Albania: Staff Report for the 2016 Article IV Consultation, Seventh Review Under the Extended Arrangement, and Request for Waiver of Applicability and Modification of Performance Criteria

Over the past few years, Albania has successfully maintained macroeconomic stability amidst a turbulent external environment. However, growth remains sluggish due to a weak Euro Area recovery and risk-averse banks. The current account deficit is expected to remain elevated as import-intensive FDI picks up. Headline inflation will likely remain subdued, due to imported disinflation and domestic slack. The medium-term outlook remains favorable, provided the reform momentum is maintained.

Abstract

Over the past few years, Albania has successfully maintained macroeconomic stability amidst a turbulent external environment. However, growth remains sluggish due to a weak Euro Area recovery and risk-averse banks. The current account deficit is expected to remain elevated as import-intensive FDI picks up. Headline inflation will likely remain subdued, due to imported disinflation and domestic slack. The medium-term outlook remains favorable, provided the reform momentum is maintained.

Context

1. Albania is gradually recovering from a protracted growth slowdown. The country weathered the global financial crisis well, but economic difficulties in key Euro Area trading partners (Italy and Greece) and stagnant bank lending have weighed on economic activity in the post-crisis period. A gradual recovery is now underway, supported by prudent policies and a gradual restoration of confidence.

A01ufig1

CESEE: Real GDP Growth

(Percent)

Citation: IMF Staff Country Reports 2016, 142; 10.5089/9781475519426.002.A001

Source: IMF, World Economic Outlook database.

2. Reforms are progressing, backed by the ruling coalition’s strong legislative majority. Since the approval of the Extended Arrangement in early 2014, the authorities have implemented ambitious and difficult structural reforms, including in pensions and the electricity sector. A substantial stock of central government arrears was cleared. An ambitious fiscal consolidation is underway and public debt is projected to have peaked at 72 percent of GDP in 2015. These achievements have allowed a successful Eurobond issuance and a recent credit rating upgrade. However, other reforms critical for improving the business environment—including those related to property rights, NPL resolution, the judiciary, and governance—are lagging (text table and Box 1).

Implementation of the Recommendations from the 2014 Article IV Consultation

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3. The main policy priority is to continue lowering fiscal vulnerabilities while advancing structural reforms to achieve sustainable growth. Given prospects of lower commodity prices for the foreseeable future and a slow recovery in Europe, Albania will need to reorient towards a more diversified and open growth model. Faster implementation of structural reforms will be critical to strengthen competitiveness, improve the investment climate, and catalyze stronger growth. The ongoing Extended Arrangement and prospective negotiations for EU accession provide a strong impetus to advance these reforms.

Recent Developments

4. Economic growth is gradually strengthening while inflationary pressures are subdued (Figure 1). GDP growth accelerated to 2.6 percent in 2015, from 2.0 percent in 2014, driven by higher electricity production due to exceptional rainfall, a pickup in tourism, and a recovery in construction. Nevertheless, growth remains below potential. Headline inflation is very low (0.3 percent in March 2016), reflecting low food and fuel prices as well as fading base effects from the impact of the floods last year, while core inflation remains negative reflecting imported disinflation and domestic slack.

Figure 1.
Figure 1.

Albania: Background and Outlook

Citation: IMF Staff Country Reports 2016, 142; 10.5089/9781475519426.002.A001

5. The current account deficit narrowed temporarily in 2015 but remains large (Figure 2). Despite reduced oil exports, a one-off reduction in electricity imports (due to improved hydropower conditions) and strong tourism receipts helped narrow the trade deficit. Remittances, accounting for 5.7 percent of GDP, have remained broadly stable despite weak growth in the main source countries (Greece and Italy). Consequently, the current account deficit declined from 12.9 percent of GDP in 2014 to 11.1 percent of GDP in 2015. However, risks from the large external deficit are limited, as more than three quarters of the current account deficit are financed by foreign direct investment.

Figure 2.
Figure 2.

Albania: External Sector Developments

Citation: IMF Staff Country Reports 2016, 142; 10.5089/9781475519426.002.A001

6. External financing remains ample, primarily due to FDI inflows but also increased external borrowing by the public sector. FDI is mainly concentrated in the oil sector and has slowed down recently with falling crude prices. However, FDI remains strong at around 8–9 percent of GDP on the back of large energy projects, such as the Trans Adriatic Pipeline and the Statkraft/Devoll hydropower project. With a Eurobond issuance in November 2015, gross FX reserves climbed to over six months of imports at end-2015.

7. Fiscal performance is broadly on track. The 2015 fiscal deficit target was met with a comfortable margin (Tables 2a2b and Figure 3), despite persistent tax revenue shortfalls. Fiscal revenues underperformed by 0.6 percentage point of GDP, due to lower-than-projected imports of fuel and tobacco products in Q4. However, an across-the-board underexecution of recurrent expenditure (0.8 percent of GDP), including further savings on public support to the electricity sector, allowed the authorities to meet their overall budget target comfortably. In the first two months of 2016, the fiscal deficit has been lower than projected: fiscal revenues came in as expected, but the authorities underexecuted their budget, by nearly 0.5 percent of GDP.

Table 1.

Albania: Basic Indicators and Macroeconomic Framework, 2013–21

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Sources: Albanian authorities; and IMF staff estimates and projections.

In December 2015, INSTAT made small revisions to the real and nominal GDP estimates for 2014.

Table 2a.

Albania: General Government Operations, 2013–21

(Percent of GDP)

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Sources: Albanian authorities; and IMF staff estimates and projections.

Includes the property tax, the simplified profit tax for small businesses, and other local taxes.

There is a structural break in 2016, reflecting the transfer of central government employees to local governments, as part of fiscal decentralization.

Spending contingencies are reported according to their economic classification at outturn.

As reflected in official data and not accounting for arrears accumulated outside of the budget prior to 2014.

Following the approval of the program, Fund purchases are reported under foreign financing. Similarly, secured funding by the World Bank is reported under foreign financing.

Table 2b.

Albania: General Government Operations, 2013–21

(Billions of leks)

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Sources: Albanian authorities; and IMF staff estimates and projections.

Includes the property tax, the simplified profit tax for small businesses, and other local taxes.

There is a structural break in 2016, reflecting the transfer of central government employees to local governments, as part of fiscal decentralization.

Spending contingencies are reported according to their economic classification at outturn.

As reflected in official data and not accounting for arrears accumulated outside of the budget prior to 2014.

Following the approval of the program, Fund purchases are reported under foreign financing. Similarly, secured funding by the World Bank is reported under foreign financing.

Figure 3.
Figure 3.

Albania: Fiscal Developments

Citation: IMF Staff Country Reports 2016, 142; 10.5089/9781475519426.002.A001

Program Performance

8. The program is on track (MEFP ¶5–6 and MEFP Tables 1, 3a, and 3b):

  • All performance criteria and most indicative targets were met. The authorities are seeking a waiver of applicability for the end-April ceilings on the general government’s primary fiscal balance and primary expenditure, for which data are not yet available. Staff expects these PCs to have been met. The December 2015 indicative target on contracting non-energy guarantees was missed by a very small margin (0.03 percent of GDP). Going forward, the authorities are proposing to remove this IT, as non-energy guarantees are now fully captured in their fiscal framework. The IT on the accumulation of new central government domestic arrears was missed by a small margin (0.09 percent of GDP) in December 2015. However, the authorities will repay all accumulated arrears by mid-2016, except for those on court decisions regarding layoffs and expropriations which will be settled in accordance with a special Council of Ministers (CoM) decision. As a remedial measure, the authorities are improving public investment management and seeking rapid implementation of multi-year commitment limits.

  • Most structural benchmarks (SBs) were implemented, albeit one with a delay. Of the six SBs, three were met on time. Of the remaining three, one was implemented with a delay (as a prior action), and one is proposed to be rescheduled. The need to build support and allow sufficient time for consultations with stakeholders delayed amendments to the Budget Law, but these were submitted to Parliament in early May 2016, as a prior action. The roll-out of the new treasury IT system (AGFIS) to 15 budget institutions has been delayed to end-May 2016, to allow time to train new users of the system. The need to fine-tune the implementation plan to restructure the tax agency’s headquarters delayed its adoption to May.

Table 3a.

Albania: Balance of Payments, 2013–211

(Percent of GDP)

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Sources: Ministry of Finance; Bank of Albania; donors; and IMF staff estimates and projections.

Historical data for 2013 reflect old BPM5 estimates which record insourcing services as goods. The data from 2014 onwards reflect BPM6 treatment of textile insourced manufacturing, which is recorded as services.

Includes unidentified flows of private transfers, which are projected to decline gradually over the medium term with the decline in remittances as a share of GDP.

Net of valuation changes in 2013–14. In projections for 2015–21, valuation effects are assumed to be zero.

Table 3b.

Albania: Balance of Payments, 2013–211

(Millions of euros)

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Sources: Ministry of Finance; Bank of Albania; donors; and IMF staff estimates and projections.

Historical data for 2013 reflect old BPM5 estimates which record insourcing services as goods. The data from 2014 onwards reflect BPM6 treatment of textile insourced manufacturing, which is recorded as services.

Includes unidentified flows of private transfers, which are projected to decline gradually over the medium term with the decline in remittances as a share of GDP.

Net of valuation changes in 2013–14. In projections for 2015–21, valuation effects are assumed to be zero.

Public and publicly guaranteed debt only.

Public and private external debt, including arrears. Debt stock converted into Lek at the e-o-p exchange rate.