Statement by Carlo Cottarelli, Executive Director for Albania and Paolo Di Lorenzo, Advisor to Executive Director, February 17, 2016

Background: In February 2014, the Executive Board approved a three-year Extended Arrangement with access equivalent to SDR 295.42 million (492.4 percent of quota). So far, four purchases totaling the equivalent of SDR 123.1 million have been made, and another one equivalent to SDR 57.76 million will be made available upon completion of the fifth and sixth reviews. Recent Economic Developments: Economic recovery is underway, but growth remains below potential and inflationary pressures are limited. Nonperforming loans (NPLs) have started declining but are still high, and credit growth remains sluggish despite substantial monetary easing.

Abstract

Background: In February 2014, the Executive Board approved a three-year Extended Arrangement with access equivalent to SDR 295.42 million (492.4 percent of quota). So far, four purchases totaling the equivalent of SDR 123.1 million have been made, and another one equivalent to SDR 57.76 million will be made available upon completion of the fifth and sixth reviews. Recent Economic Developments: Economic recovery is underway, but growth remains below potential and inflationary pressures are limited. Nonperforming loans (NPLs) have started declining but are still high, and credit growth remains sluggish despite substantial monetary easing.

Our Albanian authorities would like to thank staff for comprehensive and candid discussions during the mission to Tirana and for the in-depth analysis of the state of economy, reform programs and the policy framework provided in the informative staff report.

The Albanian authorities broadly concur with staff’s appraisal and the overall policy recommendations. The positive performance under the Extended Arrangement reflects their full commitment to reforming the economy while putting public finance on a sound footing, with the goal of improving competitiveness and making Albania an increasingly attractive destination for foreign investors. Robust market confidence, underpinned by Fund’s engagement as well by the financial support from IFIs and from the EU, has permitted the successful issuance last November of a five-year Eurobond worth €450mn.

Real growth is accelerating but output gap still remains negative.

The economy has been growing at increasingly high rates since the inception of the program. Real GDP growth in 2015 is estimated to have accelerated from 2 percent in 2014 to 2.7 percent, whereas it was just 1.1 percent in 2013. Against the backdrop of unfavorable external conditions, in the third quarter of 2015 the economy has grown at the sustained pace of 3 percent on a yearly base. Investment growth (12.6 percent) is the largest source of growth while households’ consumption is recovering. Growth is expected to gain further traction during the current year. The effects on the value of exports of the drop in oil prices should be offset by good performance of services (mainly tourism) and manufacture, in the context of a recovering external demand.

Domestic demand will further strengthen with the decrease in economic uncertainty, as reforms’ effects gradually materialize. The accommodative monetary policy and the completion of the arrears clearance program will create favorable conditions to keep investments on a sustained pace of growth. The continued strength of foreign direct investment will also reflect the launch of some major projects in the energy sector (like the Albanian section of the Trans-Adriatic Pipeline), with positive spillovers on export capacity. Low inflation is offering a reduced contribution to nominal GDP growth. Despite a recent hike, driven principally by food prices, CPI has been below the 3 percent target for the fourth consecutive year, reflecting the negative output gap as well the low imported inflation.

Public finances are constantly improving.

Sound fiscal policy has always constituted a fundamental pillar of the authorities’ reform strategy. Consequently, after the sizable adjustment in the primary balance achieved in 2014 (1.6 percentage points net of the effects of an increasingly negative output gap), a further improvement has been recorded in 2015 despite a widening output gap. The overall deficit was considerably lower than planned. This has to be ascribed to the authorities’ strong commitment to efficiently keeping expenditure under control while at the same time allocating available resources to the clearance of the large stock of arrears accumulated until 2013 – amounting to around 4 percent of GDP. This process has almost been fully completed one year ahead of the schedule.

Looking ahead, the structural adjustment of almost 1 percent envisaged for 2016 will permit to achieve a primary surplus for the first time since 2010. The recently approved budget includes permanent new measures amounting for 0.6/0.7 percent of the GDP and focusing primarily on streamlining the tax system and making it more equitable. Such measures are designed with the aim of reducing tax avoidance, while supporting the recovery. Our authorities are confident that their strategy to promote tax compliance will increasingly bear fruits during the year, raising tax revenue (especially from VAT) above what included in staff’s budget scenario. Tax collection will further improve as a result of the ongoing modernization and reorganization of the tax administrations bodies. A modern risk and tax credit audit system is in course of implementation, with more resources devoted to audits on large taxpayers and on tax refunds. A technological platform in course of realization will permit to introduce electronic invoices and to track business transactions in real time. Appropriate fiscal space for growth-enhancing public investment has been preserved and might further augment (by 0.3 percentage point of GDP) contingently on additional revenues coming from higher tax compliance.

Compared to the last review, strong budget execution has led the debt-to-GDP ratio for 2015 to be well below the target; the target for 2016 has remained broadly unchanged in nominal value despite the fiscal impact of less-than-expected growth, and is only somewhat higher than originally target due to cyclically lower GDP level. As in the program original request, the authorities remain committed to bring the debt-to-GDP ratio below 60 percent by 2019.

The reform of local governments has reduced their number and increased their responsibilities. Resources will be no longer provided by central government transfers, as a new tax on urban land has been adopted while preparatory work is undergoing (with the assistance of WB and IMF staffs) in order to launch a valuation based property tax in the 2018. The Ministry of Finance will continue to monitor closely the finances of local governments.

The authorities acknowledge that there is room for improving the management of public investment projects. In order to avoid the formation of new arrears, priority will be accorded to the conclusion of ongoing projects while multi-year commitments limits have been introduced in the budget. Public investment management will benefit from the forthcoming FAD technical assistance mission.

The monetary stance will remain accommodative while financial stability will be further strengthened.

Monetary conditions were eased last November, when the policy rate was set at an historical low of 1.75 per cent. The monetary authorities believe that the medium term scenario warrants the prosecution of a low rates policy. At the moment, average annual inflation is forecast at around 2 percent in 2016 and is expected to reach the 3 percent target during the 2018. Financial markets are liquid, the banking system is healthy and lending rates are slowly declining. Credit in national currency is increasing, offsetting the continuous fall of the credit portfolio in foreign currency.

The authorities are firmly committed to tackle obstacles to a smooth monetary policy transmission mechanism. Non-performing loans, as a ratio to total loans, have declined by almost five percentage points in one year and the authorities are working to create the conditions for bringing them further down. Financial support from the World Bank will permit to further improve financial sector performance, but capitalization and liquidity ratio are already strong, respectively at 16 percent and 41 percent. After the adoption of the CRD IV and Basel II frameworks, a very important new step will be the adoption of a new resolution Law in line with the EU directive.

On the external side, over the past years exchange rate volatility has been very low. The authorities reiterate their intention to intervene only for small pre-announced amounts which are not intended to alter the market forces. Sizable reserve coverage provides an adequate safeguard against adverse shocks. The Bank of Albania has also undertaken concrete steps towards a further development of the payment system. The National Committee on Payment Systems was established in October 2015. This inter-institutional committee will contribute to enhancing the security, stability and efficiency of the national payment systems in Albania. The strengthening of the internal audit and risk management will be one of the main priorities of the Bank of Albania.

Finally, the Bank of Albania is actively implementing the recommendations of the 2015 safeguards assessment report.

Since the inception of the program, structural reforms have been successfully tackling long lasting weakness.

Albania will benefit fully from a global recovery only if it will be able to make further progress on structural reforms and advance towards the EU accession. The reduction in NPLs will be facilitate by the implementation of the recently approved strategy which includes, among other things: a reform of the bankruptcy law addressing impediments to judicial enforcement, in line with best international practices; the introduction of out-of-court procedures of debt restructuring, with the aim of improving collateral execution; and amendments to the Civil Procedure Code to speed foreclosure procedures and debt collection.

Progress on energy sector reform has been remarkable, as recognized in the report. Distribution losses have sharply declined, together with the amount of guarantees provided by the public sector. Collection rates have moved to 100 percent. Based on the achievements so far, the power sector could become self-sustaining by 2018 and it is even possible that part of the resources included in the 2016 budget will be saved. A new electricity Law, compliant with the Third EU Energy Package, was adopted in April 2015 and represents a decisive step forward on the long path towards full energy sustainability. A working group has been set up to identify the best option for restructuring and privatizing the profitable oil company Albpetrol. In order to diversify energy sources, a natural gas master plan scheduled for completion in November 2016 will examine all aspects related to the introduction of a gas market.

In addition, a decision was made to privatize through an open tender the state insurance company INSIG, which is valuated at around $16 million.

Concluding remarks.

Under the first two years of the program, the Albanian authorities have implemented a broad range of bold and politically challenging policies aimed at (i) reducing current expenditures, (ii) actively improving tax compliance and reducing informal economy, in order to increase tax revenues in a growth friendly and socially acceptable manner, (iii) minimizing contingent fiscal risks stemming from the energy sector and from the accumulation of arrears, (iv) strengthening financial sector stability and intermediation, and (v) improving the business environment. Our authorities reiterate their strong commitment to the program as one of their major policy anchor along with EU accession.