Albania: 2001 Article IV Consultation and Review Under the Poverty Reduction and Growth Facility—Staff Report and Public Information Notice on the Executive Board Discussion

Sound macroeconomic management, supported by structural reform, has characterized Albania's performance under the current Poverty Reduction and Growth Facility (PRGF) arrangement, although poverty and emigration remain pervasive. Privatization is moving forward in the telecommunications sector and has largely been completed in the mining sector. Fiscal performance so far in 2001 has been in line with the budget. Executive Directors supported the fiscal policy framework for the remainder of 2001 and welcomed the ongoing improvements in revenue collection, supported by the authorities' efforts to strengthen tax and customs administration.

Abstract

Sound macroeconomic management, supported by structural reform, has characterized Albania's performance under the current Poverty Reduction and Growth Facility (PRGF) arrangement, although poverty and emigration remain pervasive. Privatization is moving forward in the telecommunications sector and has largely been completed in the mining sector. Fiscal performance so far in 2001 has been in line with the budget. Executive Directors supported the fiscal policy framework for the remainder of 2001 and welcomed the ongoing improvements in revenue collection, supported by the authorities' efforts to strengthen tax and customs administration.

I. Introduction

1. A mission visited Tirana during April 11-26 to hold the 2001 Article IV consultation discussions and conduct the final review under the third annual arrangement under the Poverty Reduction and Growth Facility (PRGF). 1 Albania’s relations with the Fund are summarized in Appendix I.

2. The Executive Board concluded the 2000 Article IV consultation on June 9, 2000 and approved the request for the third annual PRGF arrangement on June 30, 2000. Executive Directors commended the authorities for having maintained macroeconomic stability and improved tax collection, and encouraged them to give the highest priority to privatizing the Savings Bank. Directors reiterated these comments at the most recent Board meeting, on January 26, 2001, on the first review under the third annual arrangement. They also welcomed the further progress made in structural reform, especially in enterprise privatization, but expressed serious concern regarding the electricity crisis. Following the completion of the first review under the third annual arrangement, the cumulative disbursements reached the equivalent of SDR 40.34 million—which included a Kosovo-related augmentation of SDR 9.74 million—out of the total SDR 45.04 million committed under the three annual PRGF arrangements.

3. Political stability was maintained during the run-up to the general elections—the first round of which was held on June 24, 2001. The Socialist Party, which is leading the governing coalition, did well in the first round of the elections and is committed to continued close cooperation with the Fund following the end of the current arrangement on July 31, 2001. The hostilities in neighboring Macedonia have not so far had a major impact on Albania but an escalation might dampen the expected growth in foreign investment.

4. The authorities are determined to complete their Growth and Poverty Reduction Strategy paper (GPRS) through a participatory process by mid-2001—they have chosen this title for their paper to stress the growth element in their strategy. Given the timing of the general elections, the schedule for preparing the GPRS, and the budget cycle, discussions on a possible successor arrangement are expected to be completed after the Annual Meetings.

5. The World Bank has been collaborating closely with the Albanian authorities, notably as regards the participatory process for preparing a poverty reduction strategy, the establishment of a medium-term expenditure framework (MTEF), the reform of the electricity sector, and the privatization of the Savings Bank (Appendix II). The second disbursement of the Bank’s Structural Adjustment Credit was made at end-2000 and the Bank is planning a Poverty Reduction Strategy Credit (PRSC) in 2002 to support the authorities’ poverty reduction plans.

6. The timeliness and quality of the macroeconomic data are adequate for program monitoring, but the data continue to suffer from serious deficiencies, especially in the real sector (Appendix III). A Report on Observance of Standards and Codes on data dissemination was prepared in June 2000 and Albania participates in the General Data Dissemination System.

7. Albania maintains exchange restrictions in accordance with Article XIV, in the form of outstanding debit balances on inoperative bilateral payments agreements (see paragraph 41 below). 2 Albania has not accepted the obligations of Article VIII. It does not maintain any exchange restrictions subject to approval under Article VIII. The authorities have requested the publication of the staff report for the 2001 Article IV Consultation and the final review under the Third Annual Arrangement under the PRGF.

II. Macroeconomic Developments and Performance Under the Program

8. Sound macroeconomic management, supported by structural reforms, has characterized Albania’s performance under the current PRGF arrangement, but much remains to be done to alleviate poverty and reduce emigration. Since the collapse of the disruptive pyramid schemes in 1997, and despite the Kosovo crisis in 1999, cautious financial policies and generous external support have permitted sustained real growth, a significant easing of inflationary pressures, and sizable reductions in the overall and domestically financed fiscal deficits (Table 1, and Figures 1 and 2). Structural reform has included privatization of the second largest bank and the mobile telecommunications company, as well as major improvements in tax and customs administration. However, Albania remains one of Europe’s poorest countries, with poverty concentrated in rural areas and reflected in ongoing outward migration—estimated to have totaled over 600,000 (about 18 percent of the current population) since 1991. While a continuation of strong growth and the decline in unemployment will help alleviate poverty, limited access to basic social services and low public expenditures on health and education—resulting in high infant mortality and a drop in school enrollment—highlight serious structural problems.

Table 1.

Albania: Basic Indicators and Macroeconomic Framework, 1998-2004

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Sources: Albanian authorities and Fund staff estimates and projections.

Very preliminary estimates owing to lack of national accounts.

Current account excluding official transfers.

Revenue minus current expenditure.

Including interest payments for bank restructuring.

Excluding privatization revenues.

Including bonds for bank restructuring (lek 4.3 bn for 1999; lek 20.3 bn for 2000).

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

Figure 1.
Figure 1.

Albania: Monthly Economic Indicators, 1995-2001

Citation: IMF Staff Country Reports 2001, 117; 10.5089/9781451800708.002.A001

Sources: 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/ The real rate is the nominal rate minus annualized filtered inflation.
Figure 2.
Figure 2.

Albania: Economic Developments and Prospects, 1993-2001 1/

Citation: IMF Staff Country Reports 2001, 117; 10.5089/9781451800708.002.A001

Source: Albanian authorities and Fund staff estimates.1/ Staff projections for 2001.

9. During 2000 and into 2001, strong economic activity has been fuelled by vigorous domestic demand. Based on the limited data available, GDP growth is estimated at 7¾ percent in 2000, supported by an increase of more than 15 percent in construction and transport activities, while output in the agricultural and industrial sectors grew by about 5 percent. In the latter sector, performance was hampered by end-2000 electricity shortages and privatization-related disruptions of production in the government-owned mining sector, which also adversely affected exports. Both investment and consumption have been buttressed by steady increases in private remittances by Albanians working abroad and by greater confidence in the economy.

10. Electricity shortages caused disruptions in economic activity during the winter of 2000-01 and continue to threaten growth prospects; however, much-needed reforms in the electricity sector have been initiated. Years of neglect, in conjunction with unfavorable hydrological conditions, led to disruptive power shortages during the last quarter of 2000 and the first months of 2001. In response, the authorities have embarked on an extensive reform of the electricity sector, endorsed by the World Bank and other donors in December 2000. In line with the targets, tariff collection has improved and power losses have been reduced. A new schedule of flat tariffs has been approved and illegal connections have been made a criminal act. Based on these positive achievements, World Bank and other donor-financed projects in the transmission and distribution sectors have resumed.

11. The external position strengthened further during 2000, reflected in higher official exchange reserves. The worsening of the trade balance in 2000, by about 3½ percent of GDP, was offset by strong inflows of remittances and a strengthening of measured tourism services, leaving the current account deficit roughly unchanged at 7 percent of GDP (Table 2). 3 Recorded imports increased by 33 percent in euro terms (14 percent in dollar terms) owing to vigorous demand, sizable electricity imports, and improved registration. Exports were affected principally by disruptions in the mining sector, and increased by only 8 percent in euro terms (and fell by 7 percent in dollar terms). Large privatization proceeds and occasional foreign exchange interventions contributed to a sharp rise in official reserves, to $648 million—4.4 months of imports—by end-March 2001, well above program targets (Table 3), The exchange rate, which appreciated against the euro during most of 2000, has been stable in recent months, despite a significant decrease in the interest differential during 2000. Early data from 2001 show strong growth in both exports and imports, and continued large capital inflows (mainly privatization-related).

Table 2.

Albania: Balance of Payments, 1999-2005

(In millions of US dollars)

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Estimated revisions to 1999 tourism services receipts and expenditures based on new methodology introduced in 2000, Staff estimate.

Excluding IMF.

The figure for 2001 corresponds to the clearance of arrears to Turkey (and the penalty interest imposed and forgiven) as a result of the rescheduling agreement finalized in May 2001.

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

Includes imports (official transfers) related to the Kosovo crisis; excluding Kosovo-related imports the trade deficit in 1999 would be 18.0 per cent of GDP.

Debt service excludes penalty interest imposed (and forgiven) on the arrears rescheduled with Turkey in 2001.

Includes arrears.

Table 3.

Albania: Quantitative Performance Criteria and Indicative Targets for 2000-2001 1/

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The performance criteria and indicative targets er

Performance criteria, except for tax revenues and revenues collected by the Customs Department, which are indicative targets.

The indicative targets for 2001 assume privatization receipts of Lek 13.2 billion and budget support of Lek 1.8 billion.

The indicative targets for June-December 2001 are derived using the end-2000 exchange rate.

12. Inflation has edged up since mid-2000, mainly on account of rising energy and housing costs, but it is within the authorities’ 2-4 percent target range. Owing to cautious monetary policy and an appreciation of the lek relative to the euro, inflation remained subdued, averaging about zero for 2000 as a whole. Year-on-year inflation turned positive in September 2000, accelerating to 4.2 percent in December—reflecting an unusually large seasonal hike in the prices of fruits and vegetables—and falling to 2.5 percent in May 2001.

13. Motivated by below-target inflation, monetary policy has eased considerably since the beginning of 2000. In the period to April 2001, T-bill rates fell by 6-7 percentage points, to 7½ percent for 3-month bills and 10 percent for 12-month bills, while bank deposit rates declined by 1-2 percentage points, to the range of 6½-9 percent. Accordingly, the spread between T-bill and deposit rates has narrowed considerably, to more reasonable levels. Interest rate reductions in the period to July 2000 were instigated by lower floors on deposit interest rates—the main instrument of monetary policy until the Bank of Albania (BoA) switched to indirect instruments in mid-2000—and through repo operations thereafter. After initial fluctuations, weekly repo rates have stabilized at about 6½ percent since February. The decline in market interest rates has been helped by higher-than-projected privatization receipts, which have limited the need to issue T-bills and, thus, contributed to an increase in commercial banks’ excess reserves. The ongoing broadening of the market has also contributed, by promoting competition among investors and by reducing the market share of the Savings Bank. Annual broad money growth has been fairly stable, at around 12 percent, while private sector credit has continued to grow rapidly, albeit from a small base (Table 4). Most credit is provided to small and medium-sized enterprises, for both trade and investment, and denominated in dollars.

Table 4.

Albania: Monetary Aggregates, 1999-2002

(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 the Technical Memorandum of Understanding; derived using the program exchange rate.

Target for the period after completion of the program. Derived using end-2000 exchange rates.

14. Fiscal policy remains broadly on track, mainly due to a strong tax revenue performance and lower-than-budgeted expenditures. The overall deficit (excluding grants) declined by about 2¼ percentage points (1¼ percentage points excluding Kosovo-related expenditures), to around 9 percent of GDP in 2000 (Table 5). This outcome was below both the budget projection of 9½ percent of GDP and the staffs earlier estimate of 9¾ percent of GDP, reflecting lower-than-expected foreign-financed capital expenditures. End-December indicative targets for the domestically financed deficit—at 3¼ percent of GDP—and for total tax revenues were met (see Table 3). Fiscal performance so far in 2001 has been in line with the budget and the end-March targets for tax revenue collection and the domestically financed deficit were met.

Table 5.

Albania: Government Revenues and Expenditures, 1997-2001

(In percent of GDP)

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Notes:

Includes solidarity tax and non tax revenue collected by Customs Department.

In 2001 expenditure on work incentive programs (lek 400 million) has been reclassified under subsidies.

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

15. Improved revenue collection—which led to an increase of 29 percent in tax revenues in 2000—has largely been the result of the implementation of measures agreed under the program. Corruption and smuggling have been reduced significantly through the strengthening of the Customs Department’s investigative and internal audit functions, the imposition of disciplinary measures, and a new merit-based remuneration system. Personal income tax and VAT collection have benefited from efforts to raise the number of registered taxpayers. These measures have more than offset the revenue loss that resulted from reductions in customs tariffs, the electricity crisis, and nonpayment of taxes by the state-owned electricity and oil companies. Underperformance in certain nontax revenue categories was compensated by reduced current expenditures by the respective ministries.

16. Expenditures in 2000 did not reach the budgeted level as recorded foreign-financed capital expenditure fell considerably short of the projected amount. Implementation problems continued to plague foreign-financed investment projects; spending on such projects was the equivalent of 0.7 percentage points of GDP less than planned—although measurement uncertainties prevent a reliable assessment—while other investment expenditure was higher than budgeted (by 0.3 percentage points of GDP). Spending on health and education increased in real terms by around 2 percent, but decreased slightly relative to GDP and fell ½ percentage point below the budgeted total, mainly due to poor implementation capacity (see Table 5).

17. Despite the fiscal efforts of the past three years, public debt has been rising, although it remains in line with international averages for comparable poor developing countries. Total debt has risen from around 62 percent of GDP in 1998 to about 69 percent in 2000, reflecting mainly a rise in domestic debt as a result of bank recapitalization. Based on the staffs projected medium-term fiscal path, the debt dynamics are expected to improve owing to rapid growth (see Box 1). However, a combination of much lower growth, higher interest rates, and a large exchange rate depreciation, would jeopardize debt sustainability, thus requiring remedial measures. Albania’s public debt is below the average for selected non-HIPC PRGF-eligible developing countries (88 percent of GDP) and for the Euro Area (73 percent of GDP), but it is somewhat higher than for transition economies (50 percent of GDP). 4 Moreover, public debt accumulation has helped finance infrastructure investment and needed social programs. It has also helped avoid deflationary pressures that would have resulted from the absence of significant alternative investment options for deposit-taking institutions. External debt has been more or less stable at around 28 percent of GDP and is quite low by international standards. Its net present value of about 16 percent of GDP lies significantly below the average of 40 percent for the non-HIPC PRGF-eligible countries. 5

18. Significant progress has been made in privatization of state-owned enterprises, including the Savings Bank (Table 6). The tender for privatization of the Savings Bank was announced on June 29, in spite of coordination problems during the past few months involving the international consultants. The Bank was fully recapitalized in December 2000, and its fiscal functions in the 9 largest cities and 70 pension offices are being divested to other financial institutions in order to reduce the Bank’s dominance. In the telecommunications sector, a second mobile phone license was successfully sold to an Anglo-Greek company in January 2001, following the sale of the mobile telecommunications company (AMC) in July 2000; and the Law specifying the privatization formula for the fixed-lines telecommunications company was approved by parliament in May 2001, after some delay. Privatization of the mining sector has largely been completed, with the recent approval of concession contracts for a large number of copper and chrome mines. Progress in privatizing the various parts of the state oil company has been rather slow, but these entities, as well as the state-owned insurance company, are expected to be privatized in 2002. A new joint venture agreement with foreign companies for oil exploration envisages investments of $200 million over the next four years.

Table 6.

Albania: Structural Performance Criteria and Structural Benchmarks Under the Third Annual PRGF Arrangement

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Albania: Medium-Term Debt Sustainability

Albania’s public debt has risen in recent years but remains below that of similar developing countries. Albania’s overall public debt rose from 62 percent in 1998 to about 69 percent of GDP in 2000, but remains moderate compared with about 88 percent of GDP for 12 non-HIPC PRGF-eligible countries (for which domestic debt data were available in GFS and IFS). Albania’s net present value (NPV) of public debt, while lower at 57 percent of GDP in 2000, is closer to the average of 68 percent for the same non-HIPC PRGF-eligible countries. Within this total domestic debt remains relatively high at 41 percent of GDP (compared with the average of about 28 percent of GDP for the same non-HIPC PRGF-eligible countries). This Box provides an overview of the analysis in Chapter 1 of the Selected Issues Papers, which examines Albania’s projected debt dynamics for the period 2001-10 under alternative assumptions. The results suggest that Albania’s public debt dynamics are unlikely to be a cause for concern over the medium term in light of the strong growth prospects.

The gradual fiscal consolidation envisaged over the medium-term (2001-10) will reverse the upward trend in the public debt-to-GDP ratio (see Table). Public debt is projected to decrease to 50 percent of GDP by 2010 (40 percent of GDP in NPV terms). This assumes that real GDP will grow at 6 percent per annum over the medium term; inflation averages 3 percent per year; nominal domestic interest rates average about 9 percent (equal to medium-term nominal GDP growth); the dollar exchange rate remains unchanged; foreign financing will be restricted largely to concessional loans until 2004 and becomes less concessional thereafter, with the interest rate rising from around 1.1 percent to 4 percent by 2010; foreign grants decline to zero by 2010; and privatization receipts are phased out by 2004. It also assumes that the necessary structural reforms continue to alleviate pressures on the budget through broadening the tax base, improving tax and customs administration, strengthening expenditure management, and restructuring the social security system.

Table: Medium-Term Debt Sustainability

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