A high carry but a burgeoning current account deficit too
Overview:
Interest in Moldova is increasing for two contrasting reasons. Following conflict in the Caucasus there are concerns in some quarters that other "frozen" conflicts such as Transdniestr may be destabilised by Russia's more aggressive foreign policy. However, investors are also starting to notice that Moldova has the highest interest rates in the region and is therefore interesting from a carry trade perspective. In fact, the Transdniestr issue does not appear to have the same immediate potential as a flashpoint as has unfortunately proven to be the case in Georgia. On the other hand, an increasing focus on the need for disinflation has persuaded the authorities to hike interest rates and let the Leu appreciate. But the currency has probably now appreciated too far and too fast and the current account deficit is widening sharply.
Recommendation:
With policy rates of 18.5% and a currency appreciating against both the Euro and the US$, Moldovan local interest rates appear very attractive. However, dramatic currency appreciation and accelerating domestic demand will likely push the current account deficit out to almost 20% of GDP this year. While FDI inflows are strong they finance only about half of this external account imbalance. Given its delicate geo-political position Moldova does not have an imminent EU Accession prospective to underpin this story. A growing risk of a currency correction suggests a neutral recommendation.