Albania: Request for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility

This paper evaluates Albania’s Request for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF). Sound financial policies under the previous PRGF-supported program helped stabilize the economy and restore high growth, but poverty remains widespread. The authorities’ medium-term strategy aims to promote inclusive growth, as the country continues to be plagued by poverty. The proposed PRGF arrangement is justified by the authorities’ commendable performance under the previous PRGF arrangement and their strong measures for addressing the remaining policy challenges.

Abstract

This paper evaluates Albania’s Request for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF). Sound financial policies under the previous PRGF-supported program helped stabilize the economy and restore high growth, but poverty remains widespread. The authorities’ medium-term strategy aims to promote inclusive growth, as the country continues to be plagued by poverty. The proposed PRGF arrangement is justified by the authorities’ commendable performance under the previous PRGF arrangement and their strong measures for addressing the remaining policy challenges.

I. Introduction

1. Following the successful completion of the 1998–2001 program, supported by a Poverty Reduction and Growth Facility (PRGF) arrangement, in July 2001, two missions visited Tirana during October 24-November 8, 2001 and April 2-17, 2002 to discuss a new three-year PRGF arrangement and the 2002 budget.1 Program documents were issued to the Board in January 2002 (EBS/02/10, 1/24/02). However, after the circulation of these documents, the government resigned over internal political differences and the scheduled Board meeting was postponed. A new government was formed on February 22. The authorities’ Growth and Poverty Reduction Strategy (GPRS; EBD/02/14, 1/23/02) was submitted in December 2001, followed by a brief supplement in May 2002. Albania’s relations with the Fund are summarized in Appendix I.

2. In concluding the 2001 Article IV consultation and final review under the PRGF arrangement, Executive Directors commended the authorities’ sound macroeconomic management and progress in structural reforms, in particular further efforts to improve tax administration and broaden the tax base. Directors stressed the need for ongoing electricity sector reform and continued improvements in the business climate. They encouraged the authorities to give high priority to the timely privatization of the Savings Bank.

3. In the attached Letter of Intent and Memorandum on Economic and Financial Policies (MEFP), the authorities describe the economic program for which they request support under a three-year PRGF arrangement with access equivalent to SDR 28 million (57 percent of quota) (Attachment I). In light of Albania’s relatively small balance of payments needs, phasing policies, and continued eligibility for IDA-only resources, no EFF resources are proposed.

4. While the new government, led by former Prime Minister Majko, has been accepted by the feuding factions, political uncertainties have not been eliminated. In particular, presidential elections in June could renew political turmoil. However, support for stability-oriented policies and structural reform, as well as continued close cooperation with the Fund, remains broad based.

5. Albania has received assistance from the World Bank in a number of areas (Appendix II). The Bank is preparing a Poverty Reduction Support Credit (PRSC)—scheduled for June 2002—and several other sectoral credits.

6. The quality of macroeconomic data is adequate for program monitoring, but serious deficiencies remain (Appendix III). Albania participates in the GDDS, and a ROSC on data dissemination was published on the Fund website in May 2000. In relation to the proposed PRGF arrangement, staff conducted a safeguards assessment of the Bank of Albania (BoA) and found that, in general, controls in place to manage resources, including Fund disbursements, are adequate. Staff is finalizing the resulting report and will monitor the continued implementation of minor recommendations to improve the BoA’s control systems.

II. Recent Developments

7. Sound financial policies under the previous PRGF-supported program helped stabilize the economy and restore high growth, but poverty remains widespread. Under this arrangement, which followed the disastrous 1997 collapse of the pyramid schemes, all quantitative performance criteria were met and most structural measures were implemented, albeit some with delays. Despite rising average incomes, Albania remains one of the poorest countries in Europe. Poverty is most prevalent in rural areas and has led to large-scale emigration.

8. Real GDP growth in 2001, while still high, was adversely affected by unfavorable weather conditions and other supply shocks. It is now estimated at 6½ percent compared with an earlier estimate of 7¼ percent (Table 1, Figures 1 and 2). Agricultural growth amounted to only 1½ percent, while construction activity and private sector manufacturing remained relatively strong—as businesses were mostly protected from electricity shortages. Recorded unemployment continued to decline, to 14½ percent at end-2001.

Table 1.

Albania: Basic Indicators and Macroeconomic Framework, 1998-2005

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

Estimated based on indirect information in the absence of national accounts.

Current account excluding official transfers.

Revenue minus current expenditure.

Including interest payments for bank restructuring.

Including bonds for bank restructuring (lek 24.6 bn for 2000).

Includes arrears, with the exception of those transferable ruble arrears for which the value is subject to reconciliation and rescheduling agreements have yet to be reached with creditors.

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

Figure 1.
Figure 1.

Albania: Monthly Economic Indicators, 1995-2002

Citation: IMF Staff Country Reports 2002, 135; 10.5089/9781451800654.002.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 real rate using annualized seasonally adjusted CPI inflation.
Figure 2.
Figure 2.

Albania: Economic Developments and Prospects, 1994-2002 1/

Citation: IMF Staff Country Reports 2002, 135; 10.5089/9781451800654.002.A001

Source: Albanian authorities and Fund staff estimates.1/ Program projections for 2001 and 2002.

9. Despite reform efforts, electricity supply has been severely constrained by low rainfall, and power outages have been extensive. Following an already dry 2001, river flows in the first quarter of 2002 were the lowest in decades. At the same time, since the adoption of an action plan for the electricity sector at end-2000, developed in consultation with the World Bank, efforts toward reducing excessive demand have gained momentum and the quarterly targets for reducing technical losses and improving bill collection have been met. A two-tier tariff system for households was introduced in January 2002, with a lower rate for consumption below a threshold to minimize the impact on the poor (MEFP, ¶10). The updated action plan for 2002-03 foresees further measures to reduce theft and complete installing meters throughout the country.

10. Due largely to supply shocks, headline inflation rose from 3.5 percent (y-o-y) in December 2001 to over 6 percent in the first four months of 2002. As with the mid-2001 surge in inflation, this reflected mainly steep increases in fruit and vegetable prices (caused by a bad harvest), import bottlenecks (resulting from severe winter conditions), similar price increases in neighboring countries, and the electricity crisis. Core inflation has remained at around 3 percent.

11. Interest rates have been raised to help prevent the spread of inflation, in the context of a rise in domestic currency in circulation (Table 2). The BoA raised the key repo rate from 6½ percent in mid-2001 to 8½ percent by April 2002. A sharp increase in base money since late 2001 did not reflect a policy loosening but higher demand for lek cash, due to two events:

Table 2.

Albania: Monetary Aggregates, 2000-03 1/

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

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Sources: Bank of Albania; and Fund staff estimates.

Data exclude the balance sheet of the Bank Asset Resolution Trust (BART). In particular, private sector credit of lek 6.1 billion is excluded as of September 2001, when it was transferred to the BART from the Savings Bank.

Projections made before data on the Dec. 2001 outturn, and the sizeable end-year currency conversion, were available.

Derived using end-December 2001 exchange rates.

Including credit transferred to the BART.

  • As was common throughout the region, the end-2001 conversion of euro area cash into domestic currency cash and foreign currency deposits, and consequently recorded money (by 1½ percent of broad money), was larger than expected. However, lek deposits did not rise as anticipated, and the BoA exceeded its projected end-2001 NDA level by Lek 8 billion (6 percent of reserve money).

  • During late March and early April 2002, about 10 percent of total bank deposits were withdrawn, as unfounded rumors spawned a temporary loss of confidence in the two largest banks. As the BoA—appropriately—provided liquidity to the affected banks, both NDA and currency in circulation rose further, while recorded broad money fell due to the withdrawal of foreign currency deposits.

12. Recent monetary and electricity developments have influenced the current account, but the exchange rate has remained fairly stable. Stronger-than-expected end-2001 import growth (due mainly to imports of fuel and electricity generators) was more than accommodated by exceptionally high private remittances, reflecting an inflow of euro area cash held by Albanians working abroad (Table 3). The lek appreciated slightly as a result of euro currency conversion, and has weakened only modestly since mid-March following the withdrawal of bank deposits. At end-March 2002, external reserves remained above their end-2001 level (more than 4½ months of imports).

Table 3.

Albania: Balance of Payments, 1999-2010

(In millions of US dollars)

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

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 principally to the clearance of arrears to the Turkish Export-Import Bank in May 2001 (USD9.4 million in overdue interest forgiven; USD17.6 million rescheduled at 6M Libor+0.5%, 15 years maturity, 5 years grace) and the Turkish Central bank in December 2001 (U5D0.5 minion in penalty interest forgiven; USD5.1 million rescheduled at 6M Libor+0.5%, 15 years maturity, 5 years grace; 20 equal semi-annual instalments).

The figure for 2O02 corresponds principally to the clearance of arrears to Russia (Rbl 142.8 million converted at official rate of USD I=Rbl0.6 to USD 238.0 million; after an up-front–discount of 70%, 50% debt reduction was applied under the 1998 Paris Club agreement; the remaining USD 35.7 million will be rescheduled at Libor+2%, 6 years grace, 23 years maturity) and China (USD38.9 million rescheduled at 3.5%, from 2004 to 2015). Both agreements are expected to be finalized in 2002Q2.

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.

Includes arrears, with the exception of those transferable ruble arrears for which the value is subject to reconciliation and rescheduling agreements have yet to be reached with creditors.

13. Notwithstanding end-2001 revenue shortfalls, and further moderate slippages in early 2002, the fiscal deficit has remained well within the budgetary targets (Table 4). At 8.5 percent of GDP, the end-2001 deficit (excluding grants) was one percentage point below the budget, reflecting lower spending—notably on operations and maintenance and foreign-financed projects. Domestic borrowing, at 3.1 percent of GDP, also stayed below its ceiling. Poor realization of foreign-financed expenditure particularly affected the health sector, where total outlays are estimated at 2½ percent of GDP, vis-à-vis the 3 percent previously projected. During the first quarter of2002, tax collection improved relative to end-2001, but customs revenues were still below projections, in part owing to rumors of management changes and the eventual dismissal of the director general. Both overall and domestic financing remained within budget projections, with lower capital spending offsetting revenue shortfalls.

Table 4.

Albania: Government Revenues and Expenditures, 1999-2002

(In percent of GDP)

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Sources: Ministry of Finance; and Fund staff estimates and projections;

Include soliderity tax end non tax revenue collected by Customs Department.

From 2002 part of the wage bill will be transferred to local authorities in form of unconditional grants in the course of fiscal decentralization. This amount has been taken out of the total grant amount to show total wage allocations explicitly. Local government may spend on local infrastructure besides operations and maintenance.

Includes interest cost of bank restructuring.

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

The expenditure figures based on the functional classification prior to 2001 are provisional.

14. Structural reforms have continued, but delays in privatizing Albtelekom have sharply reduced scheduled privatization receipts in 2002. With the European telecommunications sector weakening further in early 2002, the tender for privatizing Albtelekom, announced in January 2002, yielded no expressions of interest and the process is not expected to be completed this year. Interest in buying the Savings Bank has also been limited—notwithstanding extensive marketing efforts with the IFC’s assistance—and only two banks are proceeding to the next stage (due diligence). Selection of a buyer is currently planned for mid-June. (The 2002 budget does not assume any privatization receipts from the sale of the Savings Bank.) Following an interruption caused by political developments, the legislative process for structural reform was resumed in March with the adoption of the deposit insurance law and the law on the Investment Promotion Agency.

III. The New Program

15. The authorities’ medium-term strategy—described in the GPRS—aims to promote inclusive growth, as the country continues to be plagued by poverty. Transformation into a market economy over the past decade has been interrupted by episodes of social and political instability. Despite progress in structural reform, private business activity is hampered by still inadequate legal, physical, and financial infrastructure. Albania’s growth outlook depends particularly on progress in reducing electricity shortages. Moreover, low productivity in agriculture—which still accounts for as much as half of GDP—and inadequate quality of—and limited access to—education and health care, remain principal sources of poverty (GPRS, Section III.A). Against this background, the GPRS constitutes a comprehensive approach to addressing structural deficiencies. It provides a coordinated framework for donor support that should help eliminate infrastructural bottlenecks—in particular in relation to electricity and transport. This, together with improvements in governance and the legal framework—guided by EU standards—and reductions in administrative barriers, should support private sector activity and help achieve the strategy’s growth objective. The GPRS identifies spending priorities consistent with poverty reduction goals, while its fiscal consolidation targets aim to strengthen financial stability and enhance the provision of credit to the private sector. Thus, it provides a sound basis for a new PRGF arrangement.

16. Within the umbrella of the GPRS, the proposed three-year PRGF Arrangement focuses on ensuring a sound macroeconomic environment as a pre-condition for sustainable growth. In particular, the program aims to mobilize resources for priority expenditures, while ensuring fiscal and external sustainability. To this end, it includes measures to improve tax administration and limit unproductive spending (including budgetary subsidies to public enterprises). Moreover, the program includes actions to promote private sector activity through privatization, financial sector development, and sustainable provision of electricity (see below).

A. The Macroeconomic Framework

17. Prospects for price stability and growth remain relatively favorable in the context of a sustainable fiscal strategy. Assuming essential structural reforms continue, growth is expected to decelerate marginally to 6 percent in 2002, mainly on account of the electricity situation, but return to about 7 percent in subsequent years. Private investment should serve as the engine for growth, with ample scope for an acceleration of mining and other industrial activities, an expansion of tourism, and for further productivity gains in agriculture. Inflation is expected to return to the upper end of the 2–4 percent target range by end-year, as supply constraints ease and higher interest rates start having an impact. The current account deficit is projected to moderate to 5½ percent of GDP by 2005, in part reflecting the programmed fiscal consolidation (see below).

B. Fiscal Policy in 2002 and Beyond

18. Fiscal policy under the program aims to reconcile financial sustainability with the provision of adequate resources for priority spending. The overall deficit is targeted to fall from 8 percent of GDP in 2002 to 5¼ percent in 2005, with somewhat lower consolidation in 2002 than in later years, reflecting the need for higher electricity subsidies (see below). Albania’s public debt ratio—which is already lower than in the majority of other PRGF countries—would drop further by about 6 percent of GDP in 2002, largely owing to debt forgiveness, and continue to decline, albeit more gradually in the medium term (see Box 1 for an analysis of fiscal sustainability).

19. Over the medium term, the scope for higher priority spending is dependent on improved expenditure management and more effective domestic revenue mobilization.

  • The strategy aims to stabilize total primary expenditure at 28½ percent of GDP. The authorities are committed to the continued development and recurrent updating of the medium-term expenditure framework (MTEF) and the GPRS to provide a coherent framework for identifying priorities and ensuring consistency between annual budgets and the wider poverty reduction strategy. They intend to boost spending on primary education and health care, in particular for rural areas, and to implement their fiscal decentralization program, in conjunction with improved tracking of local expenditures. The fiscal ROSC tentatively planned for 2002 is expected to enhance fiscal transparency and facilitate a more timely reporting of expenditures.

  • Revenues rise from 23 percent of GDP in 2001 to 26½ percent by 2005 through further improvements in tax and customs administration and an expanded tax base. This target is supported by three major considerations: (i) the authorities’ successful record in improving collection through reform; (ii) the still high level of fiscal evasion; and (iii) the bold measures for strengthening collection under the program (Box 2; MEFP, ¶16; and GPRS, Section IV.C).

20. For 2002, the fiscal program aims to reduce the overall deficit by ½ percentage points to 8 percent of GDP—based on an increase in revenue by over 1 percentage point of GDP. Domestic borrowing is targeted at 3 percent of GDP.

  • The budget envisages a reorientation of expenditure toward reducing poverty and upgrading basic infrastructure (MEFP, ¶17). The GPRS identifies health and education as priorities for poverty reduction. Accordingly, and given severe problems in retaining and motivating qualified personnel, the provision of health care and education is to be strengthened through relatively higher wage increases—averaging 12 percent—as well as augmented outlays on operations and maintenance to address quality concerns. More broadly, with real public sector wages still below their 1996 levels, adequate salary increases are a key component of efforts to build a more effective public service and, for particular agencies, combat corruption. Nonetheless, differentiation of the pay rises and further streamlining of public employment will keep overall personnel expenses constant in terms of GDP. The judiciary is being granted a salary increase slightly above average to improve governance, while top civil servants—for whom staffing problems are most pressing—have already received even higher pay rises. Parametric reform of the pension system was initiated in consultation with World Bank and Fund staff. It aims to strengthen its financial sustainability, reduce reliance on the budget, and address rural poverty.

  • The authorities are implementing strong measures to achieve their ambitious revenue collection target. So far, implementation has been broadly on track, but problems persist regarding the proper valuation of imports, transparency of tax assessments, and tax compliance by public enterprises. Also, given ongoing weaknesses in the collection of customs revenues in the wake of senior personnel changes, Fund staff is monitoring the situation closely. It is also important to ensure proper and transparent application of tax laws, in particular concerning tax assessments (MEFP, ¶16).

Albania: Assessing Fiscal Sustainability

In view of revisions to the macroeconomic framework, this box re-assesses fiscal sustainability in Albania (see the July 2001 staff report for an earlier analysis).

The baseline scenario envisages a gradual decline in the overall government deficit to 5½ percent of GDP by 2005 and 2 percent of GDP by 2010. Accordingly, the debt-to-GDP ratio will be on a declining path, reaching around 48 percent of GDP by 2010. Key assumptions are real GDP growth of 5–7 percent per annum; inflation in the range of 2–4 percent; an unchanged nominal exchange rate (implying an annual real appreciation of 1–2 percent); and an average nominal interest rate of 6¼-6¾ percent (much of which is locked in by long-term concessional loan agreements). The projections also assume a continuation of essential structural reforms to promote private investment and growth, and to mobilize domestic revenue—reflected in a higher revenue-to-GDP ratio (albeit with declining gains after the program period). The fiscal path, while cautious, provides scope for increased expenditure on GPRS-identified priorities—in particular strategic public infrastructure investments with high expected returns and largely foreign financed on concessional terms—although the overall expenditure-to-GDP ratio is projected to decline marginally by 2010, reflecting relatively high up-front infrastructure spending.

Sensitivity of Public Debt Ratio to Macroeconomic Shocks, 2003-2010

(In percent of GDP)

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