Albania: Staff Report for the 2002 Article IV Consultation, First Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility, and Requests for Modification and Waiver of Performance Criterion

This paper examines Albania’s 2002 Article IV Consultation, First Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF), and Requests for Modification and Waiver of Performance Criterion. Economic growth appears to have fallen below a 7 percent estimated historical average, to 4.7 percent in 2002. High foreign investments and private remittances in 2001 have maintained robust import demand, reflected in a widening trade deficit in 2001 and the first half of 2002. The IMF staff supports the authorities’ request for completing the first program review and the request for a waiver.

Abstract

This paper examines Albania’s 2002 Article IV Consultation, First Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF), and Requests for Modification and Waiver of Performance Criterion. Economic growth appears to have fallen below a 7 percent estimated historical average, to 4.7 percent in 2002. High foreign investments and private remittances in 2001 have maintained robust import demand, reflected in a widening trade deficit in 2001 and the first half of 2002. The IMF staff supports the authorities’ request for completing the first program review and the request for a waiver.

I. Introduction

1. Discussions for the 2002 Article IV consultation, a financing assurances review, and the first review under the Poverty Reduction and Growth Facility (PRGF) arrangement were held in Tirana during October 10–25, 2002.1

2. The last Article IV Consultation was concluded on July 13, 2001, and the PRGF arrangement (SDR 28 million—57 percent of quota), consistent with the authorities’ November 2001 National Strategy for Socio-Economic Development (NSSED)2 (HTTP://www.imf.org; and JSA, http://www.imf.org), was approved on June 21, 2002. In the attached Letter of Intent and the supplementary Memorandum on Economic and Financial Policies (MEFP), the Albanian authorities request completion of the first review and a waiver for the nonobservance of a structural performance criterion. Albania’s economic program is also supported by the World Bank through several sectoral lending programs and a Poverty Reduction Support Credit (PRSC) approved in June 2002. In October, the European Union invited Albania to start negotiations on a Stabilization and Association Agreement (SAA).

3. Protracted political skirmishes have affected policy implementation and the investment climate. However, the government formed in July 2002—the third since the June 2001 elections, and led by former prime minister Nano—was based on a broad agreement within the ruling socialist party. A new president was also elected by consensus in June. Nonetheless, policy-making remains politicized and governance weak, posing serious risks to the pace of reform.

4. Major deficiencies in macroeconomic data hamper policy formulation and evaluation, and were emphasized in the context of the Article IV discussions. But reporting has been adequate for program monitoring and surveillance. Albania participates in the GDDS, and a ROSC on data dissemination was prepared in June 2000. A fiscal ROSC is scheduled for early 2003. The July 2002 safeguards assessment noted that, in general, adequate safeguards were in place to manage Fund resources, including Fund disbursements.3

5. Albania maintains restrictions in accordance with Article XIV, in the form of outstanding debit balances on inoperative bilateral payments agreements, which were last reviewed in the 2002 Article XIV consultation.

II. Background

A. Growth and Poverty Reduction During Transition

6. Sound financial policies and market reforms during most of the 1990s have fostered growth and macroeconomic stability. Albania has progressed toward a market economy, with the development of a new legal system; the privatization of all small- and medium-sized enterprises, and of many larger entities; land reform; and trade liberalization. Progress has also been made on several indicators of governance (see tabulation), but much remains to be done. While the absence of national accounts and other data deficiencies preclude a fulsome analysis (Box 1), annual GDP growth is estimated to have fluctuated within a 5–10 percent range—except in 1997, when activity was disrupted by the pyramid scheme collapse.

Data Issues

Albania’s macroeconomic database falls short of international standards, although, with extensive technical assistance (see Appendix III), significant progress has been made. The May 2000 ROSC mission outlined the key remaining deficiencies. It is especially important to strengthen the coverage of source data to capture formal and informal economic activities, This box identifies relevant key data issues concerning macroeconomic statistics.

  • The first official GDP data (1998–2000) are expected to be published in early 2003. These estimates are based on very limited source data and show large discrepancies between expenditure and production estimates (about 5 percent of GDP on average).

  • There are no reliable and comprehensive private sector activity and investment data. A quarterly index of retail sales, based on tax records, has been compiled since 2001. However, the index might not offer a satisfactory estimate in the case of Albania, because its results vary with collection efforts. Other sectoral activity indicators (for example, electricity consumption, private sector telecommunications activity, and building permits) also suffer from large collection lags. In addition, structural improvements, while welcome, impede annual comparison.

  • Data on external private transactions are also deficient. There are no official data on FDI or private external debt; tourism surveys require further refinement; and the methodology for estimating workers’ remittances is highly deficient.

  • Central government budget (except for foreign-financed projects) and monetary statistics are generally adequate.

  • While regular and timely data on consumer and producer price indexes are available, comprehensive data on wage statistics are lacking.

  • Socio-demographic indicators are scarce. However, the authorities are using the NSSED to develop a system of monitoring and evaluating progress against systematic poverty indicators.

Table.

Albania: Indicators of Governance and Regional Comparators 1/

article image
Source: D. Kaufmann and A. Kraay, Growth without Governance (2002); and World Ban Interactive Governance Webtool.

Figures indicate percentages of countries worldwide that rate below the selected country for each governance indicator. Higher scores indicate a better governance outcome.

Averages are simple arithmetic averages.

7. Nonetheless, poverty remains pervasive, with per capita income in 2001 in the order of US$1,200. A 1998 survey found that one in every two families was living on less than US$2 a day. Poverty is concentrated in rural areas, and compounded by inadequate basic social services, including health care, and utilities. It has motivated large-scale seasonal and permanent emigration, with the ensuing remittances providing an informal safety net. The authorities’ NSSED seeks to address these problems.

8. Moreover, growth has been unbalanced, and its sustainability is not ensured. Growth has been supported by high external inflows (totaling about 20 percent of GDP since 1995) and, in part, reflected transitional catch up. It has been concentrated in the construction and services sectors. As external inflows taper off, growth increasingly needs to be supported by an expansion of tradables, in particular industry and mining. However, investment in these sectors is hindered by administrative barriers—reflecting general weaknesses in governance and law enforcement, and widespread corruption—resulting in a large underground economy.5 Inadequate infrastructure exacerbates these constraints, in particular, the underdeveloped financial and transportation systems and severe power outages—as reliance on hydropower renders power supply prey to periodic droughts. In addition, emigration and low spending on education have limited the availability of qualified workers.

9. In concluding the 2001 Article IV consultation, Executive Directors stressed the need to build on past achievements with further structural reforms and improvements in governance, in order to sustain rapid growth and alleviate poverty. They also stressed the need to strengthen tax and customs administration and broaden the tax base to accommodate the required expansion in social expenditures, while keeping the public debt within prudent limits.

10. Consistent with these recommendations, the authorities’ economic strategy contains wide-ranging measures to improve the environment for private sector activity. The approach, outlined in the NSSED, includes:

  • Legal and institutional reforms toward more transparent tax and licensing procedures, a functioning land market, and a more effective judicial system.

  • Infrastructural improvements, through expanding the transportation network and reducing electricity shortages—by strengthening bill collection and aligning tariffs to costs to reduce excessive power use, while diversifying energy supply over the medium term.

  • Increasing public spending on health and education by over 20 percent in real terms during 2002–04.

  • Steps to strengthen the financial sector, by privatizing the large Savings Bank, facilitating the provision of credit, and introducing a new bankruptcy law.

11. Within this framework, the PRGF arrangement supports efforts to ensure a sound macroeconomic environment—a key precondition for sustained growth. Monetary policy aims at maintaining inflation within a 2–4 percent range, with intermediate targets for base money, and using indirect instruments within a floating exchange rate system. To promote fiscal and external sustainability, the overall deficit is to be lowered from 8½ percent of GDP in 2001 to 5¾ percent of GDP by 2005, thereby gradually reducing the public debt ratio. To reconcile increased poverty reduction and infrastructural spending with fiscal consolidation, and given the extensive fiscal evasion, ambitious goals were set for improving tax collection.

B. Recent Developments

12. Economic growth during 2001 and 2002 appears to have fallen below the 7 percent estimated historical average, although it is hard to gauge the extent of the slowdown (Table 1, Figure 1 and 2). Agricultural production was adversely affected by drought in 2001 and flooding in late 2002, while industrial production was hit by protracted electricity shortages. Moreover, political uncertainty and pressure on taxpayers have undermined private investment. In 2002, growth was also affected by delays in reform and privatization, and stagnant public investments. The slowdown is visible in a lower-than-expected expansion of tax revenues and, since mid-2001, patchy export performance.6 But import growth has been strong.

Table 1.

Albania: Basic Indicators and Macroeconomic Framework, 1997-2005

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

Estimated based an 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 ON for 2000).

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

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

Figure 1.
Figure 1.

Albania: Monthly Economic Indicators, 1994-2002

Citation: IMF Staff Country Reports 2003, 063; 10.5089/9781451800661.002.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, 1994-2003 1/

Citation: IMF Staff Country Reports 2003, 063; 10.5089/9781451800661.002.A001

Source: Albanian authorities and Fund staff estimates.1/ Program projections for 2002 and 2003.

13. High foreign investments in 2001 and a surge in remittances late in that year have maintained robust import demand (Table 2). Strong growth in capital good imports throughout the period has been accompanied by high imports of fuel and electricity generators in 2001Q4, and of consumption goods in early 2002. As a result, and notwithstanding fiscal restraint, the trade deficit widened in 2001 and the first half of 2002, while the hike in remittances at end-2001 contributed to a temporary improvement in the current account. The exchange rate has remained fairly stable, with a gradual depreciation during the first half of 2002 following the euro conversion-related appreciation in late 2001 Sustained inflows of official financing (and the depreciation of the dollar) contributed to a further increase in official reserves to about 5 months of imports of goods and services in December 2002.

Table 2.

Albania: Balance of Payments, 2000-2010

(In millions of US dollars)

article image
Source: Ministry of Finance; Bank of Alhania; donors; and Fund staff estimates. and projections.

Excluding IMF.

The errors and omissions in 2002Q2 largely reflect preliminary estimates of the currency valuation effect on gross reserves, subject to further discussions with the authorities.

The figure FOR- 2001 corresponds PRINICIPALLY TO THE clearness 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 (USD0.5 million in penalty interest forgiven; USD5.1 million rescheduled at 6M Liber-0.5%, 15 years maturity, 5 years grace; 20 equal semi-annual installments).

The figure for 2002 corresponds principally to the clearance of arrears to Russia (Rbl 142.8 million converted at official rate of LSDl=Rbl0.6 to USD 238.0 million; after an up front discount of 70%, 50% debt reduction was applied under the Paris Club agreement; the remaining USD 35.7 million will RESCHEduled at Libor+2%, 6 years grace, 23 years maturity) and China (USD38.9 million rescheduled at 3.5%, from 2004 to 2015). The agreement with RUSSIA WAS finalized in May 2002 and the agreement with China was finalized in 2002Q4.

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.

14. Tax collection shortfalls since end-2001 have likely reflected lower-than-expected GDP growth, delays in reform, and managerial changes, in the context of ambitious targets. The overall shortfall is estimated at about ¾ percent of GDP in 2002—about half of the budgeted rise in the tax to GDP ratio. An October 2002 FAD tax and customs administration mission found that as the targets appeared unfeasible, attention had shifted from reform efforts toward excessive pressure on the relatively small base of regular taxpayers. A new “road tax”, introduced in August 2002 to help finance additional road construction, provided only a small offset during its initial phase.

15. The fiscal deficit has nevertheless remained well within the budgetary limits (Tables 3 and 4). The overall deficit (excluding grants) declined to 8½ percent of GDP in 2001 and is estimated at 7½ percent in 2002. In both years, below-target receipts were more than offset by ad hoc spending cuts on operations and maintenance, and public investment. Combined with external debt forgiveness (Table 2), this has reduced total public debt to about 64 percent of GDP from about 72 percent at end-2000. The 2002 budget was amended in May to accommodate shortfalls in privatization receipts.

Table 3.

Albania: Government Revenues and Expenditures

(In percent of GDP)

article image

Includes solidarity tax (discontinued in 2003) and non tax revenue collected by Customs Department.

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

Includes 1 billion lek of tax on vehilces in 2003, also included under local and property taxes.