Albania
Ex Post Assessment of Longer-Term Program Engagement
Author: International Monetary Fund
Publication Date:
10 Mar 2005
eISBN:
9781451800791
Language:
English
Keywords:
ISCR; CR; economic activity; pyramid scheme; budget deficit; current account; public expenditure; fiscal policy; banking system
Download PDF (380.2 KB)

This report presents an Ex Post Assessment of Albania’s Longer-Term-Program Engagement with the IMF. Albania has been engaged in a series of IMF-supported programs since the beginning of transition. This report provides an overview of economic developments and the overall role of the IMF in Albania. It reviews the implementation of financial policies, and looks into selected dimensions of structural policies. The report summarizes the record on meeting conditionality and the nature of Bank-IMF collaboration. The considerations for future program engagement are also examined.

Abstract

This report presents an Ex Post Assessment of Albania’s Longer-Term-Program Engagement with the IMF. Albania has been engaged in a series of IMF-supported programs since the beginning of transition. This report provides an overview of economic developments and the overall role of the IMF in Albania. It reviews the implementation of financial policies, and looks into selected dimensions of structural policies. The report summarizes the record on meeting conditionality and the nature of Bank-IMF collaboration. The considerations for future program engagement are also examined.

I. Introduction

1. Since 1991, when its isolationist rule came to an end, Albania has made significant headway in securing macroeconomic stability and in transforming the economy into a market-based system. Still, in part reflecting its precarious starting point, Albania remains one of the poorest countries in the region, with considerable shortcomings in the governance and institutional frameworks and with enormous infrastructure needs. Albania also remains vulnerable to domestic political and regional instability.

2. Episodes of political uncertainty and social instability have hindered policy making and implementation. Election considerations eroded the government’s policy resolve in the first half of 1996. In early 1997, the collapse of the financial pyramid schemes triggered a near civil war-like situation, with the government losing control over large parts of the country. An episode of civil unrest in September 1998, in the wake of the shooting of a prominent opposition politician, resulted in a change of government. The crisis in Kosovo in March 1999 precipitated a flood of refugees into Albania which placed considerable strain on the social and economic infrastructure. Political divisions led to three changes in government within the first twelve months after the June 2001 elections, and infighting within the ruling socialist party continued in 2003. With Albania’s politics remaining relatively divisive and confrontational, and parliamentary elections scheduled for mid-2005, political economy considerations are likely to play an important role in policy making in the period ahead.

3. Albania has been engaged in a series of Fund-supported programs since the beginning of transition, with two interruptions. A Stand-By arrangement (SBA) in 1992–93 was followed by a three-year arrangement under the Enhanced Structural Adjustment Facility (ESAF), which lapsed after two years as understandings could not be reached on the third annual program. In the second half of 1997, following the pyramid scheme crisis, a six-month program was supported under the Fund’s post-conflict emergency assistance policy. This was followed by two ESAF/PRGF1 arrangements, with a one-year hiatus in between during 2001-02 owing to the prevailing uncertain political climate. The current PRGF arrangement will expire in June 2005 (Table 1). Altogether, Albania has been engaged in Fund-supported programs for 110 out of 148 months during September 1992–December 2004.

Table 1.

Albania: History of Fund-Supported Arrangements

(In millions of SDRs; unless otherwise spec1ified)

article image
Source: IMF, Finance Department.

4. This report presents an ex post assessment (EPA) of Albania’s longer-term program engagement with the Fund.2 Section II provides an overview of economic developments. Section III discusses the overall role of the Fund, reviews the implementation of financial policies, and looks into selected dimensions of structural policies. Section IV summarizes the record on meeting conditionality and the nature of Bank-Fund collaboration. Section V examines the considerations for future program engagement, and Section VI concludes.

II. Overview of Economic Developments

5. The period since transition can be divided into three phases: (i) the post-transition slump and restoration of macroeconomic stability (1991–95); (ii) a period of faltering policies and a severe economic fallout from the collapse of the pyramid schemes (1996–mid 1997); and (iii) a period of post-conflict stabilization and renewed reform (mid 1997–2004). The salient aspects of each period are as follows.

A. Phase 1: The First Years of Transition

6. The initial post-transition slump was steep, but Albania made exceptional progress during 1993–95 under Fund-supported programs. By 1992, output had contracted by one third from its 1990 level, inflation had risen to triple digits, and the external current account deficit was equivalent to almost 40 percent of GDP. Economic activity rebounded sharply thereafter, with real GDP growing by around 9 percent annually during 1993–95.3 By 1995, annual inflation had fallen to single digits, the external current account deficit was reduced sharply to 6½ percent of GDP, the dependence on foreign aid had decreased markedly, and foreign reserves were rebuilt to the equivalent of almost three months of imports from about one month in 1992 (Table 2 and Figure 1). The key factors contributing to this strong rebound included fiscal tightening; financial discipline at the state enterprise levels; early privatization of large tracts of the economy, including agriculture; elimination of almost all price controls; and sweeping liberalization of the exchange and trade systems. The building blocks of a modern tax system, a two-tier banking system, and the basic legal framework for a market economy were also put in place during this period.

Table 2.

Albania: Selected Economic Indicators, 1992–2004

article image
Sources: Albanian authorities; and IMF staff reports.

Export-weighted. In 2004, October 2004 over December 2003.

Figure 1.
Figure 1.

Albania: Selected Economic Indicators, 1992–2004

Citation: IMF Staff Country Reports 2005, 088; 10.5089/9781451800791.002.A001

Sources: Albanian authorities; and IMF staff reports.1/ Annual average. Figures for 1992 and 1993 are 226 and 85 percent, respectively.2/ Excludes official transfers.

B. Phase 2: Sliding into Crisis

7. In 1996, the government’s policy resolve faltered ahead of the elections, prompting the Fund to disengage from a program mode. Structural reforms were delayed. The progress in fiscal consolidation stalled, as politically motivated reductions in some tax rates and less vigorous enforcement of tax collection resulted in considerable revenue loss. The introduction of a VAT in place of the turnover tax in July, after the elections, did not improve the revenue potential much as the rate was set too low. Financial pyramid schemes mushroomed on an unprecedented scale during the year—nominal liabilities of these schemes are estimated to have reached nearly 50 percent of GDP by end-1996. With the illusory increase in wealth fueling domestic demand and imports, GDP growth remained rapid, the end-year inflation rate nearly tripled, and the current account deficit widened.

8. In early 1997, Albania plunged into a deep economic and social crisis. A collapse of the pyramid schemes triggered large-scale social unrest and widespread destruction of public facilities, including most customs posts and many tax offices. The government’s authority crumbled completely. Economic activity contracted steeply owing to supply disruptions as well as depressed demand. Tax collections dropped. The lek depreciated by over 40 percent during the first half of the year, as remittances from abroad declined markedly and foreign aid virtually ceased. Consequently, inflation soared. The Bank of Albania increased interest rates sharply during this period and refrained from significant foreign exchange market intervention, thereby avoiding depletion of official reserves.

C. Phase 3: Post-crisis Recovery and Renewal of Reforms

9. The political landscape changed following elections in mid-1997, and the new government embarked on a two-stage strategy to put the Albanian economy on a stable path of recovery and reform, with support from the Fund. Macroeconomic stability was speedily restored and sustained. Economic activity rebounded strongly from the crisis-related downturn and the pace of real GDP growth settled at around 7 percent in 2000-01. Severe energy shortages and floods resulted in a marked slowdown in activity in 2002, but the growth momentum recovered the following year. Inflation came down sharply from its 1997 peak, and has generally remained in the 2–4 percent range since late-2002. Confidence in the lek also returned quickly with political and economic stability. After an initial narrowing, the external current account deficit fluctuated in the 7–8 percent of GDP range during 1998–2004. A new tax package introduced in October 1997, including an increase in the VAT rate from 12½ percent to 20 percent, substantially strengthened the fiscal framework. In conjunction with other measures, the overall budget deficit was brought down progressively. The structural reform agenda since mid-1997 has included liquidating the pyramid schemes; strengthening tax and customs administration; enhancing the efficiency of the civil service; improving public expenditure management; privatizing state-owned banks and setting the foundations for a modern financial sector; accelerating enterprise privatization; creating a functioning market in agricultural land; and addressing Albania’s governance weaknesses.

III. Achievements and Continuing Challenges Under Fund-Supported Programs

10. Albania’s prolonged use of Fund resources, and the detailed and comprehensive nature of the programs on the basis of which these resources were provided, have been appropriate considering that Albania’s starting conditions were perhaps the worst of any transition country. Decades of strict central planning and self-imposed isolation had progressively weakened the economy and left it completely ill-prepared for the transition to a market economy. Institutional structures were rudimentary and weak. The harshness of the communist regime had instilled a strong distrust in the state among the Albanian people. Thus, a complete overhaul of Albania’s economic and social institutions was needed, under economic conditions that could hardly be worse. Following the discarding of the old order, output fell to a level comparable to the poorest regions in the world and inflation was spiraling upward.

11. Albania has come a long way from this starting point, with significant accomplishments but also continuing challenges. This experience is reviewed thematically in this section. Section III.A provides a bird’s eye view of the role of the Fund in Albania’s transition. This discussion is followed, in sections III.B–III.D, by an examination of various dimensions of policy implementation, notably as regards budgetary management and structural policy delays or failures.

A. The Role of the Fund—Overview

The evolving objectives of Fund-supported programs

12. The main objectives and policies of Fund-supported programs have generally been sound, having been changed in an appropriate and timely manner as circumstances have evolved. Under the SBA in 1992, at the beginning of transition, and during the program supported by post-conflict emergency assistance in the second half of 1997, after the pyramid scheme crisis, the primary aim was to stabilize the financial situation and arrest the downward slide of the economy. Nevertheless, even though policy-making was dictated by the crisis situation, both these programs were intended to be precursors to programs with a medium-term horizon. Thus, the first steps of major structural measures were also taken. Under the SBA, a priority was to inject market forces into the economy and establish an appropriate relative price structure at the very outset of the transition process. Under the post-conflict emergency assistance, priority was given to creating a solid foundation for fiscal consolidation, taking control of the pyramid schemes and winding them up, and preparing the state-owned banks for privatization and liquidation.

13. The main goals of the ESAF-supported programs that followed these two shorter-term programs were to consolidate the initial achievements in stabilization and to lay the foundation for sustained growth through a wide-array of structural reforms. From 2000, mid-way through one of the ESAF/PRGF arrangements, new emphasis was put on inclusive growth and poverty reduction. Accordingly, the focus of policies was broadened to include reorienting government spending toward priority areas for poverty reduction while ensuring fiscal sustainability, and improving governance and the business climate for the private sector.

Performance under Fund-supported programs

14. The macroeconomic objectives of the Fund-supported programs were generally achieved. Financial policies were decisively implemented, fostering macroeconomic stability and growth. In most years, the inflation and external current account deficit outturn were lower than projected under the programs, and the growth performance was in line with program expectations (Figure 2). More striking, inflation has been brought down to the levels of Albania’s main trading partners in the European Union. Although Albania’s initial post-transition slump was steeper than that in the other transition countries in central and eastern Europe, Albania has caught up with other transition countries in the cumulative increase in real GDP since the beginning of the transition process (Figure 3). Fiscal consolidation, together with rapid growth, contributed to a significant reduction in both the external and public debt burden. As ratio to GDP, external debt declined by one half from the time of the 1997 crisis to 20 percent of GDP at end-2004. Over the same period, public sector debt fell by over one fourth to 56 percent of GDP.

Figure 2.
Figure 2.

Albania: Projections and Outturn of Inflation, Current Account Deficit, and Private Transfers, 1993–2004

Citation: IMF Staff Country Reports 2005, 088; 10.5089/9781451800791.002.A001

Source: IMF Staff reports.
Figure 3.
Figure 3.

Albania: GDP developments, 1990–2003

Citation: IMF Staff Country Reports 2005, 088; 10.5089/9781451800791.002.A001

Sources: Albanian authorities; World Economic Outlook; and World Development Indicators database.

15. Implementation of structural reforms proceeded at an uneven pace, but was satisfactory overall. In general, measures that had an immediate impact on stabilization were implemented in a timely manner, whereas measures important over the medium term were subject to delays. In macro-critical areas, the authorities persisted in staying the course and progress did take place incrementally. There has been substantial—even if still incomplete—progress in building the institutional foundations of sound macroeconomic policies. In addition, public administration has been rationalized, the government’s role in production has been reduced sharply, and the commercial banking sector is now entirely in private hands. However, implementation of measures in areas outside the Fund’s mandate and not covered by conditionality—for example, law enforcement and fight against corruption—has been weak.

16. However, the achievements remain fragile. Risks remain on account of pervasive poverty, lingering administrative capacity weaknesses, continued divisive politics, and slow progress in improving governance. The virulence of the pyramid scheme crisis of early 1997 is a reminder of the potential fragility of the situation. While partial indicators suggest that poverty may have decreased over time, the 2002 Living Standard Measurement Survey found that one fourth of the Albanian population lived below the absolute poverty line and that the non-income dimensions of poverty were also high. In the context of governance weaknesses, there is concern about the quality and sustainability of the strong growth performance.

Aspects of program implementation

17. Ownership of the program agenda was a key factor in the successful implementation of the programs. Except during 1996–mid 1997, the authorities stayed committed to taming inflation and maintaining price stability and to safeguarding fiscal and external sustainability. Even during the Kosovo crisis, the authorities pursued cautious financial policies, though structural reforms suffered.

18. The approach to program design and conditionality was detailed, hard-nosed, and increasingly complemented by capacity building. In view of the authorities’ limited capacity to formulate and implement macroeconomic policies and structural measures, all the programs were covered by very detailed conditionality, which served as a blueprint for reforms, kept the authorities focused, and helped mobilize internal support for the adjustment and reform efforts. This was complemented by extensive technical assistance from both bilateral and multilateral sources to improve institutional and administrative capacity, with key contributions from the Fund. Given the institutional weaknesses, structural measures in the early years of transition were chosen to concentrate on the most pressing issues. As reform efforts became more broad-based and more complex than the first round of structural changes under the SBA, administrative weaknesses often became binding or political interests came to the forefront, thereby leading to implementation delays. Sometimes, though, delays arose from circumstances beyond the control of the authorities, such as a weakening global market environment and the Kosovo crisis. Generally, in the event of implementation delays, the missed measures were converted into prior actions for completion of the program review or, if appropriate, deadlines were moved back and the authorities reiterated their intentions to stay the course. When uncertainties were deemed to be particularly high—such as at the start of the 1992 SBA, the program supported by emergency assistance in 1997, and the first-year program under the succeeding ESAF arrangement in 1998—most of the key structural measures were implemented as prior actions.

Program-based engagement ebbed and flowed with ownership

19. The interruptions in program-based engagement were triggered by faltering policies or by uncertainties about program ownership. Thus, in 1996, understandings could not be reached on the third-year program under the ESAF arrangement because of election-related policy slippage and the government’s unwillingness to take sufficient corrective measures after the elections. Governance was weak during this period and developments eventually culminated in the pyramid scheme crisis in early 1997. The circumstances surrounding the second interruption were different. Final understandings on the current PRGF arrangement were kept pending for almost one year during 2001-02 because of elections and subsequent political feuds that led to three changes in government. However, the entire period of this second hiatus was covered by interim understandings on a detailed policy framework. Thus, unlike in the first period of disengagement, there was no deterioration in the macroeconomic situation, though progress in structural reforms was stifled. The Fund re-engaged in program mode after both interruptions once the political climate stabilized and the authorities showed credible commitment to renewing adjustment and reform efforts.

B. Fiscal Policy Implementation

20. Fiscal consolidation has been the centerpiece of the authorities’ economic policies since the beginning of transition. The budget deficit (including grants) declined from about 19 percent of GDP in 1992 to 5¼ percent of GDP in 2004. Domestic borrowing by the budget was consistently in line with the programmed limits. However, the overall deficit outturn always was lower than envisaged under the program, owing to shortfalls in foreign-financing. Although the fiscal consolidation was impressive, the budget formulation process was weak and the objective of higher pro-poor spending was not met. The discussion below sheds further light on these and other dimensions of fiscal policy execution.

21. Albania’s fiscal adjustment has been striking, but marred by enduring problems of composition.

  • The improvement in the fiscal position was particularly sharp in the initial phase of transition, when the budget deficit fell by 10 percentage points of GDP during 1992–95. The fiscal position deteriorated during 1996–97. Since 1998, when the full-year effect of the October 1997 tax package went into force, the budget deficit has dropped by 5 percentage points of GDP (Table 3 and Figure 4).

  • Fiscal consolidation during 1992–95 relied, quite appropriately, on the compression of current expenditures—a cutback in personnel costs in 1993, and a progressive reduction in subsidies to enterprises and in operations and maintenance expenditure.

  • The fiscal strategy envisaged since 1998 under the last two PRGF arrangements—namely, achieving fiscal consolidation through higher revenue mobilization, reliant on continued enhancements in tax administration, while creating room for higher spending on priority areas for poverty reduction (viz., health, education, and social safety nets)—has not materialized. First, the reduction in the overall budget deficit since 1998 is explained by decreases in expenditure, both current and capital. Tax revenue did increase gradually, but from 2000 onward these gains were almost entirely offset by declining non-tax revenue.4 Second, expenditure on priority areas did not increase as a ratio to GDP and fell short of the budgeted level as well (Figures 5, 6, and 7).

Table 3.

Albania: Government Revenues and Expenditures, 1992–2004

(In percent of GDP)

article image
Source: EPA team calculations based on tables in IMF staff reports.
Figure 4.
Figure 4.

Albania: Fiscal Balance, 1993–2004

(in percent of GDP)

Citation: IMF Staff Country Reports 2005, 088; 10.5089/9781451800791.002.A001

Sources: Data provided by Albanian authorities; and IMF staff reports.1/ Budget figures for 1996 were not available.
Figure 5.
Figure 5.

Albania: Government Revenue, 1993–2004 1/

(in percent of GDP)

Citation: IMF Staff Country Reports 2005, 088; 10.5089/9781451800791.002.A001

Sources: Data provided by Albanian authorities; and IMF staff reports.1/ Budget figures for 1996 were not available.
Figure 6.
Figure 6.

Albania: Expenditure Developments, 1993–2004 1/

(in percent of GDP)

Citation: IMF Staff Country Reports 2005, 088; 10.5089/9781451800791.002.A001

Sources: Data provided by Albanian authorities; and IMF staff reports.1/ Budget figures for 1996 were not available.
Figure 7.
Figure 7.

Albania: Expenditure on Priority Areas, 1998–2003

(in percent of GDP)

Citation: IMF Staff Country Reports 2005, 088; 10.5089/9781451800791.002.A001

Source: IMF staff reports.

22. Tax revenue collections and foreign-financed capital expenditure have persistently underperformed. Since mid-1999, tax collections were being monitored under Fund-supported programs by way of quarterly indicative floors. These benchmarks were typically not met, except in 2000. In four out of the six revenue shortfall years during 1998–2004, the shortfall exceeded 1 percent of GDP. The shortfalls were primarily in the areas of VAT, customs duties, and excise taxes (Table 4). Faced with the prospect of lower revenues, the government typically undertook cuts in operations and maintenance expenditures and in investment in order to remain within the domestic financing limit. In order to guard against haphazard cuts, budgets in the past few years incorporated contingency reserves, but these were not enough and spending cuts had to be identified. The ad hoc expenditure cuts and shortfalls in foreign financing were the main reasons for spending on priority sectors falling short of the budgeted levels.

Table 4.

Albania: Deviations in Tax Collections from Budgeted Levels, 1998–2004

article image
Source: EPA team calculations.

A negative sign denotes that actual collection was lower than the budgeted level.

23. The shortfalls in foreign-financed capital expenditure have been explained in Fund staff reports in terms of optimistic projections by the authorities, inadequate donor coordination, and procurement delays.

24. Fund staff reports ascribe blame for tax revenue shortfalls to ongoing weaknesses in customs and tax administration—owing to delays in reform, frequent managerial changes, and political uncertainties—but this view was only partly shared by the tax experts who had provided technical assistance to Albania in 2002-03. In their technical assistance reports,5 the tax experts observed that further improvements in revenue administration were indeed key to increasing tax collections in a sustainable manner over time. However, they also argued that: (i) revenue gains from improved administrative efficiency, including better compliance, built into the budget projections were overly optimistic;6 and that (ii) Albania’s low revenue effort was overstated on account of its large agricultural sector. When expressed as ratio to nonagricultural GDP, revenue performance of indirect taxes in Albania was comparable with that in several central and east European transition countries (Table 5).

Table 5.

Comparative Structure of Tax Revenue in Selected Eastern European Countries, 2001-02 1/

article image
Source: Compiled by the IMF technical assistance mission on Albania: Selected Issues in Tax Design, February 2004.

Period average.

25. The authorities set ambitious revenue targets believing that it would lead to higher collections than otherwise, because of the increased incentives on the part of the tax collectors. Insofar as revenue collections have increased over time (see Figure 5), the authorities have a point. However, in the opinion of the tax experts providing technical assistance, the setting of unrealistic revenue targets had detracted attention from the reform efforts necessary for sustained revenue performance and had caused tax and customs officials to exert excessive pressure on a relatively small base of regular tax payers.7 Indeed, there is evidence in the governance literature that providing incentives to tax inspectors to collect revenues more aggressively can result in undesired side effects in the absence of complementary administrative reforms. Harassment problems can be mitigated if tax administration is computerized, the information base is centralized, and there is an effectively functioning appeals court. These complementary organizational requirements were not fully in place in Albania when the incentive system for tax collection was introduced in 2000.

26. As the Fund staff team for Albania became aware of the considerations noted by the tax experts, it did propose more realistic revenue projections in the 2002-04 budgets, and called for specific supporting measures. But, the projections were clearly not scaled back sufficiently. The underperformance continued (see Table 4 and Figure 5). In the context of the preparation of the 2005 budget, the Fund staff has strongly reiterated the desirability of realistic budget revenue projections since there were indications of the authorities being reluctant to scale back ambitious targets as they felt that the budget would otherwise be difficult to pass through parliament because of the implications for spending.

27. With the prospects for revenue gains from enhancements in tax administration looking more limited than had been projected earlier under the Fund-supported programs, expenditure prioritization and improved expenditure management become crucial requirements for preserving spending on priority areas. Whereas the authorities have made notable progress in containing personnel cost while improving public sector salaries, public expenditure management in general has lagged, as noted below.

  • Personnel costs in the budget declined from 9 percent of GDP in 1992 to about 6½ percent of GDP in 2004. Steady reductions in staffing levels in budgetary institutions—by about one half overall during 1992–2003—created room for general wage increases and for increased differentiation in public sector salaries considered necessary for tackling the problem of high turnover of skilled staff and poor governance. Average real wages in the budgetary sector increased three fold during 1993–2003 and nearly doubled during 1998–2003. According to an ongoing World Bank project, by 2002, the salaries of those in the civil service, including sector chiefs and specialists, had come up to par with salaries of their private sector comparators (Tables 6 and 7).8

  • Progress in computerizing treasury operations and debt management has been slow, and these tasks are still performed manually for the most part. According to World Bank staff, who have taken the lead in the policy dialogue in this area, efforts to modernize the financial management system have been pushed along as rapidly as has been feasible, given the government’s absorptive capacity constraints. This being the case, perhaps these efforts should have started earlier. Efforts are in the early stages to enhance the accountability of all budgetary institutions and to strengthen the capacity of both line ministries and ministry of finance for strategic planning and management of public investment, including externally-financed projects. There is still some way to go in synchronizing the annual budget, the Medium-Term Budget Program, and the National Strategy for Socio-Economic Development. Policy coherence and coordination among the lead agencies involved in the reform process are ongoing challenges.

Table 6.

Albania: Budgetary Sphere Employment and Wage Developments, 1992–2003

article image
Source: EPA team calculations based on data provided in IMF staff reports and by World Bank staff.
Table 7.

Albania: Public Sector Salaries Relative to Private Sector

article image
Source: World Bank staff.

28. Finally, given the persistent over performance on the macroeconomic front, might the Fund-supported programs have accommodated a more relaxed fiscal stance, which could have provided more domestic resources for anti-poverty spending? With the benefit of hindsight, the answer appears to be yes. As noted earlier in paragraph 14, macroeconomic performance was better than program expectations. Further, private remittance inflows—a key element of private national saving—also were virtually always larger than projected in all Fund-supported programs, and concerns about their likely decline proved unfounded (Table 8 and Figure 2). Thus, the risks to fiscal and external sustainability have turned out to be more moderate than assessed by the Fund staff when setting the fiscal deficit targets. On the other hand, it should be recognized that data weaknesses hampered the staff in monitoring developments, in making macroeconomic projections, and in policy formulation. Further, the fiscal deficit, though declining, was running at a fairly high level for much of the period. Under these circumstances, targeting a conservative fiscal policy stance is understandable.

Table 8.

Albania: Projections and Outturn of Private Remittances, 1993–2003

article image
Source: EPA team calculations based on data in IMF staff reports.

For 1996, there was no Fund-supported program.

A negative sign denotes that the projection was lower than the outturn.

C. The Monetary Framework

29. The Bank of Albania (BoA) has followed an eclectic approach to monetary management within a flexible exchange rate regime, guided by the monetary program drawn up in consultation with the Fund staff. In recent years, the BoA also has publicly announced its informal inflation target of 2–4 percent with the aim of anchoring expectations and encouraging policy discipline. This approach has served Albania well in bringing down inflation and keeping it low, and the BoA has gained credibility as the guardian of price stability. The BoA has considerable legal and operational independence.

30. The adoption of a flexible exchange rate regime at the beginning of transition was influenced by the lack of a reserve cushion and the uncertainties of transition. This regime proved particularly invaluable during the pyramid scheme crisis, enabling the BoA to preserve its foreign exchange reserves essentially intact. A flexible regime was retained after the crisis. A change in the nominal anchor was felt unnecessary, as it would not buy much in the way of policy credibility and because high and sticky inflationary expectations were not considered to be a problem in Albania.

31. Within a flexible exchange rate regime, the BoA has intervened periodically on a temporary basis to smooth exchange rate fluctuations without affecting underlying trends. The lek appreciated steadily for a while since mid–1997, driven by large inflows of official assistance and private remittances. However, since early 2002, there has been little cumulative appreciation both vis-0-vis the euro and on a nominal effective basis. With relative price differentials with the main trading partners exhibiting a flat trend, the real effective exchange rate has moved in line with the nominal effective exchange rate (Figure 8). Against the backdrop of Albania’s weak export performance, the question arises whether real exchange rate appreciation has created a competitiveness problem. Fund staff analysis during the 2002 Article IV consultation concluded that the effect of exchange rate appreciation on exports has likely been limited and that export performance has likely been impaired by non-price factors.9 Developments in the exchange rate and the relevant non-price factors since 2002 (see paragraphs 39–40), do not seem to call for any modification of these conclusions.

Figure 8.
Figure 8.

Albania: Exchange Rates, 1994–2004

Citation: IMF Staff Country Reports 2005, 088; 10.5089/9781451800791.002.A001

Sources: International Financial Statistics (IFS); and Fund staff estimates.

32. The conduct of monetary policy operations has become more refined over time. During the 1990s, the BoA relied on bank-by-bank credit ceilings and kept minimum deposit rates positive so as to induce growth in domestic currency deposits. Following extensive technical assistance from the Fund to create the pre-conditions—developing the instruments and strengthening bank supervision—the BoA switched to indirect tools of monetary management in mid–2000, with repo auctions becoming the key policy instrument for controlling bank liquidity. The floors on deposit rates were also removed. However, because monetary transmission in Albania is poorly understood—in the absence of a meaningful credit channel and with widespread dollarization—efforts to manage inflation directly are still supported by indirect targets for net domestic assets and net international reserves. The BoA’s aim is to move to formal inflation targeting over the medium term. Accordingly, it has initiated steps to strengthen its analytical capacities, with technical assistance from the Fund.

D. Selected Dimensions of Structural Policies

Financial sector reform

33. The pyramid scheme crisis in early 1997 symbolized the most costly policy failure on the part of the authorities and, to some degree, weak Fund surveillance. Delays in fundamental reform of the banking system, and the consequent imposition of tight controls on bank credit, contributed to the emergence of an active informal money market. The failure of the government to implement its own laws and regulations allowed the pyramid schemes to mushroom to enormous proportions. Significantly, there was no reference to the growth of unauthorized banking activities in any Fund staff report for Albania before the 1996 Article IV consultation report that was issued in February 1997. According to that report and another Fund staff study,10 it was not until August 1996, when the true nature of the schemes became increasingly apparent, that a strong warning was given by the Fund staff and this was followed by a further warning from Fund management in October. However, these warnings were not heeded by the authorities. Even at the time of the Article IV mission in mid-November 1996, on the eve of the collapse, the Fund staff were able to discuss the risks posed by the proliferation of financial pyramid schemes only in the abstract.11

34. A comprehensive strategy to reform the commercial banking system began only in early 1995—three years into the Fund’s engagement in Albania—as evidence mounted that the state-owned banks were not capable of effective financial intermediation in a market-oriented environment. In the early years of transition, all three state-owned banks had serious managerial and accounting problems, poor credit evaluation, and lackluster follow up on overdue loans. To complicate matters, the custom of non-payment of loans to state-owned banks was entrenched and procedures of the legal system had made loan recovery very difficult. Thus, more than one fourth of all credit granted since the reorganization of the banking system in mid–1992 was in the non-performing category by end-1994. The restructuring efforts undertaken during 1995–96—an initial cleaning up of balance sheets, change in management, and a branch rationalization program—did not have much success in repairing the efficiency and financial health of the state-owned banks. At end-1996, on the eve of the pyramid scheme crisis, all three state-owned banks were insolvent.

35. Following the pyramid scheme crisis, the focus shifted toward privatizing the banks. The authorities heeded the Fund staffs advice on avoiding ambitious restructuring plans to increase the banks’ net worth. The Rural Commercial Bank, the most flagrant bad lender among the three state-owned banks, was liquidated ahead of schedule in March 1998. The restructuring and privatization of the other two banks took longer than was envisaged. The National Commercial Bank (NCB) was transferred to foreign investors in November 2000. After an unsuccessful attempt in the first half of 2002, despite extensive marketing efforts with assistance from the International Finance Corporation, the Savings Bank was eventually privatized in early 2004—four years past the target date first specified as a structural benchmark under a PRGF arrangement.

36. The delays in bank privatization were beyond the control of the authorities, but they did not have any negative fall-out, unlike in the early stage of transition. The sales were being sought under difficult conditions—the NCB around the time of the Kosovo crisis and the Savings Bank under a weak global market environment. Under these circumstances, the privatization timetable, supported by Fund conditionality, was perhaps too ambitious. The authorities ought to be given credit for persevering with the chosen strategy and for taking steps in the interim to safeguard the soundness of the two banks: while awaiting privatization, both banks were placed under the supervision of foreign advisors and were restricted from any new lending. In parallel, the authorities initiated measures to strengthen the bank supervision and regulatory framework.

Enterprise sector reform

37. Enterprise privatization proceeded more slowly than expected but has been largely completed, except for a few strategic companies. In the early years of transition, many small- and medium-sized enterprises (SME) were privatized through auctions. For the larger enterprises that were more difficult to privatize, a mass privatization program was introduced in 1995, but the process came to a halt in 1996, in part because of restitution claims. The privatization program was reactivated in 1998, but implementation fell continuously short of targets set under Fund-supported programs. The causes of the delays were many: domestic political tensions, poor coordination among ministries, unresolved financial and legal disputes, uncertainties caused by the Kosovo crisis, and lack of investor interest. The privatization of the fixed-lines telecommunications company and the oil sector has experienced significant delays—the original deadlines were end-1998 and end-2000, respectively—and still remains outstanding. Against the backdrop of poor management and improper pricing, the delays in restructuring and privatization came at a cost: the large state-owned enterprises accumulated a huge stock of inter-enterprise arrears.12 There are no analytical studies on the impact of privatization on enterprise performance in Albania, but anecdotal evidence suggests that the loss of domestic inter-linkages that existed prior to privatization and competition from imports resulted in the demise of many SMEs; those that had links with foreign firms flourished.

38. Failure to address the problems in the electricity sector in a timely manner had an important bearing on the growing power shortages, posing a threat to growth and macroeconomic stability, but with reforms in the electricity sector now back on track the energy situation has begun to improve. Chronic failure to address the problem of illegal use and nonpayment, together with below-cost prices, encouraged excessive demand for electricity, and led to the suspension of World Bank credit and other donor support for power projects in 1998. The power supply situation deteriorated from 2000, owing to poor hydrological conditions, necessitating increased electricity imports and budget subsidies of about ¼—½ percent of GDP annually. Recognizing the magnitude of the power crisis and its wide-ranging macroeconomic and social implications, the authorities began implementing a rolling action plan for the restructuring of the electricity sector in 2001, and the Bank and donor community resumed their support once the commitment of the authorities was visible. Some of the action plan measures were supported by Fund conditionality, which kept up the pressure for implementation. The quarterly targets under the action plan for reducing non-technical losses and improving bill collection rates have been consistently met—reflecting progress in installing meters, enforcing disconnection of nonpayers, and in organizational improvements in the electricity company. These measures, together with annual tariff adjustments since 2002, restored the electricity company to profitability in 2004, which will facilitate the planned elimination of subsidy for electricity imports from 2005. The close oversight of an inter-ministerial committee and the coordinated approach adopted by the donors were important factors behind the progress in electricity sector reforms thus far.

Governance issues

39. Progress in improving the overall business climate has been slow. The 2002 Business Environment and Enterprise Performance Survey (BEEPS) found that little improvement was achieved in reducing corruption and improving standards of the judiciary since the first BEEPS was undertaken in 1999. In 2004, Albania ranked 108th out of 145 countries in the Transparency International Corruption Perceptions Index with a score of 2.5—on a scale of 0 (highly corrupt) to 10 (highly clean)—unchanged from the score received in the previous two years. In its March 2004 annual report and, more recently, in the context of the negotiations on a Stability and Association Agreement with Albania, the European Union expressed concern about insufficient progress in law enforcement and the fight against organized crime and corruption. The World Bank’s ongoing operations on improving governance in Albania have focused on a wide array of legal and judicial reforms as well as on measures to depoliticize personnel management practices, to limit the scope for corruption by reducing discretion and ensuring clear and consistent regulations, and to require declaration of assets and financial holdings by public and elected officials.

40. Weaknesses in governance and inadequate infrastructure have stymied a broad-based and export-driven economic expansion. In the first years of transition, growth reflected supply response in agriculture and trade to reform measures. However, during the past five years, growth has been focused on construction and services, supported by large inflows of private remittances. Industry and other tradable sectors have not yet taken off. As highlighted in a 2003 report by FIAS, domestic and foreign investment in these sectors is hindered by administrative barriers—reflecting general weaknesses in governance and law enforcement, and abuse of power by government officials. The initial surge in agricultural growth was not sustained as the frequent absence of secure tenure or clear property titles has hampered development of a functioning land market and impeded investment in this sector; the property restitution law approved by Parliament in July 2004 is expected to remove this obstacle.

IV. Benefits of Fund Support, Conditionality, and Bank-Fund Collaboration

41. Besides providing a policy framework and financing, the Fund arrangements played a key role in catalyzing financial support from other multilateral agencies and the donor community, and in mobilizing internal support for reforms. The share of Fund resources in Albania’s total financing requirements declined over time, especially under the current PRGF arrangement. Fund-supported programs provided the basis for significant balance of payments support from other multilateral and bilateral sources and for three Paris Club reschedulings (Table 9). Fund support also facilitated internal political consensus on appropriate policies. For the most part, policy slippages arising from political uncertainties or cracks in ownership were temporary. However, as noted earlier, there were two occasions (viz., 1996 and 2001-02) when the political uncertainties were prolonged or the environment was not conducive to consensus on reforms and enactment of cautious macroeconomic policies, and the Fund disengaged from a program mode.

Table 9.

Albania: Sources of External Financing, 1992–2003

article image
Source: EPA team calculations based on data in IMF staff reports.

For 1992–95, SBA and ESAF arrangements.

For 1997–2001, support under Emergency Post-Conflict assistance policy, and ESAF/PRGF arrangement.

For 2002-03, PRGF arrangement.

Includes errors and omissions, which were negative in 1992–94.

42. Structural conditionality under Fund arrangements was extensive, and addressed areas critical for achieving program objectives. As discussed earlier in paragraph 18, conditionality increased policy focus and internal support, and did not appear to undermine program ownership. Even after the new guidelines on streamlining conditionality were put in place in 2002, the number of conditions, though fewer, remained large—a reflection of the enormous structural agenda. The measures covered by conditionality can be classified into the following main categories: fiscal management and control, payments discipline, budgetary implications of enterprise reforms, financial sector reform, privatization, and—in the early years of transition—price and trade liberalization. Since mid-2003, Fund-supported programs have included a range of conditions supporting the strengthening of governance—in particular, relating to fiscal policy. There was considerable reliance on prior actions in structural conditionality; about one fourth of the structural measures were required as prior actions for program approval or completion of program review.

43. There was close cooperation between the Fund and World Bank on matters relating to structural reforms in Albania. The Bank played a lead role in policy dialogue in several areas with significant macroeconomic impact. These included financial sector reforms, power sector reforms, social sector and pension reforms, as well as public expenditure management and public administration reforms. The measures worked out between the authorities and the World Bank in these areas were incorporated into the Fund-supported programs on a selective basis. This approach successfully increased pressure on the authorities to maintain momentum. The overlap in conditionality decreased with the introduction of the new guidelines on streamlining conditionality in 2002. Notably, conditionality on land market reform and employment in budgetary institutions were dropped from Fund-supported programs, while that on public expenditure management was limited to measures for improving budget control of foreign-financed projects and state-owned enterprises. This streamlining of conditionality did not have any adverse effect on the achievement of programmed macroeconomic adjustment. In general, there was little friction between the Fund and Bank staff in reaching a consensus on the timing and details of reforms in the overlapping areas of interest.

44. The record on meeting program conditionality was on the whole good. The standard quantitative performance criteria (PCs) and benchmarks were always met, though the quarterly indicative targets on revenue collection were persistently missed, except in 2000. Measures subject to prior actions and structural PCs were implemented on a timely basis for the most part. In the majority of instances when the PCs were not met, the measures were converted to prior actions for the completion of program review.13 The record in achieving structural benchmarks was weaker, with delays being experienced, particularly in the areas of tax and customs administration and privatization (Table 10).

Table 10.

Albania: Structural Conditionality and Performance under Fund-Supported Programs

article image
Source: Staff reports.