Statement by Arrigo Sadun, Executive Director for Albania, and Francesco Spadafora, Senior Advisor to Executive Director, September 7, 2011

The global crisis left Albania fairly unscathed and ushered in the needed economic rebalancing. The policy framework has been challenged in the post-crisis environment significant headwinds. Despite improvement, external imbalances remain elevated. Fiscal consolidation in terms of a more realistic macroeconomic framework will require credible measures and sustained efforts. Financial sector supervision and regulation will need to stay ahead of evolving challenges. Boosting productivity by attracting foreign investment is essential for higher sustainable growth.

Abstract

The global crisis left Albania fairly unscathed and ushered in the needed economic rebalancing. The policy framework has been challenged in the post-crisis environment significant headwinds. Despite improvement, external imbalances remain elevated. Fiscal consolidation in terms of a more realistic macroeconomic framework will require credible measures and sustained efforts. Financial sector supervision and regulation will need to stay ahead of evolving challenges. Boosting productivity by attracting foreign investment is essential for higher sustainable growth.

On behalf of the Albanian authorities, we thank staff for the continued close and constructive cooperation, as well as for the very informative report.

Overview

Albania has weathered the global crisis better than most other regional and European economies, and is leading the recovery in the region. Generally prudent macroeconomic policies, low external debt, a sound banking system, and adequate foreign exchange reserve buffers allowed the authorities to use the available policy space accumulated in the boom years to mitigate the impact of the crisis. As a result, Albania escaped a recession, and growth continued at above 3 percent in both 2009 and 2010.

Strong export growth since the beginning of 2010 has helped narrow the large current account deficit, from above 15 percent of GDP in 2008 to 12 percent in 2010. Robust inflows of foreign direct investments have increased their importance as a source of financing of the current account deficit, overtaking remittances in this role in 2010. The country was also able to place a €300 million debut Eurobond in October 2010.

The authorities have more favorable expectations than staff on the outlook, as they currently project that growth will return to a pace of 5 percent or higher in the near term. This projection is based on the country’s strong fundamentals, as well as on large public investments in infrastructure in recent years.

The authorities underscore the high degree of consensus in the policy discussions with staff, and agree that the simultaneous achievement of higher growth, resilience against risks, and external sustainability is within reach. Their policies remain focused on preserving macroeconomic stability and external sustainability, consolidating public finances, and advancing structural reforms.

Fiscal Policy

The crisis has inevitably led to deterioration in the government’s fiscal position. After declining from 70 percent of GDP in 2000 to 54 percent in 2007, public debt has drifted up (driven by its external component), approaching the 60 percent of GDP statutory limit; however, the ratio declined between 2009 and 2010 (Table 1 of the report). Facing underperforming revenue, significant corrective measures adopted in mid-2010 limited the budget deficit to 3.7 percent of GDP, below the initial target of 3.9 percent set in the original 2010 budget.

The authorities concur with staff that fiscal consolidation represents the key policy challenge for the near- and medium-term, given the need to contain public debt and rollover requirements.

To this end, in July 2011 further expenditure cuts were adopted through a mid-year budget review to keep the budget close to the original target of 3.5 percent. Moreover, the revised Macroeconomic and Fiscal Framework 2012-2014, approved by the government in July 2011, targets a budget deficit of 3 percent over the medium-term and a public debt-to-GDP ratio below the statutory limit.

Going forward, the authorities expect that a return to faster growth, together with their ongoing efforts to boost tax administration, can increase revenues and relieve budget pressures.

Given the growth of current expenditures, the authorities envisaged less pronounced increases in the public wage and pension bills in the future; they also intend to re-launch pension reform efforts, while remaining mindful of the challenges to achieve the needed political consensus.

The authorities share the staff’s view on the need for a strong fiscal rule to firmly anchor expectations of a sustainable conduct of public finances. The authorities agree that public debt can constitute a desirable anchor, and they consider the existing legal debt limit of 60 percent of GDP to have proven its value. They take note of the staff’s preference for an expenditure-based rule, but are looking at augmenting it with a mechanism to guard against procyclicality, though they have not yet reached definite conclusions on a new debt target.

Monetary and Financial Sector Policies

The inflation targeting framework and flexible exchange rate have served Albania very well, and have provided resilience throughout the global crisis. Inflation largely stayed in the target range of 3±1 percent and inflation expectations remain well-anchored.

The monetary policy stance has been accommodative but responsive to inflation risk. In July 2010 the Bank of Albania eased its policy rate in response to fiscal consolidation; as headline inflation overshot its target band because of rising food and fuel prices, the policy stance was tightened in early 2011. The authorities concur with staff that a monetary stimulus would need to be conditioned on fiscal adjustments and continued anchored inflation expectations.

The banking system has proven its resiliency through the crisis, as banks remain generally sound and well-capitalized. Deposits declined substantially but only temporarily in the midst of the crisis, and their current level is much higher than before the turmoil.

Financial sector policies were adjusted to safeguard financial stability and revive credit growth. Preventive macro-prudential measures adopted prior to the crisis have helped to contain the build-up of imbalances in the banking sector prior to the crisis. The latter led to the adoption of further macroprudential policies, including higher capital requirements, tighter liquidity, and credit risk controls; they were subsequently lifted in the face of steadily increasing deposit funding, improved liquidity conditions, and adequate capital buffers.

While bank profits are recovering, the steep increase of nonperforming loans, from 3 percent pre-crisis to 15 percent in April 2011, is a source of major concern. The authorities share the staff’s view that a swift resolution of nonperforming loans (including by faster resolution measures) and other crisis legacies is a key near-term priority.

The developments in the euro area periphery have led the authorities to more closely monitor the positions between parent banks and their subsidiaries/branches, while engaging in proactive contacts with regional and European supervisors and central banks in order to advance contingency planning. While market volatility surrounding the euro-area periphery was reflected in the domestic markets, all Greek-owned banks remained in compliance with prudential ratios, although their liquidity levels have been somewhat reduced.

In response, the Bank of Albania has stepped up liquidity monitoring across the system and is updating its stress-testing framework to better capture liquidly risks. Jointly with the Fund and the World Bank, the Bank of Albania is also working to keep the framework for emergency liquidity assistance in line with changing developments and challenges. Increasing prudential liquidity ratios is being contemplated. Finally, the authorities intend to mandate higher-than Basel II norms, as well as recent EU proposals.

Structural Reforms

The authorities agree that a favorable investment environment is a vital condition for further attracting large-scale international investors and boosting productivity, which is key for higher sustainable growth. They concur with staff that securing property rights and improving contract enforcement are immediate priorities. The authorities would also like to highlight the progress in improving transport infrastructure, and they see the need for initiatives to help tap the vast agricultural potential so as to diversify exports and broaden the sources of growth.

Albania: 2011 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Albania
Author: International Monetary Fund