Statement by Carlo Cottarelli, Executive Director for Albania and Marco Senatore, Advisor to Executive Director, February 20, 2015

This paper discusses Albania’s Second and Third Reviews Under the Extended Arrangement and Request for Waiver for the Nonobservance of Performance Criterion, Waiver of Applicability of PCs, and Rephasing of Future Disbursements. The program is on track. All end-June, end-September, and available end-December quantitative PCs were met. However, the continuous PC on the accumulation of external arrears was not observed because of technical delay with one interest payment. The IMF staff supports the authorities’ request for the completion of the second and third reviews under the Extended Arrangement, waiver of applicability of PCs, and rephasing of future disbursements.

Abstract

This paper discusses Albania’s Second and Third Reviews Under the Extended Arrangement and Request for Waiver for the Nonobservance of Performance Criterion, Waiver of Applicability of PCs, and Rephasing of Future Disbursements. The program is on track. All end-June, end-September, and available end-December quantitative PCs were met. However, the continuous PC on the accumulation of external arrears was not observed because of technical delay with one interest payment. The IMF staff supports the authorities’ request for the completion of the second and third reviews under the Extended Arrangement, waiver of applicability of PCs, and rephasing of future disbursements.

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

The authorities are committed to carry ahead the wide-ranging reforms envisaged by the Extended Arrangement with the Fund, with particular reference to tax administration, pension reforms and arrears payment, while addressing the issue of nonperforming loans (NPLs) in the financial sector and problems in the energy sector.

The positive performance under the program reflects the commitment of Albanian authorities to such reforms and to the cooperation with the Fund which is needed to successfully pursue them.

Economic developments and outlook

After the continuous slowdown experienced in the last few years, an economic recovery has begun, and real GDP growth is estimated to have reached 2.1 percent in 2014. This is the result not only of higher petroleum production but also of a broad-based pickup in agriculture, trade, and manufacturing.

The current account deficit is estimated to have increased to 13.3 percent of GDP, mainly due to higher electricity imports and declining petroleum exports. The positive financial account received a significant contribution from direct investments, which are expected to have remained stable, at around 8 percent of GDP.

For 2015, a significant contribution to growth (GDP is projected to increase by more than 3 percent in real terms) should come from recovery of private demand. Confidence is expected to improve also due to low interest rates and a recovery of public investment.

Fiscal policy

In 2014 the public debt-to-GDP ratio in Albania is projected to have increased slightly, to about 71 percent. Such figure, which represents a historical peak, includes unpaid bills and government arrears (about 2.6 percent of GDP, compared to 5.2 percent in 2013).

The estimated deficit for 2014 is of 5.7 percent of GDP but preliminary data which became available after the mission suggest that deficit may have been lower.

The measures to clear arrears envisaged under the EFF program aim at providing liquidity to the real sector. Indeed, in Albania arrears represent a significant obstacle for economic growth, as they contribute to the high level of NPLs and constrain credit growth. Against this backdrop, the authorities are reinforcing public financial management to prevent the accumulation of new arrears (through the extension of the AGFIS treasury system to 15 budget institutions), while clearance of the existing stock will continue, together with progress in auditing and verification of paid arrears.

More generally, the authorities are committed to fiscal consolidation, in order to reduce the debt ratio below 64 percent by the end of the program in 2017 and below 60 percent of GDP by 2018. They are also committed to the attainment of the fiscal deficit target for 2015 (4.8 percent of GDP including new guarantees).

To this aim, the 2015 budget envisages measures such as: a) increase in the excise tax on cigarettes, b) increase in the circulation tax on gasoline and diesel and c) increase in the withholding tax (from 10 percent to 15 percent, in line with the tax on other personal income) for interest, rent, dividends and capital gains. On the spending side, savings will be achieved from improved targeting of disability benefits and restraint in capital spending, as envisaged at the time of the first EFF review. Moreover, local government debt will not increase.

Tax administration (an area where the Fund has provided technical assistance to the authorities) is being improved, as the General Directorate of Taxation (GDT) is preparing a new corporate strategy for medium and long term capacity building and the establishment of a Risk Management Unit (RMU) in GDT. Moreover, the IT system is going to be updated.

Tax refund scheme will also be improved in 2015, in order to ensure that refunds are paid accurately and on time. To this aim, the new VAT law became effective on January 1, 2015, establishing risk criteria as the basis for undertaking an audit of VAT refunds. Moreover, a pension reform has been approved by Parliament in July 2014, with an increase in the contributory period and retirement age, as well as with the removal of the benefit ceiling.

Monetary policy

On February 5, 2015 Mr. Gent Sejko was appointed by the Parliament as the new Governor of the Bank of Albania (BoA). Monetary policy is aimed at preserving price stability under an inflation-targeting framework, while the exchange rate remains fully flexible and determined entirely by market forces.

Against this backdrop, given weak inflationary pressures and inflation expectations skewed to the downside, on January 28, 2015 the Supervisory Council of the BoA lowered the policy interest rate by 0.25 percentage points to 2 percent. The accommodative stance includes also forward guidance to financial markets.

The transmission mechanism of monetary policy is expected to be improved as the performance of the banking system strengthens, confidence in the economy increases and external financial market conditions improve.

Financial sector

The implementation of the 2013 FSAP recommendations is going ahead, through the active commitment of the BoA and the Ministry of Finance. Several recommendations have been implemented under the World Bank’s Development Policy Loan. In 2014 the BoA’s Supervisory Council approved a new regulation on managing the risk of bank’s large exposures, a new guideline for systemic banks on preparing recovery plans, and changes consolidating the risk-based approach to supervision. The BoA’s stress-testing toolkit is being improved.

The banking sector is well-capitalized and liquid. Moreover, several measures have been undertaken to address the issue of NPLs, which are relatively high. In particular, the civil procedure code has been modified to minimize execution suspension gaps. The amendment to the Tax Law was approved in April 2014, in order to remove impediments to the loan write-offs from banks’ balance sheets. Moreover, at the beginning of this year a new regulation, requiring mandatory write-off of loans categorized as “lost” for more than three years, came into force and should help reduce NPLs by 3 percentage points in 2015. A contribution to the reduction of NPLs is also coming from arrears clearance.

The regulatory framework for the nonbank financial sector will also be strengthened, and to this aim the operational and financial independence of the Albanian Financial Supervisory Authority (AFSA) is being improved. The regulatory framework for investment funds is also being strengthened, in order to introduce liquidity and capital requirements and require the calculation of net asset value on a mark-to-market basis.

Structural reforms

With a view to increasing the growth potential of Albania, the authorities are undertaking structural reforms in several areas.

Measures introduced to improve the business climate include the establishment of the National Economic Council, an advisory body which includes representatives from the business community, key ministries and multilateral partners. Several issues have also been addressed by an inter-ministerial working group, including starting a business, paying taxes and registering property. Through these initiatives, Albania recorded the biggest improvement (from 108th in 2014 to 68th place in 2015) among all countries in its Doing Business rank.

In the energy sector, a draft law was submitted to Parliament in December 2014, with a view to restructuring the relationship between the three public power companies, as well as ensuring full independence of the energy sector regulatory authority (ERE). Moreover, in January 2015 tariffs were adjusted, in particular eliminating the subsidized lower block for retail tariff for households, increasing tariffs for commercial users and adapting purchase price for electricity to current import prices. In October 2014, the authorities launched a campaign to enforce criminal penalties for electricity theft and disconnect service for nonpayment of bills. Also due to such initiative, electricity distribution losses have declined. Another priority is now the increase in collection rate on amounts billed, which will benefit from a World Bank project. In general, structural reforms in the energy sector should remove the need for government guarantees by 2020.

For the agricultural sector, a strategy will be prepared by mid-2015, to clarify the legal environment and verify ownership in the land registry and cadastre.

The authorities are also committed to making the public administration more efficient and professional, including through continued training and improved capacity at the local level. Finally, local government reform is proceeding as planned.