers) are examples. It i s assumedthat trade barriers erode the net price receivedby exporters. In this sense, trade barriers are modeled as transaction costs with a formal treatment similar to an export tax. 2.26 For the modeling exercise, it is assumedthat the government reduces these barriers to export. This works to increase the net price of export goods. As a result, the exporting sectors expand and the demand for the inputsusedinthe sector (grapes, apples, labor) increases. This, inturn, causes an increaseinthe price o f the inputs, such as wages and the price of raw apcultural goods with an impact on householdincomes. 16 2.27 The costs associated with export barriers are again derived from the Costs o f DoingBusiness Survey and the exporter and importer survey carriedout for this study. The average reported cost o f the range o f barriers to exports, as a share o f the value o f a shipment, was 12 percent. The most important components were associated with tax administration, customs officers, road authority, standards verification, and veterinary and sanitary controls. Inaddition, the exporter and importer survey revealed that the average transport cost reportedby Moldovan exporters i s around 12 percent o f the value o f the shipment. It i s assumed that the costs associated with these export barriers are reduced so that the net price faced by exporters increases by 6 percent. Given a total cost associated with these export barriers o faround24 percent, the reductiono fprices by 6 percent could Wages and be generatedby a reduction o f 25 percent inthese costs. agricultural incomes 2.28 Initial results show that reducing the costs o f exporting has a positive impact on are sensitive to changes in export the labor income o f the household. When firms are able to realize higher prices for their prices. Factors, such product, they hire more workers, which tends to pushup wages. The response o flabor as inefficient income inMoldova to changes inprices i s found to be quite elastic (and statistically customsprocedures, significant) - a 1percent increase inthe price o f industrial goods causes wage income to which reduce the increase by 3.2 percenta7It i s estimated that agriculture income increases with export price received by prices, too. The response i s less elastic, around 2.5 percent, but still high. It i s also exporters in statistically significant. The interpretation, as before, i s that an increase inthe price pt Moldova will have causes firms to demand higher amounts on raw agriculture goods producedby the significant impact on household(such as grapes) and this drives up the prices o f agricultural inputs. household incomes. A dpercent increase 2.29 As noted above, a substantialproportiono f agriculturalincome and expenditure in prices received inrural areastakes place innon-cash form. Inthis exercise, itis assumed that the impact for exports o f higher prices on in-kindincome i s exactly compensatedby the effect on higher generates average consumption expenditures, and, therefore, only focus on the share o f income generated gains in the order of by cash activities. The impacts by incomelevel are shown inFigure 2.3. It is clear that 5percent of initial the effects o f reducing export barriers on income are positive at all income levels. For household householdsbelow the poverty line, a 6 percent increase inprices received for exports expenditure. This generates average gains inthe order o f 5 percent o f initialhousehold expenditure. These would lead to afall in povertyfrom 48.3 large effects are explainedby, first, the substantial increase inprices and, second, the high to 43.3percent, elasticities o f wages and agriculture income. Interestingly, the welfare effects increase equivalent to with income as they cross the poverty line and move upthe income distribution. This i s 200,000 Moldovans because the share o f labor income intotal household income increases as households leavingpoverty. become richer. The implications for overall poverty are that the head count ratio falls by 5 percentagepoints from 48.3 percent to 43.3 percent, equivalent to almost 200,000 Moldovans leavingpoverty. These are substantial impacts and point to the significant impact on poverty that could be achieved ifbarriers on exports inMoldova were to be reduced. It is also interesting to note that there are no losers inthis experiment. This i s an instance, then, inwhich all households are on the same side o f the market inthe sense that all o f them are net suppliers o f labor andraw agricultural inputs. 'These elasticities are derived using regressionanalysis and utilizing the monthly variation in the informationon sources of income from the Moldova HouseholdBudget Survey and the observed changes in prices. 17 Figure 2.3. Impact on Poverty o f Reducing Barriers to Export 10 .-.-C E8 0 0 m Cm cme m 6 n 4 3.5I 4I 4.5I log5I per capita expenditure 5.5 I 6I 6.5 I 7I 7.5 I Source: Author's calculations 2.30 Market Access in Developed Countries. Finally, the poverty impacts are examined, at the household level, of an increase inthe quantity of Moldovanexports as a result o f an improvementinaccess to European and RussianMarkets. This could follow from a reduction informal trade barriers, although, as noted earlier, tariffs and quantitativerestrictionson imports from Moldova are low inthe EUand Russia. It could also be the result o f a better standards infrastructure inMoldova that allows Moldovan producedproducts easier access to foreign markets. Improvements are modeled inmarket access as an increaseinthe labor income and agricultural income of Moldovanfamilies. The linkage is that better access to worldmarkets leads to higher demand for labor and agricultural inputs. As above, this leads to an increase infactor prices and household income. Inthe medium-run,there i s an additional important effect of market access. This i s relatedto the substitutioninproduction. Farmers employed insubsistence agriculture and inother own-production activities may shift to wage-labor and cash crops. This may bethe case becauseofhigher demand for labor or because farmers decide to sell their land and elect to work for a bigger farm enterprise. Since these mechanisms take time to take place, these effects are modeled as representingmedium-runand longruneffects. Improvements in As a consequence, it is assumedthat the share o fhousehold income originating incash- overseas market agricultural crops and inlabor markets increaseswith higher market access. access, together with the reduction of 2.3 1 This simulation shows that improvementsinoverseasmarket access couldreduce barriers to import andthe head count ratio by4.5 percentage points from 48.3 to 43.8 percent. Ifthis exports in Moldova, improvement inmarket access (with substitutionpossibilities inproduction) were to would reducepoverty occur together with efforts to reduce constraints on imports and exports, as discussed 37.4percent, above, there would be a large decline inpoverty, from 48.3 percent in2002 to 37.4 equivalent to 390,000 percent. This impliesa reduction inthe head count ratio of 10.2 percentage points, which Moldovans leaving i s equivalent to over 390,000 individuals leavingpoverty inMoldova. poverty. CONCLUSIONS 2.32 Since Moldova i s a small and open economy, factors that impinge on trade are likely to have a significant impact onpoverty. The simulations undertaken inthe.chapter show how policy initiatives which reduce the cost o f importing and exporting inMoldova and, which leadto easier access to overseas markets, could have substantial impacts on poverty, reducing those inpoverty by about 10percentage points. 18 CHAPTER3. TRADEAND FOREIGNINVESTMENT PERFORMANCEAND STRUCTURE: LIMITED DIVERSIFICATION CONSTRAINS FUTUREPROSPECTS~ INTRODUCTION 3.1 Upon independence,almost all of Moldova's exports and 80 percent of its Moldova was imports took place with other Former Soviet Union (FSU) countries. Trade representeda highly large share of domestic output with Moldova integrated into Table 2.1Trade inhods and Sewices the Soviet supplyingagricultural and agroprocessedproducts, p e r c e n t o fGDQ Union, trading as well as consumer durables and high-tech 1988 2003 over 100 mldova 102 136 resources -- and most consumer goods from the industrial inputs -- most notably primary energy defense systems, and importing almost all percent of its output. Armenia 126 90 rest of the Union o f Soviet Socialist Republics Azerbaijan 100 107 (USSR). As showninTable 3.1, Moldova's pre- Be l m s 118 154 independencetrade ratio was only exceededby Georgia 92 67 * Armenia and Belarus. Kazakhstan 58 93 3.2 The disintegrationof the Soviet Unionhad KyrgyzRepublic Russia 78 81 The a profound impact on the Moldovan economy and 47 53 disintegration of its external trade relations. Independence was Tajikistan 76 125 the Soviet Turkmenistan 85 94 * Union had a accompanied by a severe dislocationinthe trade Ukraine 74 110 profound impact and payments system, the establishment of a 71 78 on the complex and uncertain legal and regulatory * Uzbekistan 2002 Moldovan environment among the newly independent states &WM: WorldDeRhpWnt I d k t o and ~ Bilk& andSagen (1990). economy and its and trade restrictions(especially on exports) that, external trade among other things, ledto a dramatic decline intrade inthe 1992-1994 period. In relations addition, Moldova experienced a massive terms of trade shock - estimated to be at least 20 percent of GDP - as prices on previously subsidized importedenergy and exported agricultural and agroprocessedproducts adjusted to world levels.' Since export and import prices inthe Soviet Union were not market determined it i s difficult to precisely estimate the extent of the trade collapse inthe period immediately following independence.The order o f magnitudeof the decline intrade i s probably similar to the decline inGDP, droppingby more than 50 percent between 1991and 1994. Following this initial decline, however, trade has recovered and the trade to GDP ratio now stands at 136percent (Table 3.1). 3.3 Numerous empirical studies have shownthat the beneficial effects of trade and investment opennessare quite large. These studies indicate that countries which are more fully integrated into the internationaleconomy achieved higher rates of economic growth. Inpart, thisreflectsthe stronglinkbetweenparticipationininternationaltradeandthe transfer of technology andknow-how. Inthe case o fMoldova, however, there i s some The data used in this chapterreflect only officially recordedtrade flows. The poorquality of trade andnationalaccounts data complicatesthe analysisof tradepolicy and trade developments. Moldova has a large and flourishing "informal" sector meaningthat some economic activity is not includedinofficial statistics. This informal sector is quite large, with estimates of its size rangingfrom 30 to 50 percentof official GDP. It is also well known that CIS trade statisticshave a numberof flaws related to the under recordingof trade flows. Inthe caseof Moldova, these flaws are complicatedby the exclusion of economic activity and trade emanatingfrom Transnistria agateway for smugglinggoods into and out of - Moldova.For example in2000 the outsideworld reported trade flows with Moldova that was 50 percentlarger than those registeredby the Moldovan Customs department. Estimatedby consideringonly the increaseinenergyprices and assumingthat other prices increasedinline with inflation. See, Jonathan Walthers "Trade inNewly IndependentStates", World Bank, 1994. 19 concern that trade openness has not brought the expectedresults. Inpart, this reflects the fact that Moldova has yet to significantly diversifyits trade patterns away from its Soviet past. As discussedbelow, Moldova's exports are still concentrated ina few commodities and are still largely destined for the CIS market. As the remainder o f this study suggests, the concentrated direction andcommodity compositionoftrade reflects, inpart, anumber o f underlyinginformal trade barriers and impedimentsthat have inhibited diversification, Despitethe appearanceof a liberal "formal" trade regime, Moldova's trade openness i s not necessarily synonymous with liberal policy openness. Finally, utilizing market exchange rates to measure the ratio oftrade to GDP may give a misleadingpicture o f trade openness intransition economies." If, instead, the trade is compared to GDP measured at Purchasing Power Parity (PPP) exchangerates, the Moldova economy i s not a particular open one -in2002, trade i s less than 20 percent of GDP measured on PPP basis and it has been declining since independence." It i s still clear, however, for a small economy like Moldova, closer integrationinto the World economy and the rapid growth inexports must serveasthe engineofsustainablegrowth. OVERALL TRADE PERFORMANCESINCE 1995 Following the 3.4 Following the tumultuous period after independence, by the mid-l990s, initial shock of Moldovantrade started to gradually recover as relations with the original CIS markets transition, were reestablished and as new trade relations were made with other countries. Over the external trade 1994-1997 period, trade grew rapidly with exports increasing by 55 percent and imports recovered with increasingby more than 75 percent (inU S dollar terms). Moldova's export recovery was exports and fuelledprimarilyby the reestablishment oftrade relations with Russia. While most other imports growing stronglyfrom transition economies, particularly the Baltic Republics and the countries of Central and Eastern Europe, were redirecting their trade away from the FSUduring this period, 1995 to 1997. Moldovawas increasing its dependenceon the CIS and Russian markets. By 1997 the In theperiod CIS, primarily Russia, was the destination for 70 percent o f Moldovanexports. When the following the Russian financial crisis hit the region in 1998, Moldova experienced its second major 1998Jinancial trade shock. Inthe two year period followingthe crisis, Moldovan exports droppedby crisis, exports half, primarily the result of the 60 percent decline inexports to Russia. The significant and imports depreciation of the leu (see Figure2.1), combinedwiththe decline indomestic demand, dropped by hag ledto a similar sharp decline inMoldovan imports. Starting in 1999, 3.5 Inthe periodfollowing the Russianfinancial crisis, Moldovantradehas Moldovan trade experienced a secondround of strong growth driven, inpart, by economic recovery inits experienced a maintrading partners. Between 1999 and 2003, merchandise exports have grown, on second round of average, by about 18percent per annum while imports have increased even faster - strong growth. averaging 29 percent per annum over the same period. Growthinboth exports and major difference from the earlier period -- it i s geographicallybroader. Trade with non- imports has continuedto be strong in2004. This second wave o f trade growth has one CIS countries has grown more rapidly than trade with CIS countries. Barter transactions have also been practically eliminated-the share o fbarter intotal merchandise trade declined from 22 percent in 1995 to slightly more than 1percent in2002. Despite the rapid growth intrade, however, the level of exports in2004 have only just reached the peak levels obtained in 1997. lo forexample,EBRD,TransitionReuort2003. See, "ThechoiceofPPPratesforconvertingGDPintoUSdollarsisimportantbecauseMoldovaismuchricherwhen measuredin PPP rather than current market exchangerates. Consequently, the ratio of trade to GDP is lower at PPP rates than at marketratesbecause it eliminates the distortions innon-tradegoods. Oneway to interpret theseresults is in terms of the long-termtrade potentialofMoldova comparedwith its current trade levels. Inthe long term, the difference betweenGDP in PPP and current US dollars is likely to narrow. 20 Moldova has consistently (Figure3.1). Over the1995- been running 2003 period, the trade deficit Figure 3.1 Exports,Imports & Trade Balance, 1995-2003 large trade 2000 I , 80 deficits. averaged about 21 percent of GDP and has been exhibiting a deterioratingtrend. Thepre ~ andpost 1998trade deficits differ inone importantway - their financing. Inthe early part of the 1990s, the trade deficit was financed primarily through accumulation of 1995 1996 1997 1998 1999 2000 2001 2002 2003 external debt. Loans from Trade balance, % o fGDP - Exports .. ..Imports .+- IntemationalFinancial Source: IMFBalance o f Payments. DIRECTIONOF T A 3~2 predichaand~ealisedshares OfIntra-cIs TRADE Actualshare Predicted Actualshare o f inter- share ofinter- ofktra-CIS "Gravity 3.7 Usingso-called republic republic exports, 2003 " modelspredict "gravity" models", a large exports, 1985 exports,l985 that Moldovan numberof studieshavebeen ~ ~ ~ 97f i 27 ~ 18 tradefrows undertaken that explore how Azerbdjm 94 24 16 should be the normalizationof trade ~~1~~ 90 32 55 redirected away relations should alter the from the CIS ~ ~ ~ ~ 94 g i 20 ~ 50 towards theEU. geographical composition of Kazakhstan 90 27 23 trade of the transition KyrgyzRepublic 98 37 35 economies. Giventhe huge mldwa 95 26 54 size and proximity of the Russia 68 16 15 EuropeanUnion, it i s not Tajikistan 86 26 18 surprisingthat these models 91 22 42 predict that, absent any Ukraine 84 33 25 policy impediments, the Uzbekistan 84 26 44 trade flows o f transition economies shouldbe Note: Inter-republic exports incbhdthe Baltic states, whichare not the members of the CIS. However,the statisticaldiscrepancyis rather small. redirected away from the SOUYCS:a " k i et d.(1996), IMFDirectiom ofTrade Statistics. K Council o f Mutual Economic Assistance (CMEA) towards the EU. Indeed, as shown in Table 3.2 most CIS countries have undergone a massive reorientationof trade. For most of these countries, this adjustment has taken place very rapidly and by now, many o f l2Agravitymodelrelatestheleveloftrade betweentwo specific countries tothe sizeoftheirrespectiveeconomiesand the cost of shipping goods to each other. This cost may have been influenced by geographical distance as well as the cost of transport and any policy-related obstacles that hinder trade. 21 these countries are trading primarily outside of the CMEA region. Moldova, however, exports - much less than predictedby these models. Inthe chapters that follow, the along with Belarus, Turkmenistanand Uzbekistan, hasredirected its trade - particularly domestic and external reasons why this might be the case will be explored. Moldova, 3.8 Ascan be however, has seen from Table Table 3.3 Geopapllical Clomnpositionof Trade redirected its 3.3, Moldova's Avg.pwth Avggmowth trade much less exports remain 1995 1996 1997 1998 1999 2000 2001 2002 2003 1995-1997 1999-2002 Exports,mitUS$ 746 653 874 601 428 456 550 623 776 8% 16% thanpredicted highlydependenton 2 63% 69% 70% 70% S7% 59% 62% 56% 2% 14% 14% by these models Rusl the CIS markets. 48% 56% S9% SS% 44% 46% 45% 38% 40% 19% 13% UMne 8% S% 6% 7% 7% 7% 10% 10% 7% -10% 18% particularly Russia. Othtr 6% 8% 6% 7% 7% 7% 7% 8% 7% 1% 19% Although the share zz.15 37% 31% 30% 30% 43% 41% 38% 44% 46% -3% 18% 12% 10% 9% 12% 21% 21% 21% 22% 23% -2% 20% Exports remain o f exports going to Other bwia 14% 9% 6% 9% 8% 8% 7% 9% 11% -26% 25% highly these countries has 12% 12% 14% 9% 14% 12% 11% 14% 11% 19% 10% dependent on been declining since L n l m t s , id.US$ 841 1072 1171 1023 587 777 892 1038 1399 18% 24% the CIS markets 1997, when it CIS 68% 61% SO% 43% 41% 34% 38% 39% 42% 2% 25% olwRussla 33% 30% 28% 23% 26% IS% 16% IS% 13% 8% 7% reached it's post- U W 27% 24% 18% IS% 13% 14% 17% 20% 22% -5% 41% independencepeak Other 7% 6% S% S% 4% S% S% J% 7% -4% 43% norrCIS o f 70 percent, the 32% 39% SO% 57% 59% 66% 62% 61% S8% 47% 24% olw EU-15 14% 17% 19% 27% 27% 29% 28% 26% 28% 38% 26% CIS still remainsthe RorParia Othtr 7% 6% 8% 11% 14% IS% 10% 9% 7% 32% 4% 12% 16% 23% 19% 18% 22% 24% 25% 22% 6% 31% destination over 50 SOW: UNComtrade& t h e percent of Moldovan exports. The increase innon-CIS exports has beenmainly the result o f increased exports to the EU-15, with the share of exports to Romania and other countries exhibiting little overall change. The increasednon-CIS share was driven, inthe first instance, largely by the large drop intrade to Russia following the 1998 financial crisis. Since then, however, exports to the European Union (EU-15) have grown broadly inlinewith total exports, so that the share ofEUexports intotal exports hasremained relatively constant at about 21-23 percent. ThesigniJcant shft in the trade 3.9 The shift of Moldova's exports towards the EU- Table 3.4 Eqioi-ts to EU flows ofother 15 has not reached levels comparable with other "late @ercent ot total exports) "late reformers" suchas Bulgaria, Lithuania, Romaniaand 1995 2003 reformers" Slovakia. As showninTable 3.4, inthe later half of the Bulgaria 39 57 reflects both the 1990s, these countries dramatically reorientedtheir Lithuania 36 42 improvedpolicy exports andnow sendbetween one-half and two thirds o f M O h 12 23 environment of their exports to the EU-15 twice as much as Moldova. - these countries The reorientationis noteworthy given that Moldova is Romania 54 68 and the located inthe same geographical region and has a similar S l a g k i a 37 61 steadfast pursuit naturalresource end~wment.'~The significant shift inthe of their E U CIS, avg 19 25 aspirations. It trade flows o f these countries reflects boththe improved Source: IMFDirectionso f Trade. suggests that policy environment of these countries and the steadfast similar policy pursuitoftheir EUaspirations. It suggeststhat similar policy changes inMoldova, changes in combined with Moldova's reinvigorated EUaspirations, could have similar effects. Moldova could have similar 3.10 Moldova imports have undergone a much faster reorientation with the share of efsects. imports coming from non-CIS countries increasing rapidly since 1995. This patterni s similar to other transition countries. The share ofimports from the EUgrew very quickly inthe early and mid 1990sand by 2003, over a quarter o f Moldova's imports came from the EU.An equally important increase innon-CIS imports comes from the l3Withtheexception ofRomaniawhichhassomeoilreserves. 22 countries of Central and Eastern Europe. Within the CIS, the proportion of imports coming from Russia has declined dramatically while the share of imports coming from Ukraine has rebounded andnow exceeds Russia. COMPOSITIONOFTRADE 3.11 Modem trade theory suggests that Moldova's comparative advantage lies inits skilled and inexpensive labor force and the quality of its agricultural lands. With the globalization o fproduction, one would expect Moldovato increasinglyparticipate inthe production of products that employ labor intensive processes. Such production Moldova has integration has already taken place inthe Moldovan apparel indu~try.'~ European notyet been clothing producers supply materials and product specifications to the Moldova garment able to expand producers who, for their part, supply only manufacturingslulls and low cost labor. its participation Unlikemany other EasternEuropeancountries, Moldova hasnotyet been able to expand in the global production its participationin the global production chain to higher value assembly operations. This chain to higher study suggests that a number of domestic impediments, such as excessive delays in value assembly transiting Moldova's internationalborders as aresult of cumbersome and bureaucratic operations customprocedures, reduce the attractivenessof Moldova for these types of operations despite it's inexpensive andrelatively skilled labor force. 3.12 Inaddition Moldovan to being Table 3.5. Expoi-tcoiiceiilmtioii exports are also heavily geographically Nr.of commodities Export concentration Share ofithe three concentrated in concentrated, exported' inde? largest products3 afew product Moldovan exports 1995 2003 1995 2003 1995 2003 categories and are also heavily have become concentrated ina Bulgaria* 1114 1092 0.09 0.10 17.6 33.4 increasingly few product Lithuania 1080 1106 0.09 0.18 20.7 32.7 concentrated categories andhave MbldOWQ 763 597 0.13 0.30 39.4 53.3 over time. become Romania 982 10'31 0.12 0.12 31.3 34.5 increasingly Slovakia 1002 1162 0.09 0.18 18.3 27.1 concentrated over 11Numbero fp ~ ~ hatttsh fm-digit l e d(HS, 1988#2]; ma~imrUn 1300. 21H e f l & - H k c W index was calculatedaccord;lg to the formula time. As shown in Table 3.5, the share -&X-G $ 5 x = value o f exports o f product i o f the top three '-F 239 = " b a r o fproductsat the 3-d@ SITClevel export products in 31Three-digit level.App-1 ( v p 84 inSITC Fkv.2) ws consideredOIIS product. total exports has 411996year is presentedinsteado f 1995. increased from 39 Souues: UN Comtrade database to slightly over 53 percent between 1995-2003. Over the same period, the number o fproductsthat Moldova has exportedhas fallen, declining from 765 in 1995 to 597 in2003.15 3.13 Moldovanexports are dominated by wine, food products and apparel products. Wine i s the single most important export item, comprising28 percent o f total exports in 2003. Foodproducts make up about 27 percent of exports, with apparel contributing 15 percent o f exports. Since wine and food products are mainly exportedto Russia, these goods were particularly hard hitby the 1998 crisis. Inthe two-year period followingthe crisis, the value of these exports to Russia contractedby 56 percent. Even in2003, after four years of robust growth, total exports o f wine and food amounted to only 72 percent l4SeetheTextile CaseStudyinPartI1ofthis study. l5Definedas thenumberofnon-zero4-digit HSexportcategories. 23 of their pre-crisis level. Perhapsthe most noticeable trend inexports, as noted above, has been the steady growth of apparel exports to EU. These exports have grown at average o f 25 percent per year since 1998.As a result, the share of apparel intotal exports has increased from 3 percent in 1995 to 15 percent in2003. 3.14 While imports are dominated by energy, they are, ingeneral, more diversified While imports are dominated thenexports. Energyhasbeen the single biggest import itemthroughout the 1990s.The by energy, they share o f energy intotal imports, however, has beenconstantly declining and by 2003 had are, in general, fallen to 21percent of total imports, significantly below the 46 percent share recorded in more diversified 1995. Invalue terms, energy imports declined from 1995 to 1998 but have remained then exports. relatively constant since then. On the other hand, the import o f manufactures have been on the rise and replaced energy as the leading import group, reaching 30 percent of 2003 imports. Imports of food products and chemicals and fertilizers have also been increasing inbothrelative andabsoluteterms andaccountedin2003 for 14and 12percent oftotal imports. There is a 3.15 The commodity compositionof total trade disguises a significant difference signifcant between Moldova's trade with the CIS countries and its trade with the EU.In2003 ,for dzflerence example, wine exports made up about 27 percent of Moldova's total exports. However, between wine comprised only 0.9 percent ofthe exports going to the EUbutnearly 50 percent of Moldova's trade the exports going to the CIS. Similarly, while apparel exports comprised 15 percent of with the CIS total exports, they made up only 0.2 percent of exports going to the CIS but over 47 countries and percent o f exports going to the EU. As these examples illustrate, Moldova exports a very its trade with different product mix to the EUthan it does to the CIS. In2003, less than 10percent of the EU. the products being exported to the CIS are also exported to the EU. FOREIGNDIRECTINVESTMENT There is a need 3.16 Moldova, like many transition to increase both economies, inheriteda capital stock and Table 3 6 ForeignDhctInvestment the quantity and production methods and practices that, by (average, 1995-2002) quality of westem standards, are largely obsolete. There Yo ofGDP US$per investment as i s a needto increaseboththe quantity and capita well as acquire quality o f investment as well as acquire Bulgaria 4.4 70 technology and technology and design skills, production Lithuania 3.9 122 design skills, &fddO+'Q 4 8 I 8 production methods, plant management techniques and Romania 2.? 46 methods,plant market expertise. Foreigndirect investment Slovakia 3.? 233 management (FDI)can play a crucial role inhelping SmallCIS* 2.9 15 techniques and Moldovaovercome the legacy of its soviet era CentralCIS** 29 39 market capital stock. Not only does FDIincrease the * Arm&, Go& F!.epublic, Tajikistan expertise. level o f financing available for investment, it andUlkrkistan. provides a means for the transfer o f the most **Belam, Kazakhstaqh s i a andUkraine, modem and efficient technologies and Xource: WorldDevelopmentIndicatow techniques from westem firms. There is a growing body o f evidence that suggests these more modemtechnologies and techniques "spill-over" into the domestic economy, thereby directly and indirectly contributing to economic growth. The positive link between FDIand firm level productivity suggeststhat the ability o f Moldovato attract FDIinthe futurewill beakey determinant of economic growth. 3.17 Despite rising absolute FDIinflows, Moldovahas consistently ranked inthe bottom third of countries inEastern Europe and Central Asia interms of total cumulative direct investmentinflows and FDIper capita. Over the period 1995-2002, FDIflows to Moldova had averaged only US$18 per capita. By comparison, neighboring Romania 24 hadmanagedto attract inflows on the order of Table 3.7 Geographical Compositionof FDI US$46 per capita while Lithuania and Slovakia percent had experienced FDIflows 7 to 12times as large. Russia 22.9 Moldova has EU 32.9 consistently 3.18 The source ofFDIintoMoldova is quite incl, Great 6.4 ranked in the diverse and, to a large extent, reflects its trade Spain 6.2 bottom third of patterns (Table 3.7). Russia i s the single largest France 5.3 Germany 4.5 countries in foreign investor, holding almost a quarter o f the USA 10.0 Eastern Europe total stock FDI.The EUas a group accounts for a Off shorezones* 6.9 and Central third of FDI,with Great Britain, Spain, France and 3.6 Asia in terms of Germany, eachcontributing about 5-6 percent of 23.6 total cumulative Liechtenstein, cypnrs, Malta, Cayman Island total FDI. The USA is the secondlargest source I Source: NationalBa*ofMoldova direct investment for FDI,with a 10percent share of total FDI. The large share of FDIcoming from off inflows and FDI shore zones suggests that Moldovan investors might be seeking profit expatriation, fiscal per capita. benefits or additional legalprotection o f their investments that they would not receive as domestic investors. FDI is largely 3.19 As shown inTable 3.8, the Table 3.8 SectoralBreakdownof FDI concentrated in largest share of FDI, slightly less than percent Leading investors the energy and 44 percent, i s concentrated inthe energy Energy and water 43.9 Russia, Spain water sectors. and water sectors, with Russia and Spain Ago-processing 23.0 USA, Germany, Spain beingthe major players. Infact only two Commerce 12.0 Netherlands, USA Transport & communications 10.6 France, Netherlands The risks transactions, the Gazprom(Russia) Building industry 2.6 Greece associated with investment inMoldova gas and Union Hotels & restaurants 2.6 USA, Canada foreign Fenosaprivatizationof the three central Other 5.3 investment in and southern electricity distribution Source: Department of Statistics and Sociology, Moldova Moldova are companies, account for the biggestpart o fMoldova's FDI. Ago-processing has attracted currently vey about a quarter of all FDIwhile commerce and transport and communications are the high. The legal only other sectors that have receivedany noticeable amounts of FDI. and institutional environment for 3.20 FDImaybemotivatedby anumber ofreasons. Itmaybe "resource-seeking" in foreign the sense that FDIi s triggered by the availability ofnatural resources. It may also be investment does "market-seeking", with the aim of establishing a foothold to serve a local market because not appear to be of its size or growth rate or to overcome trade barriers. Since Moldovahas little inthe conducive to way of naturalresources and lacks market size, its attractiveness to FDIi s determined large inflows of primarily by the ability o f foreign investors to take advantage of local assets, such as foreign capital. skilled or inexpensive labor, to achieve efficiency gains. IfMoldova is to 3.21 The risks associatedwith foreign investment inMoldovaareperceivedto be very enjoy the high.The legalandinstitutional environmentfor foreign investment doesnot appearto be economic conducive to large inflows o f foreign capital. There i s little stability inthe range of bene$ts of FDI, legislation affecting investment inMoldova and the implementation of rules and it mustprovide regulations often causes substantial problems for enterprises. The cost o f operating in a stable legal Moldova i s also influencedby the local barriers that raise the cost of imported inputs, the framework and ensure that high cost o f capital, the lack o f adequate infrastructure and services, and the highcost of regulations are the regulatoryburdenimposedby the government. The experience from the countries of applied in a Central and Eastern Europe and the Baltics suggests that the extent and breadthof the transparent and reform effort i s a key factor to attractingforeign capital. IfMoldovai s to enjoy the predictable economic benefits o f FDI, it mustprovide a stable legal framework and ensure that manner. regulations are applied ina transparent andpredictable manner. 25 Box 3.1 Moldovan Market Share Overall, since Moldova is a small country, its marketsharesinthemain Table 3.9. &Iolclova &I;u.ket Share export markets is insignificant,ranging 011Pdaior Exuoi-tMarkets fromameager 0.006 percentoftotal (Moldwans k o f totalimports) EUimportsto about 0.7 percentof Russiaimports. With the exception of 1996 2003 Romania,where Moldova presencehas MQ - - 1.4 0.7 declinedsignificantly, Moldova -wine (1121) 62.5 40.3 positioninthesemarkets changedlittle -spirits andliquors (1124) 22.9 8.8 since 1996. While overallmarket share i s expectedlylow, some specific -tobacco (12) 3.7 1.2 Moldovanproductshold a sizeable w i n s - - 0.4 0.3 share ofthe Russian, Ukrainian and -wine (1121) 14.8 63.3 Romanianmarkets. Moldovan wine, for example, hasa significantand -glass containers (6651) 0.5 34.5 growing marketshare ofboth the - refined sugar(06 12) 0.0 31.O Russianandthe Ukrainianmarkets Eu .' .' despitethe significantcontractionof 0.1 -thisinexpensiveMoldovanwineshave marketfollowing the Russiancrisis -aPPare1cx9 -nuts (0577) 0.3 0.x survivedbetter onthe Russianand -juice (05x5) 0.x 0.2 Ukrainian markets then their more R ~ H ~ Q R ~ Q - - 0.7 0.3 expensive competitors.Moldova -sunflower oil (4234) 12.1 98.O succeededinbuilding a significant presence on the neighboringRomanian -glass containers (6651) 32.6 21.4 marketsinproductsthat where barely I/ datainsteadof2003 2002 traded in 1996,such as, sunfloweroil. Numberinbrackets denotes SITC classification Unfortunatelyit couldnot hold its ..zero or insignifhlt leadingposition inthe fast growing market for glasscontainers. InUkraine Source: UNComtrade database glass container exports performedmuchbetter andcaptureda significantpartof amuch-reduced market. The same is true for refinedsugar. As canbe seen from Table 3.9, Moldova's presence inEUimportsis extremelysmallbothoverallandinthethree largest exportitems:apparel, nuts and fruit juices. Moldovahas succeededinincreasingits share inthe apparelandnutsmarkets, buthas lost grounds inthe fruitjuice market. 26 CHAPTER 4. DOMESTICTRADE POLICIESAND REGIONALAGREEMENTS: FORMALSTRUCTURES UNDERMINEDBYWEAK IMPLEMENTATION INTRODUCTION Moldova has a 4.1 Duringthe decade since independence, Moldovahas moved from a very very liberal restrictive to a liberal statutory trade regime. The 1993 Moldovanimport tariff schedule statutory trade includedrates o f up to 300 percent. These rates were doubled for the non-Most Favored policy regime. Nation (MFN) countries. Exports and imports were also severely restricted by non-tariff However, in measures, such as pervasive licensing, quotas, and state trading. Inaddition, there were practice, the wide-ranging price controls inthe domestic market and foreign-exchange restrictions. way that trade and other 4.2 Moldova drastically liberalizedits trade regime inthe midand late 1990s and policies are joined the World Trade Organization (WTO) inJuly 2001. Moldova's current trade implemented in regime is rankedby the JMF as a "one" (the most liberal) on a ten point index o f the Moldova restrictiveness o f formal trade policies.16 However, the way trade policies and other creates policies, which impact on trade flows, are being implemented, i s creating substantial substantial barriers to imports and exports. barriers to imports and 4.3 The challenge for Moldova i s to address the range factors that unnecessarily raise exports the cost o f undertaking trade inMoldova and to create an environment for trade that i s conducive to growth, economic development andpoverty reduction. This needs to take place inconjunction with efforts to ensure consistent application o fWTO requirements, especially those regardingthe protection o f intellectual property, customs valuation, sanitary, phytosanitary measures and technical barriers to trade. Further, Moldova would benefit from the more effective implementation o fregional trade agreements, which are currently underminedby uncertainty and extremely weak formal dispute settlement mechanisms. THE MOLDOVANTRADE REGIME The average 4.4 When Moldovajoined the WTO, the maximumbound rate agreed to was 35 per import tariff in cent. This level o f bindingi s relatively low compared to other countries at a similar level Moldova is o f development but i s highrelative to more advanced developing countries and to relatively low. developed countries. Negotiations on market access at the WTO, such as those that are However, the taking place under the current Doha Development Round, typically concern reductions in import tariff has the bound tariff rates. become more complex in 4.5 As is typically the case, the tariffs that Moldova currently applies are muchlower recent years. than these boundrates. The 2003 tariff schedule has 14tariff rates inthe range o f zero to 25 per cent, with the majority o frates inthe lower brackets, leading to a simple unweighted average tariff o f 6.5 per cent - 10 percent for agricultural goods and 4 percent for industrialgoods.17The weighted average tariff i s 4.6 percent. Table 4.1 shows that the average applied tariff inMoldova i s low compared to other countries in the region and i s similar to that applied by advanced countries such as the Czech Republic and the EU. l6Only 27 of 183countrieshavebeenassignedthis rank. "Thisisbasedonadvaloremratesonly.AccordingtotheIMFArticleIVstaffreport,theaverageduty,includingspecific duties (which are applied toproductssuchas tobaccoand alcoholic drinks), is 6 per cent. 27 Thecurrent tariff 4.6 While the average tariff, and the schedule is more low level of dispersion around that tariff, Table 4.1: Comparisonof AverageApplied complex than the compares favorably with other countries in Tariff Rates one applied in the the region, the current tariff schedule i s Country Simple average late 1990sand the more complex than that previously applied tariff, percent wider range of inthe late 1990s, which hadonly 4 ratesof Moldova(2003) 6.5 tariff rates has Azerbaijan (2002) 14.1 0, 5, 10 and 15 per cent. Tariffs have been increased the Albania (2001) 8.6 administrative recenlty increased on a number of products, Bulgaria (2001) 12.1 burden in such as finished textile products, Czechand Slovak applying trade agricultural commodities and processed CustomsUnion(2001) 5.9 policy and foods, up to rates of 35 per cent. These Estonia(1998) 0.0 collecting tariff changes, however, have not affected the Hungary (2001) 8.8 revenue. overall averge tariff rate. The current Poland(2002) 12.0 approach to tariffs has anumber of Romania(1999) 24.2 disadvantages. First,the wider range of Slovenia (2002) 11.2 tariff rates increasesthe administrative EuropeanUnion (2001) 4.7 Source: UNCTAD -TRAINS database burdeninapplying tradepolicy and collecting tariffrevenue and i s not effective inpreventing smugglingand corruption. A given amount of tariff revenue 4.7 Ingeneral, for a smalleconomy suchas Moldova, agiven amount oftariff will be more revenue will be more efficiently collectedthrough a small number o f tariff bands. efticiently Second, economic analysis tends to favor simple uniformtariff structures.'* Third, collected frequent changes to the structure oftariffs introduces a degree ofuncertainty that may through a small constrain trade. Similarly, while maintaining boundrates significantly above applied rates number of tariff provides for a degree of flexibility, it also sustains uncertaintyabout future appliedrates. bands Developedcountries tend to have lower bound rates with little, ifany, gap between those rates and the rate actually applied. 4.8 Nevertheless, the fact that current rates are substantially below bound rates impliesthat a conclusionto the Doha development roundwill have only a limitedimpact on the tariffs appliedby Moldova. This i s becausethe formulas that have been proposed for reducing tariffs (as contained inthe drafts from the Cancun meeting) are non-linear and act to reduce high tariffs proportionately more than low tariffs such as those applied inMoldova. 4.9 A further reason for maintainingfairly uniformtariffs is to avoid an escalating tariff structure. Typically counties impose higher tariffs on finishedproducts than on Tariff imported inputs to provide higher levels of effective protection for producers o f final differentiation goods. For example, the EUapplies zero duty to imports of cotton but relatively high has actually led duties to cotton fabrics and cotton clothing. The degree of protection offered to textile to de-escalating and clothing firms would be lower ifthey had to pay a duty on their imported input.This tariffs with raises substantially the pricespaidby consumers for these final products. higher duties on raw materials 4.10 InMoldovaitappearsthat tariffdifferentiationhasactually ledto de-escalating and tariffs with higher duties onraw materials and unprocessedproducts than on finished unprocessed goods. The average tariff rate on primary products i s around 11per cent whilst that on products than semi-finishedproducts i s 3.4 per cent andthe average dutyon finishedproducts i s 5 onj n i shed percent. This suggeststhat producers o f final products inMoldovawill find it more goods. difficult to compete with foreign producers inthe domestic market since they will be '*DavidTan inDevelopment, Trade, and WTU:A Handbook, The World Bank, 2002 (Chapter 52) concludesthat "there is little economicjustificationand there are many dangers inprovidingdifferentiatedtariff protectionto various sectors of industryand agriculture." 28 paying more than the worldprice for their inputs.Further, inthe absence of an effective duty drawback system, exporters who use importedinputswill be disadvantagedwhen competing inoverseas markets. The reductionof the higher duties onprimary products would lead to a more coherent structure of protection inMoldova. Theproposed 4.1 1 Further,ifsome ofthe primary products that are subject to relativelyhighduties change to the enter directly into consumption baskets, as would be the case with food, then this tariffstructure outcome o f the tariff structure could have strong negative implications for urban poverty. could have The average tariffs on agricultural products are 12.3 percent for products of animal origin, strong negative implicationsfor 10.6 percent for products of vegetable origin, 8.2 percent for fats and oils, and 10.8 urbanpoverty. percent for prepared foodstuffs, significantly higher than the 6.5 percent overall average import tariff. The current 4.12 However, inpractice, many of these imported products will be coming from free tariff structure trade partners and therefore not subject to duties In2002,73 percent of importedprimary locks in the goods came to Moldova from the CIS (mainly Russia). However, it may be that without existing the dutiesthese inputscouldbepurchasedfrom lower cost andperhapshigher quality geography of sources inother countries. Inthis way the current tariff structure locks inthe existing the sourcing of geography o f the sourcing of raw imports from the CIS. raw imports from the CIS. 4.13 There are three basic customsregimes for importation and exportationin Moldova: import for free circulation; temporary importation for inward processing; importationinto a customs free zone or free warehouse. Inprinciple, customs duties and VAT are only levied on goods importedfor free circulation. However, these regimes have been subject to changes inregulations that have contributed further to uncertainty concerning the trade regimeinMoldova. Clarification and 4.14 The customs code of 2000 stipulates that, under the inwardprocessingregime, simplification of customs duties and taxes shouldbe collected and thenrefundedupon exportationof the the customs and exported goods. This effectively undermines the processing scheme andreplaces it with a fiscal codes with scheme analogous to a duty drawback system. The fiscal code also states that VAT on regard to inward imports for inwardprocessing shouldbe collected and then refundedupon exportation, processing would withthe exceptionof light industry(clothing). A list offirms exempt from payingVAT provide a more on imports i s determined by government decision. Followingthe letter of these codes, the stable Government Decision and Customs Department instructionsledto the establishment in environmentfor a early 2003 o f a duty drawback system for importsunder inwardprocessing. Perhapsin broader range of recognition of the problems that exist inobtaining a full and prompt return of VAT, there processing activities in was intense lobbying by inward processing companies and the system was amended. At Moldova and present, an inwardprocessing firmhas to conclude an agreement with the Customs would reduce the Department to obtain a waiver from paying duties and taxes. This system does not role of prevent the functioning o fthe inwardprocessing scheme for clothing butthe formulations government inthe Customs andFiscalCodes shouldbeamendedinorder to createamore stable discretion in regulatory environment to encourageprocessing ina broader range of industries. deciding which firms and sectors 4.15 Free economic zones. There are six free economic zones inMoldovatoday: are exemptfrom Tvarditsa, Taraclia, Vulcaneshti, Otaci, Ungheni, andtwo zones located inChisinau. The duties. first two zones established were Expo-Business-Chisinau (in 1995; later subdivided into two subzones) andTvarditsa (in 1996). The impetus for zone formation was to create business friendly enclaves ina hostile business climate. Early experience with the zones inChisinauandTvarditsa was negative: dueto poor regulations, zonesbecamea convenient means to evade taxes and duties. As a rule, new zones were anchored at bankrupt enterprises. The Government learnt from the early mistakes andthe current Law 29 on Free Economic Zones, developed incooperation with the IMF, provides a more solid basis for zone development. 4.16 Free economic zones enjoy special customs regime(customs territory): Goods for final consumptioninthe zone and goods originated from free economic zones and exported either abroad or to the customs territory of Moldova are exempt from customs duties. Sales from the zone to the domestic market, however, are limited at 30 percent o f output. They feature zero value-added and excise taxes, a 50 percent reduction of the profit tax, and a 10-year grandfathering provision for the firms operating inthe zones on the change of laws and regulations. A better 4.17 Despite the increase of the number of free economic zones over the last eight strategy of years from one to six, the small size o f these zones has limitedtheir economic impact. export development Moldovan free economic zones are currently generating only about three percent of total would be to Moldovan exports. The Govemment does not plan to increasethe number o f zones any overhaul the time soon, viewingthem as avehicle ofregional development anda demonstration tool national for abetter business environment. business environment 4.18 A World Bankreview of free trade zones concludes that they canplay arole in rather then economic development if"they are appropriately set-up, well-managed, WTO compatible create tiny inincentives, andusedas anintegratedpart ofanational liberalizationandreform enclaves with pr~gram".'~Nevertheless, analysis of the impact of such zones suggests that, ina small better country such as Moldova, a better strategy o f export development would be to overhaul conditions than the national business environment rather then create tiny enclaves withbetter conditions in the rest of the than inthe rest o f the country. country. IMPORTSAND TAX REVENUES Moldova has 4.19 Table 4.2 presentsdata on the taxation o f imports from 1999-2002. A few become observations are inorder. First,Moldova has become increasingly dependent on the increasingly taxation o f imports reflectingthe weak capacity for taxation of domestic activities. In dependent on the taxation of 2002, taxation o f importsprovided almost half of total tax revenues and this share was 50 imports. percent higher than in 1999. This inpart reflects the increase inimports over this period butis also due to weak capacity for taxation of domestic activities. 4.20 Second, taxation of imports i s the primary vehcle for collectingVAT and excise tax. Excises account for over a quarter of taxes on imports andVAT for 60 percent. Eighty-four percent of excise tax and 55 percent of VAT was collected from imports. From 1999to 2002, the share of VAT inimport taxation increasedwhile the share of excise tax inimport taxationdeclined. However, as the share o f excise tax collectedon domestic productionintotal tax revenues also declined, the share o f excises collected on imports intotal excise collection increased.As a result, the importance of import taxation From the intotal tax revenuesincreased. taxation viewpoint, the 4.2 1 Third, customs duties play arather minor role inimport taxation. In2002, small collection customs duties accounted for ten percent of total taxes on imports, although it increased of customs over this periodby two percentagepoints. The average effective import tariff rate duties does not (calculated as the ratio of customs duties over the value of dutiable imports) has been very justifj the low during the whole period, fluctuating between 1.3 and 3.5 percent. Fromthe taxation administrative complexity of a viewpoint, the small collection of customs dutiesdoes notjustify the administrative highly detailed complexity of a highly detailed and variable import tariff schedule, which creates and variable incentives for commodity misclassification at customs, fuelling the scope for corruption. import tarif ~ ~~ schedule. ''Madani, D. "A Reviewof the Role and Impactof ExportProcessingZones", World Bank, 1999 30 These givenrevenues from import duties would be collected more efficiently with a more simple and uniformtariff. Table 4.2: Moldova: taxation of imports, 1999 - 2002 (Million MDL) 1999 2000 2001 2002 T o t a l tax revenues (Mil. 2,423 3,086 3,437 4,284 As percent o f total tax 18.3 21.3 19.8 15.4 VA?' 40.2 44.8 44.8 48.5 T o t a l taxes o n 34.8 39.8 40.8 44.4 Composition o f i m p o r t taxes (as percent o f total i m p o r t Custom 8.1 7.2 8.8 10.4 Excise tax on 34.2 33.3 34.3 29.1 V A T o n 1) 57.7 59.5 56.9 60.5 Share o f i m p o r t taxes in total collection o f the given tax Excise 65.0 62.1 70.7 84.0 VA?) 49.9 52.8 51.8 55.3 Average effective i m p o r t tariff rate, as dutiable 2) 3.1 1.3 2.7 3.5 Requirements for Net of VAT refunds. exports to 2, Dutiableimportsequals total importsminus imports from the CIS and Romaniaminus imports for inwardprocessing repatriate export (about 48 percentof total imports). Source: World Bank staff estimatesbasedon dataprovidedby the Ministry of Financeof Moldova earnings within a given timeperiod EXPORTREGIME can be very burdensome. 4.22 Although there are no constraints on foreign exchange, there do exist requirements for exporters to repatriate export earnings within a giventime period, which There are can be very burdensome. Inthe exporter survey carried out inthe course of this conflicting diagnostic trade study, 30 percent o frespondents said that they missedthe deadline for statements the repatriationo f export earnings at least once during2002 as a result of difficulties concerning refund getting payments from their customers. Late repatriation leadsto the levying of fines for to exporters of each day inexcess o f the deadline. Inaddition, as the chapter on the financial chapter VATpaid on indicates, there are costs of compliancewith this requirement interms of paperwork inputs. (imposed on domestic banks, not to mentionthe exporters themselves). TheMinistry of 4.23 VAT paidonbothdomestic and importedinputsis subject to reimbursement Finance suggests upon exportationo f finishedgoods. However, it i s difficultto verify how well this that slow refund is systemworks. The Ministryof Finance claims that there are no problemsassociatedwith not a major VAT refunds. According to the Ministry,the ratio ofnon-refunded export VAT as a problem, while a result of legalproceedings to actualrefunds stood at 3 percent in2000, spikedto 20 substantial percent in2001, and fell to 7 percent in2002. However, Moldovan Export Promotion number of Organization(MEPO) asserts that no more than 45 percent of export VAT refund exporters requests are beingsatisfied on a regular basis and the average time lag o freimbursement complain of late (typically, inthe form of offsets against other tax liabilities) i s about six months. refunds. Uncertainty over 4.24 The exporter survey showed that only 56 percent ofexporters actually applied for refund of VAT is a refundto which they were eligible. The responses suggest that the time between likely to constrain application and refundaverages 94 days, which slightlyexceeds the Ministry of Finance export activities. commitment to refund within 3 months. However, there i s considerable variation with some exporters reporting a delay o f up to a year. Hence, some firms are clearly being 31 disadvantaged by delays inVAT refunds and again uncertainty will act to constrain economic activity. Two-thirds of firms receivedrefunds inoffsets rather than cash. Exporters incur sufficient costs ofrefunddelays. According to the survey, the average reportedcost of delays i s equivalent to 9.5 percent of export earnings, which creates a considerable hurdle for exports. Therefore, the existing VAT refundmechanism creates considerable hurdles for exporters at least interms o f the highcost o f delays. REGIONAL FREETRADEAGREEMENTS (FTAS) 4.25 Moldovai s a participant ina number of free trade areas: the plurilateral CIS free trade area, consisting o f the former Soviet republics(withRussia andUkraine as the most important partners o f Moldova), the bilateral Romania-Moldova free trade area., and, most recently, bilateral free trade arrangements with six Stability Pact countries of South Eastern Europe. The CIS free trade area i s playing an extremely important role in Moldova's external trade absorbing over halfof the country's exports. The CIS free trade area Free trade 4.26 The CIS free trade area was established in 1992 and the two umbrellaplurilateral agreements with free trade agreementswere signed in 1992 and 1994. These agreementshave not been the CIS ratified by the Russianparliament and are not ineffect andhave been substituted with a countries are number ofbilateralfree trade agreementsamongthe CIS members. Moldovahas weakened by concludedagreementswith all CIS participants, except Tajikistan. The agreements arbitrary provide for duty-freetrade ingoods with potential exemptions (not specified inthe texts product of the agreements) and free transit of goods through the signatories' territories. The exclusions and agreementsexplicitly prohibit re-exports. There are provisions for contingency ad hoc use of protection (safeguards and anti-dumping). Moldovai s not currently subject to any anti- safeguard measures. dumpingmeasuresfrom its CIS partners. However, Russiaoften introduces safeguard measures directed towards non-members of Eurasian Economic Community (EURASEC). Moldova, although not a member of this Community, is generally unaffected. 4.27 Exemptions from the free trade regimeare introduced inthe Protocols to the above FTAs, which are elaborated annually by respective bilateral trade commissions. These exemptions are non-symmetrical. To date, the following exemptions from free trade apply: inMoldova-Russiatrade, Russiaexempts sugar (a tariff quota is ineffect ), liqueurs and spirits, and tobacco and manufactured tobacco products including cigarettedcigars, while Moldovadoes not have any exemptions; inMoldova-Ukrainian trade, Ukraineexempts sugar, sugar syrups, andmolasses while Moldova exempts spirits; and, inMoldova-Belarus trade, Belarusexempts sugar while Moldovahasno exemptions. There are no exemptions intrade betweenMoldova and the other 8 FTA participants 4.28 The FTAswithCIS countries have anumber of shortcomings: (i) web of the bilateral and multilateral agreementsundermines transparency and hampers the efficiency of the free trade area (ii) exclusions, including quantitativerestrictions, from the free trade regime can be imposedunilaterally (iii) the agreementslackpermanency; and, (iv) safeguards and antidumping measuresare applied on an ad hoc manner with little regard 32 to WTO agreements on this matter. Eachbilateral agreementi s subject to annual changes (inthe case of the exclusion of goods from free trade), or even more frequent changes (inthe case of safeguards). At present, the exclusions cover only a small percentage o f intra-CIS trade butthe agreementsdo not guarantee that this situation will persist. Hence, there is a considerable amount of uncertainty regardingthese agreements. Despite provisions for freedom of 4.29 Despite a free transit provision includedinthe FTAs,Moldovaexperiences transit, there serious problems with the transit of its trade through the territory o f Ukraine. This transit remain route i s o fparamount importance for Moldova due to the importance of Russia as an considerable export market. At different times, restrictions have includedregional transit fees (for each restrictions on theoblast of Ukraine), longprocessing times at the border damaging perishable goods (a transit of special regime for perishable goods was introduced later), and mandatory payments in Moldovan goods through Ukraine. local Ukrainian currency (and at an unrealistic exchangerate). As a result ofnumerous bilateral talks, some restrictions were repealed or relaxed, thoughnew restrictions then arose. The transit environment remains chaotic and a regime o f free transit has never been achieved. By not effectively 4.30 Moldova sits onthe Workrng Party for the accession of Ukraine to the WTO and raising this issue couldpotentially exert more pressure onUkraine by makingrequests on free transit in the accession negotiations of issues, inaccordance with General Agreement on Tariffs and Trade (GATT) Article V, Ukraine, Moldova which calls for freedom of transit and nationaltreatment. However, transit issues through is notfully Ukraine do not appear to be on the agenda of Ukrainian accession to the WTO. On this exploiting the issue, Moldova could exploit the benefits of its membership of the WTO further. benejts of its membership of the 4.3 1 The rules of origin are common across all o f the CIS FTAs and do not appear to WTO. be overly restrictive. The basic rules of origin require change oftariff heading at the 4- digit level of the CIS trade nomenclature (which i s equivalent to the Harmonized System at this level o f aggregation). However, the Annex to the Rules o f Originpresents a list of goods that are subject to differentrules, either rules which stipulate specific technological operations to be performed or an amount o f value that must be added inthe free trade area. The 50 percent value addedrule i s rather demanding. However, sensitive commodities, such as textiles and clothing, are subject to the simple change of tariff- heading rule. The Chamber of Commerce issues this certificate inMoldova. 4.32 The Rules of Origin allow for full cumulation of origin: all processing activities conducted inany of the CIS countries can be includedinthe calculation of sufficient domestic processing. This i s an important incentive for trade integration among the CIS countries and avoids the adverse effects of a hub-and-spoke systemwhere trade i s centered on the dominant member(s) of the free trade arrangement (i.e., Russia) with little interactionbetween the spoke countries. Tax residents inthe free trade area must conduct exports subject to the free trade treatment. 4.33 There i s also a mutualrecognitionagreement betweenCIS countries that should facilitate intra-CIS trade. Since the standards of CIS counties are harmonized, members should honor each other's certificates o f conformity and quality. This i s an important trade advantage for the CIS members since their national standards, which are basedon the GOST (standardization institute from the Soviet Union) system, arenotrecognized in the rest o f the world. The harmonizedstandards are formulated by the Interstate Council on Standardization, Metrology, and Certification (Eurasian StandardsCommittee), established underthe Agreement. The Council has been gradually introducingnew standards, inline with Intemational Organizationfor Standardization (ISO) standards,but more than halfo f the positions inthe standardsnomenclature are still basedon GOST. 33 The mutual recognition 4.34 The mutualrecognition agreement, however, i s underminedby the two-tiered agreement system of standards. There i s the CIS interstate set of harmonized standards as well as between CIS some differing standardsat the national level. Further, the interstate system does not countries is differentiate mandatory and voluntary standards (all of its standards are mandatory and undermined by the the list ofproducts subjectto mandatory standardsis excessiverelative to westem two-tiered system countries). Differencesinstandards are most pronounced for agricultural products, which of standards. particularly disadvantagesMoldova. Agricultural exports from Moldovato Russia are being denied access to the Russian market without additional testing inRussia. The Council can potentially act as a vehicle for integrationo f the CIS into the world trading systemifthe evolving CIS standards systemis built on the basis of intemational standards systems and inaccordancewith WTO guidelines.However, at present it i s not fulfilling this role. Another important 4.35 An important deficiency ofthe CIS trade arrangementsis the lackofplurilateral deficiency of the disputeresolutionmechanism. Although some barriers faced by Moldovainthe CIS and, CIS trade most importantly, transit issues inUkraine, are inviolation of the spirit and the letter of arrangements is the CIS agreements, there i s little Moldova can do inthe framework of the CIS as all the lack of disputes have to beresolvedpolitically at the bilaterallevel. CIS trade arrangements plurilateral shouldbe reformedinsuch a way to guaranteeapplication of the rules of the agreement dispute resolution or at least conditions guaranteedby the WTO. This should include information sharing mechanism. before trade measuresare taken and a functioning plurilateral dispute resolution and remedy mechanism to protect small countries such as Moldova. Incooperation with other CIS members, Moldovashouldaggressively pursue measures aimed at strengthening the free trade area. 0 Exemptions from the free trade regimes shouldbe eliminated. 0 A formal mechanismofcontingency protection compatible with WTO agreements shouldbe elaborated. 0 Harmonized standards should be comprised of a limitednumber of mandatory technical regulations basedon intemational standards. 0 An effective plurilateral dispute resolution mechanism within the CIS should be established. 0 An aggressiveprogramto eliminate the non-tariff and informal barriers to trade shouldbe carriedout. ROMANIA-MOLDOVA FREETRADE AGREEMENT 4.36 The Free Trade Agreementbetween Romania andthe Republic of Moldova became effective on January 1, 1995, and covered all agricultural and industrialproducts. Overall trade turnover increased from the last pre-agreement year (1994) to 2002 by between 5 and 13 percent, according to different estimates. This observation masks, however, the very different export performance o f the two countries: Moldovan exports to Romania halved while Romanianexports to Moldova doubled. The Romania- Moldova Free Trade Agreement has failed to expand aggregatemutual trade and to arrest the precipitous decline of Moldovanexports to Romania. 4.37 The key issues currently constrainingthe impact of the FTA appear to be: 0 Although there i s a mutual recognition clause inthe Agreement, inpractice, the reconfirmationof Moldovanconformity assessments i s frequent: for 80 percent of exports inthe first halfof 2002 (according to the Ministryo f Economy). Makingmutualrecognitiono f conformity assessment will require dealing with a 34 IfMoldova were to actively seek to number ofsystemic issues relatingto confidence andtrust inthe partners bring its own conformity assessmentprocedures and dealing with corruption relatingto trade regulations certificates of conformity. more into line Romaniai s inthe processof acceding to the EUand i s harmonizingits technical with those of the regulations and conformity assessment procedures with those o fthe EU.If EUand to effectively Moldova were to actively seek to bringits own trade regulations more into line upgrade testing with those o f the EUand to effectively upgrade testingand conformity and conformity assessmentprocedures this would facilitate trade with Romania and be consistent assessment with a strategy of European integration. procedures this The rules of origin(modeled on EUrules) canberestrictive, especially for wouldfacilitate sensitive products, such as textiles, clothing, and agriculture. There i s no scope trade with for cumulation of inputsfrom other countries. Trade with Romania and with the Romania and be consistent with a EUwould be stimulated ifMoldova were to be included inthe Pan-Euro areaof strategy of cumulation. European integration. THE INSTITUTIONAL FRAMEWORKFORTRADE POLICY FORMULATION 4.38 The primary agencies involved intrade policy making and implementation are the Ministry of Economy (coordinating agency), the Central Bank (exchange rates and currencyrepatriation), the Ministry ofFinance (principles o ftrade taxation), the Customs Department, and line ministries. The Ministryof Economy includes two trade departments: the department of foreign and domestic trade and the department of foreign economic relations. The Ministryi s charged with the task o f the analysis and forecasting of trade and the formulation o f trade policy. It also isresponsible for the coordination of sectoral trade policies formulated by other agencies. However, the Ministry faces considerable problems incarrying out its responsibilities. As with many other ministries, it suffers from inability to attract andretainhighlyqualified staff, as it is unable to compete inremunerationand benefits withthe private sector. It also lacks resources (financial, informational, technological, and human) for analytical work. As a result, its analytical capacity i s weak. Training andtechnical assistanceofferedby international donors have been unsystematic and have not brought enduring increasesincapacity. 4.39 The trade negotiation capacity ofthe Government is also rather limited. Since the overall negotiatingpower o f small countries suchas Moldova is not very strong, it i s essentialto form alliances inmulti/plurilateral negotiations and to use opportunities offeredby the multilateral trading system to the fullest. These strategies are difficult to implement andthey require considerable trade capacity, whichMoldova does nothave at the presenttime. As a small developingeconomy, Moldovashouldusethe WTO as a forum to defend its trade interest. However, Moldova's use of the advantages offeredby the WTO i s minimal, as illustratedby the above-mentioned example o f transit disputes with Ukraine. Operationaloptions of the use of advantagesprovidedby the WTO membership for commercial diplomacy is one ofthe areas where future trade-related technical assistancewill be very beneficial. 4.40 The efforts o f international donors have brought some positive developments in trade capacity building. Examples include U S Agency for International Development's (USAID'S)trade component ofthe Private Enterprise ProjectandTechnical Assistance for Commonwealth o f Independent States (TACIS's) program o f assistanceto the implementationof Moldova-EUPartnership and CooperationAgreement (PCA). Some useful organizations and NGOshave emerged as a result o f international trade capacity 35 building, such as MEPO, which works under the auspices ofthe MinistryofEconomy and also receives funding from internationaldonors and local businesses. However, the core government agencies, by and large, remain weak intrade policy capacity. GOVERNMENT EXPORTPROMOTION STRATEGY 4.41 Theproposed InJanuary 2002, the government ofMoldova approvedanExportPromotion exportpromotion Strategy for 2002-2005. This strategy features an analysis of major export markets and strategy has a includes a list of measures to promote Moldovan exports. However, the program has a number of number ofimportant deficiencies. First,certain proposedmeasureswould violate WTO important rules, for example, suggestedtax subsidies and subsidized credit for exporters. These deficiencies. measures have not been implemented due to budget constraints, others, such as a free trade agreement with the EU, have not materializeddue to institutional constraints and the slow pace of reform inMoldova. The strategy also envisionedalleviating the problems with VAT drawbacks for exporters by changing the collection point of VAT for imported inputs.However, the VAT collection systemhas remainedunchanged and an additional hurdlehas arisen following the newly introducedregulations on inward processing (discussed above). 4.42 Experience elsewhere suggests that a good export promotion strategy should strike a balance between offshore objectives (information gathering, market research, trade representation, and trade fairs) and onshore objectives (issues of competitiveness: quality standards, pricing, supportive services, domestic input supply, development o f new business models and practices).20 The current strategy, while addressing some of the former issues, i s very weak on the later. It i s unlikelythat progress ininformation provision will have a substantial impact inthe absence of significant efforts to improve the domestic business environment. CONCLUSIONS 4.43 Although Moldovahas a liberal statutory trade regimeonpaper, the current tariff schedule i s overly complicated. Giventhe relatively small amount of customs duties collected on imports, tariff revenueswould be collectedmore efficiently from a simple uniformtariff schedule. 4.44 The regulatory environment for the treatment ofinputs underthe inward processing regime i s complicatedand controversial. It shouldbe clarified and simplified with all inputsunder the inwardprocessing regimebeing exempted from VAT and customs duties. 4.45 The repayment of VAT for exporters can occur with considerable delay and i s paidmainly inthe form o f tax offsets rather than cash, causing extra costs for exporters. 4.46 The current free trade agreements with the CIS countries and Romaniasuffer from significant weaknessesthat limit their value to Moldova. Withregardto the CIS agreements, product exemptions should be eliminated, safeguard and anti-dumping provisions shouldbebrought into line with WTO rules to provide for greater certainty and, to preclude ad hoc measures, and there is a need for standardsreformat the plurilateral level and for an effective dispute resolutionmechanism. 2aSee Wulf, Luc De. "Why have tradepromotionorganizationsfailed, and how can they be revitalized?" PREM Notes 56, World Bank, August 2001. 36 4.47 The Romania-MoldovaFTAwouldbe improved ifthere were regional cumulation of origin and effective mutualrecognition of conformity assessment. The latter would be facilitated ifMoldova were to make significant efforts to upgrade its standards infrastructureas part of a policy towards increasing integrationwith the EU. 4.48 There is a clear needto strengthenthe analyticalcapacity of the government agencies inthe area of trade policy formulation and negotiations. Efforts towards trade capacity buildingshould be directed towards the core government agencies. The current Government Export Promotion Strategy shouldbereworked, dropping all WTO- inconsistent measures, achieving abalance between offshore and onshore objectives, and elaborating an effective mechanismo f implementation. 37 CHAPTER 5. MARKETACCESS TO THE EUROPEAN UNION: EUCOULD DO MOREBUT DOMESTICBARRIERS DOMINATE INTRODUCTION Moldovan exports 5.1 Givenits economic size andproximity, the EuropeanUnion (EU)provides a considerably less to major source of demand for Moldovan exports. While the share of the EUhas increased the EU than one substantially inrecent years, economic analysis suggests that the principal trading partner would expect on the of Moldova shouldbe the EU. Instead, Moldovantrade i s dominated by exchange with basis of "normal" other CIS countries -principally Russia-and the share of the EUinMoldovanexports trade relations. Is thisremains very low relative to what would be expectedunder "normal trade relations". due to EU trade barriers or This chapter explores why the reorientationofexports towards the EUhasbeenso constraints in limited. Inparticular, it examines whether there are significant barriersinthe EUthat are Moldova? constraining the market access of Moldovan exporters.'l policies applied in the 5-2 It is important to stress that effective market access is determined by muchmore home market can also than tariffs inthe overseasmarket. Technical regulations inoverseasmarkets can have an influence the ability of important impact on the ability of firms to access that market. Subsidies granted to firms exporters to penetrate or farmers inoverseasmarkets may also undermine the ability of firms from other overseas markets. countries to compete. As will be made clear inlater chapters, a number o fpolicies applied inthe home market can influence the ability of exporters to penetrate overseas markets. Havingto contend with, for example, the costly and time consuming clearance of customs on export, the highcost o f finance, a domestic system o f standards and technical regulations which i s at odds with internationalpractices and a range of other domestic "behind the border" barriers raise costs relative to those o f other firms competing inoverseasmarkets. TARIFFBARRIERSINTHE EU-AN OVERVIEWOF GENERALIZED Moldova receives SYSTEMOFPREFERENCES(GSP)PREFERENCES Preferential the s;znw;2ne to 5.3 Moldovai s a beneficiary under the EU's GSP scheme. The GSP allows for market under lower duties than the MFN(Most FavoredNation) rates subject to the products meeting the requirements stipulated by the EU, such as the rules of origin (see Box 4.1):' Under from preferences is a the current GSP schemethere aretwo categoriesofproductscovered bythe scheme: non- major limitation. sensitive and sensitive.23 For non-sensitive products the duties are suspendedwhile for sensitive products there is a flat rate reduction of 3.5 percentage points from the MFN rate.24Thus, the GSP scheme entails highproportionate reductions for most industrial 2'It is worth noting that the geographicalreorientationof the trade of the Centraland EastEuropeanCountries (CEECs) towards the west and, inparticular the EU, took placerelatively quickly after transitioncommenced.By 1993 and 1994it was not possibleto distinguishthe trade pattemsof most of the CEECs from those of amarketeconomy. Inthis sense, the transitionwith regardto trade was alreadycompletedbefore the Agreementsbetween the CEECs and the EUcame fully into effect, and during a time when those countries faced similar, or worse, marketaccess conditionsto those currently facing Moldova. 22Rulesof origin define the degree or natureofprocessingthat mustbe undertakeninthe beneficiarycountry for the product to qualify for preferentialaccess to the EUmarket. 23The currentGSP scheme was revised inJanuary 2002 andwill run untilthe end of December2004. The EU Commission,however, has recentlyproposed to extend the duration of the scheme until the end of 2005 since there is some uncertainty regardingthe completiondate of the DohaDevelopmentroundof multilateral trade negotiations. 24Ifthe percentagereductionunderthepreviousGSP scheme leads to alower ratethanis maintainedunderthenewGSP scheme. For goods where the duty is relatedto physicalratherthan monetaryvalues (i.e. specific duties), the duty is reducedby 30 percent. Whena duty is comprisedof both an ad valorem and specific component, as is the case for arange ofprocessed agriculturalproducts of interestto Moldova(ie., sugar confectionary), the specific duties are not reduced. When minimumduties are specifiedinthe EU's Common CustomsCode, for example, the EUduty onbeans is 13.6 percentsubject to aminimumduty of 1.6 euro per lOOkgbeingpaid, these minimumduties no longer apply for products 38 Moldova is one of the most preferred products -- where the average EUMFNtariff i s around 4 percent -- but relatively low suppliers of the EU proportionatereductions for many agricultural products --where the average MFNduty i s marketfollowing the much higher, around 20 percent. The GSP scheme also includes an additional 5 additional percentage point reduction in duties for countries implementingthe InternationalLabor preferences granted Organization (LO) codes on basic labor rights. So far Moldova i s the only GSP under the EU's labor beneficiary which has successfully applied for these additional preferences and, as such, clause. it is one o fthe most preferred partners under the EU's GSP scheme. Moldova market 5.4 The market access position o f Moldova relative to other countries will depend access to the EU upon a number o f factors. Least DevelopedCountries (LDCs) are eligible for duty free relative to other access for all products under the "Everything ButA r m s Agreement. African, Caribbean countries depends on and Pacific countries (ACP) have access to the EUunder the CotonouAgreement under theproducts and which almost all industrialproducts enjoy duty free access.25 Inpractice, there i s a range sectors excludedfiom o f country/sector exclusions from GSP preferences. Since many countries do not fully their agreements with EU utilize their GSP preferences, a proportion o f exports from GSP beneficiaries will, in fact, pay the MFNtariff. Moldova i s also competing inthe EUmarket with countries which have signed a free trade agreement or customs union with the EU-- Central and Eastern European countries, certain countries inthe Mediterranean, Mexico, South Africa, Turkey, and European Free Trade Association (EFTA) countries -- as well as countries which effectively receive duty free access to the EUunder association agreements -- such as countries inthe Balkans. The market access position o f Moldova relative to these countries will depend upon the products and sectors which are excluded from the agreement, typically certain agricultural products. THE IMPACT OF GSPPREFERENCESON MOLDOVA TRADE - COVERAGEAND UTILIZATION Almost three-quarters 5.5 There are two key elements to assessing the impact o f GSP preferences on a of Moldova's current country's total exports: the proportiono f exports which i s eligible for preferences and the exports to the EU are extent to which exports eligible for preferences are actually granted preferentialaccess. eligiblefor As shown inTable 5.1, almost 73 percent o ftotal exports from Moldova to the EUare preferences, but only eligible for GSP preferences. Most o f the remaining exports are subject to zero MFN 60per cent of eligible exports actually duties and hence, by definition, there can be no tariff preference. Only a small amount o f requestpreferences. Moldovanexports, less than 1percent, are excluded from preferences. Importantly, as discussed below, this includes wine, one o f Moldova's major industries and key exports. coveredunder the GSP. Ifthe tariff reductionprovisionsprovidedfor under the GSP scheme resultin apreferentialduty of 1percent or less then the duty is suspended. Finally, amajor exception to the scheme is made for textiles andclothing products where areductionof20 percent of the MFNrate is applied. 25The difference inmarket access for these industrial products is likely to be slight since for most products Moldovan exporters will only be subject to duties inthe EUfor products where the MFN duties exceeds 9.5 percent or where the product is excluded fromthe GSP. 39 Box 5.1 Rulesof Origin Rules of origin are an There are two elements to the constrainingimpactof rules of origin: the natureof the rules importantfactor themselvesandthe cost ofprovidingthe necessary documentation to proveorigin. Ifthe cost involved in influencing the impact satisfyingtheserequirementsexceedthe marginofpreference, thenthe GSP is redundant.Available studies suggest that the cost ofproviding the appropriatedocumentation to proveorigin can be around 3 of tradepreferences. percentof the value of the export shipment. The rules themselvescanbe very difficult to meet while remainingcompetitiveonthe EUmarket. For example, the EUrules of origin for clothing stipulate Being a member of manufacture from yam. This entails that clothingproducersinMoldova cannotimport fabric, except the Pan-European from the EUunderthebilateralcumulationthat exists under the GSP, andstill receivepreferentialaccess area of cumulation to the EU. Moldovanproducerscannotsource fabrics from low cost locationssuch as Chinaand India would allow Moldova andreceivepreferences underthe GSP. to overcome some of For those firms involvedintheprocessingof EUfabrics, conformity with the rules of origin is the restrictiveness of straightforwardsince all the materialsusedcome fromthe EU. However, for other clothing companies, the E U rules. satisfyingthe rules oforigin can bevery difficult inthe absenceof suitablypriceddomestic or EU fabrics. This is another factor which maybeconstrainingthe ability of Moldovanfirms to move into highervalue-addedproductionsystemsinthe clothing sector, as highlightedinthe case study on this sector (see Part11), inwhich firms produceclothing fromtheir own designsandsource fabrics themselves. A provisionwhich can reducethe restrictiveeffect ofrules of origin is cumulation.This allows importedinputs from specificpartnersto be countedas ifthey originate inthe countryconcerned.One possibility which is potentiallyavailablefor Moldova is tojoin the so-calledPan-EuropeanArea of Cumulationregardingexportsto the EU. This would allow Moldovato use inputsfrom CentralandEast EuropeanCountries(CEECs), TurkeyandcertainMediterraneancountries andcount these as qualifying material, subject to those materialssatisfyingthe relevantEUrules of origin. 5.6 As indicatedin the final row of Table Table 5.1: Moldova's Exports to the EUUnder the GSP in2002 5.1, in2002 only 60 Total Exportsto EU( 000) 227,828 percent o fMoldova's Total Exportsto EUofProductswith zero MFNduty ( 000) 60,560 exports which are ExportsEligible for GSP ( 000) 165,346 eligible for GSP Exports excludedfrom GSP preferences( 000) 1,922 preferences actually request entrance to the EUonapreferential Share of exportswhere MFN duty is zero (per cent). 26.6 basis. This impliesthat Share of GSP ExportsinTotal Exportsto the EU(per cent) 72.6 the remaining40 Share of exports excludedfrom preferences(per cent) 0.8 percent o f eligible exports paidthe full ExportsRequestingGSP (E 000) 99,481 MFNtariff. Thus,the Share of ExportsRequestingGSP inExportsEligible for GSP potential impact of the Per cent) 60.2 G ~for Moldovais p Source:World Bank Staff calculationsbasedEurostatdata weakened by the under-utilization of the available preferences. The reasons for this low take-up o f preferences are likely to include the difficulties insatisfyingthe rules of origin o f the EUscheme, lack of knowledge o f the scheme and, for certain products, the small margin o f preference relative to the costs o f satisfying and proving origin (see Box 4.1). 5.7 By comparison, in 1998around 47 percent ofeligible exports requested preferential access to the EU.The increase inutilization rates probably reflects the growing importance of processing EU fabrics into made-up clothing -- which i s more straightforward inproving conformity with the rules o f origin -- and increasing knowledge of the GSP scheme. The current utilization rate ofMoldova slightly exceeds that o f other CIS countries (inUkraine 50 percent o fpreferences are utilized, while in Russia and Georgia around 54 percent o f exports request preferences) and is similar to the overall utilizationrate ofthe EU'sGSPscheme. 40 The value of EU 5.8 Thepreferencesrequestedamount to animplicittransfer (the tariffrevenue that preferences granted would have beenpaidto the EUifthese preferenceshadnotbeen given) o f3.6 million to Moldova is equivalent to 1.6 to Moldova -- equivalent to about 1.6percent of the total value of Moldovan exports to percent of exports. the EU, or about 0.2 percent of GDP. Ifpreferenceshadbeen fully exploited thenthe Withfuller utilization, estimated transfer would have amounted to 2.7 percent of exports to the EUand around this transfer would 0.3 percent of GDP.26 have amounted to 2.7 Box 5.2 GSP Preferences and EUOutward Processingof Textile and Apparel percent of exports. ClothingandFootwearaccount for over 50 percentof Moldovanexportsto the EUandover 40 GSP Preferences are percent of productsrequestingpreferences. As discussedinthe Textile andApparel case study (see Part unlikely to be a key II), isdominatedbytheprocessingoftemporarilyexportedfabricsandaccessoriesinMoldova. thistrade factor determining Giventhe relativelylow share of value addedinMoldova it is unlikely that the preferencesare akey decisions to locate factordeterminingthe choice ofMoldova as alocationfor these processingactivities. The GSP, with the processing activities additionalreductions for Moldovarelatingto laborrights, providesfor a40 percent reductiononduties on clothingproducts.Most clothingproducts are subject to a 12percenttariff on importationinto the in Moldova. EU. With the value added inMoldova estimatedat 20 percentof the recordedexports from Moldova, the preferencesreducethe priceof aproductprocessedinMoldovaby less than 1percentrelativeto the situationof the full tariff beingappliedto the value added inMoldova. Itis likely that differences in labor cost andtransport cost andthe importanceofproximity to the EUmarket will bemoreimportantin determiningthe locationofthese processingactivities. Nevertheless, as Moldova seeks to undertakemorevalue addedactivitiesinthese sectors.and therefore for Moldovanfirmsto source the materialsthemselves.then the EUpreferences, andtherules of origin govemingthose preferenceswill becomemoreimportant.The current tariffpreferences for Moldova would reducethe priceof afully sourcedproductby as muchas 4.3 percent. Onthe otherhand, a successful outcometo the Doharoundwill substantiallyreduceEUtariffs on clothingproducts. For example, underthe current chairman's proposal, the tariffs on clothingproducts importedinto the EU will fall from 12to between3.2 and5.1 percent. Expandingcapacity on the basisof EUpreferences is unlikely to be a successfullong-termstrategy. TARIFF BARRIERSINTHE EU-MEASURESOFAVERAGE The average duty PROTECTION levied on Moldovan 5.9 The impact of the GSP can exports to the EU is Table 5.2. Average Tariffs on Moldova Exports impact of the preferences on the also be evaluated by identifyingthe to the EU(percent) around 70percent of the duty that would be Average MFNTariff 7.9 levied ifMoldova did average tariff leviedon Moldovan Average GSP preference (assuming full 5.9 not receive exports to the EU. As shown inTable utilization) preferences. 5.2, if Moldovan exporters didnot receive any preferences, that is, they Average GSP preferences with additional 4.1 were to pay the MFNtariff on all labor preferences (assuming full utilization) products, the average trade weighted Average GSP preferences with additional tariff that would apply to Moldovan labor preferences (with actual utilization). 5.6 exports would be 8 per~ent.~' This average i s highrelative to the overall Source: EUTAIUC database trade weightedaveragetariff ontotal 26These simple estimatesare likely to overstatethe actual transfer that occurred. This i s because clothing and footwear productsare amajor elementof Moldovan exports to the EUand such tradeis dominatedby the processingof temporarily exported EUfabrics inMoldova. For suchprocessed exports to the EU, it is only the value-addedthat is subject to EU import duties and therefore to preferences.The calculationsabove are basedon the total value of clothingand footwear importsfrom Moldova recordedby the EUrather thanjust the value-added. In2001, clothing and footwear products accounted for over 50 percentof Moldovan exportsto the EUand40 percentof productsrequestingpreferences.Some 67 percent of these clothing exports and 98 percentof footwear exportswere recordedby the EUas having processed EU materials.Assuming crudelythat the value added inMoldovais about 20 percent, then the estimatedtransfer from EU preferencesfalls to only 0.7percentof exports to the EUand0.08 percentof GDP. ''Averages are basedon 2002 duties weighted by the 2001 trade structure. Nonad valorem duties havebeenconvertedto ad valoremequivalents. 41 EUimports -- lessthan 5 percent -- reflectingthe concentration ofMoldovan exports to the EUof relatively highduty products. 5.10 Under the standardGSP, assuming all suchpreferences were fully utilized, the trade-weighted tariff on Moldova's exports to the EUwould be 5.9 percent. This i s the average tariff that would apply ifMoldova were treated inthe same manner as other CIS countries and other GSP countries not covered by special schemes. Relative to the MFN tariff, therefore, the average margin of preference enjoyed by Moldova i s 2 percentage points. With the additional preferences available to Moldovaunder the GSP labor clause, the average tariff on total Moldovan exports to the EUfalls to 4.1 percent, almost 50 percent of the MFNtariff and about 70 percent of the tariff under the standard GSP. 5.11 Under Moldova's current take-up ofGSPpreferences, the trade weighted average tariff was 5.6 percent. This average takes into account the fact that, for certain products, only a proportion of the available preferencesare actually requested and most closely reflects the actual duties that were leviedon Moldovan exports. In2002, therefore, the average tariff applied to Moldovan exports to the EUwas 1.1percentage points higher than ifpreferences hadbeen fully utilized. Nevertheless, these tariff numbers show that the average dutyleviedonMoldovan exports to the EUwas around 30 percent lower than Under-utilization of ifMoldovawas noteligible for EUpreferences.28 preferences led to the average EU tarif 5.12 The implications Figure 5.1: Distributionof Moldova's Exportsto the EU applied to Moldovan o f these different regimes According to Tariff Bands,with and Without Preferences products being 1.I for the tariffs levied on percentage points Moldovanexports to the higher than would EUarehighlighted in have occurred fall Figure5.1. As canbe preferences were seen, the distribution o f taken up. exports under different bands of MFNtariffs i s highlyskewedwith large proportions of exports enteringeither under zero -10I.... .. .... .. .... . _ _ ... . . - - -_... .... .j duties or very highduties Source: EU TARlC Tariff Band inthe range of 12to 15 percent. The GSP preferences act to increasethe amount o f exports able to enter duty free and to shift a large proportion of exports to a lower tariffband. Thus, the 45 percent of exports inthe 12to 15 percent bandunder MFNtariffs shifts to the 9 to 12percent bandunder the GSP and the proportion of exports able to enter duty free rises fromjust over one quarter to around one third. The GSP with labor provisions fbrther accentuatesthe peaks inthe distribution withjust over 40 percent of exports able to enter duty free and a similar proportion now subject to tariffs inthe 6 to 9 percent bandrather than the higher bands. 5.13 Figure 5.2 shows the impact of the lack of full utilization of preferences on the distribution o f trade accordingto the selectedtariff bands. Interestingly,it shows that under-utilizationof preferences has little impact on the proportion of exports to the EU which receive duty free treatment. Ifpreferences were fully utilized, then46 percent of exports would enter the EUduty free, whereas with the actual utilization ofpreferences, just over 42 percent a f exports enter the EUduty free. The under-utilizationof 28Again, these calculated averagetariffs will overstatethe duties actuallypaidby giving undueweight to the relatively high duty clothingsector since muchof the value importedinto the EUis not taxed. 42 preferences primarily '. 50 - affects the proportionof P,,(full GSP wlth Labor 40 - '' I % utilization of preferences) exports inthe higher tariff I ' 1. \, bandpeak. Infact, with 30 . 1 I \$ GSP wlth Labor the actual utilization of ! I I A '.(actual utiliza~fpreferences) 20. preferences, there are two I '* peaks at the upper endof I \ the distribution of exports. o . . __,_. -.-. About 25 percent of ,'. 0% 69% %12% 12.15% E%* For certain agriculture products, such as walnuts, EU preferences provide for zero duty access to the EU and a preference margin of 100per cent. Butfor other important products, such as applejuice, preference margins are smaller and the duty paid by Moldovan exporters much higher. Table 5.3: Key Sectors inMoldovan Exports to the EUand Tariff Preferences Agriculture Manufacturing Total Shelled Fruit Total Cotton Clothing Footwear Walnuts Juices Fabrics Total Exports to EU( 000) 36,611 16,673 6,109 190,987 6,403 105,535 12,101 Share RequestingPreferences(%) 66.5 84.2 21.7 59.1 97.6 51.6 93.3 Outward ProcessingTrade (%) 4.2 9.2 0 44.1 0 67.3 97.7 Average MFNTariff (%) 1.6 5.1 22.2 7.9 8.4 12.3 8.6 Average GSP Tariff (%) 5.2 1.6 18.3 6.0 6.1 9.8 5.0 Average tariff with Labor (%) 3.5 0 13.7 4.3 5.0 7.3 0.5 Average tariff with labor with actual preference utilization (%) 5.1 0.4 20.4 5.7 5.1 9.7 1.o Source: Eurostat, WTO and TAFUC databases. 5.16 Interms ofdutyreductions, amongMoldova's mainagricultural exports to the EU, the absolute reductioninh i tjuices tariffs is muchlarger (8.5 percentagepoints) 43 Margins ofpreference than that for shelled walnuts. This is, however, because walnuts have a muchlower MFN for clothing are rate to beginwith (only 5.1 percentagepoints). Indeed, the tariff appliedto fruitjuices smaller than those exports from Moldovai s very high, almost 14percent after taking into account the availablefor other manufactured various GSP preferences. Giventhe low utilization ofpreferences, a large proportion o f products. these exports to the EUpay the full MFNtariff of over 22 percent. Moldovanjuice exporters have to compete inthe EUmarket with products from Central and Eastem European countries, Turkey and anumber o f Balkan countries whose producers can export to the EUmarket free o f tariff duties. The EUduty and low utilization of preferences entail a 20 percent disadvantage for Moldovanjuice exporters to the EU relative to competitors inthe region. For walnuts, the reduction intariffs gives Moldovan producers a margin ofpreference o f more than 5 percent over suppliers from countries that have to pay the MFNtariff.*' Withinthe manufacturingsector, GSP preference with the labor provisionprovides for a 40 percent reductioninthe tariff for textiles and clothing products and an 8.5 percentagepoint reduction induties for other products, such as footwear, leads to an almost 100percent reduction intariffs. 5.17 Given that the average EUtariff i s around 4 percent, the average duty of 5.6 percent confrontingMoldovan exports to the EUcannot be deemeda major barrier to market access and increasedexports to the EU. As this section notes, however, there are a number o f products, such as fruitjuices, where duty rates applied to exports o fMoldova remainvery higheven after preferences are granted. For these particular products, the key issue is to identifythe tariffs confronting Moldova's maincompetitors. I s Moldova competingwith countries that pay the MFNtariff or countries which receive the same or better access to the EUmarket, suchas the Central and EastemEuropean countries? This Extending and issue i s partially addressedinthe final section of this chapter on the impact o f EU deepening EU enlargement. preferences for agricultural products, THE IMPACT OFENHANCED EUTRADE PREFERENCES for example, by including wine, would 5.18 Given the current structure of exports, Table 5.4 summarizes the impact on the have very small direct average EUtariffs confrontingMoldovathat would be achieved by broadeningGSP impact under the preferences. If,for example, GSP preferences were extending to all Moldovan current structure of agricultural products (including wine) thenthe average tariff confronting Moldovan trade. I t is the exporters would fall to 3.5 percent, ifpreferences were fully utilized, or 5.3 percent ifthe treatment of clothing current level of preference utilization was maintained. If,however, the EUwere to which is currently provide the same GSP preferences to textiles and clothing (currently a 40 percent crucial. reduction for Moldova) that are givento other products (a reductionof 8.5 percentage points), the impact would be more substantial, with the average tariff on total exports to the EUfalling to 2.2 percent with full utilization ofpreferences and4.5 percent under current utilization rates. Thus the impact o f EUtariff protection on Moldovanexporters would decline most ifcurrent preferences were more fully utilized, particularly inthe clothing sector, and ifdeeper preferences were offered to clothing products. Giventhe structure of current trade with the EU, extending and deepening preferences for agricultural products would have a much more limitedimpact. 29Inpractice, there is a rangeof countrykectorexclusions from GSPpreferences.Inthe case ofnuts, for example, Chile, Mexico and Thailand are excluded from GSPpreferences. 44 The exclusion of wine 5.19 Itis, ofcourse, likely that from EUpreferences Moldova's current export Table 5.4. The Impact of Deeper GSP is a major limitation structure gives a distorted view of Preferences onAverage EUTariffs for Moldova. the impact o f EUprotectionsince Average However, it is not highEUtariffs maybe Tariff Rate possible to conclude suppressingtrade inprecisely Current GSP preferences 4.1 5.6 thatprotection in the ExtendingGSP preferences to all 3.5 5.3 EUonproducts of those products inwhich Moldova Agricultural Products interest to Moldova, has a comparative advantage. One way to addressthis potential issue Extending GSPpreferencesto 2.2 4.5 while important, can Note:Tradeweightedav:age Textiles andClothin Products be the onlyfactor is to tariffs constraining the assuming thatEUprotectionism Moldova's exports Source: EUTARIC database expansion of to the EUwere similar instructure Moldovan exports to to its exports to Russia -a country with which Moldova has a free trade arrangement and the EL? hence where the majority o fproducts confrontno tariffrestrictions. For this exercise, the key issue centers around wine exports. Wine dominates exports to Russiabut comprises a small proportion of exports to the EU. I s EUprotection the mainreason behindthis?30 5.20 As shown inTable 5.5, the predicted trade weighted average MFNtariffthat would be applied on Moldova's exports to the EUifthey had the same structure as Moldova's exports to Russia i s 9.9 percent. This rate is 2 percentage points higherthan the average EUtariff given Moldova's current exports to the EU.With GSP preferences and the additional labor benefits, the hypotheticalaverage tariff would be 7.6percent. This compares with an averagetariff on current exports to the EUof4.1 percent. Since wine dominates Moldova's exports to Russia, the impact on the hypothetical tariff ifwine and related products were offered the same GSP preferences would be substantial -- leadingto an average tariff o f only 3.8 percent. The exclusion of wine fi-om the EU's GSP preference scheme has a measurableimpact onthe average EUtariffs confronting Moldova. 5.2 1 Itis not reasonable, however, to conclude that EU Table 5.5. Average EUtariffs as Appliedto Moldovan Exports to Russia (assuming full utilizationofGSPpreferences) protectionism has beenthe only or major factor constraining Hypothetical Current Export Export substantial reorientation of Structure Structure Moldovan exports towards the Average MFNTariff 9.9 1.9 EU. If,following the results Average GSP Tariff with Labor 1.6 4.1 indicatedinTable 5.5, one Provision assumes that EUtariffs on Average GSP Tariff with Labor 3.8 3.5 Provision& ExtendingGSP products of interest to Moldova Preferencesto Wine Exports are reduced such that the average Source: EUTARIC database. Unfortunately,this exerciseis not straightforward.First, the data on Moldovan exports to Russiaare not available at the same level of detail as the EUtariff schedule.Moldovan exportsdataare at the 6-digit level while EUtariffs are defined at the 8-digit level. Henceaverage tariffs at the 6-digit levelmustbe used. Second, anumberof the duties inthe EUonkey products of interest to Moldova are non ad valorem duties - usuallyspecific duties such as the duty of 13.1 eurosper - hectoliter currently levied on bottles of white wine. To calculate averages, tariffs basedon quantityneed to be converted into ad valorem equivalents. This conversion, however, dependsuponthe value per unit ofquantity.The protectiveimpact of specific duties is particularly heavy on low-value, low-quality products andbecomesless restrictive the higher the unit value of the product.The unit valueprovidesa very roughindication ofquality. Will Moldovabe able to export to the EU productsof the same unitvaluelquality as currentlybeingexported to Russia?As shown inthe case study on Wineries in Part I1of this study, wine demand in the EUis dominatedby the taste for dry wine that has ahigher alcoholic contentthan the sweeter wine that currentlydominates exports to Russia. Thus, it is unlikely that Moldovacould simply undertakea largescale expansionof exportsto the EUof the type of wine currentlyexported to Russia.Ifdemandinthe EUis such that wine exportedto the EUmustbe of a higherquality and unit value to that exported to Russia, then the duties applied in this simulationwill overstate the duties that would actuallybe applied. 45 tariff declines from 7.6 percent to 3.8 percent, then, even with some extremely heroic assumptions, Moldova's exports to the EUwould increasebyjust under 18 per~ent.~' Evenwith such an increase, Moldova's exports to the EUas a share o f total exports would only increase from the current level of around 21 percent to 23.8 percent. As noted inChapter 2, gravitymodels suggest that under "normal" trade conditions the share of Moldova's exports to the EUwould be at least double the current level. 5.22 While reducing EUtariff barriers can contribute to reorientationo f Moldovan exports towards the EU, it i s clear fromremaining chapters of this study that arange of factors inMoldova, such as the highcosts of clearing customs, the difficulties and costs o f obtaining funds for working capital and for investment and the difficulties causedby the current system ofproduct regulations and conformity assessment are equally important factors limitingthe ability of Moldovanexporters to penetrate the EUmarket. Indeed, inmany cases, removal of these domestic barriers will be apre-requisite for the successful expansion of exports to the EU. Ifthese barriers are, ineffect, prohibitive, then there can be no impact from the reduction o f EUtariffs until they are alleviated. For example, ifMoldovan products cannot satisfy the minimumrequirements necessaryto be placed onthe EUmarket, then changes inthe EUtariff will have no immediate effect and will only be exploited inthe longer-termifconstraints onthe ability of firms to invest to raise quality are removed. THE IMPACT OFEUSUBSIDIES ONMOLDOVAN AGRICULTURAL EXPORTS EUsubsidies cannot 5.23 Inadditiontotariffprotection, itisconceivablethatMoldova's accesstotheEU explain the gap market i s being constrained by the impact of EUagricultural subsidies to domestic EU between actual and producers. Table 5.6 compares the sectoral structure of Moldovanagricultural exports to potential exports to Russia -a benchmark for what Moldova's export structure to the EUmightlook like the EU without EUtariffs or subsidies -- with the structure of EUdomestic and export subsidies. Nearly 84 percent of EUdomestic support goes to 4 commodity groups: meats, dairy products, fruit and nuts and sugar. These products, however, accounted for just 6.3 percent o f Moldovan exports to Russia. Hence, the most heavily subsidized products in the EUare not a major element of the Moldovanexport basket. The subsidies for the production of all beverages and alcohol, including wine, amounted to only about 5 percent o f the total EU agricultural subsidies. Share in Share in Products which are 5.24 EUexport Moldovan EU Share in most heavily subsidies, which affect Exports to , Domestic `EUExport' subsidized in the EU Moldovanproducers Russia Support Subsidies do not comprise a through their influence on Beverages, Spirits 71.28 5.29 1.37 major proportion of competition inthirdmarkets PreparationsofVegetables, current or potential 9.49 , 2.25 0.68 Moldovan exports. and through their depressing Fruits, Nuts impact on world prices, are Tobacco 8.63 2.74 0.57 concentrated in3 sectors- Fruitandnuts 3.28 13.78 0.75 meats, dairy products and Meat and Edible Meat Offal 2.69 37.62 21.83 cereals-`that account for 84 Cereals 0.52 0.00 I 33.74 percent o f total EU I payments. These 3 products, IDairy, Eggs, Honey 0.27 16.02 27.94 [ 1 1 ~ ~ however, comprisedonly Sugars 0.08 16.09 7.10 3'Suchas aprice elasticityof demand for 5 for Moldovan products-very highrelative to standardestimatesof such elasticities and assumes fully responsivesupply inMoldova. 46 3.5 percent of Moldovan exports. Relativeto other countries inthe region, such as Ukraine and Russia, it does not appear that Moldova has a strong reveal comparative advantageinthe meat, dairy and cereals sectors. While EUexport subsidies for fruit and vegetables and beveragesrepresent arelatively small share of total EUexports subsidies, one cannot ignore that sectors of importance to Moldova, especially wine and fruit and vegetables, are subsidized inthe EU. Box 5.3 EUSubsidiesto the Fruitand Vegetables Sector. The EU protects its domestic fruit and vegetables sector through the use of a complex system of minimumimport prices (knownas entryprices) as well as customs duties. Both customs dutiesandentry prices vary throughout the year, with particularly high barriers during the main EU growing and marketingperiod.There are, however, an array ofpreferentialaccess arrangements:GSP, Cotonou, Euro- Med and agreements with the CEECs. These preferential arrangements include reduction of customs duties (frequently by 100%) and concessions on entry prices. These preferential arrangements are, however, oftenlimited by tariff quotasor reference quantities. Intemalprices inthe EUare maintainedby interventionswhich removeexcess supply-by compensatingfarmers to withdrawproductsfrom the domesticmarket, subsidizingexports or encouragingadditionalprocessing. The EUspecifies alimit onthe amount ofparticularproductsthat canbewithdrawnfrom the market. These, together with the withdrawalprices, havebeendeclining following the reform ofthe CommonAgricultural Policy (CAP) inthe mid 1990s.For example, there is now aceiling of 8.5 per cent ofthe productionof apples andpearsfor which withdrawalcompensation canbepaid, down from 50 per cent in 1997/1998.The amount ofcompensationthat can be receivedfor appleshasfallen from 10.69 europer 100kg in 1997/98to 8.81 euro per 100kg from 2002. The EU price to producers.This is backedupby a systemofnationalquotas for processingof certainproducts- regimealso comprisescompensationto processorsoffruits andvegetableswho haveto pay aminimum tomatoes, peachesandpears-with penalties, interms ofreductions inaid insubsequentyears, for overruns. The key fruit andvegetableproductsthat Moldovacurrentlyexportsto the EU, however, are not subject to extensiveEUinterventions.Ithas beenestimatedthat a50 percentcut inindustrialcountries domestic support for fruit andvegetableswould leadto an increaseinexports from developingcountries as awhole ofjust over 1 per cent. Similar estimatesshow that acut inindustrial countries import tariffs of 50 per centwould leadto an increaseof more than 12per cent indevelopingcountryexports. Given these estimates, it is unlikely that the removalof EUsubsidies for fruits andvegetableswould resultin a substantialincrease inMoldova's exports of these products. While tariffcuts are muchmoreimportant inraisingdevelopingcountryexports, for Moldovathe impactcouldbe smallergiventheprevalenceof GSP tariffpreferences. A firther issue is whether currentEUpoliciesare constrainingMoldovandiversification into a wider rangeof fruit andvegetableexports to the EU. It shouldbenotedthat, exceptfor tomatoes, EU withdrawalcompensationis only paid for productswhich satisfyacertainquality, class I1or higher,of the marketingstandards that are inforce. This entailsthat EUpolicieswill have only an indirect effect on products that do not meet these standards.It is also clear from the case study ofthis sector, that there is a rangeofvery importantbarriers and constraints inMoldova that are affectingthe ability of this sector to expandinto overseasmarkets.It is importantthat these be addressedinorder that Moldovanproducers are ableto exploit new opportunitiesthat may arise inthis sector. THE IMPACT OFEUENLARGEMENT For industrial products, the impact 5.25 Inanalyzingthe impact ofEUenlargement onMoldova, akey distinctionmust of enlargementfor be madebetweenmanufactured and agricultural products. For manufactured products, the Moldova will tend to impact of trade policy changes following enlargement of the EUwill tend to be positive bepositive as the new for Moldova and other CIS countries. There will be no significant change inrelative members implement market access to the current EUmarket since all tariff and non-tariff barriers on imports the common external tar18 which is lower from the accessioncountries have already been removed. Moldova's market access to than current tarfls the accessioncountries, on the other hand, will improve since tariffs inthe largest for many countries. markets, Poland and Hungary, will decline as these countries implement the common external tariff and adopt the EU'sGSP preferences. For example, the Polishtariff on 47 clothing products i s currently 18percent. This will fall to 12percent upon accessionand the tariff applicable to Moldova will decline tojust over 7.2 percent once GSP preferences are applied. Inthe case of Hungary, duties on bars and rods o f steel, the principal import from Moldova, will fall from 4.5 percent to zero when the EUcommon external tariff i s applied. There may also be a shift inprocessing activity to lower cost CIS countries as labor costs inthe accessioncountries increase. The adoption of EU outwardprocessing regulations may also encourage clothing producers inthe accession countries to outsource the assembly stage of the production process to low labor cost, but proximate locations, such as Moldova. Box 5.4 EUSubsidiesto theWine Sector EUpolicy towards the wine sector inthe 1970sand `80s ledto very largesurpluses of low quality table wines. Subsequent policy has tried to encourage productionof quality wines and limit the amount of low quality wines producedin the EU. The 1999 revision of EUwine policy has sought to regulate supply, through limits on replantingand payments for grubbing up vines, while providing guaranteed minimumprices for surpluses that are distilled into alcoholor fuel. Distillers are intum eligible for aid to compensate for the higher price that they have to pay to the wine producers and for the cost of storage.Productionsurpluses that are exportedare eligible for export subsidies. EU production of wine has declined substantially over the past decade from 210 million hectolitres inthe early 1980sto around 160millionhectolitresinthe late 1990s. Expenditureson export subsidies have also declined relative to the 88 million euro base for commitmentsunder the Uruguay Round Agreement on Agriculture. This reflects declining output and increasing intervention to encouragethe use of wine for distillation into alcohol and fuel. Nevertheless, in2001the EUprovided 1,197 million Euros in budgetary support to the EUwine sector, an amount that is more than ten times greaterthanthe value of output of the sector as awhole inMoldova. While the reformof the EU's wine sectorpolicy was supposedto shift interventionaway from price support, guaranteedprices in the domestic market combinedwith export subsidies ensure that EU policy still hasadistortive effect oninternationaltrade inwine products. These subsidies, by increasing thevolume ofworld exports and loweringworld price ofthisquality ofwine, adverselyaffect the very market segment inwhich Moldovanproducersare competing. Ithasbeenestimatedthat a50 percent reductioninindustrial countries subsidiesto wine andother beverages will results ina 1.8percent increaseindevelopingcountry exports. A 50 percentcut intariffs, onthe other hand, leadsto a4.4 percentincrease inexports. The impact of the removalofthese subsidies on Moldovanwine exports is likely to be limited. The impactof atariffreductionon Moldovanproducerswould be largerifthey were removedon apreferentialbasis- underthe GSP, for example. Moldova should seek 5.26 For agricultural products, relative market access conditions may worsen and topersuade the EU to there maybe substantial trade diversion away from agricultural exporting CIS countries include wine under as the accession countries, especially Poland, are given substantial preferences inthe the GSP and make a EU.32Onthe other hand, duties incertain ofthe applicant countries arehigher than EU greater number of duties and these will fall after accession. For Moldova, the impact o f EUenlargement on processed current agricultural exports will be limitedto specific commodities. The major agriculturalproducts, agricultural exports to the EUat present are sunflower seeds, for which the MFNtariff in such as applejuice, eligiblefor zero duty the EUi s zero, and shelled walnuts, which are eligible to enter the EUwithout duty under access. the GSP. Hence, market access for these products inexistingEUcountries will not change. However, Poland currently levies a duty of 9 percent on sunflower seeds. This will be reducedto zero duringthe accessionprocess. The impact of enlargement on Moldova could be limited ifthe preferences under the GSP were further enhanced. 5.27 The main agricultural exports that may be affected by EUenlargement are apple juice and wine. Here the accessioncountries -- Poland for applejuice andHungary, Bulgaria and Romania for wine -- are major suppliers of the EUmarket. Current EU 32A Doha round which leads to a major reduction in EUborder protectionin agriculture would help to alleviate this impact. 48 tariffs for these products are high.33 apple juice duties range from 18 percent for low For densityjuice to 30 percent o f highdensityjuice. Under the GSP, Moldova can export at rates o f 9.5 percent for low density juice and 21.5 percent for highdensityjuice. As noted earlier, however, only 21.7 percent o f the exports from Moldova o f applejuice entered the EUat reduced duties. Thus, the duties levied on Moldovan exports o f applejuice put Moldovan producers at a strong competitive disadvantage relative to Polishproducers who can access the EUmarket duty free. However, new opportunities may arise for exports to the new EUmembers. Duties inHungary on applejuice are currently around 39 percent and those inPolandare well over 40 percent. These duties will decline as the common external tariff and preferences towards Moldova are applied. 5.28 As notedearlier, there are no GSP preferences for Moldova onits wine products. While accession countries wine exports to the EUalso do not currently benefit from tariff preferences, as o f mid-2004 Hungarianwine producers will have duty free access to the EU.34The specific EUduties that are appliedto wine can amount to a tariff equivalent o f around 10percent or more. The duties insome o f the accession countries, however, are considerably higher and hence tariffbarriers inthese countries will decline as part o f accession to the EU, offering some opportunities o f improved market access for Moldovanproducers to these countries. 35 5.29 Inadditionto tariffpreferences, after enlargement agriculturalproducers inthe accession countries will also become eligible for EUfarm subsidies. This will make it even harder for Moldovansuppliers to compete inthe enlarged EUmarket. Prices for most agricultural products are lower inthe accession countries than inthe EUsuggesting that there will be a significant increase inproductioninthe accession countries once the policies which generate the higher prices are applied. These higher prices will lead to a decline indemand for many agriculturalproducts inthe new EUmembers. Production surpluses inthe accessioncountries are likely to arise. Part o f these will be absorbedby the markets o f the existing EUmembers, the rest may be removed from the market or exportedwith subsidies. The ability o f the EUto expand subsidized exports, however, i s limitedby the commitments made under the Uruguay Round Agreement. Under this agreement, the export subsidy value commitments o f the accession countries i s about 9 percent o f those o f the EU.Hence, a large scale expansion o f subsidized EUexports after enlargement will not be possible without violating WTO commitments. Producers in 5.30 Withregardto non-border policies, the accession countries will have access to Moldova that can the Single Market (for some sectors, certain countries do so already). The impact will produce to EU vary sector by sector according to the importance o f technical barriers to trade and standards will have government procurementdecisions, the key areas where market access i s influenced by access to a market of the Single Market. Insectors where technical regulations are important, the exporters o f over 400 million people governed by a accession countries will have improved access to the EUmarket. However, inthe main common set of health these are sectors where the CIS countries, through lack o f FDIand technological and safety capabilities are not effectively competing at present, and where the currently applied requirements. GOST regulations inCIS countries are a constraint upon export expansion to the EU. Hence, the direct impact on competition for products currently exported by Moldova will be very muted. However, after enlargement the EUwill comprise a market o f well over 400 millionpeople govemedbyharmonizedregulations for a large array o fproducts. As 33 It i s worth notingthat the EUhas alreadygranted Polandduty free access for these products, while for other applicant countries there are reducedduties underpreferentialquotas. 34 It is still not clear at present what market access conditions will prevail for Romaniaand Bulgaria. 35Average duties on wine imports inthe CzechRepublic are currently around 30 percent, those in Hungary exceed60 percent, while Polandleviesduties that comprisean ad valorem duty of 48 percentplus additionalspecific dutieswhich entailvery high applied rates. 49 Although EU trade chapter 5 indicates, ifMoldova were to upgrade its systemof standards and conformity barriers on products assessmentand rigorously adopt EUand internationalstandards, thenproducers of such as wine are products conforming to these standards would improve their access to this enormous important, there are otherfactors in market. Moldova constraining CONCLUSIONS the ability of Moldovan producers 5.3 1 Moldova faces a changing and challengingmarket access environment inwhat to sell in the EU should be the main overseas destination for Moldovan exports -- the EU.Moldova market. benefits fromthe biggest preferences that are available to developing countries under the EU's GSP scheme. EUtrade restrictionsand subsidies inagriculture are important Major barriers to exports arisefrom the factors affecting Moldovan access to the EUand other markets. While important, these high cost of customs barriers alone cannot explain the large gap between the magnitude of actual trade with the procedures, transport,EUandthe amount oftradepredictedfor "normal economic relations" between acountry andfinance, together o f similar economic size and location to Moldova and the EU.Inother words, a country with a regulatory o f similar economic features to Moldova facing the same market access restrictions as environment which is Moldova should trade more intensively with the EU.Hence, there are other factors which not conducive to the are compromising the ability of Moldovan producers to sell successfully into the EU production of market. As the rest o fthe study shows, these include the additional costs that Moldovan products satisfiing firms incur relative to rivals inother countries inclearing customs, intransporting their modern health and goods to the market, infinancing investment and working capital, and incomplying with safety standards. standards and technical regulations. Inthe case of standards andregulations, these additional costs are inmany cases prohibitive. These are issuesthat need to be addressed iftrade isto fully contribute toraisinggrowthandemployment andinalleviatingpoverty inMoldova. 5.32 Enlargement of the EUwill offer new opportunities for the export o f manufactured goods to the new applicants, while market access conditions inthe existing EUmemberswill not change.The most significant impactofEUenlargement will be in the agncultural sector. Enlargement will leadto substantial preferences for agricultural producers inthe accessioncountries inthe market o f existing EUmembers. The adverse change for Moldovan producers will be exacerbatedby the increase insubsidies that farmers inthe new EUmemberswill receive. However, the products of most interest to Moldova are not the most heavily subsidized inthe EUand a successful conclusion to the Doha DevelopmentRoundof trade negotiations at the WTO i s most likely to leadto further reductions inEUsubsidies. Inaddition, duties for the mainagricultural products exportedby Moldova are higher insome of the main applicant countries than those o f the common customs tariff o f the EU, which these countries will adopt after accession. Thus, even inagriculture, new opportunities for Moldovanproducers will arise. The key issue for Moldovanpolicy makers i s to ensure that the domestic business environment i s such that Moldovanfirms are able to exploit these new opportunities. 5.33 Therelatively highduties inthe EUonprocessedagricultural products and substantial preferences towards competing suppliers inthe Central and Eastern European countries i s an issue that Moldova shouldraise inits bilateral discussions with the EU under the Partnership and Cooperation Agreement. An objective couldbe to persuade the EU,when considering the extension ofthe GSP scheme after 2004/5, to classify a larger number o fprocessedagricultural products as non-sensitive under the GSP and therefore eligible for zero duties and to include for the first time products such as wine. This would have to bebacked upby strong efforts to identifyand alleviate constraints on the take-up of GSP preferences and to ensure that Moldovanproducers are aware that new opportunities for exports may arise inthe newlyacceding countries incentral and eastern 50 Europe. Inthe longer run,ifMoldova i s able to enter into negotiations with the EU towards a free trade agreement, it must ensure that these food products are not excluded. Addressing these 5.34 The "new neighbors" policy o fthe EUoffers Moldova the prospect of access to barriers to trade in the EUsingle market on the same terms as existingmembers. An intermediate step would Moldova will be be providedby a free trade agreement, something that is envisioned inthe partnership crucial ifMoldova is to successfully maintains that at "Moldova . does not currently possess the competitive strengthor and cooperation agreementthat the EUand Moldova have signed. However, the EU integrate into the post-enlargement administrativecapacity to take on the reciprocal obligations o f an FTA". Addressingthe architecture that is domestic constraints on trade and investment would therefore not only stimulate trade but emerging in Europe. also bringMoldovan institutions andpolicies on a pathwhereby a free trade agreement withthe EUcouldbecome areality. This inturnwould have an additional major impact on trade and particularly investment inMoldova. 51 CHAPTER6. STANDARDS, CONFORMITY ASSESSMENT AND TRADE: MODERNIZATIONTO FACILITATE MARKET ACCESS INTRODUCTION-STANDARDSAND TRADE 6.1 Standardshave come to be crucial elements facilitating transactions and trade Standards play a key bothwithin countries and ininternationalexchangebetween countries. Standards support role infacilitating markets and facilitate efficient transactions. Standards stipulate what can or cannot be trade and exchanged and define the procedures that must be followed for exchangeto take place. development whilst providingfor Thus, the ability to comply with the standardsinoverseas markets is amajor factor governments to determining access to those markets and the capacity to export. This i s true bothfor achieve objectives standards that are definedas mandatory by governments (technical regulations) so as to concerning health meet their objectives regardinghealth and safety and environmentalissues, as well as and safety. market drivenvoluntary standards which reflect the demands and tastes of consumers or the technologicalrequirementsof industrial purcha~ers.~~ 6.2 This important role of standardsintrade and development arisesbecause: Standardsare instrumental in facilitating the flow of information between consumers and producers and, inparticular, inproviding information on unobservable characteristics suchas quality. Thus, standards canreduce uncertainty for consumers. Standards indicate to producers the expectations and requirements of consumers interms o f quality and safety. For these reasons standards can contribute to higher levels of economic activity Standardsallow governments to effectively achieve their objectives concerning health and safety. Such standards, which are often mandatory, are particularly important indeveloping countries as they seek to raise living conditions. For example, standardswhich improve health and sanitation will tendto complement policies to raise productivity and increase economic growth and incomes 0 Standardsprovide an important mechanism for technology transfer to developing countries. Inthe main, technology i s expressedthrough standards and hence standards help to diffusetechnical information concerning products and processes.The needto satisfy recognizedstandards can be an effective incentive mechanism to encourage local firms to improve the quality and reliability of their products. Standardsare crucial inallowing firms indeveloping countries to integrate into global production chains, especially inmodem engineering sectors, by ensuring the compatibility and interoperability o f components made indifferentplaces. 6.3 Itis useful to distinguishproduct standardsfrom process standards.The former refer to the characteristics that goods should possess, for example, maximumpesticide residues for agricultural products or performance requirements for machinery. Process standards relate to the conditions under which products are producedand packaged. These standards can define rules for the production of the final good, for example, the procedures for processing foods. 36The WTO Agreement on Technical Bamers to Trade (TBT) defines a standard as a "document approved by a recognized body, that provides, for common and repeateduse, rules, guidelines or characteristics for products or related processes and production methods, with which compliance i s not mandatory". The development, adoption and compliance with voluntary standards are dictated by the market. The term "Technical regulations" refers to mandatory standards, which are developed and enforced by govemments to guarantee protection of safety, healthand the environment. 52 6.4 There may also be standardsthat are concerned with issues that are indirectly relatedto production, suchas the environment. For example, companies are increasingly requiringthat sub-contractors satisfy standardsrelatingto the use of hazardous chemicals inthe workplace andchemicals that areozonedepleting. A particular goodmaybe Efective conformity subject to arange of both mandatory and voluntary product and process standards. Clear assessmentand information on relevant standards i s therefore crucial to producers. accreditation systems 6.5 Inadditionto the writingof standards, anessentialelement of the system of are crucial elements in a modern standards standardization i s conformity assessment, the technical procedures such as testing, infrastructure. verification, inspectionand certification, which confirm that products fulfill the requirements, laid down inregulations and standards. There i s also the accreditation and recognition system-the audit system that ensures that conformity assessment i s working properly. Eachcountry needs a standards infrastructure, which meets its own domestic and trading needs.The development of such infrastructure will depend on the structure of the economy and the structure of exports, but i s guided by government policies. Toparticipate in the 6.6 Meeting standardsmeans that firms also incur costs interms o f investments in global marketplace, the equipment and staffthat are necessaryto ensure compliance with the requirements firms in developing that are laiddown and the costs that arise inproving conformity to the relevant standards. countries must For firms indeveloping counties, such as Moldova, to effectively participate inthe comply with global economy and to move beyond simple assembly operations, they must invest in standards and therefore must invest compliance to satisfy standards. The cost of non-compliance i s the loss of existing export in compliance. markets or the inability to expand into newmarkets. The government has an important role inproviding a fi-ameworkby which domestic firms are able to invest inhigher quality and which provides an effective and efficient conformity assessment infrastructure. 6.7 The cost of compliance is higher whenthe home country of the exporting firm has a systemdominated by mandatory standards. The costs will also tendto be considerably higher incountries where the systemo f standardslacks transparency, predictability and there is a lack o f effective management of informationconcerning standards at home and abroad. This can leadto a lack of clarity for firms inassessing which standards arerelevant for their products and an unwanted degree of discretion to officials charged with implementingthe standards system, for example, withregard to which products are inspected, when and where they are inspected and how they are inspected. 6.8 There are a range o f voluntary standards the satisfaction o f which can be an Standards are important element of competitiveness, especially for firms indeveloping countries that are increasingly tryingto compete inthe global markets. For example, the I S 0 9000 standardsrelatingto important in quality management systems provide important information to buyersconcerning the way defining competitiveness that companies deal with quality issues. Similarly, the I S 0 14000 standardsrelating to management of environmental issues within a company and standards concerningsocial accountability (i.e., labor workmg conditions within the firm) are increasingly important inattracting attentionfrombuyersinWestern markets, who inturnneedto respondto the demand for consumers inthese markets for assurances relating to the environmental and social conditions inwhich the goods are produced. 6.9 Itappearsthat Moldovaisnot doing particularly well inthisregard. Table 6.1 shows the number o f companies with I S 0 9000 certification inseveral comparator countries. Itis clear that Moldova is significantly behindother countries inthe region in I S 0 9000 certified companies. A key aspect o f I S 0 9000 i s that companies must adopt a strategy for quality management and then have that assessedrelative to intemational 53 Moldova is considerably norms and best practices. A key issue for Moldova is to encourage and facilitate more behind other companies to focus on, and take responsibility for, the quality of the goods or services countries in the they produce. Without this fundamental change of attitude the prospects for generating region in the higher value added activities and of long-run increasesincompetitiveness will be poor. number offirms having quality Table 6.1: Companieswith I S 0 9000 Certification management State 1995 1996 1997 1998 1999 2000 2001 2002 systems certified Bulgaria 3 14 42 96 199 259 469 883 as being CzechRepublic 180 366 746 1443 1500 3855 5627 consistent with international Romania 42 61 214 269 466 1032 1670 standards. Moldova 3 4 6 10 11 Standards are Source: I S 0 increasingly important in 6.10 Inmany cases, satisfyingthese requirements, althoughvoluntary inprinciple, defining may be necessaryto permitparticipation inglobal markets. It i s also important to note competitiveness that the ability to meet these standards set by buyers or contractors may also necessitate an accompanying infrasb-ucture that provides for credible independent thirdparty testing and certification. If such facilities are unavailable, then it may be very difficult for local firms to establish links with buyers and contractors in overseas markets. Standards can 6.11 While standards are a key element inmodem markets they can also act to also act as constrain trade between countries. Differentstandardsand conformity assessment signzjkant procedures indifferentcountries raise the costs of exporting. Producers may have to barriers to trade. change their product to be acceptedinforeign markets with the associatedcosts of redesign and of runningnew administrative systems for control of products for separate markets. This intum undermines the ability o f firms to reap the benefits, interms of lower averageproduction costs that arise from larger scales of production. 6.12 Mandatory standards can act as barriers to trade, even ifthat i s not the intention of the govemment concerned. For example, a EUregulation designed to protect human healthrequires that milkproducts beproducedfrom the milk o f cows milked mechanically. This effectively excludes imports from many developing countries whose farmers have been unable to invest inmachinery. 6.13 There are often significant costs relatedto conformity assessment for exports to overseas markets. Governments often do not recognize the tests performedinthe exporters home market so that exporters have to undertake expensive tests inthe foreign market. 6.14 These issues underlie the concernsthat ledthe WTO members to agree upon disciplines on the use of mandatory standardsby governments to limit the impact of standards as a constraint upon internationaltrade flows. The WTO agreementson Technical Barriers to Trade (the TBT agreement) and on Sanitary and Phytosanitary measures (the SPS agreement) imply obligations for Moldovabut they also offer opportunities. THE WTO AGREEMENTS ONTECHNICAL BARRIERSTO TRADE AND SANITARY AND PHYTOSANITARY STANDARDS 6.15 The SPS Agreement lays down disciplines for the use o f sanitary and phytosanitarymeasures while the TBT Agreement regulates all other technical standards. Both the TBT and SPS Agreements have similar scope and structure. The aim of the Agreements i s to prevent governments from using standards and conformity assessment 54 Theaim of the SPS procedures as protectionist measures. Governments are still allowed to use such measures and TBTagreements is to the extent necessaryto meet legitimate objectives (food safety, animal and plant health to limit the use of inthe caseofthe SPS Agreement, andissuesofnational security, preventionofdeceptive standards and practices, human safety, the environment, etc., inthe case o fthe TBT Agreement), but conformity assessment they must not be applied ina way whichundulyrestricts trade. that constrain trade while allowing 6.16 Both Agreements are basedon two key principles.First, standards and governments to conformity assessmentmustbe non-discriminatory. That i s foreign products must be achieve legitimate affordedthe same treatment as domestic products (the principle of "national treatment") objectives concerning and there mustbe no discriminationbetween products from different foreign countries. issues such as health, Thislatterprinciple is equivalent to the well-known Most FavouredNationprinciple that safety and the underpins the WTO. Second, the use of standardsmustbejustified. environment. Harmonization with 6.17 A number of instrumentsare createdto support the key principles. international Harmonizationplays a special role inthe Agreement. Both Agreements encourage standards plays a key Members to harmonize their standardswith those developed by a given set of role in the agreements. international standardization organizations. The encouragementi s strongest inthe case o f the SPS Agreement that obliges Members to basetheir SPS measureson international standards and furthermore states that a national measure that conforms to an international standard i s automatically assumedto comply with the requirements of the SPS Agreement. Inreality, theserules translate into anencouragementrather than a strict legal obligation for two reasons.First, standards less strict than international standards are unlikely to be questioned by trading partners who will not see them as barriers to trade and, second, standards stricter than internationalones are explicitly allowed subject to certain conditions. Theagreements 6.18 The SPS Agreement i s very demanding inthis aspect. SPS measures that deviate require that measures from internationalstandardsmust bebasedon scientific evidence. An assessment of the that deviatefrom risks to human, animal or plant life and health, takmg into account risk assessment international techniques developedby the relevant internationalorganizations, must be provided. A standards must be Membershouldeither produce ariskassessment itself or, ifavailable, provide one justified using developed by other Members or internationalorganizations. Disputes inthe WTO have scientific evidence. revealed that the demands of risk assessment are higheven for developed countries. 6.19 The TBT Agreement allows Members to apply national standardsthat deviate from international standards ifthe latter are deemed ineffective or inappropriate means for the fulfilment of the legitimate objectives beingpursued becauseof, for instance, climatic or technological problems. Developing countries are explicitly allowed to deviate from internationalstandards ifthese are not appropriate to their development, financial or trade needs. 6.20 Control and conformity assessment procedures are subject to similar rules that prohibit discrimination inthe treatment of imports and domestic products and encourage Transparency of the use of international standards and practices. standards and conformity assessment 6.2 1 The trade distorting nature o f standards is oftenrelatedto the lack o f regimes and clear and transparency o f the requirements for exporters. Therefore, the Agreements require that timely notifications of Members establish notification procedures through which other Members are informed o f new standards and forthcoming standards. Furthermore, an EnquiryPoint mustbe established through which procedures are key other Members can obtain information about the standards and conformity assessment requirements under the procedures. Also relatedto transparency is the existence o f an SPS Committee and a TBT Agreements. Committee that meet 2-4 times a year and discuss issues relating to the operation of the 55 Agreements. Participationinthe Committees i s open to all Membersand allows themto be informedabout and to discuss other Members standardsinan informal way. 6.22 Theregulation ofthe use ofstandardsbecomeseffective throughthe existence of a bindingmechanism o f dispute settlement. When a Member believes that a standard or conformity assessmentprocedure of another Member violates the disciplines established bythe Agreements, that Member mayrequest consultations. Ifthese fail to resolve the issue the complaining party may request the establishment of a panel o f three independentexperts that will investigate and determine whether the measurecomplies with the Agreements. Ifnotthe Memberfound inviolation ofthe Agreements is forcedto follow the recommendations o f the panel report. A decision may be appealedbut the subsequent opinion of the Appellate Body i s final. Ifa Member does not abide by the rulingo fthe Dispute Settlement Body, the complainingMember may take punitive measures. 6.23 The SPS and the TBT Agreements have anumber of implications for Moldova. The obligationsconcemthe setting of standards,conformity assessment andthe transparency of the system: Where intemational standards exist, harmonizationi s encouragedyet there i s still room for the design of different standards that take into account the special needs of Moldova, inparticular if such standards are less strict than intemationalones. ShouldMoldovadesire to set standards that are stricter than the intemational standards, Moldovahas the right to do so, but this right is conditional on the existence of ajustification for the stricter standards and that the standard doesnot undulydiscriminateagainst imports. 3) There are many areas where no intemational standardexist. Inthis case, Moldova may still set standards, but only if standards arejustified and do not discriminate. The agreements also provide important 4) The Agreements oblige Moldovanot to discriminateagainst imports or between opportunities to be different suppliers of imports inthe application of conformity assessment notiJied of other procedures and encourages these procedures to follow intemationalnorms. countries proposals to Moldova should comply with the notification requirements of the Agreements change or introduce procedures and maintain an EnquiryPoint. new standards that may affect Moldovan 6.24 The SPS andTBT Agreements provide opportunities as well as obligations for exports and to contest Moldova. While the obligations concem import measures, the opportunities address those n ~ ~ u r eifthey S export market access. The exploitation of such opportunities requires capacity buildingin arefelt to contradict the areas of government-business cooperation, participationinWTO Committees and in theprovisions of either agreement. the dispute settlement system. For Moldova to be 6.25 Moldova has access to the notifications of other Members through the WTO able to beneftfrom secretariat inGeneva. Mechanisms are necessaryto provide for such informationto be the WTO made available to Moldovan companies when relevant. The transfer o f informationmay Agreements, there includeanalysis ofthe severity andnature o fthe information which, when compared with must be effective the interests o f the business community, will indicate the relevance of a givennotification management of for Moldovan export interests. Procedures must also be inplace to informthe government information from of the interests and priorities o f the business community. Effective govemment-business WTO noti3cations cooperation will allow Moldovanfirms to be aware of upcoming changes inimportant and strong legislation inthe main export markets. cooperation between government and 6.26 Moldova also has the opportunity to participateinthe discussion of changes in business. regulatory requirements inthe SPS and TBT Committees, including issuingformal 56 comments and to suggest changes to the Memberinquestion. This opportunity will dependonthe capacity to participate effectively inthe meetings. Again, goodcooperation between government and the business community i s key as i s the availability of the necessaryfinancial andhumanresourcesto participate inWTO meetings. 6.27 The dispute settlement systemoffers the Members of the WTO an opportunity to challenge the legislation of foreign countries. Yet, it must be emphasisedthat considerable human, technical and financial resourcesare necessaryto formally conduct a case through the entire dispute settlement system.The demand for such resourcesi s lowered, though, ifcooperation i s established with other Members that share the same interests. 6.28 Box 6.1 provides some examples of how certain developingcountries have been able to defendtheir export interests throughthe use WTO consultation and dispute settlement procedures. However, ingeneral, developing countries use these provisions to a much lesser degree than developed countries, despite the fact that barriers to trade causedby standards and conformity assessmentimpingemost heavily on developing country exports. The box also provides a briefdescription of how one developing country has developed an effective system for disseminating to local businessesinformation on newtechnical regulations and conformity assessmentprocedures inoverseasmarkets that are notified to the WTO. STANDARDSAND CONFORMITYASSESSMENT INMOLDOVA 6.29 Under the previous Soviet regime, standardization systems were createdto serve the needs ofthe command economy, where the state dictated what to produce, how to produce it and inwhat quantities. For that to happen, the standards hadto be mandatory and explicit like a recipe. Any changeto the existing standards was the result of research, Thesystem of which was concentrated inthe state-owned research institutes andreflectedthe guidance standards and of the Congress of the Communist Party. Only the very big industrial factories hadtheir conformity own research and development units, but again they didnot base their work on consumer assessmentof the previous regime is demand and market conditions. not consistent with 6.30 It should benotedthat technicalregulations as appliedinmany economies are the requirements of fundamentally different from the mandatory standards, which were usedinthe soviet a modernflexible systemand still prevail inMoldova. Technicalregulations have a public good function economy. and their mainpurpose i s to specify performance indicators, limits and thresholds rather than design or descriptive characteristics, which i s typical of the GOST standards. For example, a technicalregulation on a fire-resistant door could specify that "the door must be fire resistant with a 30-minuteburnthrough time" and it shouldnot specify how the product mustbe made, e.g., "the door mustbe made of steel, one inchthick". The GOST standardsprovide very little flexibility to firms insatisfyingthe requirements. Moldova is significantly behind 6.3 1 All former Council for MutualEconomic Cooperation(COMECON) countries other countries in have undertaken steps towards modernizingtheir standardization infrastructureand the region in introducinginternational standards. While countries such as the CzechRepublic have modernizing its essentially completedthis process, Moldovahas progressed little inthis aspect o f standards system, transition to a modemmarket economy. Moldova's institutional structure inthe area of with many of the standardization, metrology, certification and accreditation still resembles most o f the features of the features of the former system o f centralized control, which results ina highdegree o f former system still in government control and influence over the placing of products on the market. place. 57 Box 6.1 Opportunitiesunder the TBT/SPSAgreements Example1:EUandSardines a EU regulation only allows sardines (sardina pilchardus) found near Europe to be labeled as sardines. Other species (such as sardinops sagax) found off the coast of Peru and Chile could not be labeledas Sardine. 1 Peru requested a panel to consider whether the EU regulationwas consistent with the TBT agreement InMay 2002 the panel ruled infavor of Peru citing the codex standardfor canned sardines which allows for a number of different species to be labeled as sardine and the "ongoing obligation" to reassess existing technical regulations in the light of new or revised internationalstandards (TBT Art 2.4) Example2: EUandAflatoxins 1 In 1997 the European Commission (EC) proposed to adopt a standard of 4ppb in cereals, ediblenuts anddriedh i t 1 15 Countriessuch as India, Mexico andPakistanraisedissue inSPS Committeeandrequested detailedrisk assessmentsusedindesigningthis new standardfromthe EU a As aresult of consultations, the EUrevised the standard for peanutsto that ofthe draft codex standardandreconsideredthe inspectionproceduresfor cereals, dried fruits andnuts 1 Furthermore, the formal discussionof theprobleminthe SPS Committeeallowedexportersto be aware of the pending legislation before entry into force and drew the attention of internationaldonorsto the adjustment difficulties. Example3: BrazilandNotifications The enquiry point for TBT has developed a tool called "Alerta Exportador" which enables exporters to receive daily e-mail updates- without incurring any costs - on new WTO/TBT notifications of technical regulations and conformity assessment procedures in overseas ' markets. This systemenables enquirypoints to cover all businesssectorswithout inundatingfirms with irrelevant information. 6.32 Three years ago, for the first time, the Government stipulated that the application o fnational standards would become voluntary, except where areference ina technical regulation i s provided, resulting inmandatory requirements. However, technical regulationshave not yet beenelaborated and at present Moldova continues to use the old approach of mandatory standards.Moldovadoes not have any specific regulations or requirements covering electrical safety, telecommunications equipment, medical devices and other types of equipment.This must make it difficult for the government to achieve objectives regardinghuman safety.37 6.33 Limitedprogress has been made inbringingthe standardization system inline withbest internationalpractice. The keyreasons are that there is no budget allocation for this task and the possibility of adoptingdirectly international or other countries' technical Littleprogress has been regulations and standardshave not been exploredrigorously. Members of the working made on a key objective groups that have been established within the relevantministries are not experienced in of moving to a voluntary drafting technicalregulations, which may leadto the creation o f unsuitable regulations system of standardization -due to lack of that resemble more the existing mandatory standards. Currentlythere isno scope to hire commitment, in terms of consultants from outside the respective ministryto assist the established working groups budgetaryfunds, and with drafting regulations. More generally, little has been done to provide information to failure to directly adopt business and the public about international standards, EUrequirements, the system o f -international standards. "UkraineisadoptinganumberofEUdirectivesintheseareas.Theseso-called`mewApproach"directivesallowfora more flexible approach in satisfying mandatory regulations.The directives state the essential requirements and leaves firms' flexibility incomplying with these requirements. At the same time the European standards organizations (CENELEC and CEN) are given the task of drawing up voluntary standards, compliance with which are then presumed to show consistency with the regulation. 58 conformity assessment, how the system of accreditation i s working and the importance of these issues for trade. Muchneeds to be done intraining staff of the various agencies. 6.34 Ukraine, on the other hand, has set forth a plan of harmonizationwith international and European standards.In2003 Ukraine transposedabout 500 international standardsinto its national system. By the end of 2003 Ukraine hadadopted around 1500 international standardsout of about 9000 that it set as a goal under its current agreement with EU.In2003 the Department of Standardization inMoldova transposedsome 22 international and European standards into national standards.Despite the ambitious program set upby the MoldovanGovernment concerning the transition towards the voluntary systemof standardization and elaboration of technical regulations by 200538, there i s neither adequate financial nor technical support. Lack of capacity inmost of the governmental institutionsresponsible for the implementationof this programremains a major constraint. Moreover, the programitself does not set down any targets such as the number ofrequiredtechnical regulations. The current system in 6.35 Theslowprogress in adopting a modern, transparent standards system Moldova lacks contributes to a negative business environment. The current systemi s overly complicated transparency and with no clear rulesregardingapplication, which leaves too muchroom for discretion. simplicity -the roles of diferent Functions, relationships andresponsibilities of different state bodies comprising the departments are not systemare not clearly definedand very often are overlapping. Informationis notreadily clearly deJined and available and the rationalebehind some of the requirementsis not made clear to those there is too much that have to apply them. For example, there are three bodies issuingrequired certificates scopefor discretion. for food -the Preventive Medicine Department within Ministryof Healthcare, the As a result there is a MinistryofAgriculture andMoldovaStandard.Manyofthe itemstestedbyeachbody heavy burden onJirms are the same. Inspections are also overlapping, with differentdepartments of the same in complying with agency being incharge o f various aspects of the inspectionprocess. Information from standards in the Costs of DoingBusiness surveys suggeststhat Moldovan businesses are subject to more domestic and overseas inspections than businesses inneighboring countries, such as Ukraine ad Bulgaria. markets. 6.36 Under the current system the overall costs of obtaining the necessary certijkates are high. The need to certify goods andproduction processesi s dauntingboth for exporters and importersbecauseof the highdirect and indirect costs. Producers are often required to certify each imported input,the productionprocess as well as the final product. A large proportion of companies (almost halfinthe Costs of DoingBusiness Survey) report having to make unofficialpayments to obtain the necessarycertificates relating to standards on imported products. The survey for 2003 suggests that the official payments that must be incurred to obtain the necessarycertificate confirming the compliance of an importedproduct with Moldovan standards averages $97, while the average unofficial payment exceeds $140. 6.37 At present, companies who seekto export to the EUmarketare often severely constrainedbyhaving to incur highcosts to have their product tested and certified overseas inthe absenceof suitable local testingcapacity and the fact that certificates from Moldovanbodies are seldom recognizedinternationally. For example, certification of organic nutproductionexported to Germany has to be renewed every 6 months and each visit from an international certifying company costs $5,000 plus$2,000 perproduction test - once before processing and once after processing. This can amount to $18,000 per year, which is a highburden for firms inan economy such as Moldova to bear when 38Moldova establishedthe following two major institutional pillars inorder to implementa systemof voluntary standards and technical regulations: (a) an intergovemmentalSteeringCommittee to supervisethe processof conversion of mandatorystandards into technical regulations and implementationof the voluntary systemof standardization;and, e)a National Programfor Elaborationof Technical Regulations2003-2008with the priority for the agri-processingsector. 59 tryingto compete on intemational markets. Upgradingtesting facilities and measuring equipment i s essential for reducing the costs of conformity assessments. 6.38 This highlightsthat without accessto adequateinfrastructure relatingto standards and conformity assessment, companies incountries suchas Moldovamay have difficulty discoveringthe relevant requirements inoverseas markets and face highcosts in demonstrating compliance with those requirements. However, developing countries have only limitedresources available for investmentinthe conformity assessment infrastructure. Ofparticular importance regardingexports is intemationalrecognition o f accreditation bodies. For suchrecognition, conformity assessment bodies must show that they are competent, interms of experience, humanresources, facilities and organization. Here technical assistance, as i s envisagedunder the WTO/TBT Agreement plays a vital role. Suchassistanceneedsto upgrade equipment intesting laboratories but also to facilitate greater participation o f Moldovan institutions and personnel inintemational organizations, such as Intemational Laboratory Accreditation Cooperation) ILAC. Theslow pace of 6.39 The slow pace of adoptionof internationaland European standards inMoldova adoption of means that firms who wish to export overseas, say to the EU, as well as sell inMoldova, international and will often have to design different products to meet the different standards inthe different European standards markets, have to incur multipletesting costs and obtain a number of certificates of and the absence of appropriate testing conformity. The experience of other countries inthe region, such as Bulgaria, shows that and certifxation once a system o f voluntary standards was introduced, companies who hadredesigned facilities means that their export productsto conform to the requirements of the EUMarketwere also able to Moldovan firms expand their sales inBulgaria as well as other CentralEuropean markets. The adoption of have to incur EUstandardsthroughout Eastem Europe is animportant factor affectingthe access of substantial costs in Moldovan exporters to these markets. Such access will remain more difficult while the sewing overseas domestic system inMoldovaremains mandatory with a low level o f adoption of these modem standards. 6.40 One sector, of particular relevance to Moldova, where international and EU standards are becoming increasingly important i s fresh fruit and vegetables. Consumers inmany countries havebecome increasinglyaware andconcernedwiththe safety ofthe fresh produce that they consume and the environmentaland social dimensions o f production systems. These concems have ledto an array of responsesfrom both governments andprivate companies. Inorder to minimize microbiological risks, measureshave been taken to require or obtain "voluntary" adoption of Hazardand Critical Control Points (HACCP) and producttraceability programs inthe fresh produce sector. Countries have sought to reduce or eliminate the use o f certain types of pesticides, reduce the acceptable levels o f pesticide residues and strengthen residue-monitoring programs. Concerns about the possible spread of exotic pests or plant diseases have ledto the strengthening o f phytosanitarycontrols. Broader concems have been embodied inan array o f industryor company-specific "codes of practice" with which suppliers, both Effective domestic and international, are beingencouraged or required to comply. Awareness of, government- and compliance with, these standards will be a prerequisite ifMoldova i s to penetrate business higher value markets inthe EUand Eastem Europe. It is crucial that an infrastructure partnerships are exists to provide for independent thirdparty testing and conformity assessment. Inother necessaly in words, it i s not only necessaryto comply with these standards but also to be able to addressing the increasingly demonstrate compliance ina way that meets the requirements o f buyers. complex 6.41 There are many examples from other developing countries o fhow effective standards issues in sectors such government and private sector initiatives at the sectoral level can address such problems asprocessed relatingto standards ininternational markets and pave the way for overseas market 60 access and significant exports, see Box 6.2 for an example. The role of the government i s to provide a clear and effective institutional framework, while companies must take responsibility for quality and compliance with modem standards.There i s clearly a need for increased contact and cooperation between government and business concerning standards issues inMoldova. Box6.2 GovernmentandBusinessCollaborationon Standards: andExamplefrom The PeruvianAsparagus Industry The Peruvianasparagusindustryprovidesan exampleof where industryleadersand govemment specialistsrealizedthat it was inthe bestinterestsof the industry,as well as the countryas awhole, to adopt nationalstandards inline with internationalnorms, andhave greatlybenefitedas aresult. Over thepast decade, Peruhasquickly risen to become one ofthe world's largestexportersof asparagus.By producing productsthat meetinternationalstandards, Peruvianasparagusexportershave increasedproductionand worker efficiency andgeneratedclient loyalty, while drasticallyreducingthe industry'sriskoftrade disruptionsdue to quality, food safety or plantdisease issues. Peruhasbeenable to gain access to industrializedcountrymarkets for its asparagusbecausethe industry and governmenthave worked togetherto market andmaintainquality nationalproductsthroughthe adoption ofnationalstandards inaccordancewith intemationalnorms. In1997, Spanishsanitaryauthoritiesclaimed that two cases ofbotulismwere causedby consumptionof cannedPeruvianasparagus, Peru's largestmarket for this product. DespitePeruviangovemmentandprivatesector assurancesto the contrary, press coverage ofthe botulismscare left anunfavorableimpressionamongconsumersinEuropeanmarkets, causingsalesto slump. This incidenthelpedmotivatethe industryandgovemment to cooperateandtake action, and reinforcedthe fact that one careless exporter couldindeeddisrupt markets, suchthat everyone involvedthe asparagusexportchainneededto work together to prevent future problems. Beginningin 1998, government officials with the PeruvianCommissionfor ExportPromotion (PROMPEX) convincedthe asparagus industryto first implementthe Codex codeofpracticeon food hygiene, not because it was the easiestbutbecauseit was the mostnecessary. PROMPEXspecialistsworked closelywith industryleadersandproductionmanagersto assurethe properimplementationofgoodhygiene standards. As aresult ofbetterhygienepractices, the industry saw improvedproductionmethods, and worker efficiency andproductquality. This first successful experience with an industrystandard, together with commitmentsof govemment support andthe increasingdemandsfromclients for certifiedproducts, gave industryleadersthe confidenceto work with the PeruviangovernmentandPROMPEXto develop and implementnationalstandards. Thus, whenthe nationalfresh asparagusnormswerepublishedinearly 2001, becausethe industrywas already familiar with the conceptof standards, producersquickly compliedwith little argument. These nationalnorms establishedaquality andperformancebaseline for the industrythat allowedmanyto generate the skills andexperienceneededto voluntarily certify under othermore stringentinternationalstandards. They includedHACCP, traceability systems andGoodAgricultural Practice(GAP) certification. Many largeexportershavereachedthe level where they cannow be certified under the evenmore strictEuro- 'RetailerProduceWorking Group's standards of GoodAgricultural Practices(EUREPGAP) protocol. From: Diop, N., S. Jaffee, 2004 ` Global Trade and Competition in Fresh and Processed Fruits and Vegetables' forthcominginAksoy, A., Beghin,J. (eds) GlobalAgricultural Tradeand Developing Countries, WorldBankandOUP Industrial development 6.42 The limited modern conformity assessment infrastructure in Moldova denies couldbefacilitated if businesses theservices that they need toparticipate in global markets. Many countries testing institutions have found that they can achieve their objectives regardinghealth, safety and consumer were to become more protection by establishing just three national monopolies within the national standards business oriented. structure: scientific metrology, ina centralised or decentralised structure; accreditation, possibly with different organizations for laboratory and certification body accreditation, and standardization 6.43 Many govemments have concluded that it i s desirable to leave the ever more complicatedand costly conformity assessment activities as much as possible for the markets themselves to fundand establish. Following this principle, it i s widely agreed, that all other conformity assessment activities, except from the three above, may be seen as technical services, where competition couldbe established. Industrialdevelopment i s promoted when these services are provided inresponse to business drivendemands. 61 Moldova should consider how to provide an environment that encourages the private provision of the servicesrelatingto inspection, sampling, testing, and certification. Achieving international 6.44 The relevant institutions inMoldova should participate more effectively in recognition and internationalbodies relatingto standards and conformity assessment. This bringsbenefits providingfor greater not only innot only inbeing able to representthe interests ofproducers and consumers in participation in the framing ofnew or amendedstandardsbut also is being aware of trends inscientific international standards knowledge as well as consumer demands of relevance to domestic producers and and conformity standard setters so as to be able to anticipate future changes and developments. Greater assessment institutions is participation of internationalbodies relating to accreditation, inspectionand certification important in supporting bodies would help to enhance the reputationof Moldova and assist inthe modernisation Moldovan business. o f the Moldovan system through the demands that membership brings.For example, A key issue is the becoming a signatory o f the InternationalAccreditation Forum's (IAF) multilateral independence of the recognition agreement i s an important step indeveloping internationalrecognitiono f accreditation body in local accreditation. Ofparticular relevance here i s the independence of the accreditation Moldova body, an issue that needsto be clarified inMoldova. Box 6.3 summarizes the experience o f two European countries regardingthe independence of the accreditation body. Box 6.3 The Independenceof the Accreditation Body: Experiencesfrom Europe InDenmark,since theearly 1970's thenationalaccreditationbodyhadbeenorganizedas one oftheofficesin an agencywithin the Ministry of Enterprise. The accreditationbody enjoyedfull signatorystatus to all relevant intemationalmultilateralrecognitionarrangements.Yet, inpeer evaluationsby acceditorsfrom other countries, recommendationshadrepeatedlybeenmade suggestingchangesto the managementand organizationalstructure towards ahigherdegree ofindependencefor DANAK. The criticism was based on observationsthat DANAK did not have aproper accreditationboardandthat it was under the full controlofthe govemment agencyto which it reported.As aresult ofthis andalignedwith govemmentprivatizationpolicies, in2002 the accreditationbody was establishedas an organizationallyandeconomicallyindependentnon-for-profit foundationandmovedfrom the agencyinto rentedofficesinanindustrialdistrict. Poland had developed its national accreditation service in the 1990's as a branch of the National Centre for Testing and Certification, the PCBC.It was housed inthe same building and was reporting to the same top-level management, as did several testing laboratoriesfor which it had issued accreditation.Arrangements to ensure suficient independenceand safeguards against adverse organizationalpressure were severely questionedby peer evaluators when Poland applied for signatory status to European Accreditation Multilateral recognition arrangements. The Polish application was rejected, and reorganization was necessary. Today, the accreditation body is still located in the same building as the testing and certification centre, but apart from separate managementandreportingstructures, intemalhallways from the smallpart of the building occupiedby the Polish lAccreditation Centre have been sealed off, and a separate front door has been constructed in order to signal it's Iindependence.Nevertheless, the time it took to reorganize the accreditationbody after the initial rejectionmeant that Poland was one of the last Eastem and Central European countries to enter the mutual recognition arrangementsof EuropeanAccreditation. Ref: ISO/IECGuide61. 6.45 The current system acts to discourageforeign direct investment and constrains innovation and strategies towards product differentiation Adequate and appropriate conformity assessment infrastructure and transparent, non-arbitrary regulations and procedures are key factors affecting the location decisions of multinational firms. Countries meetingworld standards tend to attract more investors. This constraint on FDI limits the transfer of technological knowledge to Moldova, especially ofprocessesand procedures that would raise quality inMoldova. The current standards, some o f which date back to 1938, remain too prescriptive and allow little or no flexibility to firms to introduce new materials or apply new processes. Firmswishing to make even minor change to their product will typically have to endure a longprocess o f changing the current standard. Strict packagingrequirements also stifle the competitive strategies of Moldovanfirms inthe domestic market. For example, it i s difficult inMoldovato have promotions such as offering "25 percent more cookies for the same price''. 62 CONCLUSIONS 6.46 To provide for its companiesto effectively compete on internationalmarkets it i s necessary for Moldova to modernize its systemo f standards and conformity assessment. This facilitation oftrade shouldbe integratedinto abroadstrategy towards meeting government objectives concerning raising healthand safety levels inthe domestic economy. At the same time an increasing focus on quality shouldbe at the forefront of export promotion activities inMoldova. These aspects of the standards and conformity assessment systemcould be brought together inthe context of a national quality plan. Box 6.4 briefly discusseshow suchplans have been usefulinother developing countries. IBox 6.4 National Quality Plans: Experiences of Other DevelopingCountries. InEgyptduring2001-2003 atask force was set upto arrangeanationaldebate andto establishthe future modernization and development of standardization and conformity assessment activities. Interministerial coordinationandprivatesectorparticipationwere amongthe issues high onthe agenda. The Egyptianprocesshadbeen inspired inpart by a large project in India in the late 199O's, which lead to the adoptionofanationalquality planfor India. Both of these cases were supportedand facilitatedby EuropeanUniontechnicalassistance. The existence of anationalquality planhas pavedthe way for additionalfunding for targeted development of laboratories, accreditationsystemsetc. 6.47 The essential elements of such a quality strategy, a number of which are already embeddedinthe Government' s nationalprogram, would involve The effective implementation of a transparent and open system of voluntary standards with technical regulations to define mandatory requirements.A more simple system shouldbe implementedwith a clear delineation of tasks between the different Government departments involved. A rapid adoption of international and EUstandards whererelevant accompanied by a stock takmg o fexistingstandardsandthe removal ofthose which are obsolete ina modem economy. It may be useful, as inother transition countries to set targets for this process and to adopt internationalstandardswithout translation, this speeds upthe process, allows companies that are ready to immediately produce to these standards and avoids codifying translationinto national standards. The objective should be to provide a systemwith flexibility for firms insatisfying standards inthe domestic market and abroad while effectively allowingthe government to pursue its objectives regardinghealth and safety. Careful consideration shouldbe given to adopting EU"new approach" regulations inareas where there areno standards at present to protect human health, such as, electrical safety. Increasinglinksbetween government and business and more effective participation of business in theprocess of standard setting. More effective informationmanagement is requiredto increase awarenesso f quality issues and to allow domestic firms to be informedo fproposed changes instandards in overseas markets. This requires that Moldovamake the most of the opportunities created by membership o f the WTO. Withregardto conformity assessment there is aneed to establish an international reputation o f independence and competence for the national body responsible for the accreditationof testing, inspectionand certificationbodies. This requires a much greater level of participationinrelevant international organizations. Greater competence would follow iflocal staff were to participate inassessment teams working inother countries and/or through inviting foreign accreditation 63 bodies to Moldovato conductjoint assessments. This i s an area where foreign .assistance could assist inachieving amore effective conformity assessment system. Itis also necessaryto establish a reputationfor highquality andindependent testing and certification bodies which can provide the services that are required for companies inMoldova to meet the demand of overseasbuyers.A more business-oriented approach is required in the conformity assessment institutions. Within an overall quality strategy it will beimportant to identify prioritysectors, such as food processing, whereby effective government-business approachescan be developed to provide amodem quality orientated industrysupported by an appropriate and efficient standardsand conformity assessment framework. 64 CHAPTER 7. CUSTOMSADMINISTRATION: HIGH BORDERRELATEDCOSTSUNDERMINE COMPETITIVENESS INTRODUCTION Ineflcient and 7.1 Reductions intariffbarriers around the globe and changes insupply chain costly border management practices, such as a greater reliance onjust-in-timedeliveries, have resulted procedures inarelative increaseinthe importance ofborderprocedure-related trade transaction exact signiJicant costs. Inefficient and costly border procedures exact significant cost onboththe cost on both the businesses that have to use them as well as the authorities that have to administer them. businessesthat have to use 7.2 For businesses, border-related costs are bothdirect, such as expenses relatedto them as well as supplyinginformation to the relevant border authority, and indirect, suchas those arising the authorities from proceduraldelays, lost business opportunities and lack of predictability inthe that have to regulations. The cost of inefficiency to governments includes unsatisfactory revenue administer collection and smugglingproblems, as well as difficulties inimplementing trade policies. them. Inefficientborder procedures are also likely to leadto poor export competitiveness and make a country less attractive to foreign investment and reduce the ability o f domestic firms to participate inglobal production networks. Despite recent improvements, 7.3 InMoldova, theGovernmenthasachievedsomesuccessinimprovingthe customs services o f the Moldovan Department of Customs and reducing the associatedtrade and regulations are transport impediments. Unfortunately, surveys of Moldovanbusinessesreveal that, still perceived despite recent improvements, customs regulations are still perceived as cumbersome and as cumbersome costly, imposing a significant impediment to foreign trade operation^.^' These and costly, perceptions are the result of (i) complicated, non-transparent, and often changing imposing a significant Customs procedures, (ii) long delays for clearing goods or proceeding through the border, impediment to (iii) difficulties inapplying modem Customs standards, such as the WTO Agreement on foreign trade Customs Valuation and (iv) corruption. operations. CORRUPTION While Customs 7.4 The new management o f Customs has taken strong action against corrupt has started to practices. So far, the mainstep has consisted of removing local chiefs and other officials take strong who were reportedas beingcorrupt. Customs' ownperceptioni s that they have action against corrupt successfully ridthemselves of their most corrupt elements. The management of Customs practices, considers that more favorable reports from the businesscommunity confirm that nearly 70 impression. percent of all 7.5 trucks report While recent business surveys no longerperceive Customs as one ofthe most thepayment of corrupt agencies inMoldova, bribes are still considered very muchpart of the clearance bribes. process. As showninFigure7.1, nearly 70 percent of all trucks crossing Moldovan borders report the payment of bribes (down from the 82 percent reported in2002). Among the South East European (SEE) countries recently surveyed, only Romaniahas a higher frequency o fbribepayment inthe most recent survey.40 Insofar as corruption raises the costs of Moldovanbusinessesengagedintrade, ongoing efforts to reduce 39See, for example, the recent Cost of Doing Businessand BusinessEnvironmentand EnterprisePerformancesurveys undertakeninMoldova. It shouldbenoted, however, that Customsis usuallyblamed unfairly for all difficulties encounteredat bordercrossingseventhough other border agencies play a majorrole there. 40Cycle3 surveyresults from InterimReport 111of the Trade and TransportFacilitation in SouthEastEuropeProgram, February 11,2004. 65 Figure7.1 Paymentof Bribes at Border Crossings (Percentof truckscmssingborders) corruption at Customs will Romania improve the Moldova Macedonia competitiveness of these Albania firms. It should be Croatia recognized, however, that Serbia other countries inthe region Bosnia have also been undertaking Bulgaria efforts to reduce corruption 0 10 20 30 40 50 60 70 80 90 at the border. Therefore, to Source Cycle 3 survey conducted for TTFSE project improve Moldova's competitiveness relative to these other countries, Moldova will have to continue striving to achieve results with its anti-corruption efforts. Reducingthe range of tariff categories as well as simplifyingcustoms rules and procedures will, inaddition to reducingthe administrative burdenon Customs and the business community, also help reduce the scope for corruption at the border. 7.6 The current approach to fightingcorruption, boththrough disciplinary measures undertakenby the Customs Administration itself as well as the interventionof the National Center for Combating Organized Crime and Corruption (NCCOCC), has had some success inreducing reported levels of corruption at the border. Experience inother countries has shown, however, that longer-termapproachesto detecting and combating corruption will require, among other things, the reinforcementof internal auditing and the establishment of an ethics unit within Customs. THE EFFICIENCY OF CUSTOMSREVENUEMOBILIZATION While the 7.7 As noted inChapter 4, Moldova hasbecome increasinglydependent on the eficiency with taxation o f imports with the Customs Administration having the responsibility o f which Customs collecting these revenues. Inthe last three years, the efficiency with which Customs has has collected collected revenues has increased significantly. Revenuescollectedper customs staff has revenues has nearly doubled, as have trade volumes and the number o f declarations processed. Even increased with these significant achievements, the efficiency of Moldova Customs lags behind sign$can tly, other countries inthe SEEregion. (See Table 7.1). In2003, the average number o f performance declarations processedper Customs officer inthe other countries o f the SEEregion was lags other more than twice as large as Moldova. These other countries also managedto clear countries in the SEE region. nearly three times the volume of trade and gathered over four times the amount of revenue per Customs officer as Moldova. The better performance o f these other countries reflects, inpart, the reform efforts made under the Trade and Transport Facilitation in Southeast Europe Program (TTFSE)project. These countries have been undertakingefforts to modernize their Customs services and aligning their performance standardswith the European Union. Moldovajoined the TTFSE project in2003 and there i s the expectation that bythe end of the project implementation period (2006-2007) Moldova will have achieved performance levels similar to other countries inthe region. Among the changesneeded are reforms to current administrative and operational procedures, including the overwhelming focus on revenue mobilization. Table 7.1. Productivityof SelectedRegionalCustomsAdministrations,2003 Moldova Bulgaria Macedonia Romania Serbia Average SEE Revenue/Staff (US$l,OOOs) 157 507 586 787 288 649 Trade Vol./Staff (US$l,OOOs) 1,577 5,156 3,101 10,251 3,945 4,370 Declarations/Staff 174 492 383 513 341 389 aExcluding Moldova. 2002 data for Albania, Bosnia, Croatia and Montenegro. Source: Trade and Transportation Facilitationin SoutheastEurope Project 66 REVENUEMOBILIZATIONAND TRADE FACILITATION Revenuegoals 7.8 While Customs has demonstratedits capacity to boost revenues, the strategy it canprove to be has pursuedincludes the setting of ambitious revenue goals.41 The Customs Department, rigid and inturn,hasassignedspecific revenuegoalsto eachCustoms office, thereby increasing unrealistic, and pressure on local managersto increaserevenues, sometimes without adequate analysis o f ofen fail to take the implications on the local economic and trade environment. into account a range of 7.9 The experience o f other countries suggests that suchrevenue goals can prove to relevant be too rigidand unrealistic, and often fail to take into account arange o frelevant economic and economic and trade factors. As managementinthe field office comes under pressure to tradefactors. meet these goals, there i s a tendency to set objectives for individual staff. As aresult, there i s a danger that the decision to control an import operation may be basednot so much on the risk of fraud but on the potential for revenue collectionthat the importer represents. Inaddition, once monthly goals have beenmet, Customs officials are often under less pressure and therefore tend to relax their level o f controls. Again, experience throughout the world suggests that the desire to meet revenue goals encourages staff to uplift values which, inturn, createsan incentive for importers to under-declare, thereby creating a self perpetuating cycle of non-compliance. Moreover, such an approach provides an incentive for importersto channel their imports through border stations known to have low revenue goals, thereby avoiding more stringent controls. The marginal 7.10 Customs control mechanisms inMoldovaare designed to increase collections on cost to society existing transactions. As discussedbelow, the application of riskmanagement i s still of Customs very limited and insufficient attention i s paidto trade facilitation. The marginal cost of control these control mechanisms to society, interms o f the additional lei collected, i s very high mechanisms is (i.e,, a highmarginal cost of compliance). This higher cost i s borne bothby the business very high. community and staff at the Customs Administration as they both struggleto deal with bureaucratic Customs procedures and regulations. Among the benefits of simplified Customs procedures wouldbe the improved competitiveness of local firms and the increased efficiency of Customs. AN OVERVIEW OFMOLDOVA'S CUSTOMS PROCEDURES 7.11 Moldova applies international standards for the movement and clearance of goods operating under a streamlined, EUcompatible, Customs code that is, onpaper, in compliance with the Kyoto conventionon the harmonization of Customs procedures. Numerous surveys discussions with a wide range ofbusinesses suggest, however, that these standards are often interpreted ina restrictive manner. Asthis overview reveals, Customs tends Customs tends to rely excessively on frequently changing documentary requirements with to rely excessively on the results beinginconsistent with the needs of amodern andcompetitive trade frequently environment. Inmany cases, costs are incurredby the importer or exporter evenbefore changing the goods reachthe border crossing documentary requirements Registration with the results 7.12 All "Economic Agents" (Le., intermediaries that are allowedto lodge being declarations on the behalf of importer or exporters) mustregister with a Customs inconsistent with the needs terminal. One of the major purposes of this registrationprocess i s to ensure that the of a modern and importing/exporting companies are legitimate. The registration process consists in competitive lodging with the appointed regionalterminal at the time o f the first impodexport trade environment. 4'Customsmanagement indicated these goals are essentially based on the previous year's performance. They do not appear to adequately take into account the changes inworkload or commercial activity at the various Customs offices. 67 transaction upto 12 different documents. Although Economic Agents may change the terminal where they clear goods, such a change requires a special application, following which the initial terminal will issue the Economic Agent with a diskette withthe registration information, together with a direct notification to the new Customs office. Changingthe place of clearancefor the importation of excise goods i s not possible. Confirmation 7.13 Inadditionto theregistrationprocess,importationcanonly take place ifthe Economic Agent (importer) has lodged a "Confumation" form with the approved terminal, along with some 15 other additional documents. At this point, the Economic Agent must also calculate and make a pre-payment the amount of duty payable. The "Confirmation" i s then acceptedby Customs, and verified against the account of the Economic Agent. When the funds have beendeposited into the Customs account, it i s registered, and an electronic message i s sent to the corresponding border crossing.42 Ifan importer decides to change the border point o f entry into Moldova, he mustlodge a new "Confirmation" or make a written applicationto the originally plannedborder crossing. Incases when the importation does not take place, or ifthe quantity o f goods shipped i s below the quantity entered on the confirmation, it i s difficult for the importer to claim an actual refund. Instead, the amout due to berefundedis usually used as pre-payment for a future operation. The processing o f a "Confirmation", whichhas to go through the same steps as an import declaration less the actual physical examination of the imported goods, can take up to 45 minutes. Borderprocedures 7.14 Although, as inmany countries, final clearance of imported goods is expected to take place at the inland point o f destination, there are several cases when goods mustbe cleared at the border. Physicalpersons, who import goods inexcess of the E m 0 0 duty- free allowance, but under a maximum value of EUR500, can declare the goods themselves with a simplifieddeclaration. Above that amount, a declaration mustbe lodged accordingto the commercial importation procedure. Cars and excise goods must also be declared at the border, and duty paid immediately. Inaddition to Customs and immigration control, entering trucks can be subject to road administration, ecological, veterinary, phyto-sanitary, and epidemiology procedures. Insome instances, such as at the Leuseniborder post, these operations have beenconveniently consolidated under a single, Customs managedpayment system, and all the agencies are locatedinthe same hall, inside the cargo section of the border station. After payment has beenmade, vehicles are allowed to proceed. Transit Physical 7.15 Trucks under aborder-to-border transit regime can be accompanied either by a inspection of "Transport IntemationalRoutier" (TIR) camet, or a specific Moldovantransit goods ranges declaration, based on the Single Administrative Document (SAD) form.43 When trucks bemeen 90 and arrive, localdeclarants prepare the transit documents (for which they charge a fee 100 of all between MDL5O and 60 - approximately US$4.5). The entire transit declaration and income trucks. 42When the border station does not have computef or fax equipment, the ``Confirmation" i s notified by telephone to the nearestoffice. 43As explained inChapter 8, TIR Camets are issuedby the Intemational Road Transport Union (IRU) of Genevato national trucking associations inparticipating countries. Each association issues TIR Camet to national carriers provided they meet the conditions and standards set forth bythe IRU.The national associations also notify the IRUwith the names of approved TIR carriers and provide the "TIR plate" which i s placedon each authorized vehicle. 68 accompanying documents (invoice, Contract for the InternationalCarriage of Goods by Road (CMR) consignment note) are then checked.44Although the authorities claim that the physical checks of the goods is minimal, surveys and discussions with a wide range o f importers/truckers suggestbetween 90 and 100percent of all incoming trucks are checkeda4' These checks can range from the simple verification of the seal to the full unloading of the trucks. Inland clearance 7.16 Trucks must report to the inlandclearanceterminal within a period of 72 hours.46 Import declarations are usually prepared by declarants (essentially clerical intermediaries), who charge a fee of US$4.5 for a simple declaration (completing a limitednumber o f fields on the S A D form), plus US$1.8 for additional items on the S A D form. Inland clearance i s basedon a five-step process: 1. The declaration is submitted to Customs at the economic and financial control section, together with accompanying documents. Importers must submit up to nine documents, some o f which have to be in original form. Customs officials check ifthe "Confirmation" was properly lodged, and the duty pre-paid. 2. A preliminary control takes place inthe statistical section, where Customs ensure that all documents are attached, and inorder. Ifthere is a document missing, the declaration is retumed. 3. The financial and economic control section checks all commercial documents, verifies the duty calculations, and ensures that the funds have been transferred to the Customs account. The value declared i s then verified. 4. It is only after this stagethat the declaration is registered, numbered, and becomes a legally binding document. 5. ' The cargo unit is incharge o f the physical examination o f the goods. Inspite o f claims to the contrary, it is likely that all shipments are subject to one form or another o fphysical examination. The importers report a rate o f checking o f at least 90 percent o f all declarations lodged. Box 7.1 Documentaryrequirementsas specified by Order 384 Order 384 o f October 24,2003, was introducedto "increase the level o f documentary control and preclude falsification o f documents". It lists all the documents that must be attached to an import declaration, either inoriginal form, or as a notarizedcopy (this latter requirement was later dropped ina trade facilitation effort). Three categories o fdocuments can be identified: - Documents that should always be producedinoriginalto Customs: transport documents, invoices, licenses, and certificates o f conformity and/or origin when applicable. - Documents that inprinciple only need to be produced the first time an importer registers with Customs: statutes o fthe entity, specimen signatures, stamps, power o f attorney. It is necessaryto produce new specimens every time the situation o f the entity changes. - Documents that, inmost other countries, would only be required ifCustoms hada reasonable doubt about the authenticity o f a transaction, butwhich are apparently systematically required inMoldova: commercial contract, identity documents, technical specifications o fthe vehicle, bankingcertificates, certificate o f expertise (issued by the Chamber o f Commerce, this document certifies that the goods meet required conditions), proofofrepatriation or transfer of funds. All thesedocuments must beregisteredby Customs, andentered inthe paper file o fthe Economic Agent. 7.17 Goods can also be declared outside working hours, and can be inspected on the premises o f importers, for a fee of Euro 20. This i s a significant and positive trade facilitation measure, althoughthe declarants still have to report to Customs, and proceed through all the documentary checks. ! 44A CMR Consignment Note ("Convention relative au contrat de transport intemational de Marchandises par Route".) is a transport document relatingto carriage by road. 45See, for example, surveys undertaken for the TTFSEproject. 46Most inland clearance locations operate between 8 AM and 5 PM, with a one-hour lunchbreak. 69 THE BURDENOF CUSTOMS PROCEDURES Delays inClearingCustoms Among the 7.18 Among the important indirectborder-related costs are those associatedwith important delays inclearing the border. Throughout Europe, the cost of a waiting truck i s estimated indirect border- at approximatelyUS$15 per hour. Applying a simple rule of thumb, waiting one day to related costs cross the border corresponds, on average, to an increase of one point inthe customs tariff. are those A study carriedout for the TTFSEin2002 established anumber ofbenchmarkestimates associated with o f the averageborder entry waiting times (180 minutes at Leuseni and Cahul and 240 delays in minutesat Palanka).47 Import clearancetimes at the Inlandterminal of Chisinauwas 500 clearing the border. minutes. In2003, a small survey carriedout at the Leuseniborder crossing showed that for most trucks (60 percent of the sample) the average clearance time was approximately 100minutes. About 40 percent of the trucks waiting at the border, however, had arrived intheprevious oneto four days. Declines inborder entry times have also beenregistered inother countries participatingthe TTFSEprogram. Border waitingtimes inthese countries have declined significantly, from an average o f 4 hours in2001to under 1hour in2003.48 At anumber ofthese border crossings, entry times have already fallenunder 30 minutes. 7.19 InMoldova, border delays alsohave directcost implications. All goods entering the country mustbereportedto an inland locationwithin72 hours. Failure to do so has an associatedpenalty rangingbetween 40 and 100percent o f the value o f the goods.49 Most o f the offenses documented by Customs refer to this overtime reporting of goods. The Effectivenessof CustomsProceduresinCombatingFraud While the intention o f the Customs procedures is to control fraud, this objective While the 7.20 intention of the i s not beingeffectively achieved inMoldova. Instead, complex procedures impose an Customs unnecessaryand costly burden on legitimatebusinesses. For example, the registration procedures is to procedure, which mustbe regularly renewed, i s unnecessarily bureaucratic, and the controlfraud, documentary requirements are burdensome. Most documents could be obtained directly this objective is by Customs, with lessriskof forgery (e.g., bank certificate, or statistical registration not being numbers), so the procedure inplace does notprovide a guaranteeofthe genuineness of effectively the Economic Agent, Similarly, the "Confirmation" procedure corresponds to a achieved in systematic advance clearance o f the goods, although Customs have little means of Moldova verifyingits element^.^' As it isnot a declaration, there areno grounds for prosecuting incorrect data it may contain. Ineffect, the "Confirmation" (i) provides dishonest importers with the possibility to test fraudulent data which they will enter subsequently on the declaration, (ii) clearance with no real benefit, and (iii) delays supports an unreasonable advance payment of duties which i s not trade facilitating. Furthermore, the Economic Agents do not receive a copy o f the Confirmations when they are acceptedat the inland terminal, and although they are expected to be forwarded immediately to the border point, truck drivers report that these Confirmations often get "mislaid". Drivers mustthencontact the importers, who inturnhave to visit the Customs house to ensure that the "Confirmation" i s sent to the right destination. Since the timeliness of the 47Underthe agreedTTFSE programbenchmarks, the average exit time at border crossing by the end of 2006 will be 20 minutes and the percentage of trucks examined will be reduced to 30 percent. 48Data i s for the pilot sites under the TTFSEprogram. 49 Under Article 231o f the Customs code. "Advance payment systems can be offered to importers when they correspond to an acceleratedrelease process. They should not be systematic. 70 confirmation i s important, this situation may encourage "facilitation" payments by unscrupulous officials. Despite the 7.21 Despite the perception that fraud is widespread, detection of irregularities is rare. perception that In2002, for example, 2,3 12offense procedureswere initiatedthroughout Moldova, fraud is which represents2.3 percent of all import declarations, a figure usually encounteredonly widespread, inhighlycompliant countries. A reviewofthese casesinafew Customsoffices shows detection of that: (i) most cases were due to reporting of goods after the 72 hour period, and (ii) a irregularities is majority o f cases are either abandonedor dismissedby headquarters, or (iii) annulled by rare. Court decisions. Often, cases consist of a detection of minor smuggling (e.g., sugar hiddenina railway carriage), while the owner ofthe goods is never detected. Customs does make occasional detections of drugs, and are aware of their necessary involvement infightingserious smuggling. 7.22 There i s also a discrepancy between detections and reported cases. While local offices report a large number of irregularities, a majority of them do not seem to be followed up, becausethe cases are minor or formal, and prosecution i s waived by headquarters. Of those that are taken to Court, an overwhelming majority are dismissed. Although it does not necessarily imply that Customs were not right, it provides an indication that judges may not have the necessarybackgroundknowledge of Customs issues to make informeddecisions. 7.23 While improvedperformance, resultingfrom increasedprofessionalism, can only start showing results after aperiod of time, immediatemeasures could be taken to (i) sensitizejudges and other officials to Customs issues, (ii) improve the offense procedures to provide better guaranteesto bona fide importers, and(iii) acceleratefeedback mechanisms so that headquarterscan make rapid rulings on abusive staff decisions. Excessive Documentation and Repetitive Verifications 7.24 As already noted, documentary requirements inMoldovaappear excessiveand verifications are needlessly repetitive. The government recently issued an order (Order 384) that has institutionalized the requirement for documentsthat, inmany EUcountries, Customs might ask only under specific circumstances. Many of the documents that have to be submitted for each operation, such as the articles o f association of the entity, have already been submitted by the Economic Agents when they first registered with Customs. 7.25 A single operation is subject to three consecutive checks: (i) "Confirmation", the A single (ii) transitdeclaration,and(iii) importdeclaration. Thefirsttwostepsrefertothe the the operation is subject to three same information as is entered onthe import declaration, butthey are not supported by consecutive the appropriate data (for example, the Confirmation describesthe goods andtheir value, checks. butit is not accompaniedby an invoice, anddoesnot show the tariff commodity code). However, they are checked and processedinthe same way as the declaration. The trarisit declarations go through all the same steps as a declaration lodged for the clearance o f the goods, and the requirement for accompanying documents i s practically the same (in addition to the other documents, a photocopy o f the passport and identitycard of the driver, andthe registration certificate o f the vehicle, are required). This has no real effect, because the same data i s verified three times usingthe same methods, and, sometimes, the same staff (inparticular the "Confirmation" and the final declaration are usually checked by the same officials, removing the possibility of a double check on staff activities). Also, ifa fraud i s suspected, or even detected, on a "Confirmation" or a transit declaration, Customs cannot take action, because (i) the goods are not present when the "Confirmation" is lodged, (ii) is no financial guarantee on the transit there 71 declaration, and (ii) there cannot be a false declaration unless an import legally, declaration has been lodged. RiskAnalysis The needfor 7.26 Riskanalysis, which allows for some selectivityinchecks, is still inits infancy in more Moldova. Customs has compiled a number of negative andpositive lists that focus on, sophisticated for example, high-riskgoods and economic agentswhose transactions needmore careful risk profiling is examination, as well as Economic Agents whose highdegree o f credibility allows them to well recognized. be subject to only documentary inspection. Despitethis positive development, numerous I n the short- routine examinations still take place with little results indetecting large-scale fraud to term a number of measures justify the burdenand cost imposed on importers. could be 7.27 Both the TTFSE project and the Customs modemization strategy, endorsedby undertaken to the Prime Minister, recognize the need for more sophisticated risk profiling. While the improve trade TTFSE project and its computerization dimension are gradually delivered, anumber of facilitation. short-term measurescould be undertaken to improve trade facilitation. First, Customs shouldreview all documentary requirementswith a view to (i) obtaining the data directly from the source rather than impose this on Economic Agents, (ii) carry out regular checks on the validity o f the information provided, and (iii) companies that are exempt considered as reliable from those documentary obligations. Customs should also consider abolishing the confirmation procedure, which does not seem to serve any purpose other than imposing advancepayment of duties (which themselves contravene Moldova's obligations under the Kyoto Convention). Finally, Customs shouldbegin to maintain a log o f irregularities to identifysuspicious Economic Agents, and introduce a basic form o f selectivity essentially basedlargely on random selection o f declarations; basedon preliminary results, start preparinga more sophisticated database. (The immediateresult shouldbe a reduction of 50 percent of the number of physical examinations). Box 7.2 Best Practices inRiskManagement RiskmanagementinCustomsadministrationsresultedfromtwo, quantitativeandqualitative, aspects of controls: Traffic was increasingso muchthat it was no longer possibleto inspect everything; Evenifit hadbeenpossibleto inspect everything,routineverificationswould always bemuch less productivethanthosewhere there was a chance ofmaking adetection. This concept of risk managementwas first usedfor selectingdeclarationsfor further physical examination. This becameknown as selectivity. Inadifferent approach, Customsstartedidentifying individualsandvehicles which they wanted to have a closer look at. This becameknown as targeting. Both systems were backedbypost release checks andinvestigations. Over time, the systemevolvedinto acomprehensivestrategy, destinedto deployresourceswhere they were mostneeded. This isbasedon the assumptionsthat (i) Customswould neverdetect or prevent all frauds, (ii) numberof alarge importerswould be compliant,therefore shouldnot be submittedto the same level of controls as suspiciousoperators, and(iii) is a cost for controls, both for the importersandthe administration, there so Customsshouldmainly (but not only) focus onmoresignificant fraud. All thesepoints mustbe supportedby an adequateorganization, sufficient legalpowers, inter-agency cooperation, andan effectivepenalsystem. IT support is necessary, but the logic of computerizedrisk managementis not artificial intelligence, andriskmanagementis only as good as thehumaninputsit requires. Selectivity i s basedon the analysis ofthe elementsof adeclarationand accompanyingdocuments, together with inputsfrom different databases (recordof offenders, list of goods that couldbedeclared under different tariff headingscanying different levelsoftaxation, or implyingdifferent types of regulations, origins). Intelligenceis also another source of information that completesthe selectivity module. Elementsof the declarationare comparedagainst one another, andagainst the different data bases mentionedabove. Ifthere is an inconsistency, or adoubtas to the authenticityofwhat is declared, 72 Ior ariskthat a fraudcouldbe committedby the importer,the Customsofficer who is reviewingthe declarationmaywant to inspectthe consignment. (Typically, the physicalinspectionwould take placeif there was adoubt as to therealnatureofthe goods, or their quantity. Physicalinspectionsare not usuallynecessaryto check values, exceptinafew cases.) Targetingrelies more onthe profile ofthe importer/driver/vehicle.It is essentiallybasedon extemal intelligence, anddoes not dependas muchas selectivityon awritten import declaration(althoughtransit documents,which includeless data, can beused), but more on apattemofbehavior. As avery broadrule, targeting would beusedat aborderpost, andselectivityat agoods clearance location. Another rule is that operations(i.e., crossingtheborder, or declaringgoods) that are not picked upfor scrutinywill notbechecked at all at this stage. Both selectivityandtargetingalsorequirea certainamount ofpurelyrandomchecks, to verify the validity ofthe currentriskprofilesandpickup declarations Post clearancechecks take place after the releaseofthe goods. These take the form o f desk reviews of declarations, with thepossibilityto ask the importersto providefurther informationand documentation. They maybe supplementedby visits to the importers. These checks are not part of any criminal investigationprocess. Investigations,which wouldnormally take place on the premisesof the importer,or any other agent involvedwith the importedgoods, are destinedto uncover criminal activities. They are usuallytriggered by the suspicionof fraud. Valuation VALUATION OFIMPORTS frauds are considered the 7.28 Valuation frauds are considered the major problem facing Moldovan Customs. major problem As inmany other transitioncountries, the Customs Administration hadno culture of facing checking declared values inan environment o f state-run foreign trade. The rapid Moldovan emergenceo f small scale importers, combined with cross border "suitcase trade" thus Customs. generatedan enormous workload for Customs, and created immediately opportunities for fraud and rent-seeking. The administrationwas viewedas incapable of controlling the large scale o frevenue erosion that was taking place. At the urgingof the IMF, a Pre- Shipment Inspectionsystem(PSI) was introduced. The PSIcontract, however, was suspendedafter beingruledunconstitutionalby the Courts. With the expiration of the IMFprogramat the endof2003, effortsto restore PSIoperations inMoldova have ended. Invoice checking Invoice 7.29 When the declarations are cleared at the inlandterminal, the invoice verification checking is essentially consists of adjusting the declared value to "minimum" price list, which i s repetitive and simply a quarterlycomputer generatedaverageprice list of previousimports (see Box bureaucratic. 5.4). As with other documentary inspections, the invoice checking i s repetitive and bureaucratic. The valuation unit inheadquarters has neither the staffing, the skills nor training to provide proper advise to field staff. This prevents the valuation unit from concentrating on its core role, which i s to seriously investigate major valuation cases, and handle the subsequent procedure inaccordancewith the principles of the WTO. 7.30 With the notable exception of the Baltiterminal, where anadhoc committee of experts has beenestablished to make initial valuation rulings incases of disputes between the importer and the administration, most valuation disputes result in freezing the process of clearing the imports inquestion. Economic Agents can then ask for conditional release, granted ifthey deposit the assessed difference induty. This deposit i s eventually released ifthe local valuation decisionis overruled by Customs headquartersor a court decision. 7.3 1 Although Moldova, as a member o f the WTO, has adhered to the Agreement on Customs Values (ACV) of the Uruguay round, which explicitly prohibits the use o f 73 The use of minimumprice lists or the applicationofdomestic market sale values, these two elements minimum price are the major sources of valuation rulingsmade inthe country. Valuation cases that are lists or the appealed are oftenrejected either by Customs headquarters, or by Court decisions. The application of fact that only a few cases are actually taken to Court is probably an indication that, in domestic market most instances, importers come to an "informal agreement" with dishonest local officials, sale values are thus further discreditingthe current valuation system. the major sources of 7.32 Reforms to improve valuation methods will take some time to fully implement. valuation The TTFSEproject incorporates a large capacity buildingcomponent designedto improve rulings made in the organization of valuation checks. Customs officials have already received extensive Moldova. training invaluation issues, and the critical aspect i s now the introduction of well-staffed structures and adequate mechanisms to carry out serious valuation control. While these reforms are beingimplemented, the following actions should betaken: reinforce substantially the valuation unitinheadquartersand focus valuation training on its members. Establishcommunications with the industryand importersto assessrealistic values for major commodities, as part of an initial valuation investigation process. Box 7.3 Minimumprice list The minimumprice list, also knownas an "orientationpricelist", is compiledfrom statisticaldata from previousimports,andconsistsofaquarterlyaverage price. Itis arrangedaccordingto the HarmonizedSystemnomenclature. The major setbacks ofthis methodare: -The nomenclaturecannot distinguishbetweenbrandsthat oftenhavevery different unit prices- for example, watchescanbe cheap or very expensive-therefore an averageprice is often meaningless. -The averagingofpastvalues inevitably incorporates under valued imports, thus dragging downwards the minimumprices. - The use of aminimumpricelist does not considertechnologicalinnovation, andits impact on the manufacturingprocess. 74 CHAPTER8. TRANSPORTATIONAND LOGISTICS: HIGH COST IMPEDESACCESS TO KEY MARKETS INTRODUCTION 8.1 The cost and quality oftransport andlogistic servicesmatter for trade High transport competitiveness. As cross-country evidence suggests, even iftariff andnon-tariff barriers costs are a to trade are substantially liberalized, the penalty of hightransportation costs has a barrier to growth, FDI negative impact on growth rates and income of countries with poor intemational transport and trade. links. Confrontedwithhighfreight andlogistic costs, Moldovanexporters musteither pay lower wages to its workers, accept lower profits or increaseproductivity. The pressure on factor prices and productivity i s even greater for firms with a high share of imported inputs. A small difference intransport costs can easily determine whether export ventures are at all profitable. Countries with higher transport are less likely to attract FDIand, since FDIi s often akey channel of internationalknowledge and technology diffusion, these higher costs may leadan economy to be further removed from the world technology frontier and impede its rate of productivity growth.s1 High transport 8.2 Transport costs also have an impact on a country's selection of trading partners. costs have an Ifexportmarkets largely consist ofpoor, slow-growing economies andthere are impact on significant costs (including transportation) of switching to richer, and faster growing ability of markets, countries may be constrained intheir export growth potential. For Moldova, the Moldova to difficulty inredirect exports towards the richer and large EUmarket reflects, inpart, redirect its these highswitching costs. trade towards the EU. 8.3 The cost structure of firms is also affected bythe quality oftransport services. If services are unreliable and infrequent,or ifa country lacks logistics providers who can operate efficiently, firms are likely to maintain higher inventory holdings at every stage o f the production chain. Firmsmay also want to holdhighinventories ifthey needto limitthe riskfor frequent changesincustomsregulations, exchangerates or product prices. AN OVERVIEW OFMOLDOVA'STRANSPORT INFRASTRUCTURE 8.4 Road.The total lengthofroads inMoldova amounts to 10,35 1km(excluding farm tracks and minor roads), o f which 64 kmare four-lane roads. Most local transport and approximately 80 percent o fpassengertravel i s by road. The major part o f the road network (7,361 km) i s under local responsibility, with the remainder (3,170 km) under national supervision. As shown inTable 8.1, Moldova's roadnetwork density -- 31km per 100km2-compares favorably with other countries inthe region. The density of pavedroads and motor vehicle ownership inrelationto population is, however, much lower. 5'Controlling for a largenumber of socioeconomic, geographic,and institutional factors, Radelet, Steve, and Sachs, J. Shipping Costs, ManufacturedExports, and Economic Growth, Presentedat the American EconomicsAssociation annual meeting, January 1998, found that developingcountrieswith lower shippingcosts experiencedmore rapid growthof manufacturingexports relative to GDP inthe period from 1965 to 1990.Inaddition, when exploring the relationship betweenshippingcosts and overall economic growth across economies, the study concludes that adoubling of the cost of transportationis associatedwith slower annualgrowth of slightly more than one-halfof apercentagepoint. 75 8.5 Rail. Moldova's rail network i s 1,153 kmlong and i s Table 8.1. Rail, Road and Motor Vehicle Densities in the principal means of transport by Selected Countries. volume. Railway rolling stock i s Motor Road Paved road vehicle Rail antiquated, the railway tracks are density density density density wide (Russian) gauge and is not kmper vehicles kmper 100 kmpermillion per 1000 100 electrified. The main 222 kmline km2 population people km2 i s double-tracked. The major Moldova 31.5 2,412 49 3.4 destinations for eastboundrail transport are the Ukrainian and Germany 64.7 7,895 529 11.4 Russianmarkets. Railnetwork Estonia 91.8 5,291 350 2.3 density is 3.4 hper 100km2, Latvia 88.3 8,994 214 3.7 which i s on par with anumber of Lithuania 104.4 14,348 265 3.1 neighboring and EUAccession countries. Poland 74.2 6,336 262 7.8 Hungary 32.5 6,698 262 8.3 8.6 Air and Sea. Moldova has Bulgaria 30.6 3,854 239 3.9 four airfields, but only Chisinau Romania 30.7 3,421 135 4.8 serves international connections. It Russia 3.3 5,087 153 0.5 has about 250,000 passengersand Belarus 24.2 5,012 109 2.7 less than 2,000 tons of cargo per year and, as such, i s considered a Source: World Bank, World DevelopmentIndicators small volume airport. The airport uses less than 20 percent of its capacity, which i s a low figure, butnot uncommon among major Eastern European airports. Moldova's shoreline consists o f a 900-meter wide frontage on the Danube River.A project to develop a port at Giurgiulesti was started in 1995 with EBRDfunding. The project stalled, however, when the EBRDwithdrew from the project. While the port i s currently operational, its quays require major reconstruction and re-equipping.The port's terminals also needto be finished and access roads needto be built. The major rivers, Nistru and Prut, are used for domestic and local transport -mainly barges and small ships. Inland waterways account for less than 1percent of goods and passengertransport. THE IMPACT OFPOORQUALITY TRANSPORT INFRASTRUCTURE Moldova 's 8.7 Moldova's existingtransport infrastructure, albeit extensive, has beenpoorly existing maintained and no infrastructure has beenadded to addressthe needs associatedwith transport changing trade pattems. Inrapidly developingcountries intransition, transport and infrastructure, telecommunications infrastructure investment may be 8-10 percent of GDP. InMoldova, albeit extensive, this share is lessthan 3 percent, mostofwhich is inthe telecommunications sector. has beenpoorly Systematic road maintenance has a highpositive impact on road users. Technical maintained. publications often cite the statistic that for every US$1 a developing country spends on roadmaintenance, road users save US$3.52 Heavy trucks and busesbenefit most from Ongoing road proper maintenance, butprivate car users also benefit from reducedaccidents and maintenance, damages, as well as reducedtravel times. 53 rehabilitation and 8.8 Ongoingroad maintenance, rehabilitation and constructionefforts have been construction insufficient to upgrade the roadnetwork to adequate levels. There is a considerable eforts have backlog o f transport infrastructure finance. Between 1995-2002,an average ofUS$5.5 million, been insuficient to upgrade the Inroadprojectsindevelopingcountries, VehicleOperating Cost (VOC) savingsusuallybringthe majoreconomic road network to 52 benefit (60 to 80 percent), followed by travel time savings (10 to 20 percent), accidentcost savings (5 to I O percent), and adequate levels. other savings, such as local roadcomponent(2 to 5 percent). 53Vehicle OperatingCost (VOC) ofheavytrucks and buses onpoor roadsis often double that on good roads, when the quality of roadis measuredby IntemationalRoadRoughnessIndicator (IRI). 76 or around 0.3 percent of GDP, was spent eachyear on road construction, repair and maintenance.s4 Funds suggestedinNationalRoadProgram for 2005-2010 cover only small sections of the roadnetwork and the availability of funds is uncertain. Moldova's road funds should be at or above 1percent of GDP, or US$16 million for the coming years. This would enableroadrehabilitation of the mainarteries, and gradually the rehabilitationof secondary roads. rmprovingroad 8.9 The major roads leadingfrom ChisinauandBalti eastwardsand westwards have quality can satisfactory capacity for long-distance roadtransport. As a result of limited fundingfor yield substantial road maintenance, the condition of the road infrastructure on these roads i s poor to beneJits to road modest while the majority of the secondaryroads are inpoor conditions. The generally users by poor condition of Moldovanroads imposes a substantial cost on the economy. Table 8.2 reducing vehicle gives a roughestimate o fthe impact ofreduced vehicle operating costs inMoldova, Operating assuming that all traffic movedon good roads instead o f poor ones. The benefits of upgradingroad quality are estimated roughly at US$lOO million for all vehicle types per year. O f course, not all traffic inMoldovatravels exclusively on poor quality roads, hence the expected savings of improvingroad quality inMoldovai s likely to be more modest -- closer to US$20 to 25 million. These savings can be contrasted to the US$Smillionthat Moldovahas used inroad construction and maintenance. To achieve these savings, there is a need for better roadmanagement and financing systems with a particular emphasis on roadmaintenance. This requires: (i) the State Road Administration to strengthen its procedures for planning and budgetingroad expenditures and assessingpriorities for road maintenance; (ii)transparent road fund, for both a national and local networks, be established to provide a stable source of funds for road maintenance; and, (iii) development of a multi-annual performance-based maintenance contracts. Average VOC, Road VOC, Road Estimated mileage per Estimated Difference in Vehicle inGood inPoor Number of vehicle total mileage VOC between Type Condition Condition vehicles (estimate) of vehicles poor and good roads US$Nehicle Km Vehicles Kmper year Million km US$million cars 0.06 0.08 150,000 7,000 1,050 21 Light Trucks 0.10 0.18 20,000 20,000 400 32 Heavy Trucks 0.22 0.33 4,000 70,000 280 31 Buses 0.28 0.40 3,000 45,000 135 16 Total ,100 The classificationof "Good" and "poor" roadsrefersto the IntemationalRoadRoughnessIndicator (IN)values. The estimateis basedon averagecostper vehicle kilometersadjustedto Moldovan fleet and cost structure inpoorvs. good roads and on estimateddataon vehicle kilometersinMoldova. "The Role of HDM-4 in Highway Management". Fourth IntemationalConferenceon ManagingPavements. Durbin. SouthAfrica. 8.10 Moldova's railway rolling stock i s antiquated. Most engines are old andrunon diesel fuel which hampers winter operation. Wagons are often o f poor quality and complaints about theft duringtransit are common. Nevertheless, measuredinton- 54 By comparison,in Estonia, Latvia and Romania, road funding is approximately 1.O percent of GDP, while in Lithuania, the funding ofroadswas on average 1.4percentof GDP in 1995-2002. 77 Rail transport is kilometers, rail transport i s the principal means of transport indomestic traffic and in theprincipal trade with CIS-countries. As shown inTable 8.3, transit transport constitutes the bulk of means of volume and transport work performedby Moldovan railways (CFM). Because of the transport in different rail gauge and complicated connections, rail transport i s not used inwestern domestic trafic traffic. Moldovanrailways are operatedintegrally with Transnistria which affect CFM's and in trade possibility to maintain its schedules, and involves additional transit costs. The authorities with CIS- countries. inTransnistria havebeenknownto temporarilyblockedthe border for export andimport freight. 8.11 While initial efforts to Table 8.3 Distribution of Cargo Traffic by Rail Domestic rail reshture the national railways Domestic Export Import Transit transport is have beenpositive, many Percent of tonnage 7 20 28 45 heavily shipperscomplain about high Percent of ton-km 5 10 17 68 subsidized while export freights. While the high tariffs Revenues (US$million) 1.0 14.8 12.3 28.1 impede the average freight revenue is Costs (US$million) 8.5 10.6 2.1 21.1 export of US0.0275 per tonkm and the us$ pertonkm 0.010 0.072 0.035 0.020 commodities average us$o*021 per Source: NEA Synthesis Report, 2002 that are suitable tonkm, the four market segments for rail have large variations from these averages. " Revenue on domestic cargoes i s about half transport. o f CFM's average cost. Import freight rate i s 1.5 times the average cost, whereas transit freights equate the average cost. Export freights are over 3.4 times higherthan this average cost. Thus while domestic freights are heavily subsidized, CFM i s extensively utilizingits monopoly status to raise the cost of rail shipments for exporters. Inimport, or, inparticular, transit traffic, CFM has less influence on total costs because much of the total transport takes place outside Moldova. The highcost o frail freight rate impedes trade as Moldovanexport commodities that utilize rail transport have few alternative means o f transport. While it i s difficult to quantify this transport inelasticity, simple cost comparisons show that road freight to, for example, Moscow i s cheaper. Nevertheless, more than 1million tons i s transported annually to Moscow by rail. MOLDOVA'SUNDERDEVELOPEDTRANSPORTATIONAND LOGISTICSSECTOR 8.12 The Moldovanlogistics market i s still inanearly stageo f development. Freight forwarding, warehousing and other logistics-related services have been privatized almost entirely inMoldova. Compared to internationalstandards, however, the range of services offered i s narrow andthe quality o f these services (such as reliability, on time deliveries and timely information) is often low. The supply i s generally limitedto basic transport services, and there are no thirdparty logisticsproviders offering extensive logistics services. Most domestic firms offer transport services inonly one transport mode. There are no domestic logistics operators capable of offering a wide variety o f transport, cargo handling andrelated information services that are commonplace inmore developed markets. None o f the major European freight forwarding firms have established their own operations inMoldova, citingthe small size o f the market, and that reliable and cost- efficient logistics solutions are difficult to arrange due to unpredictable public administrationprocedures and often corruptpractices. 8.13 The institutional or legalbarriers for road transport operators to enter the domestic market are very low. Operators from Hungary, Romania and EUhave a strong position inthe Western market, and operators from Ukraine and Russia have a very 55This figure i s derived usingtotal freight revenue (US$56.3 million) divided by the paid freight traffic (2,049 million tonkm). 78 strong position inthe Easternmarket. Enteringthe market for internationalhaulage i s difficult due to strong positions of incumbents. The shortage of roadpermits (discussed below) and the capitalrequirements -particularly for operations inthe western market - also poses a problem. ~ Box 8.1 LogisticsconsiderationsinApparel and textile industry Exportsof textiles andapparelreachedover US$ll8 million in2002, almost exclusivelywith EU countries. Upto 80 percentofthe industry'sinputmaterialsare importedfrom EUcountries, as Moldovanproducerssell onlyproductioncapacity.The only meansof competitionis the price and, in more fashionable apparel, time to customers. Thus, the industryrelies heavily on dependable and affordabletransport. Transport servicesare either bought by customers, or the Moldovanproducershavetheir own trucks. A numberoffirms feel that the deliveryreliability ofowntransport ismuchhigherandtransport costs are 20-30 percent lower than iftransport was bought from Moldovancarriers. Becauseof the relatively wide rangeof value for apparelandtextile, the share oftransport cost also varies alot from itemto item. Free on Board(FOB) value ofatruckloadof lingeriecanexceed US$300,000, whereasatruckloadof carpetsmaywell be underUS$30,000.As aconsequence, direct transport costs canbebelow 1percent 8.14 The Moldovan truckingindustrycomprises three types ofoperator: (1) operators with multilateralpermits to operateinEuropeantrade; (ii) operators with aging equipment engagedinCIS andnon-EU trade usingbilateralpermits; and, (iii) operators with old equipment operating solely inthe local domestic market. Overcapacity is persistent especially inthe two latter groups and, despite the low operational costs, profitability i s poor. The lack of trucks that maximize the number of available permits effectively hinders Moldova's trucking industryfrom benefitingfrom this cost advantage. The high share 8.15 Nearly 40 percent of Moldovan firms use "own account" transport. Inthe more of "own developed transport and logistics markets, this percentage of own account transport i s account" substantially lower. For example, inthe UK the percentage o f own account transport i s transport in under 10percent while inthe Nordic countries it is under 15percent and inLatvia it is Moldova around 25 percent. Moldova's highshare reflects the low quality of services available in reflects the low the market and the low initial investment inown equipment and transport staff. Own quality of trucks and drivers are frequently cited as givingmuchmore flexibility intransport services available in that operations than bought services. It also compensates the need for transport insurance - market. whichis reportedly relatively costly and unreliable inMoldova-- when usingcommercial carriers. Indomestic transport or distribution, it i s even more common to have own transport equipment, since the availability o f domestic distribution services i s very low, and the reliability i s also low. Moldovai s also a relatively small country by area, which facilitates having own equipment for domestic operations. However, the demand for domestic distribution is low, becausethere are no country-wide retail operations -mainly due to the very low purchasing power and consumption. 79 Moldovan 8-16 Moldovantrucfing Table 8.4 Annual cost of operating a 20 ton truck in truckingfirms firms have the lowest internationaltraffic for 200,000 kmper year have the lowest operational costs in (1,000) operational internationaltransport in Baltic CEE EU Moldova average average average costs in Europe (Table 8.4). The international impact of wage levels i s Personnel 6.4 12.2 16.0 56.6 transport in substantial to trucking Depreciation 14.0 14.9 16.2 11.5 Europe. firms' cost competitiveness. Taxltollllicenses 10.6 7.0 4.1 2.4 Cost and expenses of the insurance 3.6 2.2 2.4 3.0 driver from a EUcountry is Interest 7.0 2.6 3.2 3.6 30-35 percent of operating 18.0 21.9 18.6 21.7 costs of a 20-ton rig, and for Tires 3.0 2.4 1.2 1.8 a driver from Eastern RepairlMaintenance 3.0 1.8 2.1 4.8 Europe 14 -16 percent of Other 3.4 15.6 16.2 15.6 costs. A Moldovandriver, 69.0 80.6 80.0 121.0 on the other hand, costs Sources: IRUand staff interviews. Note: Figures do not include overhead costs as they vary significantly from one around 10percent of firmto the next. operating costs. Interest costs as well as the cost of insurance taxes, tolls and licenses are, on the other hand, more expensive inMoldovathan inCEE and EUcountries. VEHICLE QUALITYAND PERMITS Theshift to 8.17 The shift to higher standardvehicles inother countries reduces the absolute cost higher standard benefitofMoldova, and will effectively hinder Moldovancarriers to enter the EUor EU vehicles has hindered the Accession countries' markets unless they upgrade their fleets. The rapid fleet renewal in ability of neighboringcountries to meet higherEURO-standards has mostly been financedwith Moldovan leasing arrangements. Leasingis, however, seldomusedinMoldova. Moldovan trucking carriers to enter firms havebeenreluctantto havefixedmonthly leasing hires basedon the currently high the EU market. interest rate. Instead, they prefer to buy new equipment with equity. As a result, the Moldovancarriers tend to treat capital costs as "sunk cost" which leads to the selling o f road transport services under production costs, thereby further decapitalizingthese firms. 8.18 The ability of Moldovanroad transport firms to operate international depends on active participationinEuropean Conference o fMinisters of Transport (ECMT)56 This organizationissues multilateral transport permits covering the region inwhich Moldovan trucks operate. The actual number of ECMTpermits issued i s a function of the vehicles' environmental class, known as EURO-0, 1,2 or 3, where EURO 0 i s the least environmentally friendly category, and EURO-3i s the "best" ~ategory.~'The higherthe vehicle standard, the larger the actual number o f multilateral and bilateralpermits available. Together with bilateral agreements, these permits effectively limit the scope o f Moldovan road carriers' cost advantage.These increasing technicalrequirements - mainly advocated by EUcountries -effectively regulate the number o fpermits for all European carriers -including those inMoldova. The root problem of the small number o f permits available to Moldova i s its aging truck fleet. This understandably causes a lot o f complaintsby carriers towards the permit issuingnational control authority, the Moldovan Agency for International Road Transportation or AMTAI -- a separate authority under the Ministryo f Transportationand Communications. The issuance of the scarce permitsnationally has created a grey market for the permits and may have initiated certain corrupt practices. 56CEMTIECMT (European Conference of Ministers of Transport; organized under the Organization for Economic Cooperation and Development) comprises practicallyall European, and almost all CIS countries (Armenia is an observer). ''EURO-4 class will be effective on June 1.2005. 80 8.19 As of 2003, there were no EURO3 trucks registeredin Table 8.5 A Comparisonof the Complianceof the Moldovaand the number of EURO- Moldovanand Latvian Truck Fleets (in oercent) 2 vehicles remains small. On the Truck class Latvia Moldova other hand, the shift to EURO-3 2000 2002 2000 2002 standardtrucks has beenrapid inall EURO-0 73 47 95 89 EUAccession countries. InTable EURO-1 7 8 3 3 EURO-2 20 23 2 8 8.5, the evolution of the Moldovan EURO-3 0 22 0 0 and Latvian truck fleet i s compared. Total no. of trucks 5,366 5,543 4,500 4,300 Latvia has experienced a substantial Source: LatvijaAuto andAITA increase inthe percent of its trucking fleet that complies with the EURO-3 standards. The Moldovantrucking fleet still remains mostly comprised ofvehicles compliant with the older EURO-0 standard.The number ofpermits issued to national roadhaulage firms i s a function of the truck class. In2003, Moldova received 128 multilateralbasic permits, and additional permits for "Greener" (Le. EURO-1)and "Greener and safer" (i.e. EURO- 2) trucks. Becauseit has fewer higher-standard trucks, the total number of available permits i s lower than incountries withmore modern fleets. 8.20 The only way for Moldovancarriers to get alarger share ofthe highly More competitive European road haulage market i s to upgrade the trucking fleet so that it competitive complies with highertechnical standards.This meansremoving obstacles to investment ways of financing, such innewequipment.While decliningrealinterestrateswill help, morecompetitiveways of as leasing, will finance, such as leasing and foreign loans, needto complement the excessive use of be needed if equity finance. The financial market needs to develop its financing instruments and the Moldova is to taxation law needs to be revised so as to not discriminateagainst the use of leasing. rapidly upgrade its truckingJIeet 8.2 1 Unlike the ECMT, bilateral permits are negotiated so that the two countries get to Euro an equal number of permits. They come infive types: universal, bilateral, transit only, standards. bilateral and transit, and permits between third countries. Since Moldovancarriers have the lowest operations costs inEurope, their permits are likelyto be usedfirst. Ifthe issuingcountry i s a highcost country, some permits for carriers inthis country may also be left unused. This has beenthe case, for example, with Finlandand Russia, where all Russianpermits are usedwell before the year-ends, while part of the Finnishquota may be left unused. Ninetypercent of all universal permitsto Moldovahave beengivenby EU countries. Road carrier associations inEUcountries watch their Governments very closely so that low-cost countries, such as Moldova, do not get permitstoo easily. 8.22 Inadditiontothepermittoenterthecountry, countries maychargeuserfees.In Ukraine, this i s US$0.2 centsh, and inBelarusit i s US$80 for a vehicle of 15-24 tons, and US$80 for vehicles over 24 tons. InUlu-aine, most bilateral permits (8,000 out of the total of 10,000) are exempted from this road user fee. It i s also possible to enter Ukraine without a permit, but such trucks will be charged US$380just for entering or transiting the country. This fee comes ontop of all other fees andpayments, andit is very high compared to regular freights inthat trade. 8.23 Ingeneral, roadhaulage firms want to avoidcrossing Ukrainebecauseofsevere problems with unofficial payments. These tend to be problematic inthe CzechRepublic, Slovakia and Hungary too, butno unofficial fees were reported inside EUcountries. Based on interviews inMarch2003, unofficial fees on a roundtrip from Moldovato Germany, Austria or Italy amount to approx. 150 euros, and approx. 200-300 euros while transitingUkraine. The indications on unofficial payments are inline with the data obtained inthe larger survey on border crossing problems conducted by The World Bank in2001 and 2002. With42 respondentsin2002, the average for all nineborder-crossing 81 points was 72.8 euros per crossing. The 19 transport firmrespondents' average was 77.5 euros per crossing. These payments are highwhen compared to information on unofficial payments inneighboring SEE countries, butpayments may be higher ine.g. Ukraine and Belarus. Border crossing times inMoldova are also considerably higher than those inthe SEE countries. 58 Box 8.2 Logistics and Moldova's Future inElectronics Assembly Electronicssubcontracting or contractmanufacturing(CM) is not yet an establishedindustryin Moldova, unlike, for example, inHungary, RomaniaandEstonia,which have witnessed arapid growthin electronicsFDI. Giventhe closenessto EUandlow laborcosts, Moldovahas substantialpotentialto host suchoperations. Someofthe mainimpedimentsthat Moldovafaces inattractingthis type ofactivity are addressedbelow. About 70 percentof electronics CM is inChina, with alarge concentrationof componentmanufacturers inthat region.The productsrangefromhomeelectronicsandtelecommunicationsequipmentsto industrial equipment. Unitlabor costs are low inChina, but they are evenlower in, for example, BrazilandMoldova. Inelectronicsmostcomponentsare sourcedfrom East Asia. Reliabledeliveriesare essential,becauseof rapid changesindemand. A typical supplychainfrom componentsto finishedproducts involvesseveral parties, which further amplify the changes, andescalate the inventoryproblem.Furthermore, most componentsandfinishedproductshavesubstantialprice erosion, i.e. their market value decreasesquickly. InelectronicsCM, the value ofdirectmaterial(Le. componentsor sub-assemblies)is60 to 70percentof the value ofthe finishedproduct.The costof productionlines andtestingequipmentare often 20 to 30 percent ofthe total cost. Costs are directly relatedto capacityutilization, which seldomexceeds 90 percent. The share of labor costs inelectronics CM i s typically 5 to 10percentoftotal costs. Itmeansthat cheap labor initself is not sufficientto attractthis type ofproduction. Laborproductivity is akey issue, andhere Moldova has aclear advantage with is fairly skilled workforce. Currently, global electronicsindustryis facinglow demand, andfirms are strugglingto keeptheir capacityutilization on abearablelevel. Despite -or perhapsbecauseof - this,the industryi s constantly looking for new sites andregionsto combine access to marketwith low costsandhighproductivity. Moldova couldprovide some ofthese benefits. There are, however, severetrade andcustomsimpediments on import affectingtimely sourcingandon export affectingreliabledistribution. The currentlylow quality oftransportandlogisticsservices, poortransport infrastructureandahighcountryriskrating makeit difficult to promoteMoldovaas alocationfor FDI. Reducingthe time for bordercrossingtime andtrade formalities, as hasbeendone inEUAccession countries, couldquickly change the situation. 8.24 The availability o f transport permits i s a key issue determiningthe operational range o f Moldovantrucking firms. According to AMTAI statistics collectedat the border stations, 90,800 trucks inintemational traffic either entered or exited Moldovain2002. Ninety-four percent of that traffic involves nine countries: Russia, Romania, Italy, Ukraine, Germany, Belarus, Greece, Bulgaria and Turkey. Roughly 2/3, or 13,750 out of the total 22,700 Moldovan truck movements inintemationaltraffic are either import to or export from Moldova. The single most important trades are from Russia to Moldova (1,607 movements), and from Moldovato Romania (1,247). The remaining 1/3 of truck movements take place intransport between third countries, typically servingCIS countries' foreign trade. 8.25 This illustratesclearly the competitive region for Moldovantrucking firms: Italy and Germany are the only substantial EUmarkets served. The number of trucks operating there i s effectively limitedby the ECMT or bilateralpermits. Import and export traffic to EUcountries is almost inbalance, which meansthat all available permits are used. Romania, Bulgaria andUkraine are large markets, especially for incoming goods. 1,600 Moldovantruck movements took place inexport to Russia but only 450 movements took cargo form Russia to Moldova. For Moldovanexporters this increasestransport costs, 58 See, for example, Planconsult's Interim Report Ifor the TTFSE program 82 since trucks come back empty, but importers buyinggoods from Russia that can be transported by road can bargain low freights. 8.26 Data on freight revenue shows a similar pattern. Freight revenue o f Moldovan trucking firms ininternational traffic was US$26.8 million in2002. Fifty-sevenpercent o f it came from trade to or from Moldova and 43 percent came from traffic betweenthird countries, typically between Russia, Turkey, Greece andRomania. Tellingly, only 28 percent o f total revenue came from traffic involvinga EUcountry as the country o f origin or destination. This i s fairly close to Moldova's trade pattern with the EU. ESTIMATINGTRANSPORT AND LOGISTICSCOSTS INMOLDOVA TRADE 8.27 Transport cost i s usually not the most important logistics consideration for perishable items, goods with highunit value, or for intermediate goods used inindustrial processes. Transport reliability rather than cost i s increasingly more important for buyers. With increasingcargo value, transport speed i s an important issue, especially when distances grow. Inthis context, delays inborder crossingbecome important. While total border crossing waiting time i s usually around 5 to 15 percent o ftotal transport time in import and export o fRomania, Bulgaria, Bosnia & Herzegovina, andbetween 20 to 40 percent inAlbania, it tends to be between 30 to 50 percent inMoldova incomparable cases." 8.28 Just-in-time producersrequire reliable deliveries o finputmaterials -- be it apple juice concentrate or components. Electronic and mechanical assembly relies on accurate inbound shipments o f components, careful inventory management practices and dependable deliveries o f finished goods. Garments and apparel are highly time-sensitive products. Most packaged food i s distributedby retail chains usingefficient customer response requiringreliable deliveries too. Hightransport and handling costs are a key impediment to trade for most raw materials and commodities such as chemicals, fertilizers, grain andpetroleum products. 8.29 Over four-fifths o f Moldova'sexports andtwo- Table 8.6 Sensitivity of Trade to Transport Cost and Time thirdso fits imports comprise 1995 1997 1999 2000 2001 2002 timesensitive goods(Table Exports (percent Of totalexports) Cost Sensitive 8.6). The share o f time- CIS 25 33 28 31 34 30 sensitive trade has risen Non-CIS 5 3 3 2 1 1 since 1995. Time-sensitive Time Sensitive' trade especially with non- CIS 38 36 27 27 27 25 CIS countries, which i s Non-CIS 33 27 43 39 38 42 mainly trade with EUand Imports(percent oftotal imports) EUAccessioncountries, has Cost Sensitive risen dramatically and this CIS 47 35 32 24 25 25 trend i s likely to continue. Non-CIS 11 16 20 13 12 Time Sensitive `8 Similar phenomenon has also CIS 20 15 9 9 13 14 taken place inother South Non-CIS 24 39 42 47 49 50 European countries. It also Alcoholic beverages that the problemsin b/ Apparel, manufactures, food, other c/ Energy,chemicals, fertilizers western trade are different d/ Food, manufactures, machinery, other Source: UNComtrade database. 59Planconsult(2002) TTFSE Interimreport analyzed border crossing times ofroad-basedimport and export between the capitals of SEEcountries and cities such as Rome, Berlin, Istanbul, Belgrade, Ljubljana. 83 from those inCIS trade. Border delays or time-consuming documentary practices severely affect the trade of such items. It makes imported items unnecessarily costly, forces firms to runinventories at a muchhigher level than incompetitor countries, and hampers the competitiveness of Moldovan exporters selling goods that face intense competition from other low-cost countries. Table 8.7 Estimated Freight Revenue in Foreign Trade 8.30 Based on AITA (Millions ofUS$) statistics on the movements o f Import Export Total its member firms' vehicles in Roadfreight (AITA) 8.5 6.7 15.2 internationaltransport, the Rail freight CFM (excl. transit) 12.3 14.8 27.1 following calculation can be EstimatedAir Moldova 0.5 0.5 1 doneusing freights indicative Domesticdistribution of trade 10 5 13 for eachtrade. AITA members' carriers 31.3 27 58.3 combinedrevenue i sFifty-seven at million. estimated Estimatedforeign roadcarriers 15 15 30 percent or US$15.2 millionof Estimatedforeign rail carriers 30 6 36 this was generatedinMoldovan Estimatedforeign airlines 0.5 0.5 1 imports and exports, while the foreign carriers 45.5 21.5 67 remainder was generatedin traffic between third countries. Transport costs total (2002) 76.8 48.5 125.3 According to the estimate in Table 8.7, the total transport Value oftrade in (2002, est.) 1100 710 1810 cost for Moldovanimports and Transport cost of trade in exports was aroundUS$125 percent 7.0 6.8 6.9 million or6.9percent in 2002, Source: AITA, CFM, AirMoldova and UNComtradedatabase. o f the estimated trade volume in2002. This comprises freight costs only. The comparable figure for EUAccession countries i s between4 to 5 percent. 8.3 1 Idletime spent while crossing the Moldovanborder i s a considerable burdenthat raises the total transport costs o ftrade. Reducingborder-crossing time to 3 hours per truck -theaverageinneighboringcountriesaccordingtorecentTTFSEdata couldreducethe - total freight cost by approximately US$20 millionper year. This value i s arrived at using the data on trucks that crossedMoldova's borders in2002 andthe estimated average waiting times reported inanumber o f surveys. 8.32 Apart from pure Table 8.8 A Typology of Total Direct and Indirect transport costs (freight), Logistics Costs logistics costs comprise a Direct LogisticsCosts Indirect LogisticsCosts large group of direct and Overheador Inventorvcarrvinr!costs Cost of lost sales - I indirect costs (see Table Altemative Value oftime CustomerService level 8.8)." Logistics management costs OperationalI T costs costs Obsolescencecosts i s a trade-off betweena IT maintenance number ofpurchasing, Function- Transportcost (freight) Packaging production, distribution and related Cargohandling ITcosts (personnel) marketingconsiderations. Warehouse/storage Cost of Capitalin Integration of logistics Fairwayfees logistics Documentation equipment activities between suppliers Telecommunications Administration 6oInEUcountries, measurable logistics costs inmanufacturingare usually less than 10percent ofsales. Freight is usually only 1/3 of these costs. For high-valued merchandise, such as electronic equipment, freight costs may be one percent of sales or less, whereas other logistics costs are more significant. For low-valued commodities transported over long distances, freight alone can make 50 percent or more of the sales price. 84 and buyers, and shortening the response time from customer orders to deliveries along the chain i s often called Supply Chain Management. 8.33 Apart from pure transport costs (freight), logistics costs comprise a large group o f direct and indirect costs (see Table 8.8).61 Logistics management i s a trade-off between a number of purchasing, production, distribution and marketingconsiderations. Integrationof logistics activities between suppliers and buyers, and shortening the response time from customer orders to deliveries along the chain is often called Supply Chain Management. 8.34 InMoldova, costsfor documentation withtrade andtransport officials couldadd upto 2 to 3 percentageunits ofthe trade value. InEUcountries, this figure is onaverage less than one percent, albeit counted from trade with higher value and volume. 8.35 Administrative logistics costs by shippers, that i s by exporters or importers, are causedby telecommunications, IT and administrative processesinmakmgtrade work. In EUcountries, these accountusuallyone to two percent o ftrade value. They are mostly indirect costs, which may be counted invarious ways. Based on survey evidence from Moldovan firms, administrative logistics costs - such as working time of paperwork neededto organize for trade and transport -- correspond to 2 percent inimports and at least 3 percent inexports. 8.36 Inventory handling costs inlow-valued commodities is usually at 3 to 5 percent o f goods value, and for manufacturedpacked items it i s usually 2 to 3 percent. These values usedfor Moldovaare slightly higherthan inmore developed countries. 8.37 Inventory carrying costs intraded items depend on the level of inventory and the inventory turn-around cycle. These are bothaffected by the interest rate. InMoldova, the real lendingrate has averagedaround 17.4 percent. Precise data on inventory levels or inventory turn-around times were not available but other studies suggestthat these are two to five times higher than inthe US6*A conservative estimate assumes that inventory i s at least two month's worth of trade or work-in-process. This would mean that the tied-upcapital i s around US$150 millioninimports and US$lOO millionin exports. Usingthe averagereal lendingrate, this would relate to US$26 million in imports and US$17 million inexports. 63 "InEUcountries,measurablelogisticscostsinmanufacturingareusuallylessthan10percentofsales.Freightisusually only 113 of these costs. For high-valued merchandise,such as electronic equipment, freight costs may be one percent of sales or less, whereas other logisticscosts are more significant.For low-valued commodities transportedover long distances, freight alone can make 50percentor more of the sales price. See, for example, J.L. Gauschand J. Kogan, 'InventoriesinDevelopingCountries: Levels and Determinants-A Red Flag for Competitivenessand Growth'. WPS No. 2552. Washington, DC: World Bank, 2001. 63There are many reasons for firms to keep high inventories, including speculationonproductprices or exchange rates, highminimumor economical order sizes for a smallmarket, andpreparation for sudden changes incustoms regulations. In this calculation, it is estimatedthat 30 percent of excessiveinventory carrying cost couldbereducedthrough morereliable tradepracticesand transport arrangements. As an order ofmagnitude, this gives for imports 0.3 x US$26 million = US$8 million, and for exports 0.3 x U S 1 7 million = US$5 million. 85 8.38 Finally, unoficial payments in Table 8.9 Estimated Logistics Costs in Moldovan Foreign trade needto be Trade counted in.Survey (US$ millions) evidence on unofficial Import Export Total payments relatedto Estimated value o f trade in 2002 1,100 710 1,810 transport tends to vary a Transport costs total (2002) 77 48 125 great deal. These canbe Transport cost of trade in percent 7.0 6.8 6.9 around 5 to 20 percent of freights, which Other logistics costs would putthe absolute Documentationa 18 17 35 figure at approximately Administration by shippers 18 17 35 US$5 to US$20million Inventoryhandling costs 36 17 53 per annum usingthe Inventorycarrying costs 8 5 43 estimate inTable 8.9. Unofficial payments (estimate) 5 10 15 This figure seems low, Other logistics costs total 85 66 181 and when putinrelation Other logistics costs of trade in percent 9.4 11.0 10.0 to trade volume, would represent one percent of Freight and other logisticscosts total 162 114 276 the value of total trade. Total logistics costs of trade in percent 14.7 16.1 15.2 However, even this figure i s significant, Total logistics cost of trade, percent o f when compared to GDP 17.2 average tariffs inEU Total domestic logistics cost, 5 percent of GDP 80 countries. Moldova's total logistics costs 356 Moldova's total logisticscosts, YOof - 8.39 Logistics costs GDP 22.2 of Moldovan trade, a2 percentof imports and 3 percentof exports. estimated at US$276 2 percentof imports and 3 percent of exports. 4 percentof imports and 3 percentof exports. million, or 15.2 percent Source: Author's estimates. oftrade in2002, constitute a substantial barrier to trade (Table 8.9). These costs should be 5 percentagepoints lower to meet the level o f EUAccession countries, and to make Moldovamore competitive. 8.40 In2000, the transport sector accounted for 8 percent ofMoldovanGDP. Domestic, non-trade relatedlogistics costs account for 4 to 6 percent o f GDP in developed countries, but they can be substantially higher indeveloping countries. Own account transport i s widely used due to the small land area o f the country, low- performing transport markets, small transport volumes and the overall poor condition o f the transport infrastructure. Thus, the value of domestic goods transport i s notreadily available in statistics. A conservative estimate of domestic logistics costs inMoldova is US$80million in2002, or 5 percent of GDP (Table 8.8). 8.41 With costs for domestic logistics, the total logistics cost inMoldova amounts to US$356million, or 22.2 percent of GDP in2002, which is the highest figure inEurope. Total logistics costs inEUand EUaccessioncountries are inthe range o f 10 to 16 percent, and inMexico, Brazil and China between 15 to 17 percent of GDP.64 In Moldova's neighboringcountries, the corresponding figure is between 15 and 20 percent. 64See DonaldBowersox et al., 2lst Centurv Logistics:Making Suuolv Chain Intemation Reality, Council of Logistics Management,Oak Brooks: IL.,1999, and EuropeanLogistics Association, Insight to Imuact, Brussels2001. 86 Moldova's highlogistics costs are matchedby those inmost Central Asian and South Caucasuscountries, where the share i s generally between20 and 25 percent of GDP. 8.42 Logistics costs cannot be brought down to zero, but over US$70 millioncould be saved through more business friendly government policies and more efficient logistics. If, for example, the Government brings trade documentation and administrationto the level found inmost EUaccession countries, logisticscosts of firms could be reduced by about US$35 million. The more predictable trade environment would lower inventory-carrying costs by over US$lO million, evenwhen unofficial payments or inventory handling costs remain unchanged. Bringingthe averageborder crossing time to 3 hours - as i s the case inmanyneighboringcountries -- would save at leastUS$20millioninwaiting time costs alone. More efficient operations and increasedcompetition inrail androad transport could lower the total transport costs by 20 percent, equivalent to US$25 million. 8.43 These actions would bringthe total logistics costs of trade down to 12.4 percent o f trade value, and the country's total logistics costs (including domestic logistics) down to 18.7 percent of GDP. This would dramatically improve the competitiveness of Moldovan firms, enabling themto createjobs and wealth through the skilledbut low cost labor and Moldova's excellent location. It would also make Moldova a temptinglocation for foreign firms to establish mechanical or electronics assembly units,which are now practically absent. 8.44 Inmost developingcountries, investingUS$1inroadinfrastructure bringsthree times that inbenefits for road users. InMoldova, givenits poor infrastructure and its high potential for trade and traffic, these savings are likely to be higher than that. To fully capitalize on its trade potential, and to improvemobility o fpeople and goods insidethe country, Moldovaneeds substantial improvement inroad andrail infrastructure. Development o f warehouse and cold storage facilities i s also neededto facilitate market access of agricultural producers. Bringingtrade and border crossing practices at par with EUaccessioncountries, improving the efficiency ofthe transport sector, andrapidly reducing the severe backlog o f infrastructure investment, Moldova could assume its proper trade location on the edge of EU. 87 CHAPTER9. FINANCIALSERVICES: LIMITEDACCESS AND HIGHCOSTS INTRODUCTION The limited availability and 9.1 Financial services are essential for the functioning o f a modem economy. Such high cost of services are especially important for the facilitation of internationaltrade, where there i s a financial need for various servicesand instrumentsto increase speed and certainty inpayments services is an across internationalborders and indifferent currencies. Insofar as these financial important services have limitedavailability and are costly, as i s the case inMoldova, they become constraint to the important constraints for the development of internationaltrade. This chapter will briefly development of describe and analyze the performance of Moldova's financial sector, with special international emphasis on how structural and regulatory impediments inthis sector affect the provision trade. o f financial services requiredfor internationaltrade. The banking 9.2 As inmost transitioncountries, the bankingsector inMoldovadominates the sector dominates financial sector. Capital markets, contractual savings and specialized financial institutions Moldova's small are non-existent, inactive or very small. The overall depth of bank intermediation financial sector. activity, as measuredby the ratio of total banking sector assets to GDP i s still quite low. At end-2003, the total assetsofthe whole banlungsector inMoldovawere lessthan providingfinancial services to households and business -- inthe form of payment US$778 million (about 38 percent o f GDP). The success o f the banking systemin services and savings vehicles -as measuredby their capacity to attract deposits, i s also low. Total banking sector deposits inMoldovawere about US$436 million at end-2003 (about 21percent of GDP). While the banking sector has grown considerably since the regional financial crisis, it remains small incomparison with Central and Eastern European economies. For example, the average size o f the financial sector inthe new EU members i s about twice as large as Moldova's (assets and deposits of around 64 and 39 percent o f GDP, respectively). Access to 9.3 Almost all business surveys carried out for Moldova show that access to finance finance is a i s a considerable impediment to business de~elopment.~~ capacity of banks to The considerable appraise the creditworthiness of clients is still developing and as a result, banks are impediment to generally credit riskadverse. The dearth of mediumto long term credit i s not only due to business the highfundingrisk, but also becausesuch credits effectively reduce the capacity of development. bank to restructure their balance sheets when circumstances change. A legal framework that clearly establishesthe rights, responsibilitiesand liabilities of the parties to financial transactions and which provides a means to enforce legal obligations and claims efficiently i s a key ingredient of a stable androbust financial system. 9.4 Nominal lending and deposit rates inlei have been falling progressively since 1998. The lending interest rate for credit inlei has fallen from 35.3 percent at end-1999 Lending and to 19.4 inDecember 2003. Rates on lei deposit have fallen from 27.8 to14.20 percent deposit interest over the same period.66With the lendingrate falling at a faster rate than the deposit rate, rates have been the lei spreadhas fallen progressively since the beginningo f 2001, declining to 520 basis falling steadily, points at the end o f 2003. Except for abriefperiod in2001, the spread inlei has but still remain consistently remainedbelow the spread inforeign currency. The significant reductionin much higher inflation and macroeconomic volatility has reducedspreads inall transition countries. than in other Central and Eastern 65The BEEPS I1surveyshowedthat 69 percentof interviewedenterprisesusetheir own funds to finance their investment European andworkingcapitalneeds. countries. 66 Expostreal interesthavefollowed a similar pattem. Ratestumedpositiveat the beginningof 2001 andremainedaround 10percentuntil the end of 2003 when they declinedto the 5 percent level. 88 The average spreadinCentral and EasternEurope, includingthe Baltics, has fallen to less than 3.5 percent. While average spreads inthe other CIS countries have also fallen, they still remain high close to 10percent at end2003. - Reducing the 9.5 There hasbeenconsiderable consolidation inMoldova's banking sector over the number of small last few years with the total number ofbanks falling from 23 at the end of 1998 to 16 at banks will end 2003. The banking sector i s fairly concentrated with the 5 largest banks having 71 create a percent of the sector total assets, leaving 11banks to share the remaining 29 percent. As healthier the concept of economies of scale also applies to banks, the sizable number of small and banking system very small banks suggests large inefficiencies and high costs. To attract andkeep capable of household deposits, small banks must keep depositors well compensatedand this affects providing efficient, better the averagecost of fundinginthe banking system. These small banks also have neither a and cheaper diversifiedbusinessbase nor sufficient capital, makingthem more vulnerable to financial unexpected shocks or market changes. The NBMi s aware of the needto increase the services. capital of these smaller banks and has periodically increasedthe minimumcapital requirement. Reducingthe number of smallbanks further will be an important part of creating a banking sector that i s healthier and more capable of providing efficient, better Foreign banks, particularly and cheaper financial services to the economy. western banks, 9.6 Ten of the 16banks inMoldovaare majority-owned by foreign shareholders, have been vely most of which are private investors or investment companies. Only intwo cases are the hesitant to invest in Moldova. majority shareholder a foreign bank (from Russia and Romania). Several reasonsmay Increasing the explain the hesitance of foreign banks, particularly western banks, from any involvement number of with Moldova: its main internationaltrade relationsare with the CIS countries, andthe foreign banks interface withthe western economies i s very limited; it is a small economy with a low operating in degree of financial depth and sophistication; very few international companies have Moldova would economic activities inMoldova; several government andNBMrestrictionsand be desirable. regulations affect the performance o f the banking sector; and, no means are available to Banks are protect investments by owners inthe capital of banks made inforeign currency from authorized to losing their value inthe event of exchangerate volatility. lendforeign currency only to 9.7 The introductiono f foreign banks into the Moldovanbankmg sector is highly importers. This desirable. A recent survey o f case studies and a cross-sectional econometric analysis restriction findsthat the presenceof foreign banks exerts competitivepressureonlocalbanks and increases that there is a significant decline intheir overhead costs following the entry of foreign banking sector banks. Inaddition, foreign banks can offer importers and exporters the services of their risks and internationalnetworks and often bringnew financial products to the market. A reduces the methodology for enabling foreign banks to operatewith protection for the value of their competitiveness foreign exchange investment incapital may be a first step towards facilitating the activity of Moldovan of foreign banks inMoldova (as subsidiaries, branches or partners inlocalbanks). exporters. REGULATORYIMPEDIMENTS 9.8 The fear of dollarization has ledthe regulations limitinglending inforeign currency. At present, Banks are authorized to lend foreign currency only to importer^.^^ They are forbidden from lendinginforeign currency to exporters to finance local expenditures. This restrictionruns contrary to the reality of lending risks. Fromthe risk aspect, exporters with expected foreign exchange revenue are the safest foreign exchange borrowers. With limitedresources for localcurrency lending and excess resources for foreign exchange lending, the restrictions on foreign exchange loans to exporters increase `'Banks are also authorized to lend in foreign currency to other banks and, for anumber narrow range of activities, to individuals and legal entities (Le., education, medical treatment, etc.). 89 the banks' risks. They also make credit muchmore expensive to the exporters. They are requiredto pay for local currency loans above 20 percent annual interest, against an interest rate below 10percent for Dollar loans, with inflation estimated at 4-5 percent annually. 9.9 Banks are requiredto process all transactions inlocal currencies. Dollar transactions between Moldovan entities (suchas an exporter and his suppliers) require the payer to first exchange his dollars into local currency, then the local currency i s transferred to the other party who thenhas to exchange it back into dollars. Such transactions are a burdento firms, butmore important, costs substantial charges, and carry exchange rate riskto the exporters. Fiscal agent 9.10 Commercialbanks inMoldova are chargedwith various functions that are clearly responsibilities not with the scope o f banking, ifnot incompatiblewithbanking business. Among the imposed on fiscal agent responsibilitiesimposedon banks are the control over repatriation o f export banks are proceeds.68As notedinChapter 3, exporters are requiredto receive their export earnings incompatible within a limit period, set differently for different types of exports. Delays are fined at 0.3 with banking percent for each day, or a rate of more than 100percent ann~ally.~'It seems that, at the business and rate of interest on loans, it is inthe exporters' interest to repatriate their export revenue as impose early as possible. On the other hand, all of these requirement cannot and will not prevent signifcant costs on banks and those that have interest insending funds abroad from doing it (there are many ways to their clients. sendfunds abroad; declaringexport values and failing to repatriate export revenue is not one of them). While double punishing exporters, these regulations are also a costly burdenfor the banks that are requiredto monitor all transactions and report indetail to the authorities. Eliminating these regulations will save exporters a lot o f administrative hassle and double punishment, while also saving the commercial banks andNBMthe significant costs o f monitoring, recording and reporting the related data. The cost of 9.11 A roughestimate suggeststhat the costs of financial services to exporters canbe financial halved from the current level. Allowing foreign exchange loans to exporters will sewices to immediately cut real interest rates for exporters by half. The elimination of back and forth exporters can conversionbetweencurrencies for transactions with Moldovansuppliers will be halvedfrom substantially cut non-interest costs. While suchreductioninfinancial services costs will current levels. provide significant benefits to exporters, they can be achieved, without causing major problems to the health o f the banking sector, only ifthe proper adjustments are made in the financial sector. These include streamlining the sector by substantially reducing the number of banks; and eliminating all restrictions on lending, transferring andholding of foreign currency. BANKINGSERVICES FOR INTERNATIONAL TRADE AND EXPORT PRODUCTION Lettersof Credit 9.12 Exports and imports require specializedbanking services, such as letters of credits (LCs), Confirmationo f LCs, quick and low cost facilities for international transfers o f funds, exchanging from one currency to another, and a variety of guaranties. Moldovabanks provide limitedservices due to their small size and lack o f international reputation. For example, Western Europeanbanks will confirm LCs opened by Moldovan banks only against 100percent deposit by the Moldovanbank. Thisproblemwas solved The Law on Controls on the Repatriation of Funds, Goods and Services (No. 1466-XIII, January 29,1998). 69There are certain exemptions to this law and the maximumamount of the fine can not exceed the value of the non- repatriated funds. 90 Thesmall size and lack of international reputation reduces the use for 3 banks by a guaranty facility providedby European Bank for Reconstruction and of specialized Development (EBRD).The EBRD scheme, operating inmany CIS countries, will banking guaranty LCs issuedby one o f the 3 participating local banks to a foreign bank, with services, such exposure limitso f US $2-2.5 million per participating bank. While this facility solves the as letters of problem for 3 banks and for limited amounts, the problem remains unsolvedfor the other credit. 13 banks. With time, and increased demand, the exposure limitsper bank may also limit the systems ability to support imports from Westem Europe, where LCs and confirmations are the way international trade i s done. 9.13 However, it seems that importers from CIS countries are unable to use LCs as means o f guaranteeing import orders untilthe goods are received. Inmany cases, CIS exporters demand full payment inadvance for equipment and industrial products whereas Moldovan exporters are requiredto send their products and then wait for payments. In general, Moldovans face these problems intheir trade with CIS countries. They are requiredto pay for imports inadvance while receiving the revenue for their exports after shipments arrive at their destination, all without the benefit o f quick settlement and guarantied payments providedby LCs. Leasing Leasing is at a 9.14 Inmanydevelopingcountries, leasingisapopularfinancingmethodfor disadvantage emerging businesses. Inleasing, the lessee is paying a small percentage of the cost o f the due to several equipment, whereas the lessor i s financing most o f the cost (usually 75 -90 percent) laws and while holding the title to the leased equipment. InMoldova, leasing i s at a disadvantage regulations that due to several laws and regulations that prevent its development. prevent its development. 9.15 While interest paid on loans from banks carries no tax, the interest component in leasing installmentpayments carry VAT taxation. Further more, lessee i s required to deduct 5 percent o f eachpayment to the leasing company as tax advance and pay that amount to the tax authorities. Suchtax procedure does not exist for payment o f interest to banks and puts leasing at a disadvantage. 9.16 Another important facilitating mechanismfor leasing i s also missinginMoldova. Itrelates to motor vehicles. The Moldovanauthorities register motor vehicle owners. There i s no ability to register a lien infavor o f a financial institution, as common inall developed countries. Such a lien allows the authorities to hold legal owners responsible for any illegal conduct and traffic violation by the vehicle while demanding consent or waiver by the lien holder beforeregisteringa transfer o f title. InMoldova, to protect their rights, leasing companies and/or banks, financing the vehicle have to register them intheir name, exposingthemselves to owners' legalresponsibilities. Insurance 9.17 To facilitate leasing, VAT status o f lessors should be adjusted to be the same as activity in for banks. The motor vehicle registrationsystem should be adjusted to allow registration Moldova is o f liens for the benefit o f leasing companies and other providers o f funds for the miniscule and is procurement o f motor vehicles. incapable of providing Insurance insurance to foreign trade 9.18 The Insurance industry inMoldova suffers from too many companies with too activities. small capital and/or expertise to offer effective services. The industryhas 55 licensed insurance companies, o f which 49 are actually active. At present, the minimumcapital for the registration and obtaining a license for an insurance company i s MDL300,000, or about U S $20,000. The total insurance activity i s miniscule -total premium revenue for the whole year 2002 was U S $17.1 million. The industrystructure calls for immediate 91 change -one company, QBE,with foreign partial ownership (foreign ownership in insurance companies i s limitedto 49 percent by law), has 30 percent market share. The 4 largest companies have a market share of 64 percent. The other 45 companies share 36 percent of the market, or annual total premiumrevenue of U S $6.1 million. While there i s a new insurance law inpreparation, it i s not clear if it will be drastic enough to enable the emergence of a healthy insurance industry,that will be able to provide professional andreasonably priced insurance services to the private sector ingeneral and to export and other foreign trade activities inparticular. 9.19 Exporters to the CIS countries almost never insure their shipments. Instead, as indicated by a number of exporters, they send a group of guards with every shipment. Their mainclaim is that total loss is rare; on the other hand, most shipments suffer from some o f the merchandise being stolen on the way. Suchlosses are causedby border officials at the differentborders andby others, and are very difficult to prove and claim from insurance. It is, however, clear that this solution i s short-term, as long as low wages and highunemployment makes the guards available at low cost. A better performing insurance industrymay be useful inthe move from physical protection to the insurance o f shipments. ForeignTrade ReceivablesInsurance 9.20 Many countries, both developed economies and developing economies, offer exporters the benefit of insuringexport receipts. Such insurance i s offered against commercial and political risks, partly by privately owned insurance companies and partly byparastatals. InMoldova, such insurance is not available. Inmany developed economies, the export insurance facilities are intended to support exports by local companies to developingcountries. This support, when providedbeyond what would be economically rational, i s considered assistanceto boththe local exporters andthe developing countries. Other countries, less developed and unable to support such hidden subsidies, offer export insurance on a rational basis. Inthe case o fMoldova, due to the reluctance of CIS importersto provide LCs and other guaranties, the service of export insurance facility may bebeneficial. However, the feasibility o f such service, and how to create it, should be carefully evaluated before reachingany decision. CONCLUSIONS 9.21 Thebanking sector and other financial services inMoldovaare unable to provide the private sector, ingeneral, andthe foreign-trade relatedbusiness activities with efficient andreasonably priced services. This i s due to the limited financial activity and large number of small institutions, as well as to the large number of regulations, prohibitions and limitations placedby the authorities. While there are limitations to the variety and quality of financial services insmall economies such as Moldova, substantial improvement can be accomplished ina few years by following some of the recommendations discussedabove. 92 MOLDOVATRADE DIAGNOSTIC STUDY PARTI1 CASE STUDIES Fruit andVegetable Sector Case Study Textiles and Apparel Case Study Wine Sector Case Study MoldovaTrade Diagnostic Study: Fruit and Vegetable Sector Case Study September 2003 John Gray EmergingMarketEconomicsLtd. Contents: 1.Introduction.................................................................................................................................. 1 2.Key FruitandVegetables Export Markets................................................................................... 2 2.1 CIS / Russia Markets........................................................................................................... 3 2.3 Accession Countries to the European Union....................................................................... 2.2 European Market................................................................................................................. 46 3. Supply Side Issues....................................................................................................................... 6 4.Prospects for Sector Recovery..................................................................................................... 9 4.1 Walnuts ............................................................................................................................... 9 4.2 Apples ............................................................................................................................... 10 4.3 Fruit and Vegetable Processing......................................................................................... 4.4 Sour Cherries..................................................................................................................... 11 12 5.EstimatedIndustryCost Structure ............................................................................................. 12 6. Constraints to Trade................................................................................................................... 13 6.1 Taxation............................................................................................................................. 14 6.2 Transport ........................................................................................................................... 6.4 Quality and Standards ...................................................................................................... 16 6.3 Bureaucratic Requirement................................................................................................. 14 15 6.5 Market Access................................................................................................................... 18 6.6 Finance andCredit ............................................................................................................ 20 6.7 MarketInfrastructure......................................................................................................... 20 6.8 Institutional Organisation of the Trade ............................................................................. 20 6.10 Export Market Information and FDIPromotion ............................................................. 6.9 Sovereign Riskand InwardInvestment............................................................................. 21 21 6.11 Market Information-Regional Markets......................................................................... 6.12 The Need for New Investment inPlant and Equipment ................................................. 22 22 7.Conclusion................................................................................................................................. 22 Annex 1:An Overview ofthe Constraints to Fruitand Vegetable Exports from Moldova ..........25 Annex 2: Statistical Appendix ....................................................................................................... 28 1.Introduction The fresh and cannedfruit and vegetable industrycontributes to about 15percent of agricultural exports inMoldova, and provides a significant contribution to employment inrural areas, with an estimated 70,000 individuals employeddirectly or indirectly infruit production whilst over 150,000 are employed invegetable production, representing 13 and 30 percent of the total agricultural workforce respectively. Since independencein 1991,Moldova's fruit and vegetable sector has performedpoorly with declines inproduction, productivity and exports, despite favourable climatic conditions. The production of fruits and berries in2001 amounted to about 317 thousand tons, whilst an average o f 700-800 thousand tons of vegetables are annually producedinthe Republic. Duringthe past decadethe total areaunder vegetablesinMoldovahas seenadecrease ofover 30 percent', whilst output levels have seen an even more dramatic decline from over 1.2 million tons in 1991to about 690 thousand tons in20002.This decline was due inpart to the farm restructuring process, withdrawal of Government subsidies to the sector, and the relative price changes to inputs following independence which saw a dramatic reduction of agricultural inputs,and an associated fall inproductivity. Figure 1highlightsoverall production inthe fruit and vegetable sectors over the past 4 years. 1 Figure 1:Productionof Fruit and Vegetables inMoldova 800 700 2 600 500 0 5 400 v1 e 300 200 100 0 1999 2000 2001 2002 __ Source: Ministry o f Agriculture, 2003 Although vegetables are grown throughout Moldova, the mainproduction areas are located around the two major rivers of the Prut -whichruns along the country's Western border with Romania, and the Nistru, which flows inthe East. The major vegetables grown include potatoes, onions, cabbages, cucumbers and carrots. It i s estimated that about 30 percent of vegetables grown are producedon larger privately heldagricultural enterprises whilst the remaining70 percent i s scattered among small private farms and horticultural growers. Most o f the vegetablesproduced in Moldova are for the local market, with only a small trade infresh and frozen vegetables for export markets, accounting for less than 5 percent of total output in2001. The key export markets are the CIS and Romania. The fruit sector i s dominated by apples, plums andpeaches, with over 60 percent of the production found inthe north o f the country. However, the situation inthe fruit sector i s equally depressed. Outputfor fruit and berries in2002 represents about 45 percent o f 1991output of690 thousandtons (excluding grapes). The farm restructuringprocess has ledto the fragmentation of the landholding 'Based on official figures fromthe Ministryo f Agriculture. Figuresinclude potato production 1 of orchards, often with many producers owning a few trees within large orchards. Coupled with increased costs of inputs, and limitedmarketingopportunities for fresh produce (due to the limited ability ofprocessing companies to provide prompt payment for purchased fruit), the sector has seen a significant decline inthe area plantedto orchards. The area plantedto orchards has declinedby a thirdfrom 1991andnow accountsforjust over 6 percent oftotal agriculturalland. There are a variety o f fruits currently beinggrown inthe country, the most important of whichare: apples, prunes, apricots, and sour cherry. These h i t produce serve as raw material for production o fjuice concentrate, cannedproducts and inlimitedquantities for the fresh h i t export markets in the CIS and Romania. Currently fresh h i t exports account for about 8-9 percent o f total production. 2. Key Fruit and Vegetables Export Markets The fruit and vegetable export market canbe disaggregatedinto the processedand fresh h i t and vegetable market. The most significant export products remain cannedvegetable and fruit products interms ofvolume as highlightedinfigure 2.For allexport market segments, the CIS market, and inparticularthe RussianandBelarusmarkets, as well as the Romanianmarketcontinues to bethe most important interms of volume and value terms for Moldovan producers. Figure2: ComparisonofExportVolumes 1999 2000 2001 2002 Source: External Trade Yearbooks Freshh i tproduction hadseen a significant decline between 1998-1999, inpart reflecting the devaluation ofrouble duringthe Russian financial crisis, application of new EC standards by Romaniaas part o f the accessionprocess, as well as the continued supply side problems faced by producers. However, duringthe past 3 years, there has been a steady improvement inthe quantities exported as supply side problems ease, andproducers drivenby the "agrifirma" have funds to rehabilitate the orchards, and export trade resuming with Russia. Duringthe sameperiodexports offresh vegetable increased, albeit fromanextremely depressed situation, spurredby politically driven trade with Belarus, often inthe form o f bartering for other products. The key export crops were onions, cucumbers and peppers, whilst export volumes o f cabbagesand carrots saw a decline involume (CAMIB,2002). 2 2.1 CIS / RussiaMarkets The key CIS market for vegetable and particularlythe h i t sector remains the Russian market. Russiaremains a net importer o f fruit, and since 2000 the level of fruit imports have seen rapid recovery and are currently estimated to be at pre-1998 levels. Recentreports suggest that Russians consumers spend about 5 percent of their food budget on fruit, with average consumption of h i t per person per year estimated at 32 kg, althoughthis figure rises inthe major cities such as Moscow where it is estimated inthe region of 60 kgper personper year3. In2002, a series of sample surveys were undertaken inthe St. Petersburgand Moscow markets that indicatedconsumers spent on averagebetween 210-250 roubles per month on h i t andberries. The structure of market i s likely to change inthe comingyears, with h i t consumptionset to increase inline with rises indisposal incomes, whilst demand for niche and organic products i s also likely to develop. Presently the market is dominatedby oranges, bananasand most importantly for Moldova, apples, as indicated infigure 3. Figure 3: Structure of Imports of Fruit into Russian Market .1, IO/!! ," 14% W Bananas 0Apples 0Tangerines 32% NGrapes Pears 18% 1. Other Fruit Source: CNFA, 2002 The Russianmarket is prone to significant seasonalprice variation for temperate h i t s and vegetables, with increase insupply and subsequentdecrease inpricesbeingmost pronounced duringthe months from August to October, with wholesale prices falling byupto 50 percent for fruits such as apples and plums duringthis period. Much o f the fresh fruit and vegetable product exported fi-om Moldovaenters the market duringthis peak period, and hence prices that exporters receive are depressed.The following figure highlightsthe volume of fresh h i t and vegetables exports from Moldova into the Russian market. The Russianretail food sector is beginningto see significant change, particularly inthe retailingof fresh fruits and vegetables, where there i s an increasing movement away from kiosks and traditional outdoor wholesale markets to well equippedmodernfood stores. This i s particularly the case inthe larger cities of Moscow, St. Petersburg,Nizhniy Novgorod, and Yekateringburg, where consumers are spending more onbetter quality foodproducts. These figures are considerably less than the average per capita consumption in middle income countries estimated to be in the region of 161 kg per capita per year, and significantly less than the 216 kg per capita per year consumed in high income counties. 3 Moldovanfresh fruits and vegetables are not currently sold throughretail chains due to their poor quality, and badpackaging. Frozen products are often sold unbranded inthe market, and frequently inbulkform for subsequentre-packagingbywholesalers intoretailpacks.Theirreputationearned during the time of the USSRhas seen a significant erosion, as Moldovanproduce's appearance, calibration, and packaging are well below the standardso f competing product from other countries such Georgia, and Poland. Inaddition, many of the fresh fmit andvegetable varieties offered inthe market, remain essentially unchanged from product produced inthe midto late 198Os, with few early or late varieties beingdeveloped. Thus Moldovan fresh h i t and vegetable produce are often brought to the mainMoscow wholesale market where they are purchasedby re-sellers that retail the products inhosks. With significant competition inthe sector, as highlightedinthe apple sector, where Moldova currently comprises 3 percent ofthe market, advancepayment i s notprovidedby buyers, and often payments are delayed untilwholesalers are able to sell their product to the retailers. Figure 4: FreshFruit and VegetableExportsto Russia 5000.00 0.00 1999 2000 2001 2002 Source: Customs Department of Moldova, 2003 Withproblems o f supply, poor quality, and increased competition from suppliers outside the region beingable to provide low cost and more uniformquality products, Moldovan exporters have seen significant decreases inmarket share inthe Russian market. Thus the results have been a 4.5 percent decrease inquantity suppliedto the apple market during2001, as competition from Georgia, Belgiumand Germany has increased, whilst there has beenover a 40 percent decrease in peachand nectarine exports duringthe period 2000 -2002. 2.2 EuropeanMarket The Europeanfruit and vegetable markets have seenaprocess ofretail concentration over the past ten years drivenby supermarkets. Whereas imported fruit and vegetables were previously channelledprimarily through wholesale markets, the largest retailers now control over 60 percent of fresh produce imports in some EUmarkets. These supermarkets often do not compete directly with low price outlets but compete with eachother on attributes such as quality, year-round availability, presentation, productrange, and packaging4.They often make stringent demands on security o f delivery,whichMoldovan producershave up to now been unable to meet. However, changes in dietary habits stemming from increased health awareness, together with demand for convenience foods, have acceleratedthe consumptiono f fresh fruit andvegetables and the market i s set to T h i s doesnotmeanthat price i s unimportant.Consumersare sensitive to pricingpoints,and the margins of suppliers are constantly underpressure. 4 increase invalue andvolume terms for the foreseeable future. With stringent demands on quality and security of supply, Moldovanproducers have made only limitedprogress inpenetrating these European markets, as indicated infigure 5 for the case o f fresh h i t exports. Prospects for Moldovato penetrate the European market for fruit and vegetables needs to be assessedinthe light of two key on-going processes: (i) accessionprocess to the EUbothinthe the present round and beyond, and (ii) rapidly escalating technical barriers to trade infood products the arising from the progressive tighteninginareas such as phyto-sanitary controls (notably minimum residue levels -MRLs'), requirements on environmentally-friendly packaging and demands for good agricultural practice (EUREPGAP). I Figure5: EuropeanFreshFruitExportsby Value (US$) 160000 140000 120000 100000 80000 60000 40000 20000 0 I Romania Lithuania Estonia Germany Source: Department of Customs,Moldova, 2003 With the accessionprocessproceeding, the Europeanmarket is dividingfrom the extemal suppliers' point of view into three zones: The larger countries o f Western Europe (notably UK,France and Germany) which are setting the pace inthe application of the new quality and food safety standards. An overwhelmingpart of the fruit and vegetables market (upto 80 per cent) i s inthe hands o f a small number o f supermarket chains which are progressively reducingthe number o f their favoured suppliers. Accessing these chains is already very difficult and likely to prove impossible for Moldovan suppliers inthe absence o f FDI, to improve quality, invest incold chains and have access to buyersinthese markets. The remainingcountries ofthe current EU, whichare dragging their feet on application ofthe technical standards and are at present more accessiblefor new suppliers, but are likely to start progressively applying the new standardsinthe coming years; and The accessioncountries which arethemselves unlikely to apply the new standardsinthe foreseeable future but which may well impose these standards on external competitors as a non- Although this is presentlynot a significant issue as many smallholer producerscannot afford pesticides, it is increasinglylikely to becomeproblematic as larger commercialoperations develop. 5 tariff barrier to trade. This factor i s likely to prove a problem for Moldovansuppliers who may be excludedon the basis of technical standardstheoretically applied inthe EUbutnot infact adopted inaccessionand other neighbouring countries. To enter the fresh vegetable and fruit markets inEurope producers, retailers often demand that exports meet EUREPGAP requirements. GAP stands for `Good Agricultural Practice`, a minimum production standard for a good agriculturalpractice for horticulturalproducts andi s based onthe principals o f riskprevention, riskanalysis (among others by usingprinciples of HACCP), sustainable agriculture by means of Integrated PestManagement (IPM) and Integrated Crop Management (ICM). To obtain the certificate enterprises have to meet the requirements of the EUREPGAP Control Points and Compliance Criteria, and need to obtain certificationfrom an accredited firm. These requirements have further hamperedthe development of the fresh fruit and vegetable imports into the EU6 2.3 Accession countries to the European Union The key accession country for Moldovan fruit and vegetable exports continues to beRomania. However, Romania i s itself a significant producer of fresh fruit andvegetables -it i s rankedas the 1lth European fruit producer. Therefore export opportunities remain limited-for instance largest imports account for only 12percent of the fresh fruit market. Withinthis sector, the apple market holds considerable opportunity for importers, withapples contributingto more thanhalfo ftotal fruit consumptionperson. Despiteits location, and favourable accessto the market, Moldova exports account for only 3 percent of apple imports. Muchof the product exported from Moldova finds its way to the Burcharest Wholesale Market, which i s the secondlargest wholesale market inCentral and EasternEurope. With much of the fresh product competing duringthe peak harvesting season, duringJune to October, Moldovan products often compete with higher quality similar pricedproducts from Hungary and other CEE countries. Inaddition, produce from local growers are progressively increasinginquality, supported by incentives' providedby the EUas part ofthe accessionprocess. Much of the fresh h i t and vegetable exports to the market from Moldova are inthe form of bulk product, often uncalibratedand of poor quality. With poor political relations with Romania, Moldovan exporters are increasing facing higher standardsrequirements (as the processof EC accessiongains momentum) on many products. For instance inlate 2002, Romania introduced higher quality standards for onions, inaddition to changes inrequirements for packaging and labelling. Those fruit andvegetable exporters interviewedas part of the study suspectedthat Romanianproducers were not liable for the same highstandards. Thus there i s a suggestion that they are protectingthis market, and usinghigher EC standards, which onthe whole are not applicable to their own producers, as a form of anon-tariff barrier to trade. 3. Supply Side Issues Prior to the land reform process (which took place in 1999to 2001) Moldovanagriculture consisted of typical soviet state (sovkhoz) and cooperative (kholkoz) farm structures. Agro-industrial 'For a more detailed discussion, see section 6.3 Commercial farms are eligible for domestic supportwhile family farms can only receive free consultancy services and incentives to practise organic farming 6 enterprises, o f which there were many, were suppliedby the adjacent farm entities, and there was a match betweenthe supplies ofraw products produced from the farm and the capacities o f the processing enterprises. Quality control at the production level, appropriate to the requirements of the overwhelmingly soviet market were applied onthe state farms, which eachhadtheir technical cadres of agronomists, supported by technical staff at the Raion and Oblast level institutions. The landreformbroke this system. Basedon the fragmentation of land into parcels for all the eligible households (basically the full present and past farm employee cadre at the time o fthe reform). Landwas dividedinto three categories: arable, vineyards and orchards, with the majority o f farms undergoingprivatisation holding all three categories of land. Under the landdistribution process eacheligible householdreceived their share of each of the three categories of land type. This ledto an extreme fragmentation of land, especially inthe case ofthe vineyards and orchards where it was common for a family to receive a few fruit trees and part of a line o f vines. The architects ofthe landreformrelied onthe emergenceof a thriving smallholder ruraleconomy based on small household farms, combinedwith rapid development o f land markets to allow exit from farming of those individuals and households who didnot see their future infarming. Inthe event neither development has occurred. The resulting fragmented smallholdings have proved unviable inall except the most favourable areas (e.g. peri-urban areas) and the households who own the landhave neither the means (financial, technical and mechanical) to farm their land, for the most part with the young people optingrather to migrate, either intemally to greater Chisinauor to seek work (mostly illegally, inthe EU).It i s estimated that over 300,000 Moldovanadults have taken the option o f intemational migration, including a substantial part of the rurallabour force, The landreformprocess also ledto an abrupt collapse of the majority of the former irrigation schemes. Many o f these becameuneconomic with the advent of world market-based energy prices, and others succumbed to the management problemswhich arose from the fragmentation of land, as institutional arrangements for the management o f the schemes didnot keep pace with the distribution o f land. To the extent that the fruit and vegetables supply depended on irrigated water supply, this was amajor factor indepressingproductionlevels inthe late 1990sand since. Inthe three years since the landreformthere havebeendevelopments which havetended to correct these problems from the point of view of agricultural supply, even though the landmarkets remain non-transparent and ineffective, substantial concentration o f control over land has infact occurred, typically basedon extended lease-holdings taken on relatively large tracts of landby the "leaders" who emerged from the landreform process, and their more formal counterparts, "agrofirma", typically joint stock companies established by one or more leaders or commercial investors into the agricultural sector. While this development has been effective inensuringthat the larger part of the arable area i s cultivated, it has been less effective inrestoring competent management and investmentto the orchards andvineyards whichrequire a longerterm investment basedprocess for which the present lease-holding-based arrangements are not well suited. These developments have hada detrimentaleffect on the ago-processing sector. Sourcing o f reliable and standard quality supply has become a major problem, with resulting almost universal under-utilisation of capacity (often by a factor o f 80-90 per cent). As aresult, although the privatisation of the ago-processing sector inthe fruit and vegetables area i s complete, the majority o f the former enterprises have either gone bankrupt or are operating at very low and uneconomic capacity-utilisations, which compoundthe problems o fpoor quality derived from the presence of obsolete equipment. Some ago-processors are attempting to resolve their raw material supply problemsby buyingleaseholds onnearby land to take closer control of the productionprocess, but 7 for the most part they lack the financial resources to acquire land and undertake the necessary replanting of orchards whichi s now long-overdue. The lack of access to finance at the farm level has also ledto degradation of the cold chain developed inthe Soviet era, with an estimated 70,000 tons current capacity incold storage throughout the country. The lack o f suitable cooling and storage facilities throughout the country severely limits the market life of most products, coupled with the lack of irrigation infrastructure, and the highcosts associatedwith developing greenhouseproduction, leads to severe seasonalprice fluctuations. The winter seasons are characterisedwith the import of fresh items, and highprices, particularly for tomatoes and cucumbers. Summer months are characterised by glut situationwith prices significantly depressed.Figure 6 highlightsthis price variability inthe Moldovan market. Figure 6: Average Wholesale Price Data 2002 Moldova- 18 16 14 *t?u ?.o12 I O -Apples a -Tomatoes - 6 4 2 0 I Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Figuresbased on 4 wholesale marketsinChisinau, Causeni, Balti, and Cahul Source: CAMIB,2003 The rehabilitation or more likely, the development ofnew cold storage facilities is likely to have an impact on imports and the ability o f Moldovan producers to penetrate nearby markets. The revenues that exporters can receive for their product if, for instance, Moldovawas able to export stored apples inDecember to the Russian market, are estimated to at least 45 percent higher (depending on variety and quality) than the export of the same product inthe summer months. Figure7 highlights the recent trends.inimports o f fresh h i t and vegetables into Moldovapredominantly from Belarus and Romania inthe fresh and frozen vegetable sector. There are currently 5 large greenhouses operating inMoldova, with the three most significant producing vegetables, based inthe central region o f the country, and covering about 45 hectares (CAMIB,2002). These recently privatisedcompanies contribute to significant proportion ofthe 6 percent of vegetable productioncurrently under greenhouseproduction. Besides these larger players, whose technology i s often basedon more energy inefficient systems inheritedfrom the Soviet era, there are a number o f smaller players entering the market, based on more modem technologies. However, many o f these smaller greenhouse production facilities, such as those developed by the AGT Tiglan Farmer Association inEdinet RegioninnorthernMoldova, have beenestablishedwith significant support from donor fundedprogrammes. The mainvegetables produced ingreenhousesare: tomatoes, cucumbers, cabbage and peppers. 8 Figure7: Total ImportsofFruit andVegetablesbyVolume 45000 00 40000 00 35000.00 30000 00 E 2500000 ;" 2000000 ElVegetable Imports 15000.00 W FreshFruit Imports 10000 00 5000 00 0 00 I 1998 1999 2000 2001 2002 Source: Department of Customs,Moldova, 2003 4. Prospects for Sector Recovery Itwill be clear from the previous section that the collapse ofthe Moldovanfruit andvegetable sector relates to fundamental problems on the supply side, coupledwith increased competition and market access intraditional markets. Giventhe fragmentation o f the sector and the unsuitability of the former ago-enterprises as aplatform for rapid investment it is unlikelythat the sector will recover rapidly, by contrast, for example to the wine industry,which his experiencing a rapid recoverybased on inward investment from Russia for production and export into the traditional Russianmarket. Nevertheless, there are some indications of the beginnings o f a recovery inthe fruit and vegetable sector, though the pace i s muchmore gradual and dependent on specific opportunities for particular products. This section provides a brief description of some specific markets where somepositive signs of recovery can already be seen. 4.1 Walnuts: Moldova has ideal climatic and soil conditions for the production of walnuts. However, under the soviet system the product lackedofficialrecognitionas a crop, and production was haphazard around settlements and roadverges. The walnut sector has seen rapidgrowth, from a very low base, inrecentyears, founded onthree factors: the comparative advantageinproduction, the presenceof a low cost labour force which i s able to extract manually for the confectionary market with a much higher extractionrate of unbrokenkernels than mechanised methods, andpreferentialaccess to the EUmarket withno tariffduties. Theresulthasbeenaproliferation ofmarketingandprocessing operators. Marketingof the crop i s undertaken by regionally basedmerchants who buyon local markets from producers (from domestic production). Processing unitsmostly based inChisinau, do hand-shelling and export to destination markets, predominantly France. Inaddition to the processing of domestic production the industryhas attracted significant flows of importedunshelledwalnuts from Western Europe to exploit the low cost hand shelling for re-export to France and Germany, benefiting from the privileged access Moldovaenjoys inthe EUmarket. 9 Itis alleged that substantialrawmaterial supplies are also importedfromUkraine to feed into this processing and export market. As aresult exports of walnuts, whichhadnot occurred previously, started in 1993, the number of walnut processing and exporting enterprisesrose from 27 in 1998 to 58 in2000. The industryhit a crisis in2000 when India and China enteredthe market severely depressing prices. The number of processorshas since fallen to around 15, but are operating on a more stable basis. However, the apparent large number of operators inthe market i s misleading, as there are inreality 2 or 3 larger exporters, with the other companies acting as regional suppliers to these exporters. Moldova i s able to compete on the basis of the quality (size andprotein content) of its domestic supplies and continuing low cost of processing labour. There would appear to be scope for development ofthe domestic walnut sector, with the establishment of formal plantations, which could substantially increasethe yield per tree and the quality o f the nut.Inaddition there i s the potential for development of pharmaceutical products derivedfrom the shells, ofwhich there are currently large stocks. A group of investors from France are said to be interested ininvestment into this activity. There i s also a potential for the development o f higher value addedproducts through processing of shelled walnuts, and an investor inthe northofthe country is currently establishing afacility for glazed walnuts for export. The walnut sector hasbeen subjected to changing policies, with a 5 per cent tax, levied at the point o f initialpurchase by the trader, butnot recoupedby the exporter, and to an export ban imposedin 2000, butwhich applied only to individual exporters, retaining the market for the small number of corporate exporters. However, duringthe past year boththese policies have been annulled. 4.2 Apples Historically fresh appleswere a major Moldovanexports, with 99,000 MT exported to the CIS in 1994. For the supply-sidereasons set out above relatingto the fragmentation and decline of the orchards, coupledwith the impact of the Russia financial crisis o f 1998-1999, have seen export volumes fall to a mere 18,000MT in2002. The difficulties inaccessingthe Russian market inthe early 1990s, combined with the collapse of purchasing power inRussia, duringthe financial crisis o f 1998-99 ledto glut conditions on the domestic market, with prices falling to very low levels. In this situationalarge part ofthe crop went unpickedandlittlecare or attention was paidon orchard maintenance. Inthe meantime significant changes were occurring inthe CIS market as low cost apples available on a round-the-year basis, became available from countries outside the region providing a more uniformquality than the Moldovan supplies. The Institute of FruitinChisinaubelieves that only areversal of the landprivatisationprocess can leadto recovery of the fresh fruit export market, on the grounds that only larger suppliers, with control o f large orchards will have the capacity to establish standards and compete. The Institute has a monopoly position inthe market as the supplier of domestic seedlingsand exercises control over the permittedtypes of importation ofplantingmaterials, summarised inthe annual Register, which specifies the types which can, inprinciple be imported. It is estimated that of the 130,000 hectaresof apples and other fruit only 75,000 are inreasonable condition. The remainder requires substantial investment for replanting. Incontrast to the vineyards, where an active process of replanting i s now gathering momentum, ledby the recovery o f the wineries, there are no prospects for a widespread andrapid investment process inthe fruit sector. Amidst this gloom there are only smallrays ofhope ofabrighter future. One cold store dedicated to the export marketing o f improved quality apples hasrecently opened, and the initial indications are 10 that, with adequate attention to the characteristics increasingly demandedby the Russianmarket, includingregularity, size, appearanceand packaging, it i s possible to beginto recapture, at least in part, lost markets inthe CIS. 4.3 Fruit andVegetable Processing Ofthe total volume ofprocessedh i t and vegetable products, over 50% comprise oftinnedfruit, 30% tomatoes, and 20% tinnedvegetables. Surveys undertaken in 1999indicated that 112 enterprises were involved inthe processing o f h i t s and vegetables, the majority of which (about 100) comprised of small enterprises, focusing primarily on apple and tomato processing, that accounted for 80% o f total output for this industry. After independence,the 10 ago-processing companies engaged infruitjuice and concentrate production flourished, due inpart to continued government support and subsidies on electricity. However, with companies now facing hardbudget constraints after privatisation, a movement of energy prices to reflect the intemationalmarket costs, as well as a flooding on the intemational marketby lower cost producers (particularly China) had seen the number o f companies engagedin this activity declining tojust six (of these only two were operating at any scale). Capacityutilisation remained extremelylow -estimated to be inthe regionof 20 -25 percent utilisation. Weak exit mechanisms for bankrupt enterprises and poor entry incentives bothprevented necessaryenterprise liquidation andrestructuringand inhibited the entry ofnew enterprises. These weak exit mechanisms and poor entry incentives continued to perpetuateinefficiency, suppressedproducer prices (with producers often not being paid for product delivered) andmaintaineda narrow marketing channel. However, inthe past few years, the favourable intemational market prices for juice concentrate, and particularly applejuice concentrate, as well as movement away from barter trade, and modest improvements to corporate governance of these enterprises has seen improvementsto this situation. Some of the larger players, most notably "Alfa Nistru", and to a lesser extent, Orhei Vit, and Natur Vit, have beenable to make significant investment inimprovingprocessing line technology, and movingaway from very old, inefficient and poorly performingprocessing equipment o f Russian, Bulgarian, or Yugoslavian origin. There are also early signs of processing firms, ledby Alfa Nistru, moving into the financing of inputs, although on a very small scale ina few selected areas. The mainprocessedexport product remains applejuice concentrate at 65 and 70 Brix.Between 70 to 80 percent of apple juice concentrate producedi s exported, primarily to Westem European countries. A small proportion o f apple production i s processedinto "natural juice", which i s a light coloured, non-clarifiedjuice for CIS export markets, and inlimited supplies for the local market. The six largestprocessors,namely Orhei Vit, Alfa Nistru,Natur Vit, Fabricade Conserve din Consnita, Rozmiar, and Fabrica de Conserve dinFloresti, have over the past two years been involved indevelopingthe quality as well as a brand name for their products inthe key Russian market. However, quality remains low and there is a growing realisationamongst these larger players and the smaller new entrants into the sector, for the needto increase this to remain competitive and to stem the tide o f declining market shares inMoldova's traditional export markets withinthe CIS. Inthepasttwo years, the sector hasseenthe appearanceofasmallnumber offoreignfinanced ago-processors entering the market. These include the emergence of ajoint Moldovan-Australian enterprise (Aprocon-Group), as well as enterprises funded through local investment, such as 11 BasaVit JSC, and Limaghes Ltd.These players have focused on niche markets within the EU market, exploiting the system o fpreferencesthat are available to Moldovan exporters, as well as the traditional markets of Russia and the other CIS markets. 4.4 Sour Cherries Sour cherries are a traditional Moldovanproduct, which can be grownunder a wide range of climate conditions and for which the quality and flavour of the product i s widely recognised. Most commercially grown sour varieties - suchas Montmorency, the best known are cannedor frozen - for use as pie fillings or sauces, although there i s also a trend toward fresh sour cherries. For fruit processingthree different quality categoriespredominate inMoldova, which include: Juicier varieties, which are richincolour, sold predominantlyas fresh produce; varieties of large h i t size, with firmflesh, and higher sugar and acidcontent, whichare usedfor preservation; and varieties used inthe pastry-making. Although internationally sour cherries are picked mechanically, mucho f the crop inMoldova i s hand pickedthrough numerous smallholder farmers. The total area under production has seen increase, with area planted to the crop increasing to 5,400 hectaresduring 2001 from 2,900 hectares in 1997, whilst production increasing by five fold duringthe same period to over 14,000 tons, due to a large part through increasesinyield. While the bulk o f the exports are destined for the CIS market a small number of operators have started to find openings inWestem Europe. Key constraints faced by these operators are the lack o f cold chain facilities (the product has a very limitedshelf life of a few days) and the unavailability of suitable packingmaterials on the local market. A few operators export to Italy, but all packing materials (specialised barrels) are sent from Italy by road. However, this modest niche market product i s set to see increasesinexport volumes drivenby flavour preferences andprice competitiveness incomparison to key rivals inthe Italianmarket. 5. EstimatedIndustryCost Structure Dueto the highlyfragmentary nature ofthe fruit andvegetable industry, the number ofproducts produced and variations inquality, it i s extremely difficult to arrive at a set ofrepresentative products to demonstrate the effects of trade constraints upon the industry.However, for the purposes of the study, the authors have attempted to identify two key products that canprovide the basis for some order of magnitude assessments. Interms of fresh produce exports, midseasonappleshavebeen selected.Thisproductbest represents the current state o f the fresh h i t and vegetable market, namely it has seen significant declines inexport volumes, a concentration on the Russianand CIS markets, althoughthere are some signs of a revival inits fortunes. The figures indicatedinTable 1basedon consultations with exporters and producers duringthe course of the study, and the authors own observations, represent estimated costs. It i s interestingto note from the table that producer price comprises a small proportionof the final price (35 percent) whilst transport costs are high, due inpart to the small quantities exported, the lack o f refrigeratedcargo vehicles and the additional unofficial payments that are frequently requiredto cross the Ukrainianborder. Thus evenrelatively modest savings on transport costs are likely to have a significant impact on price competitiveness inthe Moscow market. 12 Table 1: Direct Cost Structure in Moldova to Produce Mid-Season Apples (Prices inUS Dollars) Inputsper kilo Percentage of total FOBPrice Producer Price (farm 0.3 35 % gate) Packaging and transport 0.15 18 % EstimatedExporter 0.10 12 % Margin Transport to Moscow 0.3 35 % (refrigerated cargo) C+FMoscow 0.85 The mainprocessed export productremains applejuice concentrate at 65 and 70 Brix.The commodity provides an interestingcomparison to the fresh product, as applejuice concentrate producedi s exportedprimarily to Western European countries, and an area which has seen modest investment inprocessing equipment, by some o f the larger ago-processing companies. Table 2 provides cost estimates basedon discussions withkey players inthe industry.However, it shouldbe notedthat this can fluctuate widely depending on the use of equipment and techniques in production, and the accuracy inrecording and monitoring o fproductionvariables. The cost structure still reflectsrelatively highenergy costs inpart due to poor efficiency inrefrigerationand low throughput, whilst labour costs are low reflecting efficiency gains made over the past few years inupdatingprocessing andpackaging lines. Table 2: Direct Cost Structure in Moldova to Produce 70 Brix Apple Juice Concentrate (Prices in U S Dollars) Inputsper ton Percentage of total Price Raw Material Purchase 408 60 % Labour 41 6 % EnergyCosts 82 12 % Maintenance Costs 47 7 % Other Operational Expenditure 102 15 % Total Cost ex-Factory 680 6. Constraints to Trade The following sections will highlightthe key constraints indicated indiscussions with producers, and ago-processors within the fruit and vegetable industryinMoldova. Table 3 attempts to summarise some of the costs of these constraints, where it has beenpossible to ascertain from stakeholders, of the mainconstraints to trade. However, given the fragmentary and diverse nature of the sector, itwas notpossible to develop a comprehensive estimationof constraints. It is important to note that the figures provide an order of magnitude assessment of these costs. 13 Table 3: Summary of EstimatedCoststo Fruit andVegetable Producers/ Processorsofsome of the Constraintsto Trade Constraint Cost to ProducersI Cost to Processors Exporter as % of as % of FOB price C+F price Delay inthe payment of VAT 2 percent 1- 2 percent Import duties for spare parts 1- 2 percent Complying with documentary requirements for export 2 percent Delays incustoms procedures at border crossings 5 percent 6.1 Taxation Historically, agriculture's tax contributionshare i s considerably lower than agriculture's share of GDP, whichhas ledto a general skepticism from Government towards exporters. This suspicion remains, and hence there i s a perceived need for tighter administrative controls to ensure that both sectors provide arepresentative proportion of the total tax take. It is within thisbackground that the Government hasplaced various taxes onkey inputsinto the productionprocess, which shouldintheory be refundedifthe produce i s exported, giventhe fact that the Government uses the destination principle for indirect taxation. The Government currently places 5 percent VAT on domestically producedh i t and vegetable products. The mainissue causing concernto exporters relates to the difficulties, time and effort requiredto obtain VAT refunds inrelation to export consignments. Itis reported that the VAT authorities apply very laborious and time-consuming procedures which typically involve the cross-chechng of all VAT invoices attachedto VAT refund claims against the original supplier's VAT account. The procedure often takes months, and only occurs ifthere i s constant follow-up from the exporter. The smaller exporters do not have either the staffnor the resources to undertake this follow-up and simply accept that they will not obtain their refimds. It i s estimated that this can cost upto 2 percent of FOBprice for smaller fresh h i t exporters, whilst it canbebetween1-2percent for agro- processors. Withthe few viable ago-processors and smaller learner enterprises inthe process o fupdating equipment, primarily from Western Europe, many have citedthe imposition of import duties (often intheregionof20percent) on spareparts*for these equipmentas amajor constraint to the necessaryprocess of technology improvements. Typically ago-processors are not eligible for even partial remission o f duty on the export component o f their production. The cost o f this constraint to ago-processors will naturally depend on the type of equipmentpurchased, the country of origin of the equipment, and the production capacity o f the plant. However, taking into account low capacity utilisation, even amongst the more efficient processors, it i s likely that this constraint can add inthe region of 1 2 percent of the total value of the product. - 6.2 Transport Moldova i s a landlockedcountry, surrounded by its borders with Ukraine andRomania. Access to andthrough these countries is therefore particularly important, as with very few exceptions, Moldova's fresh h i t and vegetables must, for cost reasons, go by land. Unfortunately exporters The most common parts of equipment that need replacement are seals, gaskets, switches, and on rare occasions plate exchangers 14 face formidable constraints inbothcountries, constraints which appear to be as closely linked to political relations between the Moldovaand its neighbours as the formalities of trade representedin international agreements. A glance at the recordedtrade statistics for freshproduce into Ukraine shows that insome recent years there has beenno export of fresh fruit and vegetables, reflectingperiods when the border has been effectively closed to such traffic. There are likelyto have been informal exports inthese years achieved by evading or bribingcustoms officials, but these are not recorded inthe trade statistics. Keyproblems identifiedbytraders who do infact export to Ukraine are (i) imposition of high the minimumvalues indeterminingtariffs to beapplied at theborder, (ii) frequent delays inclearing the border which leadto product quality deterioration, and (iii) multiplicityofrules and the effective taxes appliedwithin Ukraine at the oblast level. As a result of these difficulties the actual volume of exports to Ukraine is small and it is not regarded as an attractive market for new entry by the trade. Rather similar considerations apply to the Romanian border, with traders facing a large number of practical constraints to trade. Traders interviewedindicatedthat it was generally necessaryto engage intwo way trade (ie importing and exporting simultaneously) to obtain the cooperation o f the market officials inRomania, and to reduce the unit transport costs, as freight options were limited and there is not a competitive market for one-way freight consignments. By contrast the small number o f companies exporting intransit through Ukraine andRomania, especially to Western Europe, reportedno specific problems inobtaining the necessarytransit documentation, much o f which was organised by the transporter. 6.3 BureaucraticRequirements Exporters of fresh fruit and vegetables face numerous bureaucratic obstacles, and these are particularly burdensome inthis sector as the trade is largely inthe hand of small operators and the average consignment size and value is small. The documentation requirements to obtain an export license are formidable: W Purchasesales contract W Quality certificate issuedby the producer (specific crop, harvest date etc) W State Registrationcertificate W ForeignExchange Registration declaration W Transit and Destination Permit (from motor transport agency) W Compliance Carnet (Cargo and Passenger Transport Authority) W Manager's Certificate (CIPTI) W Customs Declaration (Chamber o f Commerce and Industry) W Goods of Origin certificate Compliance certificate (Standardisation Centre, Moldovan StandardsDepartment) Hygiene Certificate Phyto-sanitary certificate W License to Practise.(eg hit, berry crops, grapevine, orchard) W Organic certificate (where applicable) Inpracticethere issubstantialvariation inthenumber ofthesedocuments whicharerequired, dependingonthe product and the destination market, but there can beno doubt that the burdenin terms of time and the riskof loss o f quality of produce duringthe obtaining o fnecessary 15 documentationconstitute very real obstacles for Moldova's fresh produce exporters. Freshfruit and vegetable exporters interviewedfor this study estimate the cost of these requirementsto be inthe region o f 2 percent of the total value of the consignment. Inaddition to the volume of documentary requirements, the trade also complain of the frequent changes inthe requirements, often introduced by the Moldovanauthorities without any priornotice and the failure of Government to provide proper publication o f changes indocumentary requirements. It i s interesting to note some other CIS countries, such as Azerbaijan require far fewer documents to export horticulturalproductsg. At the point of custom clearancethere is a further element of arbitrariness inthe application ofthe rules and most consignments require illegal payments inorder to pass through the frontiers. Clearly the complexity ofthe rules andthe documentation requirementscreate a framework inwhich corrupt officials at the border can holdup consignments for profit. Severalcases were cited o f the imposition of bans on de facto export of goods appliedby Customs for which no legalprovision appearedto exist (eg sunflower seeds). Giventhe perishable nature ofmost fresh fruit and vegetable products the risks of loss of complete consignments through quality deterioration during clearance and documentation are very substantial and this constitutes a major barrier to entry to trade, especially for the smaller operators. Delays at the border are likely to reduce shelf life for fresh products by between 1-2days" depending on the product and the lengthof delay. This reduction inquality will leadto a loss inthe final price of the product receivedby exporters, however, it i s dependent on the method of transport (i.e. through refrigeratedtruck), the product itself, the original quality requirements, and the time inthe season when the product is exported. Inthe case of mid-season apples this is likely to result inat least a 5 percent reduction inprice. Established operators who are exporting consignments on a more regular basis have typically established working relationships with the customs department to obviate these difficulties, though the actual cost of these arrangements is not known or standard. 6.4 Quality and Standards Moldovanfruit and vegetable exporters are faced with a number of requirements interms of standardswhen exporting to the key CIS and EUmarkets. The following table below highlightsthe key standards,bothregulatory and industrystandards andissues that producers face inorder to meet the requirements invarious markets. Table 4: Summary of Quality StandardsRegimesand Issues CIS/ RussianMarket EUMarket QualityStandardsRegimeto Export Variety of GOST and GOSTR Directive2000/42/EC- intoMarkets Standards for all fruit andvegetable harmonisationof Minimum productsincluding: I ResidueLevels(MRLs) R51809FreshCabbage 8 Directives91/414 and90/642 specifications on the maximumuseof R51810Freshtomato specifications pesticides IndustryStandards/ Consumer EUREPGAPrequirements Preferences BRCFoodTechnical Standards LabelingRequirements 8 Frequentlychangesto labeling CouncilDirective79/112/EECa requirementsfor the Russian singlelegislativeframework for market(2 changesoccurred labelingfoodstuffs during2002) The documents required include a certificate of origin, certificate of quality, a contract, bank guarantee and the company's articles of association. loHighlighted through discussion with small scale fresh fruit exporters. 16 Quality StandardsRegime Inprinciplethe EUmarketisimposingrapidly increasingstandardsfor food safety andquality control, inparticular the requirements on MRLs.Currently Moldovan exporters inthe sector do not complain of difficulty inmeeting export formal export market quality standards. However, the main reason for this i s the very limitedpenetration of the markets where MRL standards would pose a problem, the limited use ofpesticides by domestic smallholder producers, and the fact that the few operators exporting into these markets have beenoperating for some years and are able to comply. Since the majority o f h i t and vegetable exports inthe fresh and processedform are destined for the Russian and CIS markets, most Moldovan exporters are familiar with the various product specific Standards issued by the Russian State Committee on Standards (GOST) which are mandatory and govern the export o f h i t and vegetable products to these markets. With Rus Standard recently opening an office inChisinau, most exporters have reported that there was no significant difficulty inobtainingthe necessaryGOST standardquality certificates. The main area where exporters face a real issuerelates to the phyto-sanitary certificate on fresh export produce, as delays inthe issue of the certificate, which it is understood i s due partly to a lack o f staff at the inspectorate offices inthe regional centres. It was also reported by some exporters that there i s often need to pay unofficialfees to obtain this certificate. Thus the delays causedin obtainingthis certificateraise realrisks for exportationof these perishable products. Industry Standards EUREGAPrequirementsare increasinglybeingrequestedby importers and retailers inthe European Union for fresh h i t and vegetable imports. EUREGAP is basedon the principals o frisk prevention, risk analysis (among others byusingprinciples of HACCP), sustainable agriculture by means of Integrated PestManagement (PM)and Integrated Crop Management (ICM), using existingtechnologies for the continuous improvement of farming systems. To obtain the certificate enterprises have to meet the requirements of the EUREPGAP Control Points and Compliance Criteria, and needto obtain certification from an accredited firm. Producers are also requiredto undertake analysis o f their maincrop at the moment of harvest, soil analysis, and possibly analysis o f irrigation andor washing water. The accreditation processrequires internationallyrecognised inspectors to visit producers, which i s extremely expensive, giventhe limitedamount ofproduce destined for the export market. It is estimated that this processwould cost about US$2,500 to undertake for eachproducer, coupled with the current low production levels, would make accreditation beyond the reach of most producers. InadditiontoEUREGAP,therehasbeenrecognition,particularlyamongstUKsupermarkets,and drivenby growing consumer concerns, for the needto develop a common set o f food safety standards to govern inspections systems, and productsat the retail level. Thus the BritishRetail Consortium has developed FoodTechnical Standards, to which the majority o f Britishsupermarkets are beingrequiredto comply to and which are subsequently beingapplied to overseas suppliers. These standards are now beingadopted by selected supermarketswithinthe EC, particularly in Switzerland, as well as companies involved inthe Global FoodSafety Initiative (Jaffee, May 2003). This newindustrystandardwill place an additional burdenfor Moldovanexporters to overcome if they areto make any significant penetrationinto the ECmarket. 17 Labelling Requirements The EC labellingrequirements have remained relatively stable over the past three years with Council Directive 79/112/EEC on the labelling presentation and advertising o f foodstuffs explicitly designed to constitute a single legislative framework for the compulsory rules on the labelling o f LabellingRequirementsFor Fresh foodstuffs. None o f the processors or fresh fruit and FruitRequestedby Moscow Retailers vegetable exporters interviewed as part o f the study identified this as an issue. Name ofproduct, variety and type Weight Despite formal standards inthe Russian/ CIS Quality Category markets, there i s frequently need to pay attention Year o fProduction specific packaging requirements demanded by Numberofh i t sperrow or layer retailers and wholesalers inthe key markets, in Gauge particular the Russian market. Labelling and GOST Standard packagingrequirements have seen rapid ProducerName andAddress improvement over the past three years, and it has f ' m l n t r x r nfnl;nin been reuortedthat some retailers and wholesalers have rejectedMoldovanproduce, due to poor quality packaging, despite the produce meeting general GOST quality standards. The adjacent text box highlightssome o f the new requirements required by retailers inthe Moscow fruit market. There i s often difficulty inobtaining the good quality packagingmaterial within Moldova, and several exporters interviewed as part o f the study, highlighted the need to import packagingmaterial from countries within the region, that are liable for import duties. 6.5 Market Access Inthe h i tandvegetable sectors, Moldovanproducers are ableto enter the EuropeanUnionmarket on preferentialaccess for a limited number o f products. The following table highlightsthe current preferential access agreements that Moldova has been able to negotiate with the EU. Table 5: Preferential Access for Moldovan Fruitand Vegetable Products into the EUMarket Product Tariff GSP GSP with Labour 2002 2005 2002 2005 2002 2005 Walnuts 4 4 0 0 0 0 Walnuts - shelled 5.1 5.1 1.6 1.6 0 0 Fruits-other 9 9 3.1 3.1 0 0 Apricots 5.6 5.6 2.1 2.1 0 0 Processed Prunes 9.6 9.6 6.1 6.1 1.1 1.1 Apples 3.2 3.2 0 0 0 0 DriedPears 6.4 6.4 2.9 2.9 0 0 DriedFruit/ Nut 2.4 2.4 0 0 0 0 mixtures Source: TARTCDatabase, 2003 Moldovan producers have been able to obtain some access to the EuropeanUnionunder the GSP (Generalised System o f Preference). As can be seen inthe table this can lead to a significant reduction inexisting tariffs. Inaddition to this, under the EC directive 2501 dated lo*December 2001, Moldova is the only country inthe CIS that has been able to receive additional benefits due to its adherence to E O labour conventions. The convention requires a country to effectively 18 demonstrate its adherence and protection of basic labour rights such as the freedom of association, the abolition of childlabour as well as the use of enforced labour, etc. Withthe introductionofthis benefit, most products that are eligible for preferentialaccess, and inparticular significant export products such as walnut, apples, and dried fruits are able to enter the EUwithout tariffs. Interms ofproducers' abilitytoaccessthesetariffsandenterthemarketondutyfreestatusfor these limitednumber of products, the followingtable indicates the value of goods that were able to enter the market on concessional terms and what inpractice has beenclaimed by Moldovan exporters. Table 6: Preferential Access Claimed for SelectedProducts (inThousands of Euro) Product Value of Moldovan PreferentialAccess PreferentialAccess Imports in EU Claimed as YOof Total Market UnshelledWalnuts 144.991 83.694 58 % Shelled Walnuts 6,673.360 14,040.775 84 % Apricots 4.739 4.739 100% ProcessedPrunes 33.729 24.045 71 % Apples 27.076 17.787 66 % Dried Fruit / Nut 140.111 138.367 98 % Mixtures Source: TAREDatabase, 2003 Itis clear that the trade inshelledwalnuts, that hasdeveloped over the past five years, hasinpart beendrivenby the preferential access that Moldovan products have inthe European market. The differencebetween the actual value o fproduct imported and preferences claimed, particularly for unshelled walnuts can be attributedto the issues relating to rules of origin, since significant flows o f imported unshelledwalnuts from Western Europe enter the Moldovanmarket to exploit the low cost hand shelling, and are then subsequently re-exported to France and Germany. Interms ofotherproductsthat havebeenable to tap into EUpreferentialagreements,driedfruit remains the only other significant crop. This low level o f penetration, despite favourable access, in part reflects supply-side reasons set out above relating to the fragmentationand decline of the orchards and the unsuitability of the former agro-enterprises as a platformfor rapid investment. Conversely Moldovanproducers on the domestic market have protection through customs tariffs for fresh vegetable imports, which is set by the State Budget Law. Currently a 15 percent custom dutyis appliedon importedfresh vegetables, with the exceptionof importedpea seeds where a 5 percent customs duty i s applied. However, vegetable and fresh fruit imports from the CIS and Romania are not subject to customs tariffs, due to bilateral free trade agreementswith member governments. Moldovan producers continue to benefit intheory through preferential access to the CIS and Romanianmarkets, however, the inconsistent application o f some o f these regimes, have increased the cost of exporting and have impacted negatively on exports, particularly to the Romanian market. 19 6.6 FinanceandCredit Access to finance remains one of the largest constraints to the development of the sector, bothfor the larger players inthe sector, as well as smallholder producers. For the larger players, inthe absence o f any significant external finance, working capitalrequirements and expansion o f the firms operations often needto be obtained through local capital markets. Where companies have been able to obtain Foreign Direct Investment these have beenrelatively scarce and been on a modest scale. With the absence of foreign banks operating inMoldova, most operators can only access the local bankingnetwork, which i s governed by a significant number of Central Bank restrictionson transactions. A few canneries that have embarked on pre-financing growers, but face considerable cash flow implications since exporters often receive the revenue for their exports after shipments arrive at their destination, without the benefit of quick settlement. Inaddition, these canneriesneed to frequently re-finance operations becauseof the short-term availability of funds. Usually credit i s available on a six monthly basis, which needsto berolledover through the drawing o f loans from other institutions, to ensurefunds are available for working capital throughout the year. For many producers however, accessingbank loansremains a distant opportunity, with banks often reluctantto provide credit to producers, despite donor support to encouragethis process, and when they are able to obtain loans, these are often at highnominalrates of interest which are frequently over 20 percent. Thus increasing access to finance on more favourable terms i s likely to leadto a significant impact on output and improvements inquality, whichare neededfor Moldovaprotect market share intraditional export markets and enable them to penetrate new markets. 6.7 MarketInfrastructure The lack of market infrastructure constitutes a major impedimentto the recoveryo fMoldova's domestic and export markets for fresh produce. There are two main aspectsto this. Firstthe absence of any developed wholesale marketing chain and terminal market inChisinau, hampers regularity and flexibility of supply for export markets. Normally the export market would at least inpart, feed off the organised channels for produce to enter the main domestic market. Operators inthe Moldova market contrast the lack of investment inwholesale marketingintheir country compared to what has been undertaken inthe countries of Eastern Europe such as Polandand Slovakia, and see this as an impedimentto entry to the export trade by operators inthe domestic market. The absence can inpart be attributedto the low volumes of h i t and vegetable crops available for export, and the fragmented and ad hoc approach adopted by many of the smaller exporters inthese fresh produce. Secondly, there i s a general lack of cold store chains and facilities, and given the small scale of most of the existing operators it i s likely that autonomous development of such facilities by the private sector will only occur slowly and inresponse to specific opportunities. 6.8 InstitutionalOrganisationof the Trade Incontrasttoother sectorsoftheMoldovaneconomy, thereisamarkeddearthofrepresentative institutions for exporters o f fresh fruit and vegetables. The contrast with the wine industry is, for example, quite sharp. Reasonscited include the small scale andnumber o f operators inthe trade, their meagre financial means, andthe tendency to regardeach other as competitors. As a result there i s no association of fresh produce exporters, and this i s reflectedina fragmentationand inability to undertake advocacy on behalf o f the sector ingettingremedial actions from government 20 on the important bureaucratic obstaclesto trade. There are, however a number of marketing cooperative bodies, typically consistingof groups of farmers, often from one region, who are cooperating to some degree to gain access to export markets. Fromthe point of view o f the Government, it would appear that the fresh produce export sector i s not regardedas a priority and there are few or no official programmes of support. The sector i s regardedby MEPO as havingpoor prospects inthe short to medium term and this i s reflectedin resource allocation for promotion activities. 6.9 Sovereign Riskand InwardInvestment It i s a notable feature of the current Moldovan fruit and vegetable export market that a majority of the enterprises whichare managing to make some progress inpenetrating export markets with higher quality products have benefitedfrom an inwardinvestmentprocess, or at the very least, from strong specific and personal contacts with companiesbasedinWestern Europe. This i s true innuts, fi-uitjuice and sour cherries. Muchofthe investmentandknowhow to effectively accessthese markets can only realistically be achieved inthe short term with inflows of FDI.The problem i s that there have beenvery few o f these initiatives and they have ledto investment only on a modest scale. It i s important that Moldovamakes a correct assessmentof the reasons for this disappointing flow of investment into a sector inwhich the country should by most accounts, have comparative advantage incertain sub-sectors. A part of the explanation lies, no doubt, inthe fact that Moldova i s not apotential EUaccession country, therefore ranks poorly with neighbouringRomania as a potential destination for inwardinvestment. However, it i s clear that other aspectsof the investment environment, which are within the control of the Moldovan government also play a very important role, and these can be summarised as issues of sovereign risk.The poor governance framework in the economy, the frequent changes inthe regulatory environment andthe lack of aproperly functioning court system to provide commercial guaranteesof contract enforcement have all be citedby the respondents inthe private sector duringthis study as factors explaining the low levels of interest and investment. Inthe nut and vegetable sector this i s particularly unfortunate, as the sector clearly needs a greatly increased inflow of external private sector expertise ifit i s to upgrade its products to the point where it can enter westernmarkets. 6.10 Export Market Information and FDIPromotion While Moldovan fresh fruit and vegetable traders have areasonable level o f knowledge about the Russian and CIS markets, the same cannot be said for European markets. Potential exporters have poor knowledge of westem markets and the potential for profitable investment for export, or even of how to set about becomingbetter informed. It is strikinghow many o f the few existing enterpriseswhich are currently exportingon a small scale to western Europe started from chance contacts stemming from visits by European investors seeking potentialpartners, as opposed to resultingfrom active searchby Moldovaninvestors. Inother words the process inthis sector has beenpassiverather than pro-active, waiting for chance encounters with visiting investors. There would appear to be some scope for increasing investment through projects aimed at facilitating Moldovan enterprises to undertake partner-search activities inEurope (and elsewhere), but this would only make sense inthe context o f a marked improvement inthe overall environment for inwardinvestment which remains strongly hostile as outlined above. 21 6.11 Market Information RegionalMarkets - Bycontrast withthe poor informationavailable to tradersandexporters onmarkets outside the region, there i s relatively good informationavailability on fresh produce markets inadjacent and nearby regional markets. The organisation CAMIB, based inChisinau forms part o f anetwork of organisations which are providing marketinginformationon a commercialbasis through a web-site. Thisprovides reasonablyupto dateinformation onproduce prices and availability ina selection of capital andregional markets inMoldova and other countries on the region, The fact that CAMIB, which originated as a donor-funded project establishedby TACIS, hasmanagedto survive on a commercial basis for several years, suggeststhat there i s a market for market information and that Moldovanexporters are usingthis mechanismto keep informed on developments inadjacent markets. 6.12 The Needfor New Investment inPlantandEquipment The agro-industrialoperations which were privatisedinthe latter 1990sall suffered fromhaving antiquated and energy-inefficientprocessing equipment, incapable of production of products to the standards requiredby even the CIS market, let alone the Western European market. The majority o f these enterprises have now ceasedoperations underbankruptcy. Of the small number which have survived, new investment inmachineryis seen as aprerequisite for progress. However, a general observation i s that, given the problems whichthe former state enterprises face, most investors are now tendingtowards new green-field investment rather than the renovation of older facilities. The implication i s that measuresto ensure access to buildingland, stability inthe policy arena and simplification of the bureaucratic requirements for undertaking new investments may play an important role inrecovery of the sector. 7. Conclusion Itis be clear from the precedingsectionsthat the h i t andvegetable export sector, which usedto make a significant contribution to Moldova's economy has undergone a profound collapse which resulted from major structural exchanges, including the fragmentation of land, the collapse of most irrigation schemes, and the rapidchange inthe demand of its traditional destination markets. These sectorshave to date attracted very little foreign investment interest, bothbecauseof the difficulties faced at a sectoral level andbecause of the wider hostile environment for inward investment. The existing enterprises are poorly equippedto develop new non-traditional markets and have little experience of the EU. Faced with this situation it would be unrealistic to expect a rapid recovery of the sector, even though a number of small existingprivate sector initiative demonstrate the potential for profitable investment ina wide range o f fresh and partly processedproducts. This study hasbeenundertaken intandem with a study o f the wine sector. A comparison between the fruit and vegetable sector and the wine sector interms of export recovery throws up some interestingand important differences: The wine sector, having finally largely completed the privatisationof wineries, hasbeen able to attract significant investment for modernisation, mostly from Russian investors. This is due to the fact that the industryhas aproduct which, with appropriate investment can bereadily marketed into the Russian market on aprofitable basis, usingthe existingproduction locations, 22 by contrast the fruit and vegetable sector offersno comparable attractive areas for investment arising directly out of the privatisation process. Most investment i s ingreen-field locations and based on substantial product innovationcompared to former export products; The fruit and vegetable sector is proving muchmore vulnerable to the adverse effects of the demanding bureaucratic requirements for export. This i s largely a function o f size. For the wineries the bureaucratic obstaclesto export trade are anuisance, but given the larger sizes of boththe companies and of their average consignments, the wineries are able to overcome the bureaucratic obstacles; Similarly inissues relatingto taxation, while the wineries are able to recover VAT and import duties on imports throughhiringdedicated staffto pursuerefunds, this is not worthwhile for the smaller fruit and vegetable exporters, who for the mostpart do not even attempt to recover the tax and duty content of their exports; While the collapse of the soviet system inMoldova's agriculture left the marketing systems and chains for wine products largely unaffected, this i s not true for fruit and vegetables, for which wholly newnetworks need to be created. While this has happenedto a modest degreethrough pureprivate sector initiative, there hasbeennopublic or donor investment to acceleratethe process, such as has occurred inother countries of EastemEurope. It i s unlikely that the fruit and vegetable export sector will develop rapidly inthe absence of accelerated development o f the domestic market, as regular supplies on the domestic market shouldprovide the launch-pad for development of export markets. The wine industryhas managed to overcome the obstaclesto trade with Moldova's immediate neighbours, which never constituted important destination markets, though transit through Ukraine was and remains important. By contrast the neighbouring states should form an important market for export o f fi-esh fruit and vegetables. However, the sector has been strongly adversely affected by the de facto barriers to trade, the frequentchanges inthe documentary requirements by Ukraine and the tendency for oblast and local level authorities inUkraine to impose barriers which are not inline with the internationally agreedprotocols. Moldova has a strong underlyingcomparative advantage as aproducer of fresh and semi-processed fruits and vegetables for export. This potential is not being achieved at present and the prospects underexistingconditions are that sectorrecovery andexport growth will only occur slowly. By comparison with the wine sector, which i s recognised as o f key national importance by the authorities, the fruit and vegetable sector has low status andreceives little, ifany, support. By virtue of the small size o fthe operators inthe sector, fruit and vegetables exports are particularly vulnerable to constraints stemming from excessive bureaucracy and an adverse trade facilitation environment. Duringthe course ofthe study, itis apparent that there are several areas where GOMcouldtake a more positive role inpromoting and supportingthe fruit and vegetables export sector. These include: Reduction of bureaucracy:key aims should be a sharpreductioninthe total number of authorities and certificates required,the abolition of the needto produce original documents by allowing the use ofphotocopies, improved discipline at customs points and the provision of adequatenotice for changes inregulations, accompanied by proper publication of regulatory and documentation changes 23 .Address the underlying obstacles to FDI: addressing this area requires fundamental changes which are beyond the scope o f this sector paper, which affect the country's poor current .reputationas a host to foreign direct investment. Examine thepotentialfor public investmentin market network infrastructure: the Government should examine the scope for development o f modem facilities as a public-private partnership, with suitable funding support from external donor organisations. Export Facilitation: Inthe context o f a wider change inthe investment environment for the sector it would become possible for MEPO to place a higher priority on attracting investment for the sector and to provide enhanced facilities for partner search and business trips to potential .market. Set target of tax-free export: the key issues which need to be addressed are the adjustments to the VAT system to achieve effective zero VAT content o f exports. This could be achieved either through movingtowards exemption o fVAT on agriculturalprimary outputs or by an overhaul o f the VAT refund system to ensure rapid processing with a minimumo f bureaucratic obstacles (such as the checking o f all original VAT invoices against supplier firm VAT returns). Progress .could also be made to ensure that spare parts and machinery imports o f exporters are effectively free o f import duties. Resolveoutstandingpolitical obstacles to trade with neighbouring countries Promote organisational developmentof exporters 24 i s v1 4 8 Y V Y 'EW !3Bfi2 .I *8 .5ed .I G V .3 E Y 0) .E cd W E Y rA -8c b W E3 .-.1 ed a5 0 N Q\ 0 W 3 0 3 N m 0 N 00 zm d 0 0 N d N 0 b 0 2 0 N m I I I W m a 0 m z N m m d d 0 \o o w 0 NNd2 00 00 0 d o m a N W N b a i-- m m m o z m 3 3 I 25m* mi 0 a, 83 23 Y mi a, .-( 358 u N 3 3 N 3 3 3 0 0 N 0 0 0 Pa d d m m 2 M m 2 MOLDOVATRADE DIAGNOSTICSTUDY TEXTILES AND APPAREL CASE STUDY November,2003 HeikkiMattila Contents Acknowledgements 1. Introduction.................................................................................................................. 1 2. Trends inTrade inthe Textile and Apparel Sector .................................................... 10 3. Barriers to Trade and the Development of Textile and Apparel Sector..................... 13 3.1 VAT...................................................................................................................... 3.2 Customs................................................................................................................ 14 15 3.4 Pre-Shipment Inspections..................................................................................... 3.3 Terms of Payment and Repatriationof Export Eamings ..................................... 15 16 3.5 LocalFinancing.................................................................................................... 3.6 Transporting......................................................................................................... 16 16 17 3.8 FDIsand Competitiveness inthe Export Market................................................. 3.7 Bureaucracy.......................................................................................................... 18 4. Conclusions and Recommendations........................................................................... 19 References......................................................................................................................... 20 Annex: Trade Statistics.................................................................................................... 23 ACKNOWLEDGEMENTS This report is basedon case studies of 15 Moldovantextile andapparel companies. The companies were interviewed duringthe study missionto Moldova duringMarch 10-21,2003. Further information regardingthe sector was receivedfromMEPO (Moldovan Export Promotion Organization) and consulting firm ARIA. All the case study firms were most co-operative and all information, includingfinancial data, was received. The management of these firms highlighted all their trading problems indetail and their contribution to this study i s highly appreciated. Mrs.MariaGheorghita worked as the localconsultant to helpwiththe textile andapparel sector. Through herpersonal contacts and experience she was able to gather valuable information about the sector, which proved very useful informing the overall picture. Mr.Veaceslav SerbetofMEPOassistedinarrangingthe visits to various companies. Through hisexperience of exportpromotionprojectswiththe textile andapparel firms he was also able to highlight severalkey trading problemsthe industryhas. The localWorld Bank Mission took care ofpractical arrangements. MsViorica Strahwas responsible for visit schedules, organized transports and gathered further information duringthe visit. Her organizing skills made the missiona complete success. Mr.LawrenceBouton, the headofthe studymissionto Moldova, participatedinseveral discussions and case study visits. His views and advice were highly appreciated and helped in focusing on the key issues o f the case study. The whole study team present inMoldova during the mission had a chance to share their views and findings daily, which proved very valuable in understanding the overall problems of trade inMoldova. 1. Introduction The textile and apparel industryi s one of the major export industriesinMoldova. Mostly the industryconsists ofgarment manufacturers. Practicallyno textile materials, such as yams or fabrics are producedinMoldova proper. There are textile mills inTransNistra, which, however, were not included inthe study. There are several carpet factories that carry out spinningand weaving o f carpets for their own use. As a result, almost all yams and fabrics for the local garment industryare imported. Textile industryi s generally understood to cover fiber production, spinning,weaving, dyeingand fabric finishing. Chemical chips, fibers or yams are the raw materials and the companies sell products like fibers, yams, fabrics, non-wovens or home textiles. The apparel industrybuys yams, inthe case of a knitwear manufacturer, or fabrics and sells readymade garments. Textiles and apparel are usually separate parts of the value chain, with the exception o f knitwear, where often, butnot always, the same company knits the material and produces the readymade garments as well. The focus of this study i s on readymade garments as no textiles are producedinMoldova. According to the Moldova Statistics Yearbook 2002 the share of textiles and apparel was 3.7 % of total industrial output. Most of the textile products are exported. The share of textile products intotal exports grew steadily reaching 18.5% in2001, butdropped in2002(10.2%), andthe export growth inthe apparel sector slowed down. It should, however, be recognized that the value added inapparel exports i s low as most exports are tolling services. Customers sendtheir fabrics for processing and the addedvalue i s only the workmanship from the Moldovan manufacturers. Nevertheless, apparel exports have grown rapidly, while domestic consumption of apparel products i s weak consisting mostly o f very low priced goods. Butdue to the low GDP level of the country, consumption of apparel products was 7 % o f total consumption in2001. Table 1.1 Share of textile and apparel industry in the Moldovan economy 1996 1997 1998 1999 2000 2001 2002 Share intotal industrial output 4.4% 3.5% 3.0% 3.3% 4.0% 3.9% 3.7% Share intotal exports 6.2% 6.7% 9.8% 14.3% 17.7% 18.5% 10.2% Share intotal industrial employment 7.0% 7.0% 9.2% 8.5% 8.5% 8.7% 9.5% Source: Moldova Statistics Yearbook 2001and2002 The total industrial employment has gradually decreasedinMoldova, from 143 000 in 1996to 115 000 in2001. The textile and apparel sector currently employs more than 8000people, which i s 9.5 % of total industrial employment. The apparel sector i s no doubt an important part of the Moldovaneconomy. Itprovides industrialjobs throughout the country and the number of people employed i s growing. Many of the apparel factories are located insmall towns and even rural areas. They may often be the only industrialoperationinthat particular community. Most o f the textile and apparel companies originate from the Soviet Union era. At the moment nearly all of themare privatized. Relatively few new companies have been established since the transition to the market economy. Moldova was never a major center for textile and garment industry.There were small and mediumsize garment factories like all over the Soviet Union, and only a couple of weaving mills, which are now inTransNistra. Butnone of the large mills employing tens of thousands o f people were set up inMoldova, as the region was regarded an agricultural center for the nation. 1 1 Box 1.1 Appareltrade terminology I CM The manufacturer sells cutting and manufacturingservices only andtemporary imports all materials, which are owned by the customer. CMT The same as C M except the manufacturer buys some o f the accessories like sewing thread, buttons, etc. FOB (FullPrice,FullPackage) The manufacturer buys all materials according to the customer's specifications and at delivery invoices the full value o fthe product. PrivateLabel The manufacturer designscollections independently orjointly with the customer. The full-value products are deliveredunder customer's trademark. OPT Outward Processing Traffic is a special EUregulationgranting preferential customs treatment to EU companies, which outsource apparel production on C W C M T terms providing that materials o f EUorigin are used. ImDort dutv is Daid onlv on the value added at re-entrv to EU. Underthe centrallyplannedeconomy the garment factories hadannual productionquotas to fulfill. Materials, suchas yams and fabrics, were assignedto themandthey were received automatically according to the Plan. Production orders were also given, usually from Moscow, as marketing and sales were taken care of by other State organizations. The factories didnot need any material sourcing know-how or marketing skills. Little has changed from those days. Most of the managementoriginates from the Soviet period. The factories keep to their production function as before by beingC M or CMT producers. The only change i s that it i s the foreign customers that today provide production orders and materials. This,however, is normal withall emergingeconomies. All apparel firms start their trade at the lowest level inthe value chain, and it will take decades to reachthe higher levels. Anyhow, CWCMT trade (sometimes also referred to as OPT) i s beneficial as it contributes to the economy of the country through creating industrialjobs and foreign currency earnings. Table 1.2 Employmentand exports of the Moldovantextileand apparelsector 1996 1997 1998 1999 2000 2001 2002 People employed (1000)" 8.7 7.6 9.1 9.7 9.6 9.2 8.2 Export value ($ US million) 33.6 40.9 50.6 57.2 75.4 92.3 107.0 Export Growth 21.7% 23.7% 13.0% 31.8% 22.4% 15.9% Source: Ministry of Industryand MoldovaStatistics Yearbook 2001and2002 After privatizationthe Moldovan apparel firms had a relatively highcapacity incomparison to sales, as the former Soviet market had collapsed and there were only a few contacts to the Western world. Theoretically the companies employed close to 9 000 people, but most of the people were laidoff. In 1997a restructuringprocess was started andthe search for export clients was intensified. Exports started to grow. Several foreign investments were made at the same "Theemploymentstatisticsaresomewhatmisleading. Inmidandlate90samajorpartofpeopleemployedbytheapparelindustry were laid off due to lack of sales, althoughthey still officially were inpayroll. Once exports startedto grow more peoplecameback to work, but there was no change inthe official employment statistics. 2 time. The Moldovanapparel sector experiencedaremarkable export growth from 1996to 2002, and through increasingcapacity utilizationthe workers becamemore permanently employed. This, however, doesnot show inthe national statistics, as canbe seen inTable 1.2. The number of people employed by the textile and apparel industry fluctuated butnot really changed from 1996 to 2002, although the export value tripled. What happened was that in 1996 a majority of people inmany companies was laid off although they still officially were includedinthe payroll. When exports started to grow they were called back to work and startedto earn permanent income. The Moldovaneconomy has greatly benefitedfrom this development. The unemployment inthe sector has decreased, although it does not appear so inthe official statistics. The export value from this sector tripled. Several foreign direct investments have been made inthe textile and apparel sector securing a permanent flow of export orders and contributingwith know how and training. The foreign partners are well-known textile and apparel companies from Turkey, Italy and Germany. The value added, however, i s low as practically all apparel exports are CM. The customs statistics record exports for full value althoughmaterials inC Mproduction are ownedby customers. According to Eurostat -Comext Database, the OPT clothing imports from Moldovato EUwere EUR69.3 millionin2002, while materialexports from EUto Moldovafor thisproductionwere EUR43.9 million. The value addedwas EUR25.4 million, which is only 37 % ofexport value. The wages inthe textile and apparel industryare fairly equal to the other industrial sectors in Moldova. However, there i s a significant difference between the companies locatedinmajor towns and those inthe rural areas, where the wages may be 30 % lower. Table 1.3 Average industrialmonthlywages during the first 5 months of 2003 Legmonth US$/month Industrygeneral(excluding food industry) 1049 73.36 Machine building 1182 82.66 Furniture 1069 74.76 Light industry(includingtextiles andapparel) 1024 71.61 Industrvinrural areas 712 49.80 Source: Ministryof Industry Ininternationalapparel trading terminology C Mmeansthat the producer buysnomaterials and sells production capacity only. Everything including accessories i s supplied by the customers. In CMT the producer buys only the basic trimmings,but all materials as well as detailedproduct specifications are supplied by the customer. These kindsof companies only need manufacturing skills and production machinery, while product designs, technical specifications as well as manufacturinginstructions are providedby the customers. The garment industry, due to the low investment cost per operator, is often among the first industries inany emergingnation, and the industry starts with CM or CMT production since management slulls are not very highand connections to the import and export markets are limited. The only means ofcompetitionis the price and, inmore fashionable apparel, speed to the market ifthe location is near to the market. C M and CMT create the lowest level of loyalty from the customers' side. It is relatively easy to move production to another location ifmore favorable terms appear. 3 Customers that operate with C M or C M T are often branded manufacturers or wholesaler type marketing firms, inother words middle men inthe value chain. They sell their products further to retailers. Retail firms also source products directly from various factories, but they prefer FOB or other sourcing concepts as they do not have material sourcing organizations. This means that a CWCMT supplier i s at the end o fthe value chain, totally cut off fromthe market, and at the mercy o f the `middle-man' customer that i s looking for the lowest price. InFOBor Full-price subcontracting the supplier purchases allmaterials according to buyer's specifications, but product specifications as well as styling are still supplied by the customers. The FOBproducer must have the know-how for sourcing materials. For this he needs direct contacts to the weaving mills and continuous visits to fabric fairs must be made inorder to be up- to-date with the latest fashion information. FOBproducer must also be able to finance material purchases. FOBproducers offer more value to their customers and the customers become more dependent. Furthermore, FOB suppliers can approach the retail customers directly, and can achieve higher margins as the wholesalers are by-passed. The retail customers represent the growing part o f the market as the share o fretailer collections i s growing inthe EUand the USA. Figure 1.1 Value-adding stairway of garmenttrade. Value added Manufacturing Manufacturing, Manufacturing, Manufacturing, Material Skills Material Material sourcing, sourcing, sourcing, needed Pattem design Pattemdesign, Pattemdesign, Garment Garment design design, Marketing Production Production Production Production machinery machinery, machinery, machinery, Technology Pattem design Pattem design Pattem design needed CAD, CAD, CAD, Internet Intemet, Internet, Garment Garment design CAD design CAD WithPrivate Label the producer searches materials, designs collectionsandpresents customers product development ideas. The final decision on designs and products are made by the customers andproducts are supplied under customers' labels. This is the highest level o f value addingbefore Own Label sales, i.e. the producer designs collections and sells them under his own labels. 4 Inorder to becomeatrue FOBproducer the company musthavethe slulls andfinancial means for sourcingmaterials domestically and from abroad. Selling slulls are needed on all levels. True marketing skills are neededwith own collections. Figure1.2 The apparelindustriesinPortugalandHongKonghavegradually transformedfromCM/CMT productionto FOBPrivateLabelproducers. The Balticareais becomingaFOB area while the rest ofthe CIS countries are CWCMT producers. =-a , 70s , 80s I 90s I 00s I Own1 Italy Label The time span for climbing these steps i s long for any company and especially for the total garment sector. It took 20 years for garment industries inHongKong and Portugal to become Private Label producers, and only a few companies have succeededwith Own Label collections. Most garment suppliers inEastern Europe are still, after 10years inmarket economy, only C M or CMT producers. Moldova i s a low cost supplier inthe global supply chain for apparel. After transition to market economy the Moldovan companies carry on as CM/CMT producers, as they have neither the know-how nor financing for sourcingmaterials. Dueto the very low labor costs inMoldova, productioncapacity can be sold at a very competitive price. The only other advantage the industryoffers to its EUcustomers is closenessto the market. This is geographicallytrue, but due to the numerous trade barriers createdbythe Moldovan Government, customers cannot enjoy the same speed-to-the-market benefits offered by more liberal CIS countries. BothBrandedSuppliers and BrandedRetailers source garments from various suppliers. Branded Suppliers, suchas Nike, may not have factories oftheir own. They outsource their production and sell the products further to retailers. Brandedretailers, like Gap source their products from similar suppliers. The trendtoday i s to cut down the number of suppliers and work rather with supplypartners. The customers expect to beprovidedwith full service includingparticipationin garment and pattern design, material sourcing and manufacturing. The success o f the supply chain i s measuredat retail level. The commonly used success measures are: 5 Sell-Through i s the proportionof goods sold at first price. Due to forecast error a part of goods purchased have to be cleared at reducedprice. Long leadtime and lack of replenishment possibility are the mainreasonsfor low Sell-Throughpercentage. Sell- Through varies between60 % and 70 % intraditional up-front buying. Lost Sales is caused by stock-outs. When a retailer runs out of certain SKUs (stock keeping unit) without having replenishment possibility, potential to sell more is lost. With up-front sourcing lost sales varies between 10% and 20 %. Service leveli s the proportionof SKUs available throughout the selling season. Service level goes down when certain sizes and colors runout of stock. Service level varies between 70 % and 95 %. Stockturns measuresthe turnover rate of stocks. Inlong-leadtime and slow moving apparel business stockturns can bebetween 2.0 and 3.0. Slow stockturns, i.e. large inventories tie down capital and cause highforecast error as replenishment i s not possible. Suppliers that can contribute to the success ofretailing will be the survivors inthe global apparel business. Basic items with highly sensitive prices will be sourced from the lowest cost regions in Asia (China, Indonesia, India), andmore fashionable items from nearby regions, i.e. the Caribbean for the U S market and East Europe for the EUmarket. Retail chains and global brands want to outsource merchandising and sourcing operations as much as possible. Fullservice providers will be the winners inthe apparel industryinthe long run. Speedto the market i s important with fashionable products (long leadtime increasesforecast error), while price i s the maindriver inbasic garments. Long leadtime lowers Sell-Through percent and decreases final Gross Margin, as a larger proportion of merchandise has to be sold at reducedprices. For example Zara, the leading fashion chain inEurope says that, due to the extremely short leadtimes, they sell 80% to 85% at full price while traditional retailingreaches only 60 % to 70 % (source: www.inditex.com ). This can be quantified with the example inTable 1.4. Purchaseprices arenormally markedupby 150 % infashion retailing. Annual purchasesofUS$ 100 million would turn into US$ 250 millioninturnover and US$ 150 million inprofits, except that a major part of this i s lost through price mark-downs. Only 65 % o f merchandise sourced traditionally (from Far East with long lead times) i s sold at full price, and the rest has to be marked down and sold through clearance. In demand driven short-lead time business, which means sourcing from near-by suppliers, up to 82 % is sold at full price. As the prices are markeddownby 50 % on the average, the clearance creates very little Gross Profit dollars. Basedon these industryaverages, the example inTable 1.4 shows that by switching totally from traditional sourcing to demand driven buyingthe retailer would earn 20 % higher Gross Profit. 6 Table 1.4 Exampleof Speed-to-Marketimpacton RetailProfits Annual purchase value US$ million:100.0 Retail mark-up: 150 % Sales Gross Profit Price mark-down at clearance: 50 % US$ million US$ million Traditional Sales at full price 65 % 162.5 97.5 Sales at mark-down price 35 % 87.5 8.8 Total Gross Profit 106.3 Demand Driven Business Sales at full price 82 % 205.0 123.0 Sales at mark-down price 18 % 22.5 4.5 Total Gross Profit 127.5 (+20 %) Source: EA-ProjectsLtd This, of course is an opportunity to countries like Moldova, which interms of transporting is only a couple of days away from the EUmarket. The difference inlead-time, which i s the main cause for the above-mentioned retailers' profit loss, i s significant compared to the Far East suppliers. At the same time the customers inEUare graduallymovingtheir purchasesfurther from the immediate neighbors (Poland, Czech Republic, etc.), where costs are quickly rising. The cost o f labor inMoldova is internationally very competitive. It is much lower than inthe neighboring countries and even lower than China. Moldova offers a clear cost advantage to customers looking for a low cost source for C M production. The factory efficiency i s calculated by comparingthe actual number of direct minutes usedper product to the international standards. Evaluations were made duringfactory visits andthe average efficiency i s quite low. Oldmachinery, inefficient internal transports, lack o f work place engineering and work loadingproblems are the reasons for this. Change of seasonseems to be a particular problem. As the firms are largely dependent on customers' order allocation, they have no alternatives when the customers are unable to book production between the seasons. Infact, duringthe mission several factories hadcompletely stoppedtheir production, andwere scheduled to start again with the new season. 7 Figure 1.3 Apparel industrymonthlylabor costs includingsocial charges 3100 0 500 1000 1500 2000 2500 3000 3500 US$/" th Source: OETH, Wemer International,EA-Projects Another way o f measuring productivity is by the so called minute sellingprice, which i s especially usedwhen purchasing or selling sub-contracting services. This figure indicates the cost of one standardminute that the customer actually pays for. The C Mprice of a product can thenbecalculatedbymultiplyingthe minutesellingpricebythe number ofstandard minutesper product. The minuteselling price i s widely usedwithin internationalgarment manufacturing and trade basis for determiningthe C Mprice of a garment. Intemationalbuyersnormally know exactly how many standard minutes their products contain. Furthermore, they know from experience what i s the expected minute selling price from Portuguesecompanies, what it i s in HongKong ,Turkey and inother countries. The minute selling price inMoldova i s estimated to vary between 0.025 and 0.046 US$/min. This i s very competitive. Table 1.5 Priceof one standardminutefromvarioussources US$/min Moldova 0.035 Chma 0.05 1 Russia 0.060 Romania 0.079 Baltic countries 0.114 Yugoslavia 0.118 Portugal 0.158 Source: EA-Projects Several of the buildings inthe apparel sector are old. Some were built 30 years ago. The general condition of the older buildingsi s poor. Most of the factories are multi-floor makinginternal transporting complicated. Modem, ground floor facilities were not seen duringthe visit. All factories hadcentral heating, and one or two were equippedwith air conditioning. Social facilities, including medical care, changingrooms, canteen and toilets were o f acceptable 8 standard. Although the factory premises are notthe most modem, they are neither the main problem for these firms. The machinery and equipment on average i s old. There are only a few computerized product designand cutting facilities inthe country. Insome factories the condition o fthe machinery was very poor. It i s obvious that the firms needto investinbetter quality machinery inorder to improve quality and productivity. Internaltransport systems and work place engineering are very basic. Manual transporting of bundlesthroughout the factory requires additional indirect staff and i s inefficient. Workplaces were not well designedlacking table extensions, pick-up trays and disposal units. Hanging transport systems insewingrooms are generally missing. However, product quality was not a major concern to most companies. Customers seemed to be happy with the quality. Onthe other hand, with the aged and basic equipment the Moldovan industryproduces mostly basic andlow value addeditems. Men's suits and ladies formal wear, which quality wise are most demanding, are produced only insmall quantity and hardly at all for export. With the exception o f the Joint Ventures with foreign partners, the firms are traditionally managed. The old socialist economy hierarchy seems to have stayed and the number of indirect staff i s surprisinglyhigh. A C M manufacturer with maximum 15 % inindirect personnel i s considered internationally competitive, while many Moldovan companies have more than 30 % (Source: EA-Projects Ltd). The reasons for this are inefficient old-fashionedmanagement and local bureaucracy. Duringthe company interviews many firms complained that they need extra personnel for handling various formalities regardingimports and exports. As discussedinabove paragraphs the Moldovan apparel sector i s more competitive indirect labor costs and manufacturing costs than the CIS competitors. Interms o f material prices, quality and lead-time there is no competitive advantage.The Moldovan industryi s less competitive inplant efficiency, production facilities and FOB capability. Compared to China Moldova is more competitive indirect labor costs, minute selling price and inlead-time. The cost advantage against bothof these competitors and the shorter lead times incomparison to China are strong competitive factors that the Moldovan industry can benefitof now and duringthe coming years. Import quota limitations to the EUand USA for several apparel categories will beremovedfor imports from WTO member countries at the end of 2004. This has no direct impact on Moldova's exports, but competition inthe EUmarket will definitely be harder. According to general estimates, China will benefit greatly as most apparel categories are under quota today. In addition to havingno further limitations, prices from China will decline. The Chinese Import Export Corporations charge a fee for export licenses, which sometimes i s a major part of the product price. According to estimatesby Euratex, the prices for Chinese made goods will decline on the averageby 20 %. 9 Table 1.6 The competitive advantage of Moldovan apparelindustry compared to CIS and Chinese competitors Compared to CIS countries Compared to China Moldova is Moldova is More Less More Less competitive Same competitive Competitive Same competitive Materialprices J J Direct labor costs 4 J Minute selling price J 4 Plant effciency J J Indirect personnel J J Quality J J FOBcapability 4 J Lead times J J Production facilities J J Source: EA-Projects Ltd The objective o f this case study i s to illustrate the problems that Moldova confronts when dealing with market access issues and to identify the formal and informal barriers to trade. The economic costs o fthese barriers are estimated and specific policy changes are recommended to overcome these barriers. A representative randomsample o ftextile and apparel firms (15 companies) was interviewed duringthe mission. There are about 30 major textile and apparel firms inthe country. The total number o f manufacturing companies inthe whole sector i s around 50. The firms interviewed were located inChisinau, Beltsy, Soroca, Calarasi and Riscani. The sample included small and large companies. Most of the firms were private. There were 4 Joint Ventures, 1 fully foreign owned firm and 1company with the State as the majority owner.'* 2. TrendsinTradein the Textile andApparel Sector Very few apparel companies inMoldova design their own product lines. Inmost cases designs and product specifications are receivedfrom export customers. The firms sell tolling services and operate under a temporary import scheme. Materials sent by customers remain the property of the customer throughout processing. As result the value added by Moldovanmanufacturers is very low. The apparel companies interviewedduringthe mission sold on average 93 % o f their capacity on C M basis (cutting and manufacturing services), 2 % on full price sub-contracting basis (FOB) and only 5 % under own label. None sold Private Label services. The companiesinterviewedwith the numberof peopleemployed inbracketswere: Astroline (280), BalteanceSA (goo), Can Ind. Sport (30), CondeancaSA (560), S.A. Dana(700), FantaziaSA (400), Infinity (2300), OlgaCeban(40), RadaJoint Stock Co. (600), Sawa (25), Sor-ElitaSARL (425), Staua Reds SA (350), Covoare-UngheniJSC (400), Grinfor S.R.L. (IOO),Floare-CarpetSA (900). 10 Figure2.1 Distributionof sales between different business concepts (source: company interviews). 100 % 1 93 % 80 % 60 % 40 % 20 % 0 % CM Full Price Private Label Own Label OPT i s the main driver for Moldova's apparel exports. Materials, i.e. yams and fabrics are suppliedby EUcustomers for processing. In2001more than 80 % of textile materials were imported from the EUand 75 % of apparel exports went back to the EU. Although the value added due to selling o fprocessing services i s low, this has beenbeneficialto Moldova. Exports have grown rapidly year after year. More than 8 000 people (mainly women) have permanent jobs, some inthe rural areas ofthe country. Lay-offs have declined due to the increasingcapacity utilization. The foreign direct investmentshave brought inexpertise and know how, which like inother countrieswill have spin-offs, newcompanies that are createdbythejoint venture managers. The average annual sales per person inthe apparel firms interviewedduringthe mission was only US$755 (the average turnover per person inthe EUapparel industryin2000 was US$97 000). There i s an amazing variation intumover per person between different apparel firms ranging from US$ 327 to US$980. This is causedby different capacity utilization levels, and the fact that people may be laidoff for lengthyperiods. Some o f the firms have longperiods without orders through-out the year while others maintain continuous operations. Low capacity utilization creates financial problems. On the other handthis indicates that the sector as a whole has still a lot ofpotential to grow without further investments. The low value adding businessesgeneratevery low cashincome. The firms maybeprofitable butthe value ofprofits eamed is so low that it cannot facilitate normal investmentprograms for modernizationof technology, such as computerized pattem design and marker making systems, which would improve material utilization. On the other hand, due to the low labor cost level, the very sophisticated production systems like computerized cutters and computer controlled transport systems would not be feasible investments. The total value of textile material (yams, fabrics) imports was US$ 62.3 million in2001. The main source was Italy (37 %) followed by Germany (21 %), Romania (5 %), Turkey (5 %) and Netherlands (3 %). Other sourceswere Belgium,Korea, Slovenia, Slovakia and Taiwan. Yams imported to Moldova are usedmostly by knitwear producers. The second largest importer i s the carpet industry. The main source for yams i s Italy (40 %). Italy i s the main source for various types of fabrics as well, except for man-made fabrics, where Germany i s the main 11 supplier. Most of the yams and fabrics are actually sent to Moldovaby EUcustomers under OPT. OPT, however, i s not always utilized. For reasons of price or fashion materials are also importedfi-om other sources, such as India, Pakistan, Turkey, China andUSA. There are textile millsinTransNistra exportingmainly cottonbasedfabrics. The Moldovan apparel industrydoes not seem to use these fabrics. Politics i s obviously one reason for this, and there are few contacts betweenTransNistran and Moldovan companies. The secondreason i s the OPT exports as the EUcustomers want to take advantage of the preferential duty arrangements and sendEUmade fabrics for processing. The total value of clothing exports in2001 was US$ 91.9 million. The maindestination countries were Italy (39 %), Germany (32 %), USA(16 %), Netherlands (3 %), Romania (3 %) and Belgium(2 %). There is hardly any clothing export to Russiaor other CIS countries except Romania. A major part of clothing trade with Romania originates from EUas well. The Romaniancustomers, who use Moldova as a low cost production site ship the goods further to the final customers inEurope. Thereason for the lack of trade with Russiais that Russian customers cannot provide materials for manufacturing. They expect full-package service (design, materials and manufacturing), which currently i s available from only a few Moldovan companies. Russia couldbe a potential market for the Moldovan apparel industry,providing that the firms are willing to design products jointly with customers and to purchase the materials. Part of the materials couldbebought from the weaving millsinTransNistra, but for more commercialdesigns the fabrics must be sourced from abroad. Most Moldovan companies do not have the know how for this, and financing of materialpurchaseswould certainly be aproblem. This was infact discussedwith several Moldovan garment manufacturers duringthe mission, and they all felt that they prefer to sell CWCMT services to European customers as long as they keep receiving orders. Fullpackage sales to for example Russia would make their businessmore difficult interms o f trade bureaucracy and would require additional financing. Only two apparel companies interviewedduring the mission sold their own collections. Both of these firms were newly set up small companies, and they were experiencinggreat difficulties in getting their business started, although they bothfelt that there was great business opportunity in the domestic and exportmarkets. None ofthe other firms hadplansto up-grade their business from selling production capacity on CM basis. The Moldovan Export Promotion Organization(MEPO) has carried out several campaigns to promote Private Label and Own Labelbusiness concepts within the apparel sector. Results have beenvery modest, and it is felt bothby MEPO and the apparel companies that the current laws and regulations, through their complicity, do not encouragethe firms to move up to more demanding business concepts. The export value of garments made o f woven fabrics was US$55.1 million in2001 (men's and boys' clothing US$24.7 million and ladies' and girls' clothing US$ 30.4 million). The total export value for knitwear was US$ 15.4 million (men's andboys' knitwear US$7.5 million and ladies' and girls' knitwear US$7.9 million). Other clothing products were exportedfor US$ 21.5 million in2001 (baby clothing, T-shirts, underwear, swimwear). The main export markets were Italy, Germany and the USA. Italy i s the main export market for most o f the apparel categories. But inladies' and girls' clothing o f woven fabrics Germany i s the maindestination, and inladies' and girls' clothing of 12 knitted material USA is the mainmarket. The reason for this i s that ineach of these categories there is one large garment joint ventureproducing only for this single market and this shows in the statistics. This also indicates how customer driven the Moldovan apparel exports are. Most manufacturers inMoldovado no marketing at all. When customers have problems with sales and cannot guarantee continuous workload, the Moldovan firms have no alternatives to fill the capacity and the factories are stopped. Romania i s the only neighboring country appearing inthe apparel export statistics (4 % of ladies' and girls' clothing exports and 7 % of other clothing products). Very few of the Moldovanapparel companies were interestedinthe domestic market, as most firms producedonly for export. Only occasionally something was producedfor domestic sales. The firms felt that it i s difficult to sell to the domestic market due to the lack of organized retailing. Itwould be necessary to establish own retail distribution, like some o f the carpet manufacturers have done. The secondproblemis lack o f financing. As TransNistran sources are not used, all fabrics wouldhave to be imported, VAT and import duty paid at entry, and the companies would have to finance inventories of materials and ready made goods at the stores. The very weak financial situation of most of the apparel manufacturers would not permit this. The domestic market i s lefttotally open for the internationalretail chains, which arenow starting to enter Moldova. Their products will be sourced centrally from somewhere else and imported to Moldova, and, as result, the Moldovan apparel industrywill have practically no share of the domestic market.13 3. Barriersto Trade and the Development of the Textile andApparel Sector The managers of the 15 case study companies were interviewedduringthe mission. MEPO and ARIA representatives were also interviewed. Besideof focusingon trade barriers the team discussedvarious problems that the management encounters daily. Itbecame quite clear to the mission team that the management uses an extensive amount o f their time indiscussing and sorting out formalities, filling forms, beinginvolved ininspections and other bureaucracy, which all prevents them fiom concentrating onthe real management issues at their companies. The current trade policy ofMoldovacauses various problems to the textile and apparel sector, and the procedures seriously increase the costs for the exporters, especially inthe lower value added segment. Furthermore, the long-term negative effect i s that the bureaucracy and the financial constraints keep the industry fiom developing towards more value adding business concepts. The costs o f some o fthe barriers are difficult to estimate as many of themhave indirect impact on the ~ompanies.'~ '' Steilmann of Germany, one of the largest apparel groups in Europe, has a Joint Venture factory in Moldova producingladies coats, jackets and blazers. Production i s planned and controlled by central sourcing organization in Germany. For logistic and commercial reasons the Steilmann store inChisinau receives goods from Germany, not directly from the factory. Occasionally they could produce more garments than expected out of the fabric sent to them. The extra productioncould be shipped directly to the store, but according to the local factory management it is nearly impossible to do so due to the complicated customs procedures and regulations controlling the temporary imports of fabrics. The extra piecescan neither be retumed to Germany as the shipment quantity would notbe equal to the original order. Infact, when this occurs they prefer to let the extra material go to waist. l4 Seven apparel firms were willing to present financial data from year 2002. Inproportion to tumover the banking charges were 1.1 %, transport costs 1.1%, telecommunications 1.3 %, customscharges 2.1% and Chamber of Commerce charges 1.1YO. 13 3.1. VAT Most garment manufacturers carry out C M business and do not pay VAT when importing materials. Materials are importedtemporarily and import and export documents have to be cleared at customs against eachcustomer order. This may be difficult ifdiscrepancies happen. For example partial shipments of the order are difficult to arrange. The manufacturer may also manage to produce extra garments from the material sent to him, but due to bureaucracy it would be difficult to retumthese garments to the customer and earn additionalrevenue. The time limit for manufacturingand repatriatingeamings is 6 months. Ifthis cannot be achieved VAT will be imposedtogether with penalties. Some knitwear companies have difficulties inmeetingthis time limitas the same yam may usedover a longperiodoftime. Cutting waste i s always produced ingarment manufacturing. Between 5 % and 25% o f fabrics and other cut materials end up inthe wastebasket. These odd shape pieces are o f no value and usually they are dumped. It was understood duringthe mission that the companies have been made to pay VAT on this waste. This 1s most unusual and notpracticedinthe competing supplier countries. Such a cost significantly reduces the competitiveness of Moldovan producers. It i s also difficult to define the exact material waste percentage as it varies from one style to another. Even each cut has a different material utilizationpercentage. VAT payable oncutting waste is difficult for the customersto understandand it is unlikelythe customers are willing to compensate for it. Instead, it has to bebuilt into the C M manufacturing cost, which makesMoldovan firms less competitive. The average cutting waste i s 18 % of total material consumed. For example, the cost of fabric for one ladies' coat could be US$ 33.50. VAT on cuttingwaste of 18%wouldbe US$ 1.20. Ifthe C Mprice for such a coat is US$ 8.50, the VAT on cuttingwaste means an additional price increaseof 14.1 %. This is a serious increase of C M cost and it i s likely to reduce export orders from Moldovan manufacturers. Those companies importingraw materials at their own account are liable to pay VAT when clearing customs. Ifproducts made o fthese materials are later exported, VAT will be reimbursed, usuallywithin 3 months. Payments, however, are not made to the companies, but the balance i s kept by customs infavor o f the said company against future imports. Companies are treated differently by the VAT authorities. The smaller companies complain that they have to wait for VAT reimbursements longer, sometimes upto 6 months. They don't know when the repayments will be made, and inseveral cases enquiries have leadto penalties. Inmany cases VAT i s not repaid fully. For smaller firms, especially inthe apparel sector, delays inVAT reimbursement may cause serious financial problems. Delayedrepayment of VAT has financial consequencesespecially to smaller companies that are often paid later than the larger well-known firms. The impact o f waiting for reimbursements for 3 months calculated at current foreign currency lending terms o f 10 % annual interest and with raw materials beingat least 50 % of turnover, means 1.3 % additional cost. Incase reimbursement takes 6 months the additional cost is 2.6 %. Inreality the delay i s closer to 6 months than 3 and the average cost impact i s around2.0 %. For C M manufacturers this i s not a problem as VAT does not apply to temporary imports. 14 3.2. Customs No duty i s paid for temporary import o f material. Customs clearance charges of 0.2 % of the shipment value i s paid for each incoming shipment. Mosttextile materials are duty free anyway, butincertaincases, depending on the composition, 5% duty on fabrics and 10% dutyon accessoriesmay apply providing that the apparel companies import the materials at their own account. The firms complain that there are difficulties ingetting the duty reimbursedincase the products are exported. Clearing the customs didnot seemto be any biggerproblemproviding that all documents were in order. The preparationof documents and the clearing procedures, however, are time consuming and indirectly costly to the companies." Counter samples are often producedfor eachnew order. The sample together with price quotation i s sent back to the customer for approval. Speedto the market i s an important issue, and counter samples and quotations are expected back as soon as possible. Customers often send sample materials through international courier service, but as the same customs clearanceprocedures apply to sample materials as well, the shipments get stuck at customs for 3 to 4 days, which considering the urgency of the samples the companies find totally unacceptable. Most apparel materials can be imported duty free to Moldova, but some accessories and special materials are liable to dutybetween 5 % and 10 %. Ifa company imports materials at their own account, designs the products and exports them, there are difficulties ingettingthe import duty refunded. For example for a piece of lingerie with an export price o fUS$20.00 and material cost of $ 14.00, this would be an additional cost of 5.6 %. 3.3. Terms of Payment and Repatriation of Export Earnings Material suppliers may extendtheir credit to established customers up to 90 days. Likewise, payment terms inexports can be 90 days or even consignment. Payments are usually done at delivery for C M exports. Ifthere are delays incollecting export revenue, for example due to financial problems o f the customer or incase there i s a claim on quality or delivery, the payment may beprolonged even over the repatriation deadline. This may result inpenalties despite the reason for the delay. To solve the quality or delivery problemthe supplier may have to agree to a discount. This will create further problemsas now the shipping documents, invoice and the actual amount o f money received do not correspond. Terms of payment, when there are no difficulties with quality or delivery times, are not a problem to the C M operators as they only sell production services and are usually paid at delivery. For companies selling own labelproducts the longterms of payment create financing problems. Repatriatinglimit for foreign currency receivables mightbe exceeded for reasonsbeyond the Moldovan company's control. The penalty i s inproportion to the exceeded value. This i s not a problemto C M manufacturers as they are usuallypaidat delivery. Butto firms selling Private Label or Own Label goods the repatriating limit i s a problem. Is One of the apparel firms located outside of Chisinauwas able to comparethe customsproceduresto what they haveexperiencedin another CIS country (Latvia). InMoldova the firmneeds 3 persons on full time basisfor customsproceduresplus one driver who almost daily has to take documentsto Chisinaufor approval. InLatvia the same work is doneby 1personand there is noneedto travel to the Capitalfor getting the documentsstamped. Interms of personnelcosts it is at least 3 times morecostly to clearcustoms inMoldovathaninother competingEastEuropeancountries. 15 3.4, Pre-Shipment Inspections PSIwas highly criticizedby the textile and apparel sector. The firms felt that no additional inspections are neededas customs already inspect every shipment and matters should be agreed between the buyer and the seller anyway. As there are a lot of small shipments inthis sector the inspections were very costly. Dueto the minimuminspectioncharge the cost o f inspection could go up to 5 % or more of the shipment value. PSI o f material imports for C M production was cancelled even before the system was voted unconstitutional. PSIdoes not therefore concern most o f the apparel companies ifreactivated. However, this will be one more bureaucratic procedure that encouragesthe apparel companies to stick to their CM as importing the materials at own account would mean uncomfortable PSI procedures and additional costs. The minimumcharge increasesthe cost of inspection, and in proportion to the import value of materials the inspectioncharge could be between 3.0 % and 5.0%. For an FOB operator this means that he has to increaseexport prices by around 2.0 %. 3.5. Local Financing Local credit terms are unfavorable. Credits are for short term and interest rates are high. Interests are from 10 % to 12 % for foreign currency loans and between 18 % and 24 % for loans inLei. The companies feel that they donotget competitiveservice fromthebanks. Commissions are charged on everything, for example 1% on withdrawal of cash. The textile and garment trade is seasonal. There are highpeaks indeliveries andperiods withno orders inbetweenthe seasons. Several of the garment factories visitedduringthe mission hadno orders at all, as they were between the seasons and fully dependent on C M orders from export customers. Ifseasonalcredit lines at acceptableterms were available, the gaps between seasons couldbe filled with own production for the domestic market or for export to the CIS. Furthermore, the highfinancing costs stop the apparel manufacturers from moving up the value chain to fullpackage business. The firms pay various kindsofbankingcharges. The charges inproportionto turnover, according to financial data received from several apparel companies, were on average 1.1%. Customs clearance charges inproportionto turnover were on average 2.1 %, not the official 0.2 %. Chamber of Commerce charges (document approvals and assistance) inproportionto turnover were on average 1.1%. 3.6. Transporting Most companies inthe textile and garment sector buytransport services or they may be arranged by the customers. Two companies hadtheir own transport equipment andthey felt that their transporting costs are 20-30 % lower than the commercial companies offer. Closenessto the market i s an asset inapparel trade as short lead-times are sought by the customers. GeographicallyMoldovai s not far from the mainmarkets o f the EUbut due to the bureaucracy inMoldovaand the customs procedures at the border crossings o f the CIS countries the total transport time may be extended by several days. Companies usingtheir own transports 16 face further problems. One of the companies had difficulties inobtaining visas for the drivers. It was also difficult to officially obtain the permits and documents for boarder crossings.'6 3.7. Bureaucracy The general complaint is that laws andregulations change continuouslyand even the authorities are not always well informed. Laws may also be difficult to interpret and outside help (for example Chamber of Commerce) may be necessary for filling the requireddocuments, resulting inextra costs. All kindsofinspections seemto go oncontinuouslywith formal andinformal charges. A part o f the procedures are handledcentrally, and to companies locatedoutside Chisinau this may mean daily travel to the Capital for getting the required stamps. Formalities for a C M manufacturer are muchless complicatedcompared to Full-Price, Private Label or Own Label companies. A C M firmneeds to clear customs for incoming materials and outgoing goods, but avoids dealing with VAT and import duty reclaims. Nor i s PSIpracticed on temporary imports of material. Although customs clearance i s the only trading formality required inC Mtrade, itisnot simple. Altogether 13 different documents, as countedbyone ofthe companies interviewed,are requiredfor each shipment. Documents presentedby foreign clients, such as orders and transport documents, must even be translated and authenticated by the Notary. With higher value adding business concepts, such as FOB, PrivateLabel and Own Label, the companies must deal with reimbursements of VAT and duty, and PSIwill also apply once reinstalled. C M requires less financing since materials are notpurchased and the common terms of payment for readymade goods i s at delivery. Therefore it i s understandable that C M i s seen attractive. Inthe longrun, however, the companies shouldup-grade themselves to more value addingbusinesses inorder to reduce the risk ofbeingbypassedby customers that look for the cheapest source. This i s not happening inMoldova today. On the contrary, the firms interviewed duringthe study felt that a large part ofthe bureaucratic hassle can be avoidedby stickingto CM. The other reason i s that they do not have the management know-how or financing for the more value addingbusiness. Table 3.1 Formalitiesand expendituresrequiredby various concepts C M Full-Price Private Label OwnLabel Formalities: Customs clearance Customs clearance Customs clearance Customs clearance VAT reimbursements VAT reimbursements VAT reimbursements Import duty procedures Import duty procedures Import duty procedures PSI*) PSI PSI Financing, costs: Customs clearing costs VAT and import duty VAT and import duty VAT and import duty Practically no upto 6 months up to 6 months upto 6 months financing needed Cost o f materials for 3 Cost o f materials for 4 Cost o f materials for to 4 months to 6 months at least 6 months PSI cost up to 5 % in PSI cost up to 5 % in PSI cost up to 5 % in small shipments small shipments small shipments Occasional repatriating penalties *) PSI was not exercised duringthe mission l6 Transport costs for exports are increased by unofficial payments. CEMT permits may have to be bought via the black market. The truck driver needs to carry an extra US$150 for bribes to traffic police and customs officials inMoldova and other CIS countries that he has to cross. 17 3.8. FDIs and Competitivenessin theExport Market There are numerous examples o f emerging economies, which have greatly benefitedfrom FDIs. The best example i s perhaps China, whose booming textile and apparel exports are largely regarded as result o f thousands o f Joint Ventures. Also inMoldova there are several foreign direct investments inthe apparel sector. Despite o f difficulties and complaints, these companies seemed to be operatingrather well. Beside financing the foreign partners hadbrought intraining and know how together with new machinery. Today, however, with wide spread bureaucracy and corruption Moldova i s not very attractive to foreign investors. Several CIS countries with highapparel exports to the EU, like Estonia, Latvia, Lithuania, Poland, CzechRepublic, Slovakia and Slovenia, will become EUmembers in2004. Costs as well as the standard o f living i s expected to rise inthis countries. This will be an opportunity to Moldova. Many EUbuyers will search for more competitively priced sources inEastern Europe and Moldova should actively capitalize on this opportunity. Most o f the foreign customers buyingCM services from Moldova are manufacturers, importers or wholesalers and they sell the products further to retailers. Being intermediaries they include their own margins into the value chain. This puts considerablepressure on costs and ingeneral the C M manufacturers inMoldova are being paid very low prices. Retailers are reluctantto directly carry out this kindo f business as they don't have the know-how or resources for material sourcing. Instead they prefer to buy on Full-Price basis. Although retailers prefer to go directly to the source, they are willing to accept the intermediaries as long as they perform the requested services. Another alternative i s that the manufacturer offers these services, i.e. sells the products on full-price (FOB) basis, and no intermediaries are needed. InPrivateLabel andOwnLabelbusinessthe manufacturer even carries the product development costs, Ifthe retailer designs the products, as inFOB, and carries the design cost, the purchase price mustbe lower. When retailers make sourcing decisions they consider the various alternatives only ifthe retail price at the end meets their target. Table 3.2 The cost impact ofvarioustrade barriers canbe quantifiedby an example of a ladies coat with fabric cost of US$33.50, accessoriescost of US$2.00 and productioncost of US$8.50 Items Additional costs to CM Additional costs to price FOBprice US$ ipc US$Ipc Material imports 35.50 Production 8.50 . 8.50 DelayedVAT reimbursement 0.71 VAT payableon cuttingwaste 1.20 1.20 Additional personnelcosts due to bureaucracy 0.03 0.03 Customscharges 0.18 0.18 Chamber ofCommercecharges" 0.09 0.09 Total 10.00 46.21 Value added inMoldova 10.00 10.71 Additional coststotal 1.50 2.21 Additional costs on value added 15.O% 20.6 % " CertificatesofOrigin,ExportLicenses,etc. 18 The low labor cost (infact lower than any other CIS country) isthe mainandpractically the only means o f competition for the Moldovan apparel sector inthe EUand U S markets. Part of this advantage fades away due to the low factory efficiency, highcost of domestic bureaucracy and due to import duties. Closenessto the EUmarket 'is also an asset but the other CIS countries beat Moldova inleadtimes becauseof less internal bureaucracy. The best example i s perhaps the Baltic States, where the apparel industryi s quickly developing towards more value adding concepts under very liberal trade policies. Several firms employed designers inthe 90s and started to create own collections and offer FOB and private label services to the foreign customers. At the same time numerous Joint Ventures and fully foreign owned firms were established bringinginfurther know how and triggering new and well-organized spin-off companies. None o f this i s taking place inMoldova. The Moldovan clothing sector does not have the design and merchandizing know how, and the interviews showed that very few companies, ifany, are interestedinmoving this way. Design cooperation with export customers will not take place ifthe supplier has nothingto offer. The cost o fbureaucracy inMoldova has a significant impact on export prices, especially for companies selling low value adding tolling services. When the above estimatesare summarized C M prices are increasedby 15 % and FOBprices by close to 20 %, as highlightedintable 3.2. 4. ConclusionsandRecommendations The objective of this case study i s to highlight the problemsthat Moldovan textile and apparel sector has regarding foreign trade and recommend policy changes to overcome these barriers. The apparel companies selling C M services seemed to have relatively few barriers, althoughthe cost impact o f these barriers i s significant. Companies exportingtheir own products are ina more unfavorableposition. Basedon the interviews and other material collected duringand after the mission it i s obvious that the current barriers make the textile and garment sector less competitive especially compared to some of the other countries inEast Europe. Formal and informal barriers to trade can be summarized as follows: Slow repayment o f VAT collected at importing o fraw material and the fact that money i s not paidto the company directly causes additional financial burden. Exceedingthe repatriatinglimit for export earnings, no matter what the reason may be, results inpenalty. Imposing VAT on cuttingwaste increases costs. Itis difficult to reclaimthe import duty paidonrawmaterial imports when goods are later exportedincase the materials are not recordedfor a specific export order. Altogether 13 different documents have to be issued, approved or stamped for each impodexport order intolling services. Getting them done slows down the whole operation and increasescosts. Customs clearance i s slow for example for courier shipments. Pre-shipment inspections of imports, ifrestarted, i s a huge irritation to the textile and apparel industryand very costly due to the minimumcharge (a lot o f small shipments). Lack of local credit lines at internationally competitive terms places the Moldovan manufacturers inan uncompetitiveposition Numerous documents and inspections together with wide-spread corruption load bureaucratic costs on the firms 19 The current laws andregulations do not encourage the textile and apparel sector to work its way up from C M towards more value adding business concepts. Recommendations The current procedures andregulations governing trade inMoldova are bureaucratic and, through additional costs, make Moldova a less competitive trading partner inthe world market. BothC M and Full-Price operators end up paying additional costs. The system i s relatively easy for C M operators and demands more from companies operating at higher value-adding levels. Inboth cases customs clearancei s complicatedrequiringa large number of documents for each incoming and outgoing shipment. The main objective o ftrade policy shouldbeto ensurethe continuity o f export growth inthe sector and to encourage firms to become full service providers rather than keepingthem at the bottom o f the value-adding stairway. The CWCMT operators are very low value adding and they canbenegatively affected byrelatively smalladditional costs imposedbytrade policy. Without further investments there i s a lot ofpotential for export growth inthe apparel sector, as the general capacity utilizationis low. Plant efficiency canbe greatly improved at many factories, and by avoiding closures between seasonsproduction volumes couldbe significantly increased. This will only happen ifthe foreign customers keep findingMoldova cost wise competitive. Lack o f design, marketing, finance and merchandizingkeeps the Moldovan manufacturers away from higher value addedbusinesses. It i s also felt bythe firms that a full service provider has more bureaucratic problems and therefore most of themprefer to stay with CWCMT. On the longrunthis may turn out disastrous. The more attractive customer segment, the retailers, cannot beapproached, andthe low cost seeking intermediarycustomers will not hesitate to switch to more competitive sources once they become available. The regulations and laws governing. foreign trade should encourage, instead o fpunish,the full-service providers. This i s a specific problem for the SME sector and new entrepreneurial companies, which are short o f money. For example, delays inreimbursements have to be financed by the firms themselves as outside financing i s not available at reasonable terms. A Draw-Back system, for reimbursingVAT and duty, shouldbe implementedregardingmaterials importedat company's own account. This shouldwork on a clearing account basis for registered exporters without advancepayments. Imports are recordedand cleared at exporting, and VAT and duty i s paid only for the difference.'* VAT payable on cuttingwaste is amajor cost especially to C Mand FOB operators, as waste is of no value, at least not the original import value. It i s not common to collect VAT on cutting waste. When doing so the Moldovan Govemment puts the industryina very uncompetitiveposition. Paying VAT on cuttingwaste is difficult for the foreign customers to understand and some clients are likely to tum to other sources. Is The start of industrialdevelopmentof Portugalinthe 70s, when the country became ademocraticnation,was heavily basedon textile and apparelindushy. CM andCMT were the main ways of exportingclothingproducts inthe 70s and 80s, and gradually several companiesmoved up to Full-Pricemanufacturing. The industry was supportedby the Govemment,not financially, butby makingtrading as barrier free as possible. A Draw-Back systemon clearing accountbasis was implemented for VAT and duties, and it helped the industry immensely when they were short of financing and the domesticbankingsystemdid not operateefficiently. 20 IfPSIisre-established, theminimumchargeshouldbeabolished. Theminimumchargehitsthe entrepreneurial SME sector, which again Moldova should encouragerather than chastise. Foreign direct investments (FDI) shouldbe encouraged. FDIshave provento be the key to trading success inmany countries, including China, the world's largest apparel exporter with thousandso f Joint Ventures inthis sector.lg FDIsbringthe badly needed capital andknow-how. The usual spin-off effect o fFDIsis the birthofnewwell-managed companies. Beingemployed by anFDIis a good leamingexperience to the localmanagement. Quite often these managersset up companies oftheir own contributingto the whole industrial sector andthe economy ofthe country. The best way for a country to promote FDIsi s to establish a trade legislation, which i s fair and free of bureaucracy. Despite of the trade barriers today, most o f the largest exporters in the apparel sector inMoldovaare already Joint Ventures. CIS and especially the neighboring countries (Russia, RomaniaandUkraine) shouldbenatural export markets to the Moldovan apparel industry,like they are to the carpet industry. Butthis i s not the case as hardly any apparel i s exported to these markets. The reason i s that the Moldovan apparel producers are engaged inC M production andhave no resources or know-how for offering full-package service, which i s requiredby the customers inthe CIS countries. Access to these markets i s relatively easy ifthe firmhas own designs and i s able to import its raw materials, as demonstrated by the Moldovancarpet industry. Constantly changing laws and regulations createproblems. Not even the authorities can keep up with the current laws. There is no needto inventtrade legislation. Itcanbe copiedfrom nations that have for decades successfully carried out trade. Moldova should streamline its overall bureaucracy. The numerous licenses and permits currently requiredare hardly necessary, as they are notrequiredby many of the competingcountries inEastem Europe. They are costly and they only slow down trade. Moldovahas lower labor costs than China and i s close to the EU. These are advantagesthat Moldova should capitalize on. The low cost level i s the reason, perhaps the only one, for today's customers to trade with Moldova. Speed to the market would be appreciated by the retail customers, but they are not there as the Moldovan suppliers cannot offer full package services. Exports of apparel productshave boomed, but due to the low value added the dollar income i s modest. There is, however, great potential for growth. By utilizing the current production capacity fully, export quantities can be increased. By gradually moving to more value added business the dollar income will also grow significantly. l9The overallaccumulativeforeign direct investmentsin China grew from U S 2 0billion in 1990to US$340billion in 2002. The annualexports increasedfrom US$45 billion to U S 2 5 0billion during the sameperiod. (Source IMF) 21 References Commodity Trade Statistics, UnitedNations Statistics Division, New York Euratex Bulleting 2002/5, Euratex - The European Apparel and Textile Organization, Brussels, 2002 The EUTextile and Clothing Sector, L'Observatoire Europeen du Textile et de L'Habillement, Brussels, 2000 Gordon, J. IMF, ForeignDirect Investment and Exports The Statistical Yearbook of Moldova, Department of Statistics and Sociology of the Republicof Moldova, 2002, Chisinau Textiles, Clothing, Footwear - A World Employer, L'Observatoire Europeen du Textile et de L'Habillement, Brussels, 2000 22 ANNEX: Trade Statistics ImportofYarns,Woven Fabricsand Taiwan Knitted Material US$ 62.3 million (2001) Source: UnitedNations Statistics Division FigureA.1 Sources of all textile materials importedto Moldovain2001 Table A.1 Imports of yarns and various types of fabrics in2001 COttbtl Man-Made OthW Knitted Yam lOOO$ % Fabrics 1OOO$ % Fabrics 1000% % Fabricsl&$% Fabrics 1OOO% % 1142 49% 2460 16% 595 4 % desh 411 5 % 330 2 % 186 1 % nia 521 3 % 165 1 % 138 1 % 425 3 % Source: UnitedNations Statistics Division 23 AppadExports Other Belgium - .- -..a. Romania 2 % Germany 32 % FigureA.2 The total apparel exports were US$91.9 million in2001 Men's and Boys' Clothingof Woven Fabrics Ladies' andGirls'Clothingof KnittedFabrics CMadP Other Netherland8 Othlr 4 % f 1 % 1./. 1 .. OtherClothingProducts Men'sand Boys' Clothinp.of KnittedFabrics Ladies' andGi~is'Clothing of Woven Fabrics ._.. Other 0 */a Figure A.3 Export destinations of various types of apparel products in2001 24 Moldova Trade Diagnostic Study: Wine Sub-sector Case Study September 2003 BuddhikaSamarasinghe EmergingMarketEconomicsLtd. Contents: 1.Introduction.................................................................................................................................. 1 2.Key Wine Export Markets ........................................................................................................... 3 2.1 CIS / Russia Markets........................................................................................................... 2.2 EuropeanMarket................................................................................................................. 5 3 3. Supply Side Issues ....................................................................................................................... 7 4. IndustryCost Structure ............................................................................................................. 10 5. Constraints to Trade................................................................................................................... 11 5.1 Taxation............................................................................................................................. 5.2 Transport ........................................................................................................................... 12 13 5.4 Market Access................................................................................................................... 5.3 Quality and Standards ...................................................................................................... 14 18 5.5 Finance and Credit ............................................................................................................ 20 6.The Roleof Govemment Policy ................................................................................................ 21 7.Prospects for the Wine Sector.................................................................................................... 22 23 7.2 ExternalMarkets ............................................................................................................... 7.1 Addressing Supply Shortages............................................................................................ 7.3 Developmentof a Conducive Policy Environment........................................................... 23 24 8.Conclusions................................................................................................................................ 24 Annex 1:Summary Constraints inMoldova's Wine Sector.......................................................... 27 1.Introduction Moldova's wine sector has and continues to be one o fthe most significant agricultural sub-sectors inapredominantly agricultural economy. As anindustryit accountsfor 5 percent ofGDP, about 25 percent o f exports and accounts for 8 percent of total agricultural land inproduction. Although figures are difficult to obtain, it i s recognisedthat the wine industryprovides employment to a significant number o fruralhouseholds, with an estimated 70,000 individuals, predominantly smallholder farmers involved inthe cultivation of grapes, and a further 15,000 individuals involved inprocessing and allied industries.The significant numbers of smallholders engagedin grape cultivation, as well as those who derive employment from working on vineyards meansthat the industryhaspotentially significant impact on poverty reduction. The main grape growing regions inMoldova are situated inthe centre and southern regions, with rich soils and favourable latitudes similar to those grown inthe Bordeaux and Burgundy regions of France. Moldovan viticulture i s characterisedby a significant range o f grape varieties, predominantly o f European origin (accounting for 90 percent of varieties). The most common white wine varieties that account for about 70 percent o ftotal cultivatedland include Pinot Gris, Chardonnay, and Sauvignon, whilst the remaining 30 percent are grown with redvarieties including Cabernet Sauvignon, Merlot and Pinot Noir. Interms of types of wine produced, semi- dry and semi-sweet wines dominate, accounting for 75 percent o f production. Figure1: Moldova Wine IndustryOutput 10% 5% 10% W Dry Table Wines 0SparklingWines 0FortifiedWines Source: Moldova Export Promotion Organisation, 2002 The wine sector includes the production andbottling o fwine and other beveragesobtained fkom the fermentation ofvine-grapes. Typically wineries are classifiedinthree maingroups: Primary productionwineries which process grapes into raw wine; Secondary productionwineries which bottle up the wine; Mixedwineries where bothprimary and secondaryproductions are combined. The wine processing industryinMoldova comprises of 126primary production wineries, 6 secondaryproductionwineries and 18 mixedwineries, 7 brandy factories and 9 sparkling wine 1 producers, with almost all the wineries privatised" whilst all vineyards inMoldovaare privately owned. The majority o f wineries do not own the land, as i s commonpractice inother wine growing countries, but insteadrent from groups of farmers that have consolidated their land holdings and formed into private companies after the landprivatisation processz1. The total vineyardareahas seen adecline of over 40 percent since the mid 1980s, to about 120,000 hectares in2000 (Ministy ofdgriculture, 2002), due to: (i) President Gorbachev's anti alcohol policy; (ii) the fragmentation that occurred duringthe landreformprocess; and (iii) the relative price changes to inputs following independenceresulting insignificant terms of trade decline". Technologies basedon these previously distorted energy pricesbecame, inmany cases, economically un-viable, which prompteda few of the largest companies inthe sector to purchase modem equipment for grape processing, wine storage and bottling, mainly from Westem Europe. Despitethis investment prior to the privatisationprocess, capacity remainedlow with most enterprises usingonly 20-30 percent of their production capacity (International Business and Technical Consultants Inc., 1999). The majority ofenterpriseswithin the sector, immediately after the privatisation, were characterised by obsolete primary wine making equipment often affecting the wine's quality. This was compounded by a slow enterprise restructuring process that came at high cost to bothfarmers and the economy ingeneral. Many hadproblems of ownership, management and control, the results o f which were a large accumulation of debt and lack of investment. This ledto limited marketingopportunities for the farmer's grapes and low prices. The low prices inhibited the supply response, curbedrevenues andpreventedthe critical reinvestment requiredfor vineyard replanting. Thus in 1999 only about 500 hectareswere plantedwhilst over 15,000 hectares were uprooted. Thus a depressed spiral of lower producer levelpricesandaging vineyards, hada significant effect on overall production. Despite the reduction indomestic grapeproduction, the volume of wine bottledhas seen a steadyrise of over 32 percent since 199523.This increasehaspartlybeen attributedto changes inconsumer tastes inthe key export markets of the CIS, namely increased demand for higher quality lower alcohol wine products, and increasing preference for bottled rather than bulkwines, particularly inthe large urban centres. Coupled with this development has beenthe needfor wineries to increasecapacity utilization for the new bottling lines. With limited grape supply there has been a trendto import some bulkwines into the country for blending with local wine products, althoughthis remains very small (1.1 million liters in2002) incomparison to the total wine exported. Muchofthis importedbulkwine over the past few years have originated from Italy and Spain (over 65 percent), with other significant importers beingRomania and Bulgaria. The wine industryis currently undergoingaprocess ofchange, drivenbyprivately owned distributors, suchas "Acorex", and "Vinorum". These distributors were initially wine traders focused on the Russian market, but through profits obtainedfrom trading and other activities, have taken the opportunity presented through the privatisationprocess to purchase selected wineries inthe central and southern regionso fthe country. These players are becoming 2o The remaining 11 state controlled wineries have been placed on the privatisation list with the exception of Onoteca winery of ''Cricova.landreformprocess The pursued in Moldova was flawed in that it created a legacy of fragmented land parcels, however in the past 3 years a process of re-creation of larger farm units through the renting of land to "leaders" has meant concentration of operations on these farms. 22 Fuelcosts and chemicals used to maintain vineyards in Moldova are estimated to represent 60 percent of the final farm gate price o f grapes (Rusu, 2000). 23 Basedon Ministry of Agriculture figures 2 increasingly influential inthe organisation of the wine industry inMoldova, as the few remaining larger State controlled wineries continue to behamperedby limitedinvestment inmachinery and processes, as well as ownership, management and control issues. 2. Key Wine ExportMarkets Itis estimated that Moldovanwineries produce about 120millionbottles of still wine ayear, and 20 millionbottles of sparkling wines, ofwhich less than 7 percent are sold inthe domestic market, whilst the remaining 93 percent are exported. The main market for Moldovanwines remains Russia (accounting for over 80 percent of exports), where Moldovan wine has strong brand awarenessamongst consumers datingback to the Soviet era. The other mainmarkets for Moldovanwine are Ukraine, Belarus, Kazakhstan, and more recently, a gradual increase in exports to western Europe, and Germany inparticular. Bottled still wine i s the main export commodity to all these markets. However, there remains a considerable market inbulkwine exports, predominantly to the CIS market, although from 1997to 1999there was slightly more weightingto non-CIS countries, as firms bottledMoldovanwine inBulgaria andRomania andre- exportedthemto Russia inorder to avoid the highexcise duties payable inMoldova, at the time. Figure2: Exports of BottledStillWine Germany Latvia Kazahstan W 2002 02001 Ukraine 2000 Belarus W 1999 1998 Russia 0 2000 4000 6000 8000 10000 12000 Thousandx Dal Source: Moldova Export Promotion Organisation, 2002 2.1 The Russian/ CIS Market The Russianmarket remains the mainoutlet for Moldovan wines, and has over the past five years accounted for over 80 percent of Moldova's still bottled wine exports, and over 75 percent o f bulkwine exports. Moldovanproducers have historically competedinthe low andmediumprice segments of the Russian market, which have tendedto demand semi-dry varieties, and where the flavour profiles of their wines are familiar and often preferred over international varieties. Moldova's export profile i s similar to other CIS wine producers, most notably Georgia, where exports remain highlyconcentrated (estimated to be inthe region of 70 percent) inthe Russian market. Figure 3 highlights the major wine importers into the Russianmarket. The Russianmarket continues to be dominatedby demandfor redwine, whichmakes up 71 percent o f sales inMoscow and 64 percent inother regions of the country. The total volume of wine consumed annually inRussia is estimatedto be 300 million litres (USDA,20021, which represents a low annual per capita consumption rate compared to Westem European markets. However, per capita wine consumption has seen a rapidrise since 1998. With consumers continuing to switchfrom vodka, to "softer" alcoholic beverages,resulting inan increase inwine consumption and imports, particularly amongst younger more affluent Russians. I I Figure3: RussianWine Imports 140 120 -c4! 100 Moldova f 80 Georgia 0Other CIS 52 60 40 0Other Foreign 20 n I 1998 1999 2000 2001 Source: USDA,2002 Nearly all of the wine consumed inRussia i s importedby about 50 trading firms, which are based inMoscow andSt. Petersburg.Mostofthe Moldovanexporters have either strong linksto these companies or insome instances established some of these trading housesthat serve as wholesaler / distributor oftheir wine portfolios. Ingeneral mosttrading houseshave two departments, one in charge of distribution to speciality stores and supermarkets (where the bulk of wine sales are made), whilst the other i s responsible for hotel / restaurant sales. Trading companies often demand exclusivity for the distribution o f a wine exporter's product, whilst the number of wholesalers regularly doing business andlegally operating inthe market i s limited-it i s estimated that this has declined from 2,500 to about 250 wholesalers. Hence for wine exporters with limitedcontacts inthe market, the ability to choosethe rightdistributor becomes a critical factor for market success. Moldovanwine producers were significantly affected by the Russian financial crisis, with the devaluation ofthe ruble leadingto a 43 percent decline inthe exports of alcoholic drinksbetween 1998 and 1999. Since this period there has been a slow recovery inexports bothinvalue and volume terms, however, by 2001 Moldova's market share had declined to 48 percent, from nearly 60 percent 1997, despite the fact that Moldovanwines are not subject to duty inthe Russian market24.Part of this decline can be attributedto a gradual change inthe market demand for wine, to better quality, semi sweet and dry wines, which has ledto increasedcompetition from other producers of lower quality wines, most notably from Bulgaria, Georgia, and Hungary. Incontrast, Moldovanwines have beenviewed as a commodity product, with very little attentionbeingpaid 24NonCIS wines pay a 20 percent import duty into the Russianmarket. 4 to wine quality and packaging. Thus highermargins" that Moldovan wine exporters had enjoyed inthe past for selling a comparable quality productinthe Russianmarketas opposedto other non-CIS markets i s rapidly declining, as competition increases from within the CIS and Eastern European Countries. Thus there i s a growing realisationamongst Moldovan exporters for the needto move up the quality chainto slow the slide inmarket share and remain competitive inlow price market segment, where bottles retail around US$ 1.80 -2.20 per bottle. However, with lower margins and increased competition intheir traditional market segment, many of the larger Moldovanexporters are beginningto target the mediumprice markets where bottles can commandprices of US$3.00 and upwards. It i s worthnoting however, that the inability to reduce the reliance on the Russianmarket for the foreseeable future continues to expose the Moldovan wine industryto substantial external demand shocks. The Ukrainian market i s the secondlargest export market for Moldovan wines inthe CIS. Moldovanwines have a similar market positioning to that of the Russianmarket, i.e. sales of sweet wines, on a quantity basis. The market had seenmoderate increases involumes of product exportedover the past three years, although accounting for a relatively stable 4 percent of the total value o f exports. Moldovapredominantly supplies bulkwine to the market, which accounts for about 70 percent of exports, whilst Cognac and still wines make up the remainder of exports. This status quo is threatenedbythe deterioration of tradingrelationsbetweenthe two countries, particularly from the beginningof 2003, when the Government of Moldovaruled to remove Ukrainian ethylic alcohol from the two countries free-trade agreement. Subsequently the Government o f Ukraine retaliated by imposing similar restrictionson Moldovanproducts. In addition the Ukrainian association of wine and tobacco producers has recently announcedplans to file a request for an antidumping investigationinto the imports o f wines and cognacs from Moldova. These trading disputes are likely to have a short-term impact on the sector, with a probablere-direction of trade to other CIS member countries however, many industry commentators suggest that this will be a temporary phenomena fuelled by the poor inter-state relations at a political level, exacerbating the narrower technical grounds for limitingtrade flows. Thus there is an expectation that previoustrading levels will resume. Other markets inthe CIS have tended to play a less significant role as final destination markets for Moldovanwine, although some redirection of trade continues to occour to other markets in the former CIS, most notably Belarus and Kazakhstan. 2.2 The EuropeanMarket Thekey Europeanmarkets for Moldovawine remainpoorly developed, partly reflectingthe poor quality o f wine products producedinMoldova, and limited exposure of wineries and exporters to distributors and wholesalers inthe various European markets. However, with the advent of privatisation and refinancingthat was providedby the new owners, there has been a process o f updating technology and management systems insome of the larger wineries26,which has allowed a sufficient improvement inquality and packagingto undertake the tentative first steps of developing modest volume exports to the Europeanmarket. Much of the wine exportedto the EUhas tendedto be inbulkform, and focused on a variety o f markets primarily insome o f the accessioncounties of EasternEurope, such as Bulgaria and Romania. Interms ofbottled wine, exports to the Germanmarket and the Latvian market are the 25Discussionswith key wine exporters suggest that this premiumcouldbe as highas 25 percent 26This hasoccurredmainly inthe 30 wineries that havebeen able to obtain foreign capital 5 most significant as indicated inFigure 4. The German wine marketremains the largest market in the world for importedwines, with over 50 percent o fwine consumed comprising o f imported wines. Moldova wines predominantly serve the lowest price segment o f the market, and face significant competition from Eastem Europe wines predominantlyfrom Bulgaria, Hungary and Romania. Despite the fall inwine imports by over 7 percent, both invalue and volume terms from these competitor countries, Moldova wine imports continue to rise as indicated inFigure 4. Withinthe EUmarket the role o fsupermarket chains inthe retail of wine have beengrowing steadily since the late 1980s, ledby the United Kingdom, but gradually spreading throughout the member states o f the EU.These retail outlets work on margins o f 15-25 percent rather than the conventional 35-50 percent, which has impactedon importedwines, particularly to the lower quality end, where Moldovan producers currently compete. This segment has seen a squeeze on price whilst there i s continual upward pressure for improvements to quality and packaging. Thus although German supermarkets and hypermarkets have organised a wide variety and range o f wine presentations over the past few years, particularly from "newer wine growing regions", the Moldovanindustry has not been able to successfully break into the market due to concem over quality and reliability of supplies. These perceptions, have tended to moderate the rate o f expansion into the market, despite some success by the larger wineries incultivating contacts withthe traditional wine distributors and wholesaler networks. Throughthese channels Moldovan exporters have commenced modest shipments o fbulk and still wines into the market. I Figure 4: Moldova Exports of Still BottledWines to Europe 160 140 - 120 5 100 1;1Latiia C 80 3 W Romania 60 Germany 40 20 0 1998 1999 2000 2001 2002 Source: Moldova Export Promotion Organisation, 2002 As with all EUmarkets, wine imports are subject to tariffs which vary from 10percent to 33 percent, depending on the nature o f the product and whether they are bottled incontainers greater than or less than 2 litres. Wines containing less than 13 percent o f alcohol are subject to a duty o f between 15.3 euro and 11.6 euro per 100 litres, depending on the size o f container it i s packaged in,aswell as VAT, whichinthe case o fGermanyis 16percent. Table 1provides abreakdowno f the tariff rates for the import o f wine products into the EU.As can be notedthe duties applied are considerably less for bulkwine imports i.e. incontainers o f over 2 litres than it is for those o f less than 2 litres. 6 Table 1: TariffRatesfor ThirdCountry Importsto EU Product Duty (Euro / hecto-litre) for Duty (Euro / hecto-litre) for Containers of 2 litres or less Containers of greater than`2 litres Wine (alcohol of less than 15.3 Euro per hecto-litre 11.6 Euro per hecto-litre 13 % volume) Wine (alcohol ofbetween 17.9Euro perhecto-litre 4.1 Euro per hecto-litre 13 - 15 % volume) Other (alcohol ofbetween 24.4 Euro per hecto-litre 24.4 Euro per hecto-litre 18 - 22 % volume) Source: Wine Vision Global Exporting, 2002 However, major competitors such as Bulgariaare able to access the EUmarket through export quotas on a duty free basis makingtheir wines more attractively priced inthese low cost market segments.These agreementssupplement the initial "double zero" accords on agriculture, and under the new wine agreement imports under the quota enter the market on a duty free basis, thus eliminating EUimport duties levied at 10-33 percent ad valorem. Deeper penetration into the EUmarket, thus can only be realistically achieved inthe longer term with significant improvement inthe quality andreliability of supply, with a significant marketing effort to introduceMoldovanwines as low cost alternatives to wines from Bulgaria andRomania. However, Romaniaand Bulgaria has already obtained a significant advantage, through duty free entry into the EU, and equally importantly significant inflows of foreign investment inthe wine sect03~over the past five years which have seenthembenefit from newer technologies, know how and experience intrading and access to major Europeanbuyers. Although Latvian wine importsrepresent a marginal share of wine imports on the international stage, its demand for foreign alcoholic beverages has grown steadily, with wine imports doubling from 1997to 1999.Moldovanexporters account for about 14percent o f the wine market, which compromises mainly o f its "Kagor" wines, that target consumers inthe low and lower to middle incomebracket comprising of younger consumersand ethnic Russian consumers. As with the Russianmarket there have been significant improvements inthe presentation and bottling of the product, however, the quality remains variable and i s a maincause for the negative perceptions that Moldovan wine productshave inthe market. Despitethis significant progress has been made interms ofcognacmarketsegment where the "Belii Aist" brandisinhighdemandamongst consumers inthe middle incomebracket. 3. Supply Side Issues The production o f grapes had seen a significant decline of over 18percent duringthe period 1995 -1998dueto(i) fragmentationofthelandholdingofvineyardsafterthelandreformprocess the which ledto many producers owning small lines of vines within vineyards; (ii) the mass (voucher) privatizationprogram2*,which ledto many wineries continuing to have a lack of investment and a lack o f separation o f ownership and control, with many failing to pay farmers for the grapes supplied. Inaddition, a reduction of indirect subsidies inevitably reduced production volumes, and has been an inevitable part of market reform. Inputadjustments followingthese price changes, particularly for fertilizers, are a key factor to explaining the output decline. ''FDI in Bulgarianwineproductionhas increasedsignificantlyover the pastfive years from US$ 16.6millionin 1998to over US$81 million by 2001 Fiftypercentof the shares were distributedto farms that providedraw materials inthepast, inproportionto their volume of supply 7 The situation inMoldovawas similar to that found inRomaniaandBulgariaat the beginning of the transition period. However, these countries had the addedbenefit ofpreferentialaccess to the EUmarket, andthrough aperiodofrelativepolicy stability, foreign investment hasplayedan important role inproviding access to muchneeded foreign capital, know-how, technology and access to major Europeanbuyers. The yield productivity o fMoldovanvineyards i s low, for instance in2001, the average white grape yield was 3.1 MT/hectare (Ministry of Agriculture, 2003), which comparespoorly to that in key competitor countries such as Georgia where yields in2001 were about 5 MThectare, although they were not significantly lower than other major rivals inthe CEE, such as Bulgaria (3.2 MThectare) and Romania (3.4 MThectare). Despite this these yields remainextremelypoor incomparisonto internationalstandardssuchthe EU-15 averageof 7.8 MT/ hectare, andthose of Australia where average yields are over 13 MT / hectare. The primary reason for the low yields are due to the limited applicationof inputs(particularly fertiliser and crop-protection chemicals), limiteduse of irrigation, as well as limitedtechnical skills by farmers that have inherited small tracts o f vineyards through the privatisationprocess. Table 2: GrapeYield Comparison(MT / ha) for White GrapeType Moldova Bulgaria Georgia Australia Average 3.1 3.2 5.0 13.6 Source: Ministry of Agriculture /DCNAssociates, 2003 Despite this situation since 1998, as Figure 5 indicates, there has been a recovery inproduction causedby increases inyield from a low point of 2.3 MT/ hectare in 1998, and a reduction inthe productionof wine for home consumption as the wineries moved away frombarter trade and the rural economy became increasingly monetised. The transformationof the situation, however, was drivenby two significant developments that were anoutcome ofthe reformprocess. The privatisationprocess, coupled with stronger bankruptcy procedures has ledto a significant transformationinthe ownership structure and investment into the sector. It has allowed investors with access to significant financing to take control ofthese enterprises, thusmoving away from the barter / lowprice environment that many farmers faced, to onethat with further investment in machinery*' has increased demand for grapes inthe rural areas. 29Investmentsinprocessingequipmenthas resultedinsome improvementinwine quality 8 I Figure5: Grape Production I 800,000 2 700,000 <% S 600,000 500,000 400,000 ElGrape Production 300,000 r 200,000 2 100,000 0 1997 1998 1999 2000 Source: Moldova Department of Statistics, 2002 The secondphenomena which has emerged as a consequenceo fthe landreformprocess andthe substantial out-migration of the ruralpopulationhas been the consolidationof vineyards, through longterm leasing arrangements(often over 25 years) with many o f the smaller farmers. These new consolidated vineyards are often managedby leader^"^', and frequently form themselves into firms. The firms or "Agrifirma" have been able to obtain pre-financing o f inputsand insome cases technical assistancethrough the privatizedwineries, particularly those with foreign ownership. Ina few cases wineries have been able to directly rent out land from farmers for a 25 year period, and re-establish grape production. The recent transformationofthe wineries has abruptly revealedan excess demand for quality grapes, which despite the increase inproduction can not be satisfied by the ageing vineyards. Replanting these ageing vineyards has been a slow process, with only about 530 hectares, replantedin2002 as opposedto over 4,000 hectaresbeinguprootedinthe same year. The cost o f planting and maintaininga vineyard duringthe four years untilit bears fruit, i s estimated to inthe region of US$ 10,000, which has meant that replanting can only be realistically initiated by wineries that managedto rentland from private farmers or Agrifirma. However, many of the newlyprivate wineries have insufficient investment and lack of financial resources to undertake a significant plantingprogramme, whilst those enterprises with foreign partners have placed immediate emphasis on upgrading o f winery processing equipment, which can have an immediate affect on quality. Although sourcing o f quality grapes will remain a problem inthe short to mediumterm, with some wineries continuingto obtain grapes from within the region, most notably Bulgaria and Romania, it i s understood that those wineries with foreign partners3*will place greater attention to vineyardre-planting from 2003. Many o f these firms have completed the process o f upgrading equipment, and subsequentlyhave funds available for direct purchase of, and/ or rental of land suitable for vineyard cultivation as well as through longterm contractual relationshipswith "Agrifirma". Through discussions with winery owners and key stakeholders it has been indicated that between 1,500 and 2,000 hectares are likely to be replanted during2003/04, which i s expected to increaseinsubsequentyears. 30often former collective farm managers or brigade leaders 31Estimatedto be about 30 Wineries accordingto data from MEPO and the Ministryof Agriculture 9 Theprocesso f working more closely withAgrifirma and insome instanceswineries vertically integratingoperations, are likelyto increasequality and reduce costs, particularly transaction costs of grape collection and for on-farm investment as wineries will needto deal with fewer entities, bringing wineries closer to the Europeanmodelwhere most own their own vineyards. The likely consequences of these actions are that smallholder producers will beprogressively squeezedout o f grapeproduction, which will naturallyhave significant negative implications for poverty inthe rural areas. Withmarketing channels for grape limitedinthe major growing areas, as wineries source increasingly greater quantities from Agrifirma and their own productionplots, it is likely that farmers willrevertbackto more subsistenceforms of crop production, and continue, where available to rely on remittances fromhousehold members located inthe major urban centres or from overseas. The replantingprocesshas ledmanyproducers to take the opportunity to obtainbetter quality rootstock, from traditional wine producingareas inWestern Europe, most notably from France and Italy. However, the cost of importing vines remains highand i s estimated to between US$ 1- 1.20per vine. Inaddition firms also needto obtain approval from the National Instituteof Grapes and Wine, which althoughwas not indicatedas a significant problem for the enterprises interviewed inthis study, it was considered a time consuming process. Inorder to overcome this recent initiatives have beenunderwayto develop higher quality rootstock throughjoint ventures with Frenchfirms, one of which i s expectedto yield about 500,000 vines per year. The cost of grapeis likely to increaseinthe short andmediumterm as labour shortages grow duringpeak harvesttimes due to out-migration3*,whilst harvests fromreplanting will only be reapedafter 6-8 years. With other countries inregion, suchas Romania and Bulgaria, facing similar problems, it i s envisaged that shortagesof grapes will last for the foreseeable future. Thus the continued pressure onthe domestic grape price is likely to leadto further pressure for Moldovanproducers to progress up the quality chain, andmay encourage more wineries to vertically integrate into the productionof grape. 4. EstimatedIndustryCost Structure The privatisedsegmentsofthe wine industry continue to be dominatedby large distributing companies, many o f them havingRussian capital or beinginitially trading arms o f Moldovan wineries that were set up inRussia to promotetheir various brandnames, but subsequently established themselves as companies intheir own right.With few independent wineries working on their own (it i s estimated that the large distribution companies control about 80 percent of the market), and continued reliance on the Russian market, it i s possible to view a low to medium quality bottledredwine as a representative product from which to make an assessment of the cost structure presently facing the majority wineries inMoldova. The figures indicatedinTable 3 represent estimated based on consultations with several wineries during the course of the study, and provide a guide to the relative magnitudes of costs incurredinproducing wine inMoldova. Unlikeother CIS competitor countries, Moldovan producers have a strong preference for the importationof corks and some packagingmaterial, 32There are no reliable statistics on migration either in terms of numbers nor countries of destination as many migrate travelling on Romanianpassports or through illegal channels, especially into the European Union. Estimates of the total number who have left in the past three years vary from 500,000 to over 800,000, representingat least one third of the economicallyactive population, with a largeproportionoriginatingfromdepressedrural communities. 33Basedonapproximationsobtained through discussions with 3 wine exporters and the Wine Exporters Associationof Moldova 10 from Westem Europe, which significantly has not be drivenby internal or extemal market regulation. Table3: DirectCost StructureinMoldovato Producea Low to MediumQualityBottledRedWine (Prices inUS Dollars) Imported Domestic Percentage Inputs Inputs Purchase o f Grapes and transport to factory 0.95 70 Yo Processing (fermenting and filtering) 0.14 10 % Bottle 0.08 6 % Cork 0.04 3 Yo Labels andPackaging 0.08 6 % Cost o f certification 0.02 1% Transport to Boarder 0.05 4% Sub-Total(FOB) 0.12 1.24 As a percentage of the total FOBprice 8.8 % 91.2 % The indicative direct costs for Moldovan producers are similar to those reported inCIS / CEE competitor countries such as Romaniaand Georgia, with the cost of grape constituting the major cost o fproduction, whilst the cost of corks and packagingproducts being higher inMoldovathan those inthe majority o f the CEE countries, as producers have historically had a preference for imported corks and labels. For many o f the European wineries that owntheir own vineyards, the cost o f grape productioni s reported to be less, estimated to be inthe region of 50-55 percent in Germany, much o f which i s taken up by the highercost of labour. Other costs comprise of a similar proportion to that faced by Moldovan producers, although certificationand transport costs are less, whilst taxes and depreciation o f buildingsand equipment are includedintheir balance sheets, however, the authors were not able to obtain estimates o f these costs. 5. Constraintsto Trade Moldovanwine exports remainto be heavily dependent on CIS countries, and particularly Russia, as the major market for its wine products. Inthese main export markets Moldovan producers continue to have preferential access, through free trade agreementswith Russia andUkraine, as well as Romania, despite the fact it i s an EC accessioncountry. However, inspite of these preferences there are often inconsistent applications of these free trade regimes amongst member countries, and divergences inthe implementation o f various rules and regulations that negatively affects wine exports. 11 The following sections and Annex 1will highlight the key constraints indicatedindiscussions with wineries, distributors and stakeholdersfromthe wine industry inMoldova, with the discussion differentiating constraints according to the CIS market and the Europeanmarket. Table 4 attempts to summarize the costs, where ithas beenpossible to ascertain from stakeholders, o f the main constraints to trade. The figures provide an order of magnitude assessment o f the costs of these constraints to wineries, however, this will naturally vary for individual consignments due to variations invalue andvolume. Table4: Summaryof EstimatedCoststo Wineries of The Main Constraints to Trade Constraint Cost to Wineries as YOof totalFOB 2 - 3 percent price Delay inthe payment of VAT and Exciserefunds Laboratory testing charges for EUVI certificate 2 - 3 percent Impositionof transit bonds for transit through Ukraine 1.5 - 2 percent Transportationrequirements for transit through Ukraine 1percent EUtariffs onwine products 10percent Restrictions on the use of U S $ denominated loans 3-4 percent Delay inrepatriationof funds fines 1percent 5.1 Taxationand CustomsAdministration The wine industry's contribution to the Govemmentrevenueshasbeenthrough three forms o f taxes, namely, corporate taxes, Value Added Tax (VAT) and Excise taxes. Historically, agriculture's tax contribution share i s considerably lower than agriculture's share of GDP, which has ledto a general skepticism from Government towards exporters. Suspicion amongst Government officials remains, often with somejustification, that smuggling, under-valuationof imports, and transfer-pricing are endemic within the industry.Hence there i s aperceivedneed for tighter administrative controls to ensure that the wine sector, beingone ofthe key contributors to the economy providesa representative proportion ofthe total tax take. Itis within this background that the Government hasplacedvarious taxes onkey inputsinto the production process, which shouldintheory be refundedifthe produce i s exported, given the fact that the Government uses the destination principle for indirect taxation. The Government currently places 5 percent VAT on domestically producedgrapes, as well as a 20 percent VAT and 30 percent Excise tax on importedbottles and corks. Intheory all excise taxes are reclaimable with the exception of and althoughmany wineries face delays inreceiving their refunds, none indicatedthat this was a serious constraint to trade. Despite the Government's best efforts, delay inthe payment of VAT and Excise refunds remain a significant constraint to all wineries and exporters. Delays of over 6 months from the date of lodginga claim are commonplace, whilst ina number of instances, exporters reportedthat full claims were not refundedafter one year. Untilrecently exporters within the industrywould trade VAT receivables at a 10percent discount to reduce the impact ontheir cash-flow. However, with Govemment closing this loop hole, many firms have had to incur additional cost interms o f hiringstaff(insome casesupto 12individuals on a full timebasis) to liaise with the Tax authorities to reclaim the refunds.These measures, naturally add a significant cost to the firms 34Under WTO regulationsno direct subsidy on excise for fuel destined for road transport can be reclaimed 12 and can reachbetween 2 3 percent of - (depending on the volume andvalue of exports) ifthese taxescannotberefundedwithin 1year.Muchofthiscost is attributedto additional interest payments and staffing costs incurredinpursuingthe refund. This effective tax on exports, can be significantly higher, as these indirect taxes are often not reimbursedinfull. Text Boxl: DocumentsRequired to Clear Moldovan Customs for the Export of WineProducts ICIS/Russian Market European UnionMarket 1,Export Licence 1.Export Licence 2. Certificate of Origin 2. Certificate of Origin 3. Certificate of Conformity 3. Certificate o f Conformity 4. Wine Test Report 4. Wine Test Report 5. Hygiene Certificate 5. Hygiene Certificate 6. Phyto-Sanitary Certificate 6. Phyto-Sanitary Certificate '7. Commercial Invoice 7. Commercial Invoice 8. Declaration of Currency Repatriation 8. Declaration of Currency Repatriation 9. Deedo f Conveyance 9. Deedof Conveyance 10. Transportation Documentation 10.Transportation Documentation 11. Certificate that Authenticates the Existenceof a 11.Certificate that Authenticates the Although Moldovainpractice follows a streamlined, EUcompatible Customs Code, the custom procedures, are widely recognized by the major wine exporters as beingcumbersome and extremely bureaucratic. Text box 1highlightsthe documentation that Moldovancustoms require to export wine to the CIS and EU, however, the limitednumber o f wineries interviewedas part o f the study didnotindicatethat these hurdles posedsignificantproblems or costs for their exports, although costs for certification, particularly the VI 1is discussedlater inthe report. With the number o f documents required, the quantity o f wine that passes through the borders on a daily basis, and detailed customprocedures, the demands on customofficials i s highand often exceeding their administrative capacities. Thus payment o f some sort i s usually undertakento speedup the complex customs clearance procedures. For the CIS market, exporters often use their subsidiaries or agents to pass goods through customs inthe final destination markets. For the Europeanmarkets the customs clearance procedure i s less complicated and cleared by the domestic wholesaler / retailer. 5.2 Transport The poor quality o f transport infrastructure, particularly interms o froadandrailwaynetwork does place some additional burdenon exporters, althoughwine exporters have not indicatedthis as beingone of the more significant constraints to trade. ''Interestcharges estimatedat 24 percent, additional costs that are estimated to account for US$0.03per bottle 13 Mucho f the wine to Russia i s transported through the railnetwork, where the risk ofpilfering remains high,particularly through Ukraine and into the Russianborder, although the quantities stolen i s often small, estimated to be less than 1percent o f the cargo. Thus the quantities stolen are often too small to be recovered through an insurance claim, and therefore many of the larger firms use "hired-hands'' to protect their cargo. Despitehaving a free trade agreement with Ukraine, transit through the country places significant cost to all Moldovanwine exporters. It i s understoodthat the Ukrainianauthorities have recently introduced an additional requirement for producers exportingbulkwines duringthe winter months, the precise rationale for this was difficult to ascertain, as this has notbeen a requirement from any of the importing CIS countries. Moldovanproducers will now be requiredto use specially heated railway wagons to transit throughUkraine, which adds significantly higher transportation costs (with one winery estimating this requirement to add about 1percent to their invoice value) and can be construed as a discriminatory technicalbarrier against Moldovan wine exports. The sudden introductionof this newregulationhighlightsthe poor inter-state relations between both Govemments at apolitical level, which has ledto the introductionof measuresto limittrade flows. Trucks are often used to transport goods to the other CIS markets particularly, Belarus and Kazakhstan, where goods are insured(due to the distances covered) at about US$ 100per truck. The poor quality ofthe roadnetworkwithin Moldova andaround the region was not seen as a significant issue for the wine exporters, interms of increased costs due to damage sustainedin transit or due to damage of trucks en-route to the final destination markets. Trucks are also usedfor the transport ofbulk and bottled wine to the European markets, however, given the very low quantities currentlyshipped, many exporters reported no significant problems obtaining trucks that satisfy standardrequirements for carrying freight through Europe. However, iftrade continues to develop to thesemarkets, particularlyto Germany, thenthe agingtrucking fleet and limitednumber of trucks that satisfy European standards, are likely to increase freight costs to these markets, and ultimately, given that transport costs represent between 5 to 7 percent of the value o f the consignment, the overall cost of Moldovan wines inthese price sensitive markets. With the significant experience of exporters and transporters o ftransiting wine, longwaiting time at various border crossings, especially those transiting through the Ukraine, have been minimized and are not seen as adding significant cost to wine exports as bulkandbottledwines are not perishable products. However, transporters are frequently requiredto make a significant number o f illegal dues and fees to ensure the goods are able to passthrough the various borders to the Russian and CIS markets, as well as getting through the Ukraine boarder for the European markets . 5.3 Quality and Standards Moldovan Wine exporters are faced with a number o frequirements interms o f standardswhen exporting to the key CIS and EUmarkets. The following table below highlightsthe key standards,bothregulatory and industrystandards and issues that producers face inorder to meet the requirementsinvarious markets. 14 Table5: Summary of QualityStandardsRegimesandIssues CIS/ RussianMarket EUMarket Quality Standards Regimeto GOST Standards 117 and . VI 1Certificate Export into Markets .. 118 Russian market also requires GOST R standards Accreditation of Laboratories . Accreditation of . Only one State controlled for Testing Mandatory laboratories to test for laboratory accredited to Quality Standards GOST standards test for VI 1certificate. relatively straightforward. Low volumes and lack of competition for testing Additional "inspection" services makes certificate costs incurred by wineries expensive. for accrediting labs for GOST R standards Labeling Requirements . Frequently changes to . New guidelines labelingrequirements for introducedin2003 the Russianmarket (2 including the restricted changes occurred during use of wording and 2002) terminology on wording, Industry Standards I . Consumers prefer semi- . Consumers prefer dry Consumer Preferences dry wine with alcohol wine with alcohol percentage o f 9 % percentage o f 12% Quality StandardsRegime Since the majority o f wine exports are destined for the Russian and CIS markets, most Moldovan wineries are familiar with Standards 117 and 118 issued by the Russian State Committee on Standards (GOST) which are mandatoryand govern the export o f wine products to these markets. All the major wine exporters indicatedthat the standards do not inthemselves provide any technical problems or additional costs as it i s compulsory for all Moldovanproducers to have a laboratory as part of the MoldovanGovernment's licensingrequirements to operate as a winery. This is the industrystandardpracticeinmost wine producingcountries. Moldovanwine standards are naturally similar to the GOST standards, interms o f analysis for specific gravity, alcoholic strength, volatile acidity, residual sugars, etc. However, the current standards, according to the Union o f Oenologists o f Moldova, does have some anomalies, which it is claimedcanpermit applejuice to be considered as awine product. Although there are some differences inthese standards, the wine industryhas adopted the GOST standards as the basic industrywide standardinMoldova. There were no reported difficulties inobtainingproductthat meets the GOST standards and no wineries interviewed as part o f the study indicated any operational difficulties encountered due to differences between Moldovanand international standards. However, giventhat Moldova exports 90 percent of its wine product, it would seem prudentto harmonize national standards to those of the regional GOST standard to avoid any discrepancies. 15 A significant number o fthe larger wineries are accredited by GOST to test for all parameters for their various standards, particularly those that have significant Russian capital. The direct investment by these companies have been an effective means o f improving the technological capacities and changingrequirements to meet standards inthe Russian and CIS markets. Despite Moldovanwine exporters complying with the current GOST standards, the Russianmarket has recently introduced a GOST R standard. There are several GOST R standards and they include: GOST R 51159-98: General specifications for wine GOST R 51165-98: Sparkling wines standards GOST R 51875-2002 Standards relating to wine materials and cognacs. Exporters that do not have the relevant GOST R standard are liable, at the discretion o f the Russian customs, to have their consignment tested at the border. This naturally will add significant cost to exporters, interms o f the costs o f undertaking the tests and additional transportation costs incurred due to delays ingetting the consignment through Customs. Although many o f the larger wineries do not have problems inensuring they obtain the necessary accredited certification, many o f the smaller wineries consider the cost to be high- for example the cost o f getting the various GOST R standard booklets are estimated to cost over US$ 300. Although this single payment i s highfor smaller producers, the mechanics o f obtaining a certificate i s believed to be relatively straightforward, and given the amount o f volume that i s exported, it i s unlikely to add significant cost to exporting wine to the Russian. European Union standards for wine and wine products are less well known amongst the smaller and mediumsized wineries, but unsurprisingly are familiar with the 20 largest wineries that have had foreign investment, and who have begunlimitedexports into the European market. Wineries exporting into the European Union market are requiredto provide a VI 1certificate from an accredited institution. The VI 1certificate applies mainly for commonly traded wine and wine products, whilst the VI 2 applies only for aged wines - i.e. those o f special vintage, that Moldova does not currently produce, due to issues related to quality, and the cost o f maintaining stocks o f aged wines. The larger wineries have inthe past had difficulty inmeeting the EUstandards, particularly interms o f "tolerance" thresholds (the amount by which the actual alcohol content can vary from the stated alcohol content). For table wines there i s a tolerance o f OS%, while sparkling, effervescent, and liqueur wines have a tolerance o f 0.8%. The difference inmeeting these tolerances inpart reflect the difficulties inobtaining a uniform product that i s sourced from numerous smallholder producers, with limited control o f quality duringthe harvesting process. Despite these difficulties most o f the wineries interviewedas part o f this study didnot view this as a significant constraint. Inaddition, the process o f vertical integration and greater foreign investment inthe larger wineries are likely to see these problemsbeing overcome inthe next 5 to 7 years as progressively more wineries gain direct control o f the grape growing process. Accreditation of Laboratory Facilities Inadditionto the standards themselves, manyMoldovanwineries, have indicatedthat the process of obtaining accreditation for their laboratories for the GOST and GOST R standards frequently adds to the costs o f export. Many o f the larger wineries "invite" Russian inspectors to visit their factories on an annual basis to ensure that their facilities comply with the standards intesting and quality demanded on the Russian market. These "inspections" are fundedby the wineries and are consideredpart o fthe cost o f ensuring smooth passage through Russiancustoms for wines certified by their laboratories. 16 Since 2002 there has been some controversy regarding the status o f accreditationfor the sole laboratory in Moldova able to issueVI 1certificates, which i s state TextBox 2: Labelling controlled. The Department of Moldvin i s responsible Requirementsfor the Russian for the ensuringthat this laboratory has necessary Market infrastructure to continue testing, and i s re-accredited every year inthe Official Journal of the European Labels need to be inRussian and Union. However, during2002, the Department of shouldcontainthe following Moldvinwas unable to receive re-accreditation for the information: laboratory, inpart reflectingthe fact that the laboratory didnot have all the equipment necessaryto m Name of the Producer test for all the parameters for VI 1, which caused Legal address of the Exporter problems for exporters, with many winerieshaving to Name o f the Importer obtain certificates from accredited laboratories inthe Legal Address of the importer final destination markets. Although this process did Origin o fthe Product not add significantly more costs for the e~porters~~, it m Type o fProduct didadd time delays to exports. However, since ProductDescription February 2003 the laboratoryhas beenre-accredited. Date of Production Despite this, skepticismremains from the industry Date of Expiry regarding the ability of the laboratory to test for all the Storage Requirements parameters under the VI 1 standard. Volume of Contents per bottle due to the low volumes that are currently exported - usually these consist o f Laboratory charges for testing VI 1remainhighand are estimated to be inthe region of US$0.04 certificate. Currently this representsabout 2 - 3 percent o f the consignment value. With only one consignments of about 15,000 bottles, frequently with 3 or 4 different brands, eachrequiringa laboratory accredited there remains concern that producers are receivingnon-competitive prices for this testing. As volumes increase it i s hoped that additional laboratories will be accreditedto ensure a competitive market develops. Labelling Requirements Labelling requirements for the Russianmarket have a reputation for frequent changes with little notice givento the exporters. Exporters are requiredto meet these standardsinorder to import their product into the final destination markets. Moldovanproducers have during2002 witnessed at least 2 changesto the labelling requirements, which adds to re-printing and re-design costs o f the labels. The labellingrequirements, as they currently stand are not significantly different from requirements inother markets, with the exception of the requirement for a date o f expiry, which i s unusual for wine, as older wine, particularly redwine which predominates inthe Russian market i s consideredbetter with age. Since January 2003, the European Commission has issuednew guidelines for wine labelling, which includes the restricteduse of wording and terminology on labels. Although there i s currently a transition period, the length of which currently remains ambiguous, where wine has already been labelled will be able to enter the market. Inpractical terms, it i s envisaged that there will beno substantive negative impact onMoldovanwines, given that most wines are imported in low volume and are destined for the bulk wine segment o f the market. 36The costs incurred for the exporters only referred to the dispatch o f about 6 samplebottles of wine to the accredited the laboratory in the final destination market and obtaining customs clearanceform the Moldovan Department of Customs. 17 Industry Standards / Consumer Preferences The Russian/ CIS and EUstandardshave some variability butthe major differences lie in consumer preference requirementsbetweenthe two markets. For instance the Russian market accepts semi dry wine, with an alcohol percentageof 9 percent whilst the European market demands predominantly dry wine with an alcoholpercentageof 12percent. Inorder to obtain the higher alcohol percentage, wineries have to obtain grapes that contain 22 -23 percent sugar content, which requires apremiumpayment, and i s often difficult for growers to maintain given the current state of vineyards. The on-going investments inestablishinghigher quality vineyards and the closer integration of vineyard and processing operations are likely to see improvements in this situationinthe next 5-10years andthusnot a significantbarrierto trade. Inadditionthe increasing sophistication of the Russian consumer, coupled with their changing tastes for wine products i s likely to see consumer preferences gradually move towards those of the EUconsumer, which will require Moldovan exporters to pushfor continued quality improvements to compete in the existing Russianandemerging EUmarkets. 5.4 Market Access Moldovanwine producers continue to benefit intheory throughpreferentialaccess to the CIS and Russian markets, however, the inconsistent application of some o fthese regimes, have increased the cost ofexporting and impacted negativelyon exports to the CIS markets. The Ukrainianborder posses considerable difficulty for exporters transitingthrough itto other CIS / Russianmarkets and as a final destination market. Inparticular the application of transit bonds for agricultural products to pass throughthe Ukrainianboarder has significantly added to the cost oftransportation ofproduct to final markets inthe CIS andEurope. Anexporter is requiredto lodge a transit bond for the full value of the shipment, which i s subsequentlyreturned after the consignment leaves the Ukrainian boarder. The Ukrainian authorities claim to have introducedthe transit bondto stop smuggling between the Moldovan / Ukrainianboarder. However, the frequent changes to the amount o f the bond applicable with little notice given to the exporters, indicates that the instrumenti s beingusedto moderate trade with Russia, which i s also a significant market for Ukrainianproducts. The cost to wine exporters of obtainingbank guaranteesto cover the transit bond, i s estimated to be inthe region of US$0.02 -0.0337per bottle, which representsa cost to the wine exporter in the region of 1.5 to 2 percent o fthe invoice value o f an average shipment. Since the beginning of 2003, the Government o f Moldovaruledto remove Ukrainian ethylic alcohol from the two countries free-trade agreement, which has subsequently ledto retaliation from Ulaaine by imposing similar restrictions on Moldovanproducts. It is likely that although Ukraine accounts for about 4 percent o f Moldova's wine exports, the short-termimpact on the sector, will be aprobable re-direction o f trade to other CIS member countries. However, the current trade dispute highlightsagain the poor inter-state relations betweenthe two countries. 66. Most wine producers that export to the Russian and CIS markets trade without opening letters of credit -most Russian importers will only pay for the consignment after the shipment arrives at the destination market andusually whenpart of the consignment is soldinthese markets, hence letters of credit are not used. This practice exposes the Moldovan exporters to considerable risks 37Average figures providedby exporters. However, the cost of the bond will vary with the quantity and quality of the wine being exported. 18 of nonpayment. However, since most Moldovanexporters have a longtrading history with importers inthe Russian market and to a lesser extent the CIS market, they are able to assess, albeit, extremely crudely an importerswillingness/ ability to pay. Through such a system, wineries have been able to keep nonpayment rates down, with some wineries claiming that this may occur only 5 percent of the time.Despite this, risks ofnonpayment are further increased, as Moldovan exporter's only legalredressi s to take their case to the final destination markets, with highlegalcosts andinstitutionsthat frequently have limitedcapacity andcapability ofpursuing the rule-of-law to enforce the exporters rights. Ideally there shouldbe a simpler arbitration processthat does require firms to go throughthe court system.However, inthe absence of such a system, many firms resort to usingdebt collectors and are reportedto receive on averagebetween 50 to 60 percent of the final invoice value, ifpayment can berecovered. A few Moldovanfirms that export to the Russianmarket have complainedabout counterfeiting bottles and labels and passing them as Moldovanbrandedproducts. This has, not only an impact on the individual firm, but also a significant negative impact on the perceived quality of the Moldovan wine as well as the price o f the product. Inan ideal situation these counterfeiting claims would be taken upthrough the commercial attachk's within the MoldovanEmbassy through a dispute settlement system to remove the product andprosecute the individuals / companies involved. However, it was widely reported that the commercial attache's have limited capacity or influence to pressurize the local authorities, giventhe absence o f an effective dispute settlement systemwhereby the interests of Moldovan exporters can beproperly represented. Thus companies often incur significant expense to pursue often lengthylegal cases indestination markets. The question remains that with such significant risks attached to trading on an open account insome of these CIS markets, why haven't more firms adopted the use of Letters of Credit, and other less risky trading instruments. Within the EuropeanUnion, Moldovanwine exports do not have preferential access and are liable for various tariffs depending on the type of product imported. For still wine products the tariff varies considerably depending on alcohol volume as indicated intable 1, withtariffs for still wine packed incontainers of greater than 2 litres varying between 11to 17Euro per hecto1it1-e~~. These tariffs are significant as Moldovan companies are competing inthe lower end o f the market, and hence the introduction of a flat rate tax places a significant ad valorum tax. Given the current cost structure within Moldova's wine industry,it is estimated that these tariffs can increasethe average costs of a consignment by 10percent3'. It i s envisaged that Moldovan wine will continue to compete inthe price sensitive low quality market segments for the foreseeable future, that comprise ofa number ofEUaccessioncountries, suchas Romania andBulgaria, that benefit from European Union quotas. Exports into the EUfrom Bulgaria andRomania under the quota remain duty free, andthus with these countries increasing quota and imports, Moldovan wines will face increasedcompetition inthese markets. Quality improvement and more pro-active marketing of their products inhighervalue markets i s one way that producers can circumvent these constraints, thus reducingthe ad valorum equivalence of the tax, and diversifyingthe currently highly concentrated export trade. Inadditionto tariffs, allwine, grapemustandgrapejuice imports (consignments ofover 3,000 litres of wine or 3,000 kgs o f grapejuice or must) require an import license. Firmsinterviewedas part of the study indicated that this was not been viewed as a significant constraint to trade, with licenses often easy to obtain. 38One hectolitre equals 100lives 39Assuming that eachbottle contains 0.75 lives and FOBprice per bottlei s US$ 1.36 19 Although Moldovanwineries have inthe past exported bulkwines, to counties withinthe region, most notably to Bulgaria and Romania, as part of a re-exportbusiness to Russia and to a lesser extent the European Union, this trade has seen a considerable decline inthe past few years, as highlighted inFigure6.Muchof the re-export business through Romaniaand Bulgaria to Russia has declined as these two counties have re-focused on the Europeanmarkets, to exploit their quotas and improvements inquality that have occurred inthe past few years. Figure6: Exportsof BulkWine to EuropeanMarkets 600 00 500 00 -E 400.00 --2=30000 200.00 10000 0 00 1998 1999 2000 2001 Source: Moldova Export Promotion Organisation, 2002 Romanianproducers are inthe process of harmonisingquality requirements to match that of the EU, whilst increasing the quality ofdomestic wineproducedthrough support from the Common Market Organisation for Wine. This has ledto reducedneed for bulkwines from Moldova, as Romanianproducers are placing greater emphasis onmoving into higher quality bottledwines. 5.5 FinanceandCredit Vintners andkey stakeholders indicatedthat access to finance remains one ofthe largest constraints to the development of the sector. Although the larger wineries have had significant investmentfrom internationalfirms, with mainly Russian capital, once it hasbeen capitalised, eachwinery i s operated as a profit centre, and thus working capital requirements and expansion of the firms operations often needto be obtained through local capital markets. Naturally for the smaller wineries this i s an even greater issue. Most of the vintners suggest that obtaining loans from banks for working capital and pre- financing o f growers, that the major wineries currently undertake, were easier about 5 years ago just after the competition was introducedinto the banking sector.The banksthat initiallyemerged as a consequence from the liberalisation of the financial sector were seen as more flexible, and keener to obtainbusiness. With the absence of foreign banks operating inMoldova, most wineries can only access the local bankingnetwork, which are governed by a significant number of Central Bankrestrictions on transactions. There has recently been a tighteningo fregulations, which only permit wineries to obtainU S dollar denominated loans for imports for items such as corks, labels and insome instancesbottles. However, for the majority of their operations, enterprises are requiredto obtain lei denominated loans that have highnominal interest rates ofbetween 16to 18 20 percent compared to U S dollar loans that can be obtained between 6 -7 percent. With working capital inthe largest 10 wineriesrunningup to US$8-10 millionper annum4' and purchase of grapes amounting to some 70 percent o f working capitalrequirements the additional costs o f obtainingloans through lei denominated costs can be inthe region of US$ 500,0000 for some of these enterprises. Thus it i s estimated that this regulationplaces a 3 to 4 percent increase inthe cost of a bottle exported. With many of the wineriespre-financing grape growing andrequiredto pay for imports of corks and labels inadvance while receiving the revenue for their exports after shipments arrive at their destination, without the benefit o f quick settlement, leads to significant cash-flow implication for many o f these enterprises. Inaddition, firms within the sector needto frequently re-finance operations becauseof the short-term availability of funds. Usually credit i s available on a six monthly basis, which needsto berolledover throughthe drawing of loans from other institutions, to ensure funds are available for working capital throughout the year. These incremental financing costs can be significant for many vintners, through the hiring of additional staff, mainly accountants and lawyers, to deal with the banks and overseethis process. The Government requires that allrevenue earnedthroughthe export of wine and wine products shouldbe repatriated within 90 days. Although the tax authorities believe that this represents sufficient time, wineries and exporters have indicatedthat this infact i s a significant constraint, particularly interms o f exports to the CIS market. Since most trade to the CIS, andparticularly Russian market i s undertaken on open account, the final payment i s often provided after sales of the product inthe local market. Insome casesthere are issues ofnonpayment by the distributor / wholesaler inthe final destination market, which may meanonly part of the invoice value i s recovered ifdebt collection i s used. Thus inthe case ofnon-payment the regulation imposes a significant penalty on the wine exporters since they fail to collect the full invoice value from the distributors inthe final destination markets whilst they are also finedby the authorities. Inaddition, exports to more distant markets throughVladivostck takes about 80 daysbyroad, without factoring indelays to pass through the numerous customs points. Therefore the repatriation o f funds often takes significantly more time than the allocated 90 days, on average exporters reported that this process takes 120 days. Inorder to minimiserepatriationfines, whichare leviedat 0.3 percent ofthe total invoice payment on a daily basis after the 90 day period, exporters have to recruit staff - often teams of lawyers and accountants, to pre-empt the fine through the legal system. It i s estimated that through informal discussions with several larger exporters that this couldbe as highas 1percent of total invoice value, and are naturally higher inthe case of default inpayment where exporters can recovery only a proportion o f the invoice value. 6. The Role of GovernmentPolicy Government policy has historically been characterised by a strong interventionist approach, highlightingthe "strategic" importance it places onthe sector.Thisreluctance to reduce its presenceinthe sector has ledto limitedprogress on the privatisation of 11o f the larger wineries, most notably the Onoteca winery o f Cricova. Despite this the Governmenthas made progress on the privatisation of remainingwineries and undertaken a landreformprocess. Although it was a flawed process inthat it created a legacy o f fragmentation of the vineyards, there have been 40Figuresobtained fromthe Moldova Wine Exporters Association 21 movement towards de facto arrangements, interms of land swaps and other mechanisms, to ensure the emergence of a number of larger vineyards. In2002, the Government createdtheMoldvinAgriculturalandIndustrialDepartmentwiththe specific aims o f developinga strategy for viticulture development and the growth o f wine exports, which was been consistent with the Government's pro-activepolicy inthe sector. The Department was also responsible for managementof the 11 State owned wineries and involved in the management of a further 11partially Government ownedJoint Stock Companies. However, with the imminentprivatisation ofthese companies, their role and influence over the sector is likely to change. Although the Department inpractice has a very limitedrole, inreality many vintners, remain skeptical about their wider mandate. This is especially so after Moldavin, duringthe past year, suggestedthe introductionof an export tax of 5 percent of invoice value to subsidise credit for the replanting of vineyards. This forced the formation of an industrydelegation to lobby Government to withdraw the proposal. Current Government regulations require that all bottledwine need to be labelled inthe Romanian language. With most wine exported to countries inthe CIS and inlesser volumes to the EU, there i s often need for the vintners to obtain special permission to obtain changes to the labels depending on the requirements of the importingcountries. Thisprocess i s often time consuming and requires considerable liaisonwith Moldvin Department before permissioni s granted to use the new labels for export. Although not a significant constraint, it can be viewed as one more obstacle that exporters needto overcome, and a regulationthat has no obvious need. The Government requiresall operating wineries to pay a licence fee. Although the principal of paying a licence fee i s not incontention, there are concerns, particularly expressedby smaller vintersregardingabout the dramatic increasesinthe fee. The fee has seen a considerable increase from 1999 where all wineries were required to pay 9,000 lei per year for the licence, to the current fee for 2003, where wineries, irrespective o f size are required to pay a fee of 36,000 lei. This is effectively a tax onthe smaller wineriesthat are strugglingto restructure themselves and develop into niche markets. It would be more appropriate to develop an equitable systemthat would requirepayment basedon productionprocessedor volume of grapespurchased. 7. Prospectsfor the Wine Sector The winery sector has seena turnaround of apreviousposition characterised by a lack of investmentinvineyards, obsolete primary wine makingequipment often affectingthe wine's quality and ageing o f the vineyards. This turnaround has beenprimarily drivenby a privatisation process that has allowed investors with access to significant financing to take control of these enterprises.However, the mediumto longer term development prospects inthe sector will crucially dependon addressing supply side constraints, access to and exploiting external market opportunities, and a conducive policy environment that will facilitate rather than hinderthe development of the sector. This section will review the each of these components inrelationto potential areas of policy dialogue betweenthe World Bank and Government. 22 7.1 Addressing Supply Shortages Although many vineyards remain fragmented, a consequenceo fthe flawed landprivatisation process, the recent transformation of the wineries and consolidationof landby larger "Agrifirma" are leading to market led solutions to the key supply constraint. The replanting o f vineyards are starting to commence inearnest, drivenby the excess demand for quality grapes that is pushing up costs, and the fact that many winerieshave completed the processofupgradingtheir equipment, freeing funds for the directpurchaseor rentalof vineyards. The likely consequences o f these actions are that smallholder producers will beprogressively squeezedout of grape production. Thus there are remains no legitimate grounds for the Government to intervene inthis market ledprocess except to ensure that smallholders are fully aware of their rights as landowners, and that there are no significant impedimentsto the importationo f higherquality rootstock from Europe and other destinations. Most producers are familiar with the GOST and GOSTR standard system, whilst there i s a growing band o f wineries, predominantly with Russian investment, familiar with the European Union standards, particularly V1. The export trade i s the mainmarket driver to quality improvements, rather than through a systemo f administrative controls. Government needsto ensure that this continues to be a market drivenprocess, otherwise it will place considerable excess costs to producers and wineries.The mechanism of how these standards can be filtered down to the smaller scale wineries will need greater assessment, and be basedon industryled initiatives rather than directives from government through the Moldvin Department. The overall assessmentremains that market mechanisms are showing the potentialto addressthe key constraints on the supply side, however, it will require policy stability on the part o f Government to ensure that this processcontinues. 7.2 ExternalMarkets Access to the European markets will pose a significant challenge for the vast majority of wineries and exporters. Beside Moldovan wines perceptionwithin the market place for variable quality and unreliable supply, they also need to compete with similar and better quality wines from the Accession countries that can enter the market without the 10to 33 percent tariff that Moldovan wines face. Thus deeperpenetration into the EUmarket can only berealistically achieved inthe longer term with significant improvement inthe quality and reliability of supply, which i s already starting through a market ledprocess. However, this will need to be supplemented by a significant marketing effort, which could be facilitated either through a systemo f appellation or through a systemo f private brands. Ifthe industrycontinues to be heavily fragmented, thenit would be more appropriate to examine the possibility of introducing a system o f appellation where collective brands are developed and financed through groups of privateproducers. However, there continues to be signs of concentration withinthe industry, and it seems more likely is that the wine industrywill be dominated by a few larger exporters, as seen elsewhere in the "new world". This would mean wine marketing will bebasedon privatebrands financed almost exclusively by the individual wineries. The Russian market has seenrapid changes, particularly inthe key segments where Moldovan wines compete. However, Moldovan exporters recognise the needto move up the quality chain to slow the slide inmarket share, remain competitive inlow price market segments, and move away from the commodity product tag that they have been characterised by inrecent times. The key constraint to accessingthe Russian and CIS markets continues to be the poor bilateralrelations 23 with Ukraine which has resulted invariable applications o fcustoms regulations andrequirements. This would appear to be an area where a shift inpolicies towards creating the conditions for improved neighbourly relations would have a relatively quick economic pay-off for the sector. 7.3 Developmentof a ConducivePolicyEnvironment The current policy environment places considerable burdenon the wineries and exporters o f wine products, particularly inrelation to regulations on the repatriation o f funds, foreign currency borrowing, as well as difficulties inobtaining tax refunds. These continue to place significant costs to the industryand reduces competitiveness inincreasingly price sensitive markets. There i s urgent need for Government to re-evaluate the effectiveness and appropriateness o f these policies and move towards abolishing or amending them. However, it i s important to note that domestic customs regulations are not considered a significant constraint to trade, unlike other sectors, due to the experience that most wineries and exporters have gained over the years, to minimise delays. Moldova continues to pose a significant sovereign riskfor many investors due to its frequent changes to policy and regulations. However, the wine sector has not been affectedas significantly as other sectors interms o f inwardinvestment, and has benefitedfrom substantial capital inflows from Russia. These new Russian investors / winery owners understand the needto cultivate contacts with European markets to meet their longer-termgoals o f accessing this market. Hence they have through the recruitment o f FrenchandItalianconsultants been able to make the first tentative steps into the new market. Despite this there are significant numbers o f wineries that still require the investment, knowledge and contacts to access these newer markets, that foreign investment can bring.The recent policy instability provides a strong disincentive for European investors to provide this necessary input. The Government's reluctance to reduce its presence inthe 11state controlled "strategic wineries" continues to expose the sector to additional policy risks. With the present status quo there remains a danger that Government may opt to impose administrative controls to protect these enterprises, which may be to the detriment o f other private sector wineries. Thus the privatisationo fthese enterprises will substantially reduce these risks and may provide a signal to encourage greater foreign investment into the sector. The government's policy stance inthe wine sector has tended to place significant emphasis on the development and strengthening o f the larger wineries, often to the detriment of smaller players. The introduction o f a flat rate licensing fee i s a good example o f this policy. Withrapid changes to the mainRussian / CIS markets, and modest penetration into the European market, there are likely to be a variety of production models that will emerge to meet diverse market niches. Thus government policy should ensure measures to create a level playing field for all producers and wineries with no discrimination between size. 8. Conclusions The medium to longer term development prospects inthe sector will crucially depend on moving up the quality chainto retainmarket share inthe traditional markets o fRussia andthe CIS and gain a foot hold innewer markets o f the EU.It i s clear that market mechanisms are showing the potential to address the key constraints on the supply side, however, it will require policy stability on the part o f Government to ensure that this process continues. 24 Inadditionto policy stability the following recommendations havebeendevelopedbasedontheir potential to reduce the direct cost structure at the individual firm level and needto be viewedin the context o f the continuingpolicy dialogue betweenthe World Bank and the government. Finance Related . Abolish Regulation on TimeLimitsfor the Repatriation of Funds The current system of - finingwine exporters that do notrepatriate funds within 90 days places a double penalty for the case of open account transactions, particularly for wineries involved inexport to the Russian / CIS market. Ifclients default onpayment and giventhat funds are often repatriated after the 90 day time frame, wineries will be liable for interest charges, as well as not being able to receive their original invoice value. This regulation doesnot infact reduce the potential incidence o f smuggling of foreign exchange out of the country as there are many alternative methods which companies could adopt, such as transfer pricing, etc. With the high rates of interest charged on working capital, it i s infact inthe interests o f the exporters to recovery their invoice values as soon as possible. Thus the abolition o f this directive would save the wineries and exporters significant time and expenditure, interms of additional staff . and legal costs. Liberalisation of Regulations Relating to Foreign Currency Borrowing -Currentregulations limit the ability ofwineries to borrow inforeign currency. When they are able to obtain foreign currency it i s only for the importationof auxiliary products. It remains unclear as to why banks shouldbeburdenedwith only providing foreign currency loans for imports, when the riskprofile (interms offoreign exchange) is considerably less to lendto wineries for the export market. Thus all wineries need to access the more expensive local loanmarket where interest rates can be upto 10percent higher than rates for Dollar denominated loans. It would therefore seem appropriate to abolish this regulation and free up wineries of this significant . constraint. Simplijkation of the Tax Rebate System -The cumbersome and inefficient tax rebate system places considerable costs to firms and i s estimated to be inthe region o f 2 -3 percent of turnover for most wineries. The government will needto consider options of easingthis constraint. One methodcouldbe to examine a move towards duty and tax exempt systemfor exports based on the principal of Export Processing Zone's but at the individual winery level i.e. in-bond scheme. It i s recognised that the success o f such a scheme will needto depend on the streamliningofexistingprocedures, a clearly definednumber ofperiodic inspections, and a much improved monitoring capability. . Market Access Related Improve Bilateral Dialogue with Ukraine There i s greater needto explore the potential for - Government to Government dialogue to reduce transit costs, and the variety ofNon-Tariff Barriers that are sporadically introducedinUkraine. A shift inpolicies towards creating the conditions for improved neighbourlyrelations would have a relatively quick economic pay- off for the sector, whilst the on-going trade dispute with Ukraine shouldbe resolvedthrough WTO machinery. 25 Increase the Number of Accredited Laboratories Able to Testfor EU Standards With only - one laboratory accredited to test for the EUV1 standardthere remains concernthat producers are receivingnon-competitive prices for this testing. Currently thisrepresents about 2 - 3 percent o f the consignment value. As volumes increaseit i s hopedthat additional laboratories will be accredited to ensure a competitivemarket develops. Policy Environment Related Privatise remaining 11State Controlled Wineries -The reluctance of Government to privatise the remaining state controlled wineries continue to expose the sector to policy risks, particularly the temptation to provide continued indirect / direct support to these wineries. The privatisationof these enterprises will improve confidence within the industryand would provide an important signal for other foreign investors wishingto investinto many of the smaller wineries. Creation of a Level Playing Fieldfor all Participants Irrespective of Size - Rapid changes to existingandnew markets meant that there are likely to be a variety o fproduction/ processing models that will develop to meet the various market niches. Thus government policy will needto focus on ensuring a levelplaying field for all participants. Therefore anumber of policies will need to be reviewedsuch as the current licensingfee. The fee i s charged to all participantsthat wishto operate as a winery. However, the current flat fee o f 36,000 lei discriminates against smallholder producers. Therefore itneeds to be implementedina more equitable manner, with due consideration beinggivento the introductionof fee basedon a slidingscale basedonthe weight of grapesprocessed. Development of a Clear and Explicit Mandatefor Moldovin Department - Although the Department inpractice has a very limitedrole, i.e. manage the states shares inthe non- privatisedwineries and provide export promotionactivities, inreality the industryremains skeptical about their wider mandate. This skepticism andthe proposal to privatise the remaining State controlled wineries needs to leadto a re-examination of their mandate. A more suitable role for the Department withina free market environment, shouldfocus on facilitating the development o f exports through activities such as the promotion of Moldovan wines inforeignmarkets, andproviding assistanceto enterprises that are taking legal proceedings against non-payment or other infringements indestination markets. 26 cU .C ec c L t 45 c Ld fa c .,.tSG -..f Q cu 5 +C i I iv 3 Y 0 1 $4 4 M cd 9 IBc.' m a 3 cd 0 Y Y v) m 0 4 0 o! 0 m d3