Statement by Carlo Cottarelli, Executive Director for Albania and Paolo Di Lorenzo, Advisor to Executive Director, May 27, 2016

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.

On behalf of our Albanian authorities, we wish to thank the mission team for the constructive discussions and the valuable and tailored advice in the Report and Selected Issues Paper. As a result of strong program ownership, all performance criteria were met and the structural reform agenda remains on track. The authorities broadly concur with staff's analysis and policy recommendations and their views have been duly reported. Some specific comments are offered for emphasis.

The Albanian economy is proving its resilience in a challenging context.

Economy growth has accelerated from 2 percent to 2.6 percent in 2015. Sustained performance reflects high investment activity, including in the construction sector, as well as an improved trade balance, outweighing the large drop in government consumption and the consequences of low oil prices on exports. Leading indicators of domestic demand point to a steady pace of recovery also in the first quarter of 2016. The authorities project economic growth to reach 3.4 percent in 2016 and to accelerate gradually in subsequent years, supported by higher domestic demand, an expected improvement of the external financial and economic environment, and the impact of business-friendly structural reforms.

Regarding the composition of demand, private consumption is set to recover thanks to lower precautionary saving by households, lower fuel prices, and a projected steady increase in employment and wages. This said, unemployment remains high especially among the young and women, contributing to depressing long term growth. Private investment is also rising, both in absolute terms and as a share of GDP. On the external side, continued FDI inflows as well as tapping of the international markets to finance the budget deficit resulted in a 27.4% annual increase of the FX reserves of the Bank of Albania. As a result, the reserves cover over seven months of imports, which is well above the minimum of four months of import floor requested by the central bank.

In the fiscal area, tax collection gathered momentum in the first quarter of 2016.

Tax collection increased by over 13 percent in the first four months of the year compared to the same period in 2015. As a result, and together with the effect of tight expenditure control across all levels of government, the primary balance in cash terms turned positive, with an improvement of around 1.3 percentage points of GDP. This trend is providing buffers large enough to cope with any negative outcome of pending tax disputes. Regarding debt dynamics, after rising by 16.5 percentage points of GDP from 2008 to 2014 (below average of the SEE countries), in 2015 the debt-to-GDP ratio has basically stabilized. 2.2 billion (around 0.15 percent of GDP) of additional revenue generated by the recent privatization of the insurance company INSIG will contribute to lowering public debt. Lowering the debt ratio below 60 percent is one of the government’s key economic policy goals.

Remaining vulnerabilities require adequate action in line with program conditionality. Sustained action in broadening tax basis and reducing informality in the economy is yielding positive results in terms of business and employees registration, and the newly merged tax/customs risk unit is working well. The organizational reform of the tax administration (postponed to end-June in order to ensure an effective implementation) will be adopted along the lines suggested by the Fund’s TA missions, including the restructuring of the Large Taxpayer Office and the adoption of a modern risk management approach, paving the way to targeted audits on high value firms and sectors with higher non compliance risks.

A strong fiscal framework is critical for sound fiscal accounts. Key steps have been undertaken in strengthening the medium term budgetary framework. Amendments to the Budget Law to incorporate multi-year commitment limits have been submitted to Parliament as required by program conditionality. Building on the achievements in reducing liabilities from the energy sector and in clearing central governments arrears, the focus is now on mitigating fiscal risks stemming from PPPs or poor investment management. This should also benefit from a number of TA missions from FAD. The authorities consider PPPs an important policy tool for specific policy goals. However, several initiatives have been recently put in place with the aim of monitoring and limiting PPP related fiscal risks; an evaluation unit at the MoF will be shortly operational and entitled in evaluating new PPP proposals, recommending measures to mitigate risks and to ensure the delivering of adequate value-for-money. Finally, the authorities are committed to strengthen the information on the amount of local governments’ arrears and to address this issue in a comprehensive and transparent approach.

Monetary conditions are supporting the economic cycle.

The Bank of Albania is acting to fulfill its price stability mandate. The key interest rate has been lowered by 50 basis points in 2016. Moreover, the rate corridor has been narrowed to 2 percentage points. These decisions will support the ongoing economic recovery and the effectiveness of the transmission mechanisms. With the economy gradually returning to equilibrium during 2017, CPI inflation is expected to reach its target around the end of 2018. Bank of Albania has clearly communicated via its forward guidance that monetary conditions will remain accommodative throughout 2016 and any future tightening in 2017 will be conditional on the strength of the economic recovery. Lower government should also help improve the pass-through of monetary policy.

Credit recovery should benefit from favorable financial conditions and forthcoming legislative initiatives. Targeted macroprudential measures are facilitating a system-wide reduction in NPLs. The provision rate is in line with regional peers. Despite a resilient banking system, underpinned by adequate capitalization and ample liquidity, risk aversion has so far prevented translating accommodative monetary conditions in steady credit growth. However, excluding the effect of the loan write off from banks balance sheets, credit to the private sector has given some signals of recovery in the first quarter, with a yearly growth of 2.6 percentage points. The success of the road map agreed with the Fund for the reduction in non-performing loans will contribute to lowering perceived credit risk. By end-June, the reform of the bankruptcy law will be submitted to Parliament and measures to accelerate the reduction of NPLs through out-of-court procedures of debt restructuring will be adopted.

Finally, the absence of financial contagion from last summer’s events shows to what extent the supervision framework has strongly benefited from policies and practices deployed also in response to the FSAP recommendations. This framework will be further strengthened by the rise in capital requirements on systemic banks that expand into non-banking activities. The central bank will also devote increasing efforts to monitoring loans to unhedged borrowers. Temporary measures adopted earlier to counteract the slowdown in credit growth will be unwind by the end of 2016.

Structural reforms aimed at building a competitive and modern economic system are advancing well.

Despite recent successful reform efforts, structural vulnerabilities have slowed down economic convergence. Well aware of this, the Albanian authorities will continue to concentrate on all-encompassing structural reforms, consistently with the achievements of the fiscal targets. Judicial reform, integration of the young and women into the labor market and a more efficient and diversified energy sector are the key drivers of the country’s economic and social development.

The long awaited judicial reform is in the final stages of Parliamentary negotiation. The authorities are boosting efforts to win resistances from vested interests and have approved by the summer the constitutional amendments necessary for the reform. Once finalized, it will address the request from international stakeholders (included the Fund and the EU) to grant independence to the Courts, and ensure adequate property rights’ protection. A new law on higher education and scientific research was adopted in 2015 and the accompanying implementing laws are to follow in 2016. It establishes two agencies for scientific research and higher education funding. Albania plans to address skills-mismatches and to improve the VET system through the introduction of a dual education model.

The construction of the major gas pipeline TAP has just been launched some days ago. The feasibility study for the project of gasification system connected with TAP is expected to be presented by October. Fiscal risks linked to the energy sector have considerably declined. In 2015 the SOE energy producer KESH has been able to pay its current and outstanding tax obligations and to cover energy imports with its own resources. Defaults hours have been reduced by two thirds between 2013 and 2015; further improvements in efficiency in generation are expected from self-financed investments amounting to 1.3 billion. The removal of 35kV medium-voltage consumers from regulated tariff system is within reach and the collection rate from budgetary institutions is close to 100 percent. Investments in the core transport network has been prioritized by the creation of a Single Sector Project Pipeline which includes national priority projects aimed at improving connectivity within the country and with neighboring countries. The lifting of the moratorium on construction will eliminate the main factor explaining the huge drop in 2015 World Bank Doing Business index. A National Business Centre has been established to streamline business registration and licensing through a single stop shop.

Concluding remarks

The Albanian authorities confirm their commitment to sound macroeconomic policies in line with their Fund-supported program which remains key to long-term sustainable growth and reform agenda.

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-Press Release; Staff Report; and Statement by the Executive Director for Albania
Author: International Monetary Fund. European Dept.