Statement by Arrigo Sadun, Executive Director for Albania and Carlo Gola, Senior Advisor to Executive Director

This paper discusses key findings of the Second Review Under the Poverty Reduction and Growth Facility for Albania. The outlook for 2007 is positive, with growth projected at 6 percent. These developments owe much to good macroeconomic policies. All quantitative program targets were met. The 2007 budget is in line with the medium-term fiscal framework, which strikes a balance between reducing public debt and increasing priority expenditure. Progress in structural reform has been generally good. The program focuses on reducing fiscal vulnerabilities, improving budget management, and developing the financial system.

Abstract

This paper discusses key findings of the Second Review Under the Poverty Reduction and Growth Facility for Albania. The outlook for 2007 is positive, with growth projected at 6 percent. These developments owe much to good macroeconomic policies. All quantitative program targets were met. The 2007 budget is in line with the medium-term fiscal framework, which strikes a balance between reducing public debt and increasing priority expenditure. Progress in structural reform has been generally good. The program focuses on reducing fiscal vulnerabilities, improving budget management, and developing the financial system.

February 2, 2007

On the behalf of the Albanian authorities, we wish to express our appreciation to the staff for a well-written report, which reflects the remarkable cooperation and very constructive dialogue with the authorities. Since the first review of the latest program, economic performance has proceeded largely as expected, with all quantitative and structural performance criteria observed, apart from minor delays. The authorities have demonstrated their willingness to implement, in a consistent way, all of staff’s recommendations, and they are determined to continue on this path. The current PRGF and the Extended Fund Facility arrangement would offer the opportunity to implement the ambitious reform agenda described in the Memorandum of Economic and Financial Policies (MEFP).

1. Macroeconomic developments

Albania’s macroeconomic performance remains solid. In 2006, despite the pronounced slowdown in the construction sector and postponements in public investment, both due to the new course of rigorous permits and procurement policies, the economy recovered faster than expected from the electricity supply-induced disruptions suffered at the end of the previous year. Trade performance strengthened significantly in 2006, thanks to the recovery of the traditional sectors, helping to contain the trade deficit and reducing the current account imbalance to 5.9 percent of GDP. Inflation exhibited a rising trend in 2006, but remained within the 3 ± 1 percent target range. Inflationary pressure has been curbed by two 25-basis point increases (in July and November); by the fiscal correction in the supplementary budget, which reduced the fiscal stimulus by ¼ percentage point of GDP; and by the tightening of the supervisory and regulatory regimes. In December 2006 inflation was 2.5 percent, compared to 2 percent in the same period of the previous year.

On the fiscal side, relevant administrative efforts, aimed at increasing the tax base, are yielding tangible results: for 2006 tax revenues should be above 23 percent of GDP. The responsible conduct of fiscal policy has allowed the authorities to reach a primary balance (excluding grants) of only -0.8 percent of GDP, further reducing the total public debt to 55.7 percent (it was 65 percent only five years ago). As in the past the supplementary budget allocated unexpected revenues to high-quality capital spending, tax relief, and debt reduction.

The banking system is liquid, profitable, and well capitalized, while the level of non-performing loans is low. Nonperforming loans (net of provisions) as a percentage of regulatory capital stood at 7.3 percent in November 2006. The presence of foreign banks is high (more than 90 percent of total assets) and the banking sector is highly concentrated (the market share of the first three banks is 60.5 percent of total assets, but the entry of new foreign entities has increased competition).

The authorities are determined to preserve the current, prudent macroeconomic policy stance and further enhance the quality of the budget, the credibility of the monetary framework, and the resiliency of the financial market. In particular, the independence of the central bank will be maintained and its capabilities further increased. The authorities are also committed to proceeding expeditiously with the remaining privatizations.

2. Structural reforms

On structural reforms, significant and tangible results have been achieved since the time of the last review, thanks also to the valuable support of the Fund and donors.

  • The Large Taxpayer Office is fully operative, assessing and auditing now all large taxpayers (including for social security taxes). All VAT arrears before 2006 have been cleared. A quarterly report on VAT refund requirements and on customs administration risk assessments, under the ASYCUDA system, is being produced regularly; the feasibility study for merging small branches of the General Taxation Directorate has been concluded.

  • On the crucial issue of debt management, the authorities have recently adopted a new public debt law and completed an explicit timetable to implement a new management strategy. The average maturity of the domestic debt stock increased by over 20 percent in the last year, although it remains very short (242 days).

  • In the area of financial supervision, fundamental progress has been made: a new banking law was approved in December 2007; and an independent Financial Supervisory Authority, for the surveillance of the securities markets, insurance companies, and pension funds, has been created. In order to monitor all credit positions held by regulated entities, the authorities are determined to complete and make operational a credit bureau by the end of this year, and draft legislation has been prepared to improve the efficiency of the payment system. Transparency, risk management, and regulation on related parties have been greatly improved.

  • Progress in privatizations has been relatively slow, due to the difficulties of the electricity company KESH and the renegotiation of the sale of the telecommunication company (Albtelecom). However, the privatization of a minority stake in a small bank has been concluded.

  • The authorities are aware that the national account estimates rely on very narrow labor input data and lack plausibility, as underscored in the MEFP and noted in the recent ROSC assessment. Household and labor market surveys need to be expanded and improved. A more extensive cross-checking and timeliness of data is needed. The weights of the consumer and producer price indices have to be updated as soon as possible. The data coverage for external donor financial projects should be enhanced, as should several balance of payments statistics.

3. Program design

There is strong agreement between staff and the authorities on the design and prioritization of the program. The current fiscal framework provides a good balance between development spending and fiscal consolidation. The request for some front-loading of external nonconcessional borrowing within the limits described by the program seems acceptable. The main pillars of the program are: 1) maintaining current responsible and prudent policies; 2) reserving and reinforcing the institutional framework and enhancing administration capacity and governance; 3) further improving the business climate, the rule of law, and the attractiveness of Albania as a destination for foreign investments; 4) downsizing government involvement in non-core areas and stepping-up the pace of privatization; 5) enhancing basic infrastructures such as the transportation and electricity networks; and 6) re-establishing high educational standards and improving the health system. The authorities are convinced that the current three-year arrangement under the PRGF/EFF-supported program will provide not only a valid strategy to re-address the aforementioned problems, but also a successful exit strategy from the Fund-supported program, which will in turn pave the way for convergence with European standards.