Statement by Mr. Andrea Montanino, Executive Director for Albania and Marco Senatore, Advisor to Executive Director, February 28, 2014

This 2013 Article IV Consultation for Albania focuses on economic developments and policies that have led to weakening and imbalance of the economy. It highlights that high nonperforming loans (NPLs) are constraining credit growth, and weak external drivers are preventing a sustained reduction in external imbalances. Reduction in NPLs would safeguard financial stability and help release credit supply constraints by lowering bank risk aversion. The authorities have requested a three-year arrangement with proposed access equivalent to SDR 295.42 million.

Abstract

This 2013 Article IV Consultation for Albania focuses on economic developments and policies that have led to weakening and imbalance of the economy. It highlights that high nonperforming loans (NPLs) are constraining credit growth, and weak external drivers are preventing a sustained reduction in external imbalances. Reduction in NPLs would safeguard financial stability and help release credit supply constraints by lowering bank risk aversion. The authorities have requested a three-year arrangement with proposed access equivalent to SDR 295.42 million.

On behalf of the Albanian authorities, we thank staff for their helpful and constructive cooperation during the missions to Tirana and for the informative documents which have been prepared.

The Article IV and FSAP missions, together with the negotiation for the proposed three – year Extended Fund Facility (EFF) program, have provided valuable insight to the authorities in the pursuit of their macroeconomic objectives.

In the current juncture, Albania has the chance to improve significantly its macroeconomic environment, and, to this aim, the country is pursuing a path of wide-ranging reforms that are expected to contribute to economic recovery and to the reduction of arrears and nonperforming loans (NPLs).

The Albanian authorities assign the highest importance to such reforms and to the cooperation with the Fund which is needed to successfully pursue them.

Request for an Extended Arrangement under the EFF

The proposed three-year program under the EFF has been requested by the Albanian authorities on the basis of the estimated external financing need, amounting to about 7.1 percent of GDP in 2014-16. With the support of the program, the authorities will undertake initiatives aimed at significantly reducing public debt, bringing down NPLs in order to restore banks’ confidence in lending and introducing structural reforms to promote long-term growth, while at the same time achieving a gradual fiscal adjustment. As for the modality chosen for the program, direct budget support, it is to be recalled that, while in the current juncture domestic markets could not finance the fiscal deficit without significant risks, on the other hand external financing of the budget may be catalyzed only after the involvement of the IMF, as the country has limited access to international capital markets.

The agreement, which foresees access to Fund resources, will increase confidence in the economy and ease the impact of the fiscal adjustment required.

The authorities are aware of the risks linked with the program, but they are also committed to putting the Albanian economy on a path of sustained medium term growth, by increasing private sector credit, strengthening public finances, reforming the energy sector and improving the business climate.

Economic developments and outlook

In the last few years economic growth in Albania has continued to slow down, and for 2013 it is estimated to have reached 0.7 percent, the lowest level since 1997. This is the result of weak domestic demand, which in turn is dependent on weak confidence in the business and household sectors.

The gradual decline in the current account deficit (estimated at 9 percent of GDP in 2013), has been linked most of all with the good performance of exports and with the reduction of imports. The positive financial account received a significant contribution from direct investments, which have remained stable, at around 8 percent of GDP. In the last ten years, external debt has almost doubled, and it could reach about 43 percent of GDP in 2014, before declining in the following years.

For 2014, a significant contribution to growth should come from the initiatives aimed at reducing NPLs and clearing arrears, as well as from improved confidence. For the next years, the Albanian authorities are committed to wide-ranging reforms which, with the support of the EFF program, will significantly contribute to sustained growth.

Fiscal policy

In the past few years the public debt to GDP ratio in Albania has significantly increased, from about 60 percent in 2009 to about 71 percent in 2013. Such figure, which represents a historical peak, includes unpaid bills and government arrears (about 5 percent of GDP) linked with contracts signed by the Public Administration. Moreover, the estimated deficit for 2013 is of 4.8 percent of GDP.

In the current juncture, on one hand, domestic financial markets would be too much stressed by the volume of bond issuance which would be required to significantly reduce arrears. On the other hand, arrears represent a significant obstacle for economic growth, as they generate NPLs and constrain credit dynamics.

Against this backdrop, a significant part of the measures envisaged by the proposed EFF program is aimed at clearing arrears, in order to provide liquidity to the real sector. In this regard, a comprehensive arrears prevention and clearance strategy (APCS) has been published on the website of the Ministry of Finance (MoF). Moreover, an amended Law for Payment of Arrears on Contractual Obligations has been submitted to Parliament to define expenditure arrears and payment terms. An external auditor will be contracted to conduct risk-based audits of arrears payments.

The authorities are also committed to monitoring future expenditure commitments and avoiding arrears accumulation. For instance, all new procurement orders will be sent to the MoF for clearance prior to starting the biding process. Moreover, the reporting and approval procedures for procurement orders will be enhanced, especially for multi-year commitments. To this aim, MoF has already issued budget instructions to all central government entities to report all proposed new procurement orders for MoF clearance, and suspend issuing any new multi-year procurement orders until outer-year commitment ceilings are approved by the Council of Ministers.

The authorities also plan to start introducing commitment limits with the 2015 budget. At a more general level, the authorities are committed to fiscal consolidation, in order to reduce the debt ratio to 69 percent of GDP by the end of the proposed EFF program in 2016 and to well below 60 percent by 2019. Moreover, the fiscal deficit target for 2014 is about 4 percent of GDP, excluding the repayment of arrears.

To this aim, the 2014 budget envisages increases in the corporate income tax (CIT) rate, (from 10 to 15 percent), in excise tax rates, in fuel tax and property tax rates. On the spending side, there will be, with the exception of police officers, no increase in public sector salaries in 2014. Moreover, pension increases to cost of living adjustments will be limited. The authorities will also ease the burden of fiscal adjustment on small businesses and vulnerable groups, introducing a progressive income tax and reducing the rate for the simple tax on profit for small businesses to half the corporate tax rate.

Tax administration (an area where the Fund has provided technical assistance to the authorities) will be improved, as a foreign consultant will assist customs in tax collection. Moreover, management committees for taxpayer compliance have been established to guide decision making of the tax administration.

Some initiatives are also envisaged to reduce fraud, for instance by verifying more efficiently refund claims and, in 2015, changing the verification process to link it directly to businesses’ online tax payment records.

In the medium term, a pension reform will be adopted. To this aim, a Reform Commission will be established by the end of next March and will present a medium-term strategy to Council of Ministers for approval by December 2014.

Monetary policy

The monetary policy of the Bank of Albania (BoA) has managed to keep inflation low and relatively stable. At the same time, the impact of macroprudential measures has been low or marginal in boosting credit growth. According to the authorities, the monetary stance could be moderately expansive, taking into account the low inflation and weak demand, but they will try to avoid excessive strains in financial stability.

The BoA will improve its operational framework in order to increase the efficiency of the transmission mechanism and to promote the development of money markets. The BoA will also continue to enhance its communication strategy.

Financial sector

The BoA is fully committed to implementing the FSAP recommendations, and to using the assessment as a guideline for the action plan to advance the level of supervisory standards towards the best practices, considering that this is also the best contribution to its mandate of guaranteeing the banking and financial stability.

The banking sector is well-capitalized and liquid. Branches of foreign banks do not depend on parent funding, as they are fully funded by domestic deposits. Moreover, a number of measures will be aimed at reducing the level of NPLs, which is relatively high. In particular, a legal amendment of the Tax Law has already been submitted to Parliament to remove issues which impede the loan write-offs from banks’ balance sheets. Moreover, the regulatory framework to strengthen credit standards will be improved. The Civil Code and other laws will also be amended to improve insolvency requirements, set the payment to bailiffs in line with success rate and restrict judicial discretion in postponing borrowers’ payments. A contribution to the reduction of NPLs will also come from arrears clearance.

Moreover, the BoA will further improve its macro-prudential framework. The regulatory framework for the nonbank financial sector will also be strengthened, by improving the operational and financial independence of the Albanian Financial Supervisory Authority (AFSA). The regulatory framework for investment funds will be revised to introduce liquidity and capital requirements and require the calculation of net asset value to be done on a mark to market basis.

Structural reforms

Lack of reforms, as observed by staff, has negatively affected the growth potential of Albania. Against this backdrop, the authorities are committed to undertaking interventions in several areas.

Measures aimed at improving the business climate will include an assessment of the regulatory framework for business and a reform of business registration procedures in order to improve transparency and reduce the time spent by the businesses in this area.

In the energy sector, a Task Force will develop a medium-term strategy, in cooperation with the World Bank. By the first quarter of 2014 a plan will be designed to increase billing in the regions where there is a greater percentage of informal sectors. The Task Force and the Ministry of Energy will also develop a plan aimed at sorting out inter-company debt accumulated in the energy sector. By the first half of 2014 the tariff system will be reviewed to bring prices closer to the market prices.

For the agricultural sector, a land reform will strengthen property rights, distributing 70 percent of land titles by 2015. Moreover, the irrigation infrastructure and food safety will be improved by the Rural Development and Water administration, through capacity building.

Another area of intervention will be social protection, where a TA project with the World Bank will modernize the social assistance scheme. A new database should also be introduced by April 2014, in order to allow exchange of information on individuals among different government agencies.

In Public Administration, the authorities are committed to using meritocratic criteria in hiring new employees, in compliance with the new Civil Service Law.

The authorities will also increase investment in early child education, launch a review of the professional education system and establish apprentice arrangements with companies. A review of the legal framework will be launched in order to address the issues identified by the European Commission with a view to future integration with the EU.

Finally, statistics will be improved through better inter-agency data sharing.

Conclusion

All in all, my Albanian authorities believe that the combination of deep structural reforms, coupled with gradual fiscal consolidation, will set the stage for a return of the Albanian economy to sustainable growth, and request the Board’s support of their ambitious program under the EFF.