Albania: Staff Report for the 1999 Article IV Consultation, Request for the Second Annual Arrangement Under the Enhanced Structural Adjustment Facility, and Request for Augmentation

This paper reviews Albania’s 1999 Article IV Consultation, Request for the Second Annual Arrangement Under the Enhanced Structural Adjustment Facility, and a Request for Augmentation. Inflation fell to 2 percent in March 1999. The return to growth and low inflation reflected the government's adherence to strong fiscal consolidation efforts. The domestically financed component of the deficit was reduced to 6.4 percent of GDP in 1998 from 10.8 percent of GDP in 1997. The external current account deficit also fell sharply from 12 percent of GDP in 1997 to 6 percent of GDP.

Abstract

This paper reviews Albania’s 1999 Article IV Consultation, Request for the Second Annual Arrangement Under the Enhanced Structural Adjustment Facility, and a Request for Augmentation. Inflation fell to 2 percent in March 1999. The return to growth and low inflation reflected the government's adherence to strong fiscal consolidation efforts. The domestically financed component of the deficit was reduced to 6.4 percent of GDP in 1998 from 10.8 percent of GDP in 1997. The external current account deficit also fell sharply from 12 percent of GDP in 1997 to 6 percent of GDP.

I. Introduction

1. The discussions on the 1999 Article IV consultation and the proposed program to be supported under a second annual ESAF arrangement were held in Tirana, March 3–18, 1999, and were continued in Washington in April during the Spring meetings.1 The latter discussions focused primarily on the economic consequences of the crisis in neighboring Kosovo, which erupted on March 24 when the NATO campaign against the Federal Republic of Yugoslavia began.

2. Attachment I contains the authorities’ request for a second annual ESAF arrangement to continue support for their economic program for April 1998-March 2001. The first annual arrangement was approved on May 13, 1998 and the review of the first-year program was concluded on January 27, 1999. One third of the SDR 35.3 million (72 percent of Albania’s quota) available under the arrangement has been disbursed. In view of the increased balance of payments need arising from the impact of the Kosovo crisis, the authorities are requesting that access under the second annual arrangement be augmented by SDR 9.74 million (20 percent of quota). The authorities’ medium-term economic program is described in the updated Policy Framework Paper (EBD/99/65, 5/28/99). The World Bank also has a broad program of support for Albania and in May 1999 approved a Public Expenditure Support Credit in the amount of US$30 million. World Bank Board approval for a US$45 million multi-sector Structural Adjustment Credit (SAC) will be sought in June. Appendices I and II summarize, respectively, relations with the IMF and World Bank. Appendix III describes main areas of technical assistance being provided to Albania.

3. At the Board meeting for the 1998 Article IV consultation (EBM/98/52, May 13, 1998), Executive Directors commended the authorities for their conduct of macroeconomic policies, but emphasized that sustaining high growth would require firm implementation of structural reforms and improved governance. Directors reiterated these comments at the more recent Board meeting to review the first annual ESAF arrangement.

4. The timeliness and quality of the data are only minimally sufficient in many areas for surveillance and program monitoring2, with the most notable deficiencies in the national accounts (Appendix IV). The authorities are, however, implementing a comprehensive work program, devised in collaboration with STA, to address the main statistical deficiencies. A key step in the work program is designated as a structural benchmark under the proposed ESAF-supported program. The authorities also intend to participate in the GDDS.

5. Albania maintains restrictions subject to Fund approval under Article VIII, Section 2(a), in the form of outstanding debit balances on inoperative bilateral payments agreements.

II. Background

6. Since 1991, when 45 years of isolationist communist rule came to an end, Albania’s economy has ridden a roller coaster. The economy initially collapsed, enjoyed robust recovery, and then tumbled again in 1997 as pyramid scheme bubbles burst, taking with them a large portion of personal savings and fomenting near civil war. Albania was putting this recent episode behind it when, in March 1999, the crisis in Kosovo erupted, precipitating a tide of refugees into Albania. The refugees are placing considerable strain on the social and economic infrastructure and on the budget and balance of payments. Without sufficient external budgetary assistance on appropriate terms, Albania’s macroeconomic stability and reform program could be compromised.

7. Prior to the Kosovo crisis, macroeconomic stability had been restored and economic trends were highly encouraging. During 1998, the government adhered to its tight fiscal target, reducing the domestically financed component of the deficit to 6.4 percent of GDP in 1998 from 10.8 percent of GDP in 1997 through a combination of revenue enhancing measures and control over the growth of primary expenditures. The domestic fiscal effort supported the goals of monetary policy and end-1998 inflation declined to 8.7 percent compared to the target of 10 percent and to 42 percent during 1997 (Figure 1). In conjunction with a sharp rebound in private transfers, it also contributed to a halving of the external current account deficit from 12 percent of GDP in 1997 to 6 percent of GDP, enabling foreign reserves to climb to a comfortable 4.7 months of imports of goods and services at end-1998.3 Confidence in policies was reflected in a recovery in the lek, which had fallen by about 30 percent in nominal effective terms during the 1997 crisis. The lek appreciated by about 25 percent during the second half of 1997 and has since been broadly stable. In an environment of improving macroeconomic and domestic political stability, growth is estimated to have been 8 percent in 1998, thereby reversing the 1997 decline in output (Table 1). Policies remained consistent with agreed indicative targets in the first quarter of 1999 and annual inflation fell further to just 2 percent in March (Table 2).

Table 1.

Albania: Basic Indicators and Macroeconomic Framework, 1993-2002

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Sources: Albanian authorities; and Fund staff estimates and projections.

Current account excluding net factor services and official transfers.

Revenue (excluding grants) minus current expenditure.

Including bonds for bank restructuring.

For 1999 excluding imports of direct humanitarian aid related to the Kosovo crisis.

Excluding official transfers.

Table 2.

Albania: Performance Criteria and Indicative Targets for 1998-99 1/

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Unless otherwise noted, all figures are expressed as cumulative changes from end-December 1997 levels. There is also a continuous performance criterion on the non-accumulation of new external arrears exclusive of arrears that are subject to rescheduling consistent with the July 1998 Paris Club terms of reference. See EBS/98/77 and EBS/99/2 for a description of the limits on performance criteria and indicative targets in the program.

Indicative targets.

Performance criteria.

Defined as reserve money minus net international reserves.

These exclude holdings of nonconvertible currencies, claims on nonresident financial institutions denominated in convertible currencies; foreign currency reserves of commercial banks held at the Bank of Albania and credit and debit balances as of December 31, 1997, arising from bilateral payments agreements in clearing dollars and in rubles, and any foreign liabilities arising from debt rescheduling operations.

The end-December 1997 stock of short-term debt includes already outstanding debts with maturities of 1-5 years. The figures exclude external debt in arrears which is subject to rescheduling or is in dispute.

Figure 1.
Figure 1.

Albania: Monthly Economic Indicators, 1995-99

Citation: IMF Staff Country Reports 1999, 050; 10.5089/9781451800623.002.A001

Source: Bank of Albania, Ministry of Finance, INSTAT, and Fund staff estimates.1/ Against the currencies of Albania’s major trading partners. A rise in the graph indicates appreciation.2/ The decline in September 1995 reflects payments associated with rescheduling of Albania’s commercial bank debt.3/ Three-month deposit rate; the real rate is the nominal rate minus annualized inflation, as depicted above.4/ Preliminary estimates based on Bank of Albania and Social Insurance Institute data.

8. The authorities’ wide-ranging reform program was also broadly on track (Table 3). A first priority had been to clean up the mess created by the pyramid schemes. By March 1999, substantial progress had been achieved and the foreign administrators had made an initial offering for sale of the assets of the pyramid scheme companies and turned over the remaining tasks to local administrators. At the same time, the authorities made progress in developing the formal financial system, preparing the National Commercial Bank (NCB) for privatization and placing the Savings Bank under a foreign governance contract. Enterprise privatization also advanced, with a further 450 small- and medium-sized enterprises (SMEs) being privatized between the beginning of 1998 and March 1999, and one of the four remaining enterprises formerly under the Enterprise Restructuring Agency (ERA) being leased to a foreign investor. In the agricultural sector, where land is in private hands but holdings are fragmented, progress in developing the land market has continued with land registration and land sales transactions proceeding in line with program targets. In the public administration, overmanning was reduced through cuts in employment of about 10 percent between the beginning of 1998 and March 1999. And, in tax administration, a revised customs code was prepared, although its implementation was delayed when Parliament considerably watered down key elements. The customs code was resubmitted to Parliament in March 1999. Finally, to address more general governance issues, the government drew up and began implementing an anti-corruption strategy.4

Table 3.

Albania: Prior Actions, Structural Performance Criteria, and Structural Benchmarks Under the First Annual ESAF Arrangement

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9. The Kosovo crisis adds new challenges to the authorities’ ability to maintain macroeconomic stability and pursue their reform program. By mid-May, about 430,000 largely destitute refugees had flooded into Albania, augmenting the local population by some 13 percent. More than half of the refugees have been given shelter in private homes, the rest are in camps or hastily converted warehouses. The sheer number of refugees places a considerable strain on the social and economic infrastructure as well as on the budget, not least because international relief agencies have been overwhelmed by the speed at which the refugee crisis has evolved. At the same time, humanitarian and military supplies have clogged Albania’s ports, crowding out commercial (and taxable) imports. So far, the refugees have been provided with a warm welcome. However, the initial unifying impact of the crisis on fractious domestic political rivalries is already starting to fray.5

10. Nevertheless, reform and economic stabilization efforts are continuing. With the budget facing large, uncertain costs associated with the refugees, the government announced a freeze on public investment spending and a postponement of the 10 percent civil service pay rise planned for April 1. Spending restrictions were lifted only when the international community began to make firm pledges of budgetary assistance.6 The exchange rate has remained relatively stable with a 3–4 percent depreciation in the first week of the crisis being subsequently reversed. At the same time, some important structural measures have been implemented: Parliament passed the amended customs code; the government selected a buyer for NCB following the submission of two international tenders; and the government drafted decisions to close two more former-ERA enterprises.

11. The Kosovo crisis apart, Albania still faces tremendous development problems:

  • Poverty is widespread. Despite rapid growth in the early years of transition (1993–96) Albania’s average standard of living is among the lowest in Europe with per capita GNP only about US$800.

  • Basic structural deficiencies run deep. The financial system is rudimentary and does not put savings to their best use; the tax base is inadequate; communications are hampered by a dilapidated infrastructure; and waste and inefficiency are considerable in the public utilities.

  • Corruption and organized crime are acknowledged problems and administrative capacity is weak. Tax collection is undermined by graft and essential regulations for market economy are often not enforced.

  • The internal and external security situation remains tenuous and undermines investor confidence. Firearms looted during the 1997 crisis continue to circulate and the rule of law is not well established in some regions. There is also a risk that the Kosovo crisis could develop into a broader regional conflict.

III. The Policy Discussions

12. Albania’s development needs call for the implementation of an ambitious and comprehensive structural reform program and a concerted attack on poor governance. Initial discussions focused on a review of the reform priorities that are being supported under the ESAF arrangement After the Kosovo crisis broke, discussions turned to the steps necessary to maintain macroeconomic stability and the momentum of reforms. The authorities are well aware that the crisis creates both challenges to, and enhanced needs for, better governance and stronger administrative capacity.

A. The Macroeconomic Framework

13. Assuming refugee-related expenditures are largely financed by the international community, the impact of the Kosovo crisis on growth and inflation is expected to be small. However, this is subject to a wide margin of uncertainty as described below. Albania, in contrast to some other affected countries in the region, has negligible official trade with or through the Federal Republic of Yugoslavia and supply disruptions in the underdeveloped north of the country (which borders Kosovo) are likely to be offset by increased production incentives in other sectors. On the demand side, adverse confidence effects on local and foreign financed investment, and some switching by exporters to local markets, will lead to a shift from private investment and exports to consumption (public and private) and imports. On balance, the 8 percent growth projection for 1999, which appeared feasible before the crisis, has been retained (Figure 2). Some temporary increase in food prices (the dominant component of the CPI) may result from the crisis, but given the unexpectedly low inflation in the first quarter, such an increase is still expected to leave inflation below the 7 percent end-year target agreed at the time of review of the first-year ESAF-supported program.7

Figure 2.
Figure 2.

Albania: Economic Developments and Prospects, 1991-1999 1/

Citation: IMF Staff Country Reports 1999, 050; 10.5089/9781451800623.002.A001

Source: Albanian authorities and Fund staff estimates.1/ Estimates for 1998, program projections for 1999.

14. Uncertainty about the outlook for growth and inflation has increased substantially. In particular, if the capacity problem of the ports is not solved, output could be adversely affected as humanitarian and military imports crowd out intermediate and capital goods imports; and additional demand from the refugees could leak into higher prices. More generally, the large (and growing) refugee population stretches the already-thin administrative capacity of the government, with attendant risks of a breakdown in law and order and social stability.

15. The uncertainty is magnified for projections beyond 1999, not least because it is unclear how the conflict will be resolved. Assuming the refugees return home in early 2000, that foreign direct investment resumes, and fiscal consolidation and structural reforms continue as programmed, the medium-term scenario would not be significantly different from that envisaged at the beginning of the ESAF arrangement. Growth would average 7-8 percent per year, while inflation stabilizes at industrial country levels. If the crisis is prolonged, there would be increased risk that law and order would break down, corruption rise, and structural reforms, including privatization, would be postponed. The need to absorb the refugees into the labor and housing markets could also be a source of friction, even though they would add to potential output.

B. Fiscal Policy

16. The authorities agreed that the key objective is to ensure that the Kosovo crisis does not interfere with underlying fiscal consolidation. For 1999, the authorities plan to stick to their original budget goal of reducing the domestically financed deficit from 6½ percent of GDP in 1998 to 5½ percent of GDP in 1999 (Table 4). However, if cuts in essential development and social expenditures are to be avoided, this can only realistically be achieved if the international community finances the large budgetary cost of helping the refugees. For 2000, the authorities plan to reduce the domestically financed deficit to about 4 percent of GDP. Passage of a satisfactory budget would be a condition for completing the mid-year review of the ESAF-supported program.

Table 4.

Albania: Government Revenue and Expenditure, 1995-99

(In percent of GDP)

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Sources: Albanian authorities; and Fund staff estimates and projections.

Excluding Kosovo related expenditures.

Costs related to the influx of refugees from Kosovo after March 1999.

Almost all of this is financed by the banking system. In addition, a very small amount of treasury bills is held by the state insurance company (INSIG) and the private sector.

Including arrears and privatization receipts.

Overall balance including bonds issued for bank restructuring.

The expenditure figures based on the functional classification are highly provisional. The Albanian authorities have only recently started work on the functional classification, and statistics experts from the Fund will provide assistance to the authorities in this area in early 1999. Estimates for 1998 reflect the outcomes for the first three quarters of the year only.

Albania: Budgetary Costs of the Refugee Crisis

The Kosovo crisis imposes substantial spending pressure on the Albanian budget because the international relief agencies do not cover all the costs of the refugees and, at least initially, were not able to cope fully with even the refugees’ subsistence needs. The projected budgetary costs assume the number of refugees in Albania rises to some 500,000 in May and decreases gradually thereafter (see figure). Around 40 percent of the refugees are expected to stay in camps, while the remainder would live with Albanian families. Total budgetary expenditures are estimated at US$144 million, or the equivalent of US$33 per refugee per month (see table below). The main expenditure categories are as follows:

Social assistance expenditure of US$29 million reflects monthly payments to households hosting refugees equivalent to US$10 per refugee and a small one-time budgetary contribution of just US$14 toward the subsistence of each refugee living in a center. The latter is potentially a sizable underestimation.

A01ufig01

Figure: Refugee numbers

(in thousands)

Citation: IMF Staff Country Reports 1999, 050; 10.5089/9781451800623.002.A001

Estimated Budgetary Expenditures

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Education expenditure of US$26 million allows for the continuation of school education for refugee children. The amount covers the costs for teaching, in particular financing a summer school program to compensate for lost education time, as well as necessary spending on school buildings, text books, and other equipment to cope with the increase in student numbers.

Health expenditure of US$16 million provides for an average of 1½ hospital days per refugee as well as the cost for additional medical personnel outside hospitals and medicines and related spending on medical infrastructure. Relief organizations are assumed to provide basic medical care, including vaccination, to refugees in centers. Reflecting the poor state of health of the refugees and the predominance of old people, projected per capita health spending is more than twice that for the resident population.

Policing and defense expenditures of US$21 million largely result from spending on overtime of security personnel given the need to police refugee camps and maintain the security forces on alert. This item also includes costs for registering refugees, who have been stripped of identity papers.

Other expenditures include the cost for infrastructure, in particular for roads to Albania’s northern regions, provision of sanitation and electricity to refugee centers, and the cost of converting buildings to temporary accommodation. The estimate assumes that any additional infrastructure costs that would be incurred in winter months would be borne directly by relief agencies.

Taking into account the fixed costs of caring for the refugees, the budgetary cost would rise by US$27 million if the average number of refugees were to be 100,000 higher than assumed.

17. The budget gap resulting from the Kosovo crisis is estimated at US$154 million (4 percent of GDP) for 1999. The estimate, which is subject to a wide margin of uncertainty, almost entirely reflects expenditures related to the refugees. These expenditures are in addition to those being financed directly by the international relief agencies (Box 1). While it is assumed that the refugees will not be repatriated before the end of the year, per capita cost estimates are on the conservative side. In particular, they assume that the potentially steep increase in subsistence costs that could occur when winter approaches will be met by the humanitarian aid agencies. Given the large number of displaced persons currently in Kosovo, the number of refugees in Albania could peak at well above the assumed level of 500,000. Revenue losses attributable to the initial log-jam in the ports is put at US$10 million (2 percent of total taxes). Again, this could rise substantially if the problem of the clogged ports is not solved quickly. The authorities have asked for logistical assistance from NATO and bilateral donors.

18. The staff stressed the importance of ensuring transparent accounting for budgetary costs and external financial support connected with the Kosovo crisis. To this end, the authorities intend to draw up bi-monthly estimates of refugee-related expenditures and record them under a separate budget classification. Actual expenditures will be reported on a bi-weekly basis to the Ministry of Information and made available to the public and donor community. Financial aid donated to the government to cover humanitarian costs will be placed in a separate budgetary account in the Savings Bank.

19. The staff also stressed that the Kosovo crisis should not weaken the authorities’ resolve to strengthen tax administration. A significant part of fiscal adjustment relies on improved collection efforts, including better enforcement of tax compliance under the new Profit and Income Tax Law and measures to reduce smuggling and customs fraud.8 The authorities acknowledged that, even before the onset of the Kosovo crisis, delays in implementing the new customs code and customs reference valuation file had put their tax collection efforts behind schedule. Nevertheless, they expected to get back on track in the second half of the year such that the total shortfall in revenues would be limited to the US$10 million attributable to the Kosovo crisis.9 The staff insisted that implementation of key elements of the customs code as well as anti-smuggling measures be prior actions for Board consideration of the program. The authorities will also begin implementing a plan to collect customs debts by end-June and hire 60 additional anti-smuggling officers by the end of the year (structural benchmarks). Under the program, the staff will review tax collection on an ongoing basis with the authorities in order to identify weaknesses and agree, if necessary, on additional measures to strengthen tax compliance. Bearing in mind the difficulty in distinguishing between poor compliance and the economic consequences for revenue of the Kosovo crisis, the staff will liaise closely with the EU’s customs advisory unit in Albania to gain an independent assessment of the authorities’ efforts to strengthen governance.

20. Tax collection efforts, in conjunction with expenditure discipline, are important to ensure that there are sufficient resources for public investment in 1999. On the expenditure side, the pay increase for budget sector workers will partly be financed by employment cuts, while the compilation of a comprehensive database for recipients will help to contain spending on social assistance through better targeting of benefits. Even so, the scope for higher public investment will be limited: investment financed by the budget is set to increase from 2.3 percent of GDP in 1998 to only 2.4 percent of GDP in 1999.10 The staff emphasized that it would be regrettable if failure to meet tax collection targets forced the authorities to scale back investment spending to keep within borrowing limits.

21. Looking further ahead, the priority will be to broaden the income tax base if sufficient resources are to be generated for spending on infrastructure, health, education, and social safety nets. While the authorities accept that present resources for health and education can be used more efficiently, overall spending in these sectors at 1.5 percent of GDP and 2.8 percent of GDP, respectively, is relatively low. Finding a means of taxing agriculture will be particularly important to generate new resources—although this will only be feasible once the process of land registration is completed, and probably not before 2001. The medium-term projection assumes that the tax-GDP ratio rises from 13.6 percent in 1999 to 16.2 percent in 2002 and that non-interest expenditures stabilize at less than 18 percent of GDP (see Table 1). On the assumption that real interest rates decline from their currently high levels, interest expenditure falls sharply as a percentage of GDP and the debt ratio would be on a declining path.

22. At the same time, reforms of the public administration and budget procedures will be needed to ensure a well-motivated civil service and better expenditure planning. In particular, efforts to reduce over-staffing will continue: in 1999, abstracting from temporary positions created by the Kosovo crisis, the authorities plan to cut over 5,000 budget sector jobs (3.7 percent of the total) with some of the savings being used to increase wage differentiation (structural benchmark). Further measures to enhance efficiency in the public sector will be identified through functional reviews of the spending ministries. These have been slow getting started, but with technical assistance from the World Bank reviews in five key ministries are expected to be completed this year. Efforts to strengthen budget classification and planning and to improve cash management will also continue with technical assistance from the IMF and others. A World Bank public expenditure review is planned for 2000.

C. Monetary Policy

23. The main objective of monetary policy for 1999 is to maintain inflation at a low level. While monetary policy is in principle anchored on money growth, the authorities take a pragmatic approach that also takes into account developments in prices and the exchange rate when adjusting interest rates and credit ceilings. The sharp fall in inflation at the beginning of the year prompted the Bank of Albania to cut interest rates by 1½ percentage points. This still left interest rates highly positive in real terms (minimum deposit rates are currently 15 percent and inflation is negligible). In view of the uncertainty created by the Kosovo crisis, the Bank of Albania has, for now, put further rate cuts on hold. Nevertheless, if inflation remains below the target and the stability of the lek continues, scope would exist for interest rate cuts later in 1999. The staff noted that the case for rate cuts would strengthen if the lek were to appreciate further. While competitiveness is still viewed as adequate (see Box 2), the exchange rate has appreciated substantially in real terms since 1995. The staff agreed that the authorities should continue to maintain a market-determined exchange rate system which has served Albania well in the past.

24. At this stage, the Bank of Albania and the staff do not expect that the Kosovo crisis will have a major impact on the monetary program in 1999. While the crisis may tilt the demand for money somewhat in favor of cash, overall demand for money is projected to grow broadly in line with nominal GDP, or by about 15 percent in the year to December (Table 5). There is also likely to be more foreign currency in circulation, although there are no signs so far of significant currency substitution. With virtually no change in NFA, domestic credit expansion would be sufficient to meet the demands of the budget—assuming Kosovo costs are externally financed—and allow for sizable growth in private sector credit; albeit from a small base. However, with an expansion in net credit by the two dominant state banks currently prohibited for prudential reasons, the programmed increase in private credit will only take place—and, more to the point, would only be desirable—if banking sector reforms are carried out quickly and supervision strengthened markedly.

Table 5.

Albania: Monetary Aggregates, 1997-2002

(In billions of leks, end period)

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Sources: Bank of Albania; and staff estimates.

25. An important task for the Bank of Albania during 1999 will be to prepare the ground for a move to indirect monetary policy instruments. Since early in the transition process, the main monetary instruments have been minimum deposit interest rates in the state-owned banks, which hold the great majority of deposits, and lending limits applied on all individual banks. The relevance of the former will disappear with the expected privatization of the remaining state-owned banks, and the Bank of Albania is keen to abolish lending limits on private banks—although strict limits on credit expansion would continue to apply to banks having a proportion of bad loans in excess of 20 percent. The staff supported the Bank of Albania’s intentions, but stressed that development of the treasury bill market should be a precondition for ceasing to apply minimum interest rates, and that improvements in banking supervision are necessary before bank-by-bank lending limits are dropped. During 1999, MAE will be providing technical assistance on both on- and off-site supervision and to help the Bank of Albania upgrade its intervention techniques in the treasury bill market.

26. Thanks to the passage of a revised Bank of Albania Law in late 1997 and of a revised Banking Law in 1998, the legal framework for the financial sector is now generally good. Following incorporation of comments from LEG and MAE, the authorities intend to submit a draft law on Secured Transactions by end-June (structural benchmark).

Albania: Competitiveness

The continuing appreciation of the real CPZ-based effective exchange rate (REER) since the end of the civil disturbances in 1997 raises questions about Albania’s underlying competitiveness. However, a preliminary assessment suggests that the real appreciation has not gone too far. While any analysis is very difficult in Albania’s case given the short history of transition, the severity of recent external and internal shocks, and the many data deficiencies, the following facts support this view:

  • The appreciation of the REER during 1998 does not appear to be notably out of line with past trends (Figure 3, top panel). Disregarding the period of instability connected with the pyramid schemes, the REER has been on an upward trend consistent with the scope for appreciation afforded by rapid productivity growth in the traded goods sector (in Albania’s case, mainly agriculture). On the basis of the authorities’ commitment to further structural reform, rapid productivity growth can be expected to continue.

  • The relative price of nontradable to tradeable goods has remained fairly stable since the crisis and is significantly below pre-crisis levels (Figure 3, bottom panel). This suggests that the appreciation has not been accompanied by major incentives to shift resources away from the tradeable goods sector.

  • Dollar wages in Albania remain very low and are below levels in other low-income transition countries. Currently the gross average wage in the budget sector (more relevant wage data, unfortunately, are not available) is only US$70 per month compared with US$123 in Bulgaria, US$117 in Romania, US$213 in Lithuania, and US$249 in Estonia.

  • While the full lagged effects of the real appreciation will not yet have been felt, export growth showed no sign of weakening during the course of 1998. In the second half of 1998, exports were 32 percent higher than in the first half of the year.

Figure 3.
Figure 3.

Albania: Competitiveness Indicators 1/

(1995=100)

Citation: IMF Staff Country Reports 1999, 050; 10.5089/9781451800623.002.A001

Source: Fund staff estimates.1/ Shaded area represents a period of nominal exchange rate instability associated with the pyramid schemes.

D. Structural Policies

27. While accepting that the Kosovo crisis will divert the energies of key officials to the refugee problem, the staff stressed that it would be important to keep up the momentum of reforms. The authorities concurred, although they pointed out that factors beyond their control, such as reduced international investor confidence, could lead to some delays in the privatization program, while increased opportunities for corruption would make their efforts to strengthen governance more difficult. However, in most areas the authorities agreed that structural reform targets discussed with the staff before the Kosovo crisis remained feasible.

28. Privatizing the two state-owned banks is a priority if a well-functioning financial system is to be created. Since the authorities had selected a buyer for the NCB (prior action), the staff advised them to negotiate the terms of the sale rapidly and flexibly, while not offering concessions that could undermine the program (e.g. tax concessions, guaranteed access to Bank of Albania facilities). The authorities were also encouraged to expedite preparations for the sale of the more economically significant Savings Bank. Submission of the privatization law to Parliament is an end-September structural performance criterion under the program, with a view to initiating the privatization process in 1999 and selecting a buyer before end-March 2000 (structural benchmark). As an important first step, the staff suggested that the government put its financial relations with this bank on a clear commercial footing. In the meantime, the bank should continue to operate under the governance contract agreed with foreign advisors.

29. Likewise, the steady progress in establishing a functioning land market should continue. Agriculture is very important to the Albanian economy—it accounts for over 50 percent of GDP—and the consolidation of land holdings will be needed to engender further productivity gains. The proposed program contains targets for land registration and land transactions (structural benchmarks). The authorities will also ensure the provision of adequate office space for land registries.

30. Although the Kosovo crisis could delay privatization of selected enterprises, the preparation of strategic sectors for privatization should not be affected. The sale and liquidation of the former-ERA companies and small- and medium-sized enterprises has, after a drawn out process, largely been completed.11 Now the focus has shifted to the mining, oil, and telecommunications sectors. The authorities had hoped to jump start the privatization process in these strategic sectors with the early sale of the mobile telephone company, followed later in the year by the sale of the fixed telecommunications company. However, a quick sale is unlikely whilst Kosovo uncertainties predominate. In the other sectors, the authorities will use 1999 to carry out restructuring and to formulate their privatization strategies in conjunction with foreign advice. In the mining sector, the authorities intend to sell or liquidate all small copper and chromium mines by end-September (structural benchmark). In the oil sector, the state oil company (Albpetrol) has been split into three companies and employment will be reduced by 2,000 to 7,500 by end-March 2000. In both sectors, the requisite privatization laws will be enacted by end-September (structural benchmarks).

31. While privatization is a longer-term objective for the public utilities, stemming losses and improving the performance of the state-owned electricity company, KESH, has become a priority. KESH’s technical performance has now deteriorated to the point where power outages are the norm in many areas, impeding economic development. Losses due to electricity theft and payments arrears are pervasive and KESH’s financial performance has become so bad that it threatens to become a drain on the budget. The staff urged the authorities to continue to work with the World Bank and foreign donors to address the management and associated governance issues. As a practical measure, the staff insisted that the government ensure that KESH install special meter boxes in apartments to help reduce fraud (structural benchmark).

32. Electricity theft is a symptom of a wider problem of respect for institutions. The staff thus welcomed the authorities’ determination to strengthen governance in key areas, and in particular in the judiciary and the customs administration where the authorities are receiving technical assistance from the World Bank and the EU. In a related vein, the staff also urged the authorities to bring the pyramid scheme episode—which at root had been a governance problem—to full conclusion at the earliest possible date. Delaying the sale and distribution of remaining assets risked provoking a public that is having to accept a large financial loss. It would also be important to carry out these remaining tasks as transparently as possible.

E. Trade Policy

33. Albania has made significant progress in establishing a liberal and open trade system. In April, the authorities reduced the maximum tariff rate from 30 percent to 20 percent, bringing the number of non-zero tariffs to just three. As a result of the reform, the unweighted tariff rate declined from 15.9 percent to 14.1 percent. In addition, excise taxes on imported and domestically produced goods were unified in early 1999 and the authorities plan to remove the few remaining quantitative trade restrictions by end-July (structural benchmark). The authorities intend to reduce tariffs further in the next few years, bringing the maximum rate down to 15 percent and lowering the average rate to 10–12 percent, beginning with a reduction of the maximum rate to 18 percent in the 2000 budget. In addition, the government will remove the export bans on skins and hides, and on scrap metals, by end-July 1999 (structural benchmarks). It is committed to not introducing any new quantitative restrictions on exports or imports. Albania continues to make progress in its accession discussions with the WTO.

34. However, progress has not all been positive. In April 1999, the authorities raised the tariff on diesel from 10 percent to 20 percent, a move aimed at providing temporary protection to the local petroleum industry whilst it restructures.12 In early 1999, the authorities introduced automatic import licensing restrictions on fuel products to support the implementation of domestic technical standards. They continue to maintain non-automatic export licensing restrictions on wood and wood products which complement harvesting limits for forestry conservation purposes. The tariff increase will, however, be reversed by end-October 1999 as the authorities intend to expedite their restructuring plans for the petroleum industry. The authorities will also extend customs valuation based on the transactions value approach to all customs offices: owing to weak implementation capacity, much valuation in practice relies on minimum reference prices.

F. External Outlook and Capacity to Repay the Fund

35. Albania’s external position is projected to deteriorate sharply in 1999. Higher import demand (in addition to imports of direct aid for refugees) arising from the effects of the Kosovo crisis and from investment and development needs, in conjunction with slower export growth than originally programmed, is expected to push the current external account deficit up from 6 percent of GDP in 1998 to 12 percent of GDP in 1999 (Table 6). At the same time, lower foreign direct investment will contribute to a weaker capital account. The strong reserve position at the end of 1998 gives the authorities some cushion to absorb the adverse impact of the Kosovo crisis. However, even allowing for a small decline in reserves, the authorities will need a considerable amount of highly concessional official financing in 1999, estimated at about US$200 million, of which some US$160 million is attributable directly to the Kosovo crisis.

Table 6.

Albania: Balance of Payments, 1994-2003

(In millions of US dollars)

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Sources: Ministry of Finance; Bank of Albania; donors, and Fund staff estimates and projections.

Excluding IMF.

The large errors and omissions in 1997 reflects incomplete data for the first half of the year as a result of the crisis.

The figure for 1994 includes the elimination of arrears on medium-term debt to Paris Club creditors and the settlement of bilateral clearing account arrears (to GDR) with Germany. The 1995 figure reflects the commercial debt restructuring under the Brady deal.

The figure for 1998 corresponds to the clearance of arrears to Russia and Italy as a result of the rescheduling of Paris Club debt in Jury 1998. The stock of arrears is subject to reconciliation with Russia and Italy.

Debt forgiveness in 1995 corresponds to commercial bank restructuring under the Brady deal.

The figure for 1994 corresponds to the rescheduling of Paris Club debt in December 1993.

Includes arrears.

Excludes official transfers related to the Kosovo crisis.

Excludes humanitarian imports related to the Kosovo crisis.