Albania: Staff Report for the 2000 Article IV Consultation and Second Review Under the Second Annual Arrangement Under the Poverty Reduction and Growth Facility

The Kosovo crisis in March 1999 and the large influx of refugees placed a considerable strain on the country. Progress in structural reforms has been significant considering the Kosovo crisis. The process of privatizing about 520 small and medium-size enterprises was completed, contracts were signed for the transfer of copper and chromium mines to foreign investors, and albeit with delay, the authorities’ recently signed agreement with investors on the privatization of the National Commercial Bank. Executive Directors commended the Albanian authorities for their policies to maintain macroeconomic stability.

Abstract

The Kosovo crisis in March 1999 and the large influx of refugees placed a considerable strain on the country. Progress in structural reforms has been significant considering the Kosovo crisis. The process of privatizing about 520 small and medium-size enterprises was completed, contracts were signed for the transfer of copper and chromium mines to foreign investors, and albeit with delay, the authorities’ recently signed agreement with investors on the privatization of the National Commercial Bank. Executive Directors commended the Albanian authorities for their policies to maintain macroeconomic stability.

I. Introduction

1. A mission visited Tirana during March 5-20 to hold the 2000 Article IV consultation discussions and to discuss: i) the interim Poverty Reduction Strategy Paper; ii) the second review under the second annual Poverty Reduction and Growth Facility (PRGF) arrangement; and iii) the third-year program under the PRGF arrangement.1 Discussions were completed in Washington during the Spring meetings in April. Relations with the Fund are summarized in Appendix I.

2. The Executive Board completed the first review of the second annual arrangement under the PRGF on January 19, 2000. Executive Directors commended the authorities for their handling of the Kosovo refugee crisis, and their success in maintaining macroeconomic stability. Reiterating their views expressed at the conclusion of the Article IV consultation on June 14, 1999, Directors stressed the importance of improving tax administration with a view to providing sufficient resources for spending in key areas and meeting the deficit reduction target. They also emphasized the importance of completing privatization in the banking sector and accelerating it in other strategic sectors. Following the completion of the review, the cumulative disbursements reached SDR 30.93 million, which included a Kosovo-related augmentation of SDR 9.74 million, out of the total SDR 45.04 million committed under the three-year program.

3. In the attached letter, the authorities report on the progress under the program, request the completion of the second review under the second annual PRGF arrangement, and describe the economic policies they intend to pursue during the third annual program under the PRGF arrangement (Attachment I).2 All performance criteria for end-March 2000 were observed (Tables 1 and 2). Moreover, the authorities have prepared an interim Poverty Reduction Strategy Paper (1-PRSP) (seeEBD/00/41). In their joint assessment, the staffs of the Fund and ID A/World Bank have recommended the endorsement of the I-PRSP by the respective Executive Boards. The authorities intend to prepare a full PRSP by June 2001.

Table 1.

Albania: Performance Criteria and Indicative Targets for 1999-2000 Cumulative Change from end-December 1998 1/

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For definitions see the Technical Memorandum of Understanding.

Indicative targets.

Performance criteria, except for tax and customs revenues, which are indicative targets.

Table 2.

Albania: Remaining Structural Benchmarks under the Second Annual PRGF Arrangement

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4. The World Bank has recently prepared an update of its Country Assistance Strategy, in which a stronger focus on poverty issues has been integrated into the Bank’s sector operations in Albania. The second disbursement of the latest Structural Adjustment Credit is expected in the third quarter of 2000. The Bank is planning additional structural adjustment and lending operations that will support financial sector and public expenditure reforms in 2001. Appendix II summarizes Albania’s relations with the World Bank.

5. The political situation remains stable, with the ruling coalition led by the Socialist Party firmly in power. The main opposition party, which has until recently threatened a boycott, has announced that it will participate in the local elections scheduled for September 2000. Parliamentary elections are scheduled to be held in May-June 2001.

6. The timeliness and quality of the macroeconomic data, although adequate for program monitoring, continue to suffer from serious deficiencies, especially in the real sector (Appendix III). Albania is participating in the preparation of the data dissemination component for a Report on Observance of Standards and Codes (ROSC), and has volunteered to be a General Data Dissemination System (GDDS) pilot country.

7. 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. The Fourth Amendment to the Fund’s Articles of Agreement was ratified by parliament on July 15, 1999. Albania is participating in the pilot project for the voluntary release of Article IV reports; the 1999 staff report was published. The authorities have also requested the publication of the staff report for the 2000 Article IV consultation.

II. Macroeconomic Developments and Performance Under the Program

8. Albania has experienced a period of relative tranquility over the past year, despite the Kosovo crisis. The collapse of the pyramid schemes in early 1997 plunged Albania into a deep crisis, with public order breaking down, economic activity stalling, and the lek falling sharply. Subsequently, the government adopted a six-month program, supported under the Fund’s post-conflict emergency policy, followed by a comprehensive three-year ESAF program. Economic activity rebounded in 1998, inflation fell sharply, and confidence in the lek recovered. The Kosovo crisis in March 1999 and the large influx of refugees placed a considerable strain on the country. However, the early end to the hostilities, together with generous external assistance and the authorities’ cautious financial policies, allowed the economy to withstand the crisis. Macroeconomic stability was maintained, although structural reform suffered.

9. Growth remained strong during 1999, with some indications of a weakening toward the end of the year. GDP increased by 7¼ percent in 1999, benefiting from the Kosovo-related positive demand shock, particularly in the transport and service sectors, which grew by more than 10 percent (Table 3, and Figures 1 and 2). Investment was also strong, as evidenced by a 30 percent surge in imports of equipment and machinery and a 15 percent increase in construction activity. Agricultural output, which still accounts for about a half of GDP, increased by 3½ percent in 1999, less than the 5 percent in recent years, which reflected Kosovo-related disruptions, but also the narrowing scope for rapid productivity gains, as the progress in consolidating land holdings remains modest. A decline in imports in the fourth quarter of 1999 suggests a possible weakening in domestic demand as the Kosovo effects unwound. Exports, which had grown strongly since early 1998, also fell in the third quarter of 1999 and remained sluggish thereafter, reflecting a loss of reprocessing contracts during the Kosovo crisis, a disruption in chromium production, and an unrecorded diversion of exports to Kosovo.

Table 3.

Albania: Basic Indicators and Macroeconomic Framework, 1997-2003

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Sources: Albanian authorities and Fund staff estimates and projection.

Current account excluding official transfers.

Revenue minus current expenditure.

Excluding privatization revenues.

Including bonds Source for bank restructuring (Lek 7 bn for 1999; Lek 15 bn for 2000).

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

Figure 1.
Figure 1.

Albania: Monthly Economic Indicators, 1995-2000

Citation: IMF Staff Country Reports 2000, 074; 10.5089/9781451800630.002.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 filtered inflation.
Figure 2.
Figure 2.

Albania: Economic Developments and Prospects, 1993-2000 1/

Citation: IMF Staff Country Reports 2000, 074; 10.5089/9781451800630.002.A001

Source: Albanian authorities and Fund staff estimates.1/ Program projections for 2000.

10. Inflation turned negative in early 1999, following a sharp appreciation of the lek. Relative to the euro, the lek appreciated by 13 percent between December 1998 and June 1999, and by an additional 4½ percent by March 2000. Strong productivity growth and the diversion of Kosovo-related aid imports to domestic markets have also contributed to the deflation. Despite the pickup in oil prices, the annual inflation rate was -1.7 percent in April 2000.

11. Official foreign reserves strengthened to a level much above the program target in 1999. The current account deficit widened to 8 percent of GDP in 1999, owing to higher imports resulting from the Kosovo crisis and somewhat lower remittances, but foreign assistance and other inflows allowed official reserves to strengthen by about US$100 million, to US$480 million, almost five months of imports of goods and services. The ratio of reserves to broad money, however, remained relatively modest, at about 22 percent.

12. Fiscal policy, in reaction to the Kosovo events, turned expansionary, but it broadly realized its deficit target under the program. The budget, which initially envisaged an unchanged general government deficit for 1999 of about 10½ percent of GDP, was amended in July to accommodate Kosovo-related spending (Table 4). In the event, the deficit reached 11¼ percent of GDP, with Kosovo-related expenditure amounting to about 1½ percent of GDP, Substantial Kosovo-related reconstruction projects, equivalent to about 4 percent of GDP, were also financed with foreign resources outside of the budget. The domestically financed deficit, the fiscal target under the program, was reduced from 6½ percent of GDP in 1998 to 5¼ percent of GDP in 1999.

Table 4.

Albania: Government Revenue and Expenditure, 1995-2000

(in percent of GDP)

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Sources: Albania authorities; and Fund staff estimates and projection.

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 hills is held by the State insurance company (INS1G) and the private sector.

Including arrears and privatization receipts.

The Expenditure figures based on the functional classification are highly provisional. The Albanian authorities have only recently started work on the functional classification.

13. The authorities did not succeed, however, in realizing the tax revenue target in 1999, which was one of the main objectives under the program. State budget tax revenue was about Lek 8.4 billion (1.7 percent of GDP) below the target in 1999, about half of which resulted from the effects of lower-than-projected inflation on domestic collections, and the effects of an appreciated exchange rate on customs collections. The other half reflected weaknesses in customs and domestic tax administration. In particular, VAT collections increased by only about 3 percent and customs collections fell by 2 percent, while an improvement was reported in collections of income taxes and excises, The tax revenue shortfall was partially compensated by larger-than-projected Bank of Albania (BoA) profit transfers, reflecting higher interest rates than projected, and one-time effects of switching from cash-based to accrual-based accounting, equivalent to Lek 2 billion (0.4 percent of GDP). Against this background, the end-December budget deficit target was broadly met by cuts in investment expenditure of about ½ percent of GDP.

14. Tax collections substantially improved in early 2000, largely as a result of the measures agreed at the time of the October mission. Measures that proved to be particularly effective included changes in key personnel in the major custom houses, better control of goods in transit, the intensification of internal audit procedures, revision to reference prices, and better collection of customs debts. Moreover, efforts to reduce smuggling bore fruit as evidenced by the increase in the reported volume of smuggling-sensitive imports and confirmed by members of the business community that had been adversely affected by smuggling. In domestic revenue collection, the number of VAT-registered taxpayers has been substantially increased, and compliance strengthened (MEFP, ¶3).3 Particularly good results were realized in the collection of car registration taxes, with the number of registrations increasing 40-fold. As a result, state budget revenue at end-March 2000 on a cumulative basis was only about Lek 1 billion below the indicative target under the program, compared with the Lek 3 billion shortfall at end-December 1999. Compared to the same (admittedly weak) period in 1999, tax collections in the first quarter of 2000 increased by about 40 percent, and were about 5½ percent more than envisaged in the budget. However, VAT refunds have been slow and there have been complaints in the business community about the assessments of advance payments under the income tax law.

15. Monetary policy, which was arguably tighter than warranted in the first half of 1999, has since been more decisive in attempting to ease monetary conditions. Until May 1999, the BoA was exceedingly cautious in cutting interest rates despite the strong upward pressure on the currency and the absence of inflationary pressures. Subsequently, it has halved minimum deposit rates (3- and 12-months) in several steps, to 7.0-8.0 percent in March 2000. The last interest rate cut, however, has not yet been followed by the largest bank, the Savings Bank. Growth in broad money, at about 20 percent in the year to February 2000, has continued to be strong, reflecting output growth and increased confidence in the banking system (Table 5). Growth in lek time deposits was lower, about 11 percent, reflecting in part cuts in interest rates.

Table 5.

Albania: Monetary Aggregates, 1998-2001

(In billions of leks unless otherwise indicated; end-period)

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Sources Bank of Albania, and staff estimates.

According to the definition in Die Technical Memorandum of Understanding.

16. Financial market reform has been slower than expected. The transfer of the National Commercial Bank (NCB) to foreign investors has been delayed by several factors, the latest being the investors’ request for several put options in the contract. Regarding the Savings Bank, there has been some progress in streamlining its operations, resulting in a reported profit for 1999, Moreover, the government has started to pay appropriate fees for payment services performed by the bank. The appointment of a chief operating officer and a chief accounting officer through an international tender was delayed, owing to procurement difficulties under the supporting World Bank project. Overall, Albania’s banking system continues to be burdened with structural problems. The Savings Bank enjoys a near-monopoly position in the lek deposit and T-bill markets, reflected inter alia in a large spread between deposit rates, and T-bill rates, of about 5 percentage points for the same maturity. The share of private banks in the lek market remains meager (3-4 percent), despite its rapid growth in recent years. High lending rates, persistent deficiencies in the legal system and business accounting practices, and prudential restrictions on state-owned banks have kept private sector credit growth much below the program target.

17. While progress in structural reforms has been significant considering the Kosovo crisis, more needs to be done to create a market-friendly environment conducive to private investment.

  • During 1999 and early 2000, progress was made in enterprise privatization, but no major foreign investment deal was brought to completion, in part owing to the Kosovo crisis and cabinet reshuffles. The process of liquidating, privatizing, or transferring to local authorities about 520 small and medium-size enterprises was completed, although it attracted limited interest among private investors and only 180 enterprises were fully privatized. A contract was signed for the transfer of copper mines to a foreign investor. A concession for a chromium mine and a smelter was awarded to an Italian company, which plans to invest US$15 million over the next four years, as well as another concession for a phosphate plant. However, as of April 2000, foreign investors have not yet started operations in these facilities.

  • The collateral law was approved by Parliament, but its effective implementation is pending the establishment of a registry at the Ministry of Finance. The 1996 bankruptcy law has remained ineffective owing to internal inconsistencies, and the authorities have started to prepare a new law. The execution of court decisions in civil cases is extremely weak, with almost three-fourths of the cases remaining unenforced. Mortgage lending is negligible, as the courts refuse to support claims against residences.

  • In public administration, the government removed about 5,000 positions from the public sector payroll in 1999, and has removed a further 3,000 so far in 2000, reducing the total to about 127,000. The increase in the budget sector real wages over the past two years and progress in reviewing the salary structure have also likely contributed to increased efficiency and improved incentives in the public sector. The authorities also approved a new Civil Service Law, which is expected to be implemented in mid-2000 and are in the process of establishing a civil service commission. While the authorities have stressed their determination to eradicate corruption, graft reportedly remains widespread.

  • The authorities have made progress in liquidating the assets of the former pyramid schemes and distributing the proceeds to former investors. Moreover, after much delay resulting from a contractual dispute, the foreign auditing companies have now completed their reports.

  • Progress has been realized in land registration, with more than half of the agricultural land in use now registered, although the end-March 2000 target was not achieved. Direct indicators on land consolidation are lacking but the increasing number of transactions indicates progress in this area.

18. Albania is one of the poorest countries in Europe, with poverty concentrated in its rural regions. Its per capita GNP is the lowest in Southeastern Europe, amounting to US$760 in 1997 according to the World Bank Atlas method, around two-thirds of that of the next poorest country in the region, FYR Macedonia. Judging from the limited data available from a 1996 household expenditure survey for areas excluding Tirana, the incidence of poverty appears to reflect mainly low national per capita income rather than unequal income distribution. Almost 90 percent of the poor live in rural areas, where the incidence of poverty among children also appears to be very high. As a result of large migrations since the last survey was conducted in 1996, urban poverty has also increased, as evidenced by the spread of slum-like communities around major cities and an increase in the number of street children. Health indicators are particularly worrisome, with infant mortality, maternal mortality, and below-5 mortality comparing very unfavorably with regional averages. And while Albania has succeeded in preserving almost full enrollment in basic schools and achieving full literacy except for the oldest cohorts of the population, enrollment at the secondary level has dropped by half since early 1990s. Budgetary expenditures on health and education have fallen since the transition began, and at 2.2 percent and 2.9 percent of GDP respectively in 1999, were substantially lower than in neighboring countries (Table 6).

Table 6.

Albania: Social Indicators

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2000 World Development Indicators CD-ROM, World Bank

III. Report on the Discussions

19. With macroeconomic performance broadly on track, discussions with the authorities focused on the additional structural reforms required for keeping the economy on a fast growth track, and on the government’s plans to develop a comprehensive strategy for alleviating poverty. The mission pointed out that the current rapid output growth, which partly reflected the continuing recovery from the 1997 disturbances and the demand shock related to the Kosovo crisis in 1999, will not be sustainable unless Albania accelerates the necessary reforms for establishing a modern market economy. The authorities concurred on the need to implement further reforms, particularly in view of their intentions to reduce the development gap relative to European countries and to join European associations. The government also intends to strengthen the focus of its policies on poverty alleviation, which will require a stronger revenue effort and higher spending on health, education, infrastructure, and other poverty-related programs.

A. The Poverty Reduction Strategy

20. The authorities expressed enthusiasm for the new emphasis on poverty reduction under the program and made a determined effort to publicize the initiative and prepare an interim PRSP, in collaboration with the Bank and Fund staff. The line ministries provided valuable information on the poverty profile in Albania, as well as proposals for improving government policies in this area. The interim PRSP includes an agenda for producting a preliminary poverty assessment by early 2001, which will then be used as an analytical background for policy formulation in the first PRSP by mid-2001. Moreover, in the context of the medium-term public expenditure framework (MTEF, 2001-2003), the budget priorities for 2001 are already being defined with an explicit focus on poverty issues.

B. The Macroeconomic Framework

21. The macroeconomic framework agreed at the time of the first review remains broadly appropriate; however, reflecting the weaker demand at the end of 1999, GDP growth is now projected to be somewhat lower, at about 7 percent in 2000. Structural reforms, in particular the completion of several important privatization projects, some of which include obligations of new owners to invest in new capacities, are expected to induce an increase in private investment activity in 2000, which in combination with improved consumer confidence, and supported by the easing of monetary conditions, should compensate for the withdrawal of the fiscal stimulus. Exports should benefit from completion of several privatization projects in the mining sector, as well as stronger demand growth in partner countries than in 1999. Recent deflationary pressures, which have also contributed to a downward revision in nominal GDP for 2000, are expected to subside with the pickup in domestic demand. Admittedly, there is a downside risk for output growth should private investment be weaker than projected, which could also be compounded by the effects of the lek’s recent real effective appreciation on the trade balance (for an evaluation of competitiveness, see Box 1). In this context, the macroeconomic framework and the policy mix will be reassessed at the time of the first review under the program.

22. Over the medium term, structural reforms and foreign direct investment should allow Albania to realize its potential output growth rate of about 8 percent.4 While the possibilities for rapid productivity gains in the agricultural sector related to the transition have been largely exploited, land consolidation and improved rural infrastructure would allow higher growth rates than in 1999. Improvements in the legal framework, a better-functioning financial system, the privatization of the remaining state-owned enterprises, and improved infrastructure should attract private investment, including foreign direct investment (FDI). This should help Albania develop a modern industrial sector and strengthen its currently very weak export base (merchandize exports were equivalent to less than 8 percent of GDP in 1999), and gradually reduce its reliance on large private and official transfers.

C. Fiscal Policy

23. The authorities and the mission affirmed that there was no need to change the 2000 budget, as macroeconomic developments were broadly on track and the authorities remained committed to achieving the revenue goal. The targeted reduction in the general government deficit of 2 percentage points of GDP in 2000 and in the domestically financed deficit (excluding privatization proceeds) of about 1 percentage point are in line with the medium-term objective of fiscal consolidation. Moreover, the rather ambitious target for raising state tax revenues by 2¼ percentage points of GDP in 2000 should allow the government to increase noninterest spending by about 1½ percentage points, excluding Kosovo-related expenditure.

Albania: Competitiveness

Figure 1:
Figure 1:

Real Exchange Rate and Monthly Exports

Citation: IMF Staff Country Reports 2000, 074; 10.5089/9781451800630.002.A001

The continuing real appreciation of the lek and the recent mixed performance of exports raise the question whether Albania is facing an overvaluation of the exchange rate and, hence, a problem of competitiveness that could dampen growth. Over the past 15 months, the CPI-based real effective exchange rate appreciated by around 20 percent (Figure 1). Exports (in U.S. dollars) showed a steady upward trend between mid-1997 and mid-1999, but then fell and have since remained sluggish. However, their performance may still reflect the lingering effects of the Kosovo crisis, which led some investors to redirect production toward domestic consumption by the refugees, while at the same time demand for Albania’s exports may have suffered owing to the perceived increase in country risk.

The long-run behavior of the exchange rate and exports provides no clear picture as to the potential loss of competitiveness. The real appreciation of the lek started with the transition to a market-based economy, likely reflecting an initial undervaluation as observed in other transition economies. A partial reversal began in mid-1994 and ended in mid-1996, when the exchange rate began a relatively stable upward trend that is continuing today, with the annual appreciation averaging 12½ percent since mid-1996. While this appreciation exceeds that in neighboring countries, data deficiencies and the short history of transition make it difficult to reach a conclusion on whether it still reflects the initial undervaluation. It should be noted that until the second half of 1999 the appreciation in the real exchange rate did not appear to affect exports. On the contrary, the positive trend in the exchange rate paralleled a rising trend in export volumes and the current account deficit has improved relative to GDP.

Other indicators of competitiveness also present ambiguous evidence. Productivity in the tradable goods sector has risen substantially: Land privatization unleashed large productivity gains in agriculture; moreover, the textile and shoe industries, Albania’s main exporters, benefited from modern management and production techniques implemented by foreign investors. However, the domestic price ratio between nontradables and tradables has not increased in response to differential productivity growth, but has instead remained stable, which—from the demand perspective—indicates that internal competitiveness has not suffered. While Albania also has lower public sector wages compared with other transition economies in Europe, the difference vis-à-vis some of its neighbors in U.S. dollar terms is not large (Figure 2). (No data are available on productivity-adjusted private sector wages, which would allow a more complete analysis.) On the other hand, Albania’s economy is to a large extent driven by informal activities, e.g., family-owned farms and businesses, where wages are sufficiently flexible to adjust to changes in competitiveness.

Figure 2:
Figure 2:

Average Public Sector Wages in Selected Transition Economies

Citation: IMF Staff Country Reports 2000, 074; 10.5089/9781451800630.002.A001

Over the medium term, nonprice structural factors may be more important for competitiveness than the exchange rate. These include regional stability, investment policies, governance, legal security, and access to financial services. Improvements in these areas, which are potentially large, should result in productivity increases and would thereby alleviate the effects of real appreciation.

24. The authorities and the staff shared the view that further measures were needed to meet the revenue target, particularly in light of lower nominal GDP growth. While acknowledging the progress in tax collection in early 2000, the mission pointed out that a further improvement in revenue performance is a crucial element of the PRGF-supported program. The mission also warned against relying on unsustainable measures or imposing disputable burdens on taxpayers, including delays in the reimbursement of tax refunds. Against this background, the authorities decided to implement the following measures for strengthening customs and tax administration:

  • Regarding customs, the authorities will increase the number of staff and, with assistance from the EU Customs Administration Mission, organize training in both the internal audit and valuation units, the latter with a view to reducing excessive reliance on reference prices. The production of biweekly reports on the results of internal audit inspections and monthly reports on disciplinary actions recommenced on May 1, as a prior action for the completion of the second review (¶11).5 To provide better incentives, the authorities will implement the new remuneration system for customs officials, including a special bonus system and a new annual appraisal system for all customs officials. To curb the abuse of the special customs regime licenses for inward processing, all users of these licenses will be audited by end-2000.

  • Regarding domestic taxes, the authorities plan to increase further the number of registered small business taxpayers, strengthen efforts to collect all new tax obligations of the state-owned electricity company KESH and the oil refinery, and collect tax arrears from other taxpayers (¶12). To address concerns in the business community, they will accelerate VAT reimbursements, and amend the VAT law, which currently does not set a deadline. In the same vein, the authorities will reimburse overpaid profit taxes on time, so as to improve the accountability of government institutions. Collection of social security contributions will be reinforced by introducing social security numbers for all individuals and by amending the law with a view to strengthening the authority of inspectors.

25. The mission stressed the importance of protecting expenditures in priority areas, but argued that as long as revenue prospects remained uncertain, the 2000 budget should be executed with caution. To provide some cushion against unexpected revenue shortfalls, the authorities indicated that they would strictly follow their monthly expenditure program, which would be reviewed at the time of the next staff visit in July, and limit spending from the reserve and contingency funds to emergency cases.

26. Assuming that favorable macroeconomic developments continue, the fiscal target for 2001 would embody a reduction in the domestically financed deficit (excluding privatization proceeds) of about 1 percentage point of GDP. This would be consistent with the targeted reduction in the government debt ratio under the medium-term fiscal strategy, and with the objective of reducing domestic borrowing at high real interest rates (see EBS/00/1). Improved tax collection should also enable the authorities to review the profit tax law and explore the possibility of introducing an investment tax credit in the 2001 budget. Over the medium term, the fiscal position appears sustainable, as public debt is expected to decline substantially, by 3½ percentage points of GDP between 2000 and 2003. The tax-to-GDP ratio would increase by about ½ percentage point of GDP a year, as the formal sector of the economy gains importance, which should allow the government to increase noninterest expenditure at about the same pace, with additional resources going primarily for poverty alleviation—including expenditures on health and education. The authorities noted that the first medium-term expenditure framework (MTEF) was expected to be completed by July 2000, with the assistance of the World Bank (¶16). Expenditure plans will be based on sector strategies for health, education, transport, public works, and social protection, which will explicitly include poverty reduction goals, some of which might be used to attract foreign funding.

D. Monetary and Exchange Rate Policy

27. The authorities and the mission agreed that monetary policy should be geared towards an inflation outcome of about 2-4 percent, a level consistent with necessary relative price adjustments. The mission argued for further interest rate cuts, as the continuation of deflationary pressures might adversely affect growth performance. Moreover, any consequent easing in the exchange rate would help competitiveness. As the velocity of the lek money stock has continued to decline, the recent faster growth in foreign currency deposits likely reflects a portfolio shift from foreign cash holdings into deposits, in line with improved confidence in domestic banks. The Bank of Albania officials were initially reluctant to proceed with a large interest rate cut, as they were concerned about the slower growth of lek deposits, an indicator which they assigned high importance, while they also felt constrained by the level of interest rates in Greece and Turkey. However, against the background of recent CPI figures, they lowered short-term rates by 1 percentage point, to 7 percent, in late March 2000. As there have been no adverse market reactions to this latest cut, the staff still sees scope for additional gradual cuts in interest rates. Monetary policy will continue to be managed in the context of a flexible exchange rate regime, with the BoA’s interventions in the foreign exchange market limited to smoothing excessive short-term fluctuations. The authorities concurred that upward pressure on the lek should trigger further interest rate cuts, and that if the pressures persist, they would consult with the staff.

28. The mission extended the monetary framework for April 2000-March 2001. As the continuation of strong money demand suggested that the process of remonetization after the 1997 crisis was not yet complete, the staff and the BoA revised upward the projections for broad and reserve money in 2000. The mission also revised downward the projections for private sector credit in light of slower-than-projected progress in banking sector reform and in improving the legal framework for business credit.

E. Structural Reform

29. The mission stressed the utmost importance of reforms in the financial system, notably bank privatization and improvements in the institutional framework, for keeping the economy on a rapid growth path. On the privatization of the NCB, the mission encouraged the authorities to reach a satisfactory agreement with investors as soon as possible. Regarding the Savings Bank, the mission reviewed the steps to ensure its timely and successful privatization (¶21). In particular, the mission urged the authorities to proceed with the hiring of a chief accounting officer and a chief operating officer, and encouraged them to request additional rapid assistance to improve the accounting practices in the bank, as this would likely be of crucial importance for a successful privatization. A preliminary analysis of the profitability of individual branches has been completed (a structural benchmark for end-March 2000). The mission agreed that the tender for the privatization advisor (a structural benchmark for end-March 2000) would be announced in June, as the resources provided by the World Bank for this purpose would not be available until then. The authorities accepted that the selection of the privatization advisor by end-September and the announcement of the privatization tender by end-November would be two structural performance criteria, and that the negotiations with potential short-listed investors would start in December (structural benchmark). The Savings Bank would by that time have been recapitalized to cover its negative capital of about Lek 12-15 million (2-2½ percent of GDP); allowance for interest payments has already been made in the 2000 budget. The BoA would also prepare a draft law for deposit insurance by July 2000, with the aim of having it approved by end-2000 and implemented by the time of the SB’s privatization. The authorities intend to take further steps to open up the insurance market.

30. The mission examined progress in phasing out direct instruments of monetary policy and the reasons behind the limited participation of private banks in the T-bill and lek deposit markets. The mission agreed with the authorities’ plans to gradually remove the floors on deposit interest rates in state-owned banks (¶20). The mission advised against efforts to reduce T-bill rates by putting pressure on the management of the SB. Instead, it recommended that the spread be reduced by taking measures to strengthen competition in the market and to attract the interest of private banks and other investors, for example, by selling T-bills through tax and post offices and by better informing households and other potential investors about the possibilities of investing in T-bills. The authorities have implemented measures agreed with MAE to improve the T-bill market (end-March structural benchmark). The mission also advised the authorities to implement an information campaign aimed at developing the T-bill market, as recommended by MAE. To encourage the entry of private banks into lek operations, the mission suggested that the BoA explore measures to improve the refinancing facilities based on T-bills and introduce remuneration of mandatory reserves to reduce bank intermediation costs. The authorities intend to replace the government’s nonmarketable obligations to the BoA with marketable securities, with a view to boosting the BoA’s capacity for open market operations. For prudential reasons, the BoA would continue to enforce lending limits on banks with a high proportion of nonperforming loans, including the two state-owned banks.

31. In the enterprise sector, the mission urged the government to proceed rapidly with several privatization projects crucial to attracting foreign direct investment and enhancing overall investment activity. In the telecommunications sector, the mission advised against any further delays in selecting a buyer for the Albanian Mobile Communications (AMC) and in preparing the second mobile phone license for auction (¶24). Regarding the privatization of Albtelecom, which has been delayed owing to difficulties in financing the privatization advisor by a foreign grant, the authorities have agreed to accelerate the process by putting into place the necessary legal framework and ensuring that the auditing of the 1999 financial statements is completed by June 2000 (structural benchmark). The authorities are strongly determined to privatize the five remaining mid-sized enterprises (the brewery, winery, dairy factory, pharmaceutical factory, and the cement factory), mostly with assistance from USAID (structural performance criterion, see ¶24). In the mining sector, the authorities are finalizing the lease contract for the copper company, and are working on the next steps for the privatization of a chrome smelter and a chrome mine by end-2000. In the oil sector, the authorities have undertaken to prepare by end-April an action plan for selling and liquidating parts of the loss-making oil drilling and service company, Servcom (structural benchmark), and completing their privatization or liquidation by end-2000. The mission also urged the authorities to continue, in coordination with the World Bank, to improve the management of the public electricity company, KESH.

32. In discussing policies to attract FDI, the mission advised against relying on discriminatory fiscal incentives, and stressed instead the urgency of reinforcing good governance and law and order. The mission convinced the authorities’ not to implement their proposals for liberalizing the law on fiscal exemptions to grant incentives to foreign investors, which has only been used on a very limited basis so far. Instead it emphasized the importance of speeding up and improving administrative procedures for foreign investment and removing bureaucratic obstacles. In this context, the mission proposed that the authorities should, in cooperation with donors, establish a one-stop investment shop for foreign investors that would provide the services associated with the promotion and facilitation of FDI within the same agency. Foreign investors would also benefit from establishing a mediation center that could offer an alternative means of dispute resolution in commercial cases, as envisaged under a World Bank project. The mission supported the authorities’ decision to create a free zone in Durres this year to provide foreign investors with a strategic location and adequate administrative and logistical support for their activities, but it warned the authorities to implement appropriate safeguards and controls to prevent smuggling from the zone. The mission and the authorities were in full agreement that no exemptions from direct taxes should be provided to companies operating in the zone.

33. In relation to other areas of structural reforms, the mission reviewed progress in public administration, notably in establishing the civil service commission, and stressed its role in improving governance. The mission advised the authorities to combine the approval of the new bankruptcy legislation with a comprehensive program to train judges and other court officers in its implementation. It discussed the implementation issues related to the new collateral law with the foreign advisors and the business community, and urged the authorities to establish rapidly the registry for collateralized property. In discussing issues related to deficiencies in the legal system, the authorities pointed out that they would be receiving further assistance from the World Bank in revising the Anti-Corruption Action Plan, as well as implementing several measures to strengthen the enforcement of judicial decisions. To further the consolidation of private land holdings, the government agreed to continue with the registration of land at a rate of 150 cadastral zones per quarter (structural benchmark). The mission also urged the authorities to move ahead vigorously in completing the distribution of the assets of the former pyramid schemes.

34. The mission emphasized the importance of improving the quality and coverage of economic data deemed necessary for macroeconomic management and the implementation of the poverty reduction strategy. In particular, it urged the authorities to adhere closely to the timetable for the production of national accounts statistics agreed with ST A, as well as to start compiling monthly data on output, employment, and wages in the private sector. The authorities are currently drafting a new law on statistics with EU assistance to provide a secure legal basis for the activities of 1NSTAT.

F. External Outlook and Policies, and Capacity to Repay the Fund

35. Albania’s external position remains sustainable. With continuing large investment and reconstruction needs, the current account deficit is expected to remain broadly unchanged, at about 8 percent of GDP in 2000, and to be fully financed by projected inflows of official bilateral and multilateral support and foreign direct investment (Table 7). Additional inflows in the context of the Stability Pact are expected to pick up only in 2001 and thereafter. Small financing gaps are projected to open up in 2001 and to continue in the medium term. The external financing situation will be reassessed during the midyear review in November 2000. In the medium term, the current account deficit is projected to decline gradually as exports rise—in response to further improvements in security and public order, the investment climate, and continuing structural reforms—and private remittances grow steadily. There is considerable scope for foreign direct investment to rise.

Table 7.

Albania: Balance of Payments, 1998-2004

(In millions of U.S. dollars)

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

Excluding IMF.

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 July 1998.

Includes arrears.

Includes imports (official transfers) related to the Kosovo crisis.

Excludes imports (official transfers) related to the Kosovo crisis.

36. The government is continuing its efforts to regularize relations with its external creditors. It has reconciled estimates of arrears to Russia and Italy subject to the July 1998 Paris Club Agreement and will aim to conclude the respective bilateral agreements within a new deadline to be agreed with the Paris Club. The mission urged the authorities to expedite these negotiations. The authorities have prepared a timetable and formed working all for reconciling and rescheduling debt in arrears with the aim of removing the remaining restrictions subject to IMF approval under Article VIII, including outstanding debit balances under inoperative bilateral agreements (¶30). Apart from these arrears, Albania’s exchange system is free from restrictions on payments and transfers for current international transactions.

37. Albania’s trade regime is relatively open, and the country has made substantial progress toward accession to the WTO. The authorities remain committed to reducing the maximum tariff rate to 15 percent in 2001 and to keeping the two other rates at 5 percent and 10 percent. Import licensing of fuels aimed at supporting the application of domestic technical standards will remain automatic and consistent with the principle of national treatment.

38. Further progress needs to be made in monitoring external debt and absorbing aid. With technical assistance from UNCTAD, the government will make an external debt and aid database fully operational by end-June 2000 and will ensure timely and accurate reporting of external debt, including commitments by state-owned enterprises. The authorities have provided adequate funds in the 2000 budget for reimbursement of VAT and customs duties and for land acquisition. To speed up project implementation, which has often been delayed by issues relating to land expropriation, time-bound planning will be introduced for land expropriation and the respective timetables will be announced to the public upon the start of projects.

39. Albania should have no difficulties in servicing its obligations to the Fund (Table 8). Reserve cover is projected to remain at the relatively comfortable level of more than four months of imports, the authorities have a good record in meeting debt service payments to the Fund, and prospects for international assistance on concessional terms are good. The debt/GDP ratio is projected to rise somewhat from 26 percent in 1999 to 30 percent in 2000 before declining to 28 percent by 2004. The debt service/exports ratio will gradually rise from 4 percent in 1999 to the still modest level of 10 percent in 2002, as payments to the Fund increase, peaking at 23 percent of quota in 2001. The debt service ratio will then taper off to around 8 percent by 2004.

Table 8.

Albania: Projected Payments to the Fund as at March 31, 2000

(In millions of SDRs)

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Projections are based on current lates of charge, including burden-sharing charges where applicable, for purchases in the GRA, and on current interest rates for SAF, PROF, and Trust Fund. The current SDR interest rate is assumed for net use of SDRs.

Overdue obligations (if applicable) will be settled in full at close of business April 1, 2000.