I. Economic Developments During the Pandemic and the Outlook

The Albanian economy has been remarkably resilient in the face of the twin and consecutive shocks of the November 2019 earthquake followed by the outbreak of the COVID pandemic. A prompt, comprehensive, and flexible policy response to the health emergency along with external financial assistance, including by the Fund through the Rapid Financing Instrument (RFI), have helped mitigate the impact on the population and the economy and prepare the ground for a swift and robust recovery.

After contracting by only 4 per cent in 2020, the economy is projected to rebound by around 8 per cent this year. The recession resulted much milder than both anticipated by staff and experienced by most regional peers; the ongoing recovery has gained strength and broadened beyond the service sector, that was hit hardest by the pandemic-related containment measures. The rebound has been driven by the post-earthquake reconstruction, strong energy production, and a better-than-expected tourism season. Rising service exports and continued capital inflows have contributed to improving the external position and to a moderate exchange rate appreciation. The labor market has fared well, with employment and participation gradually returning to pre-pandemic levels and wages edging up. Inflationary pressures have remained contained despite recent increases in food and energy prices and continued monetary accommodation.

The authorities are fully aware of the high uncertainty hovering around the near-term outlook, mainly because of new waves of the pandemic and higher energy prices; they stand ready to adjust their policy response to preserve the strong momentum and rebuild policy buffers as soon as conditions allow. Furthermore, after securing a new mandate, the government is well positioned and determined to advance high-priority reforms, which will steer the economy to a more sustained, sustainable, and inclusive growth path over the medium-to-long term.

II. Fiscal Policy

The recession together with the cost of dealing with the health and economic emergencies had an adverse impact on public finances in 2020. The overall deficit widened to 6.8 per cent (from 2.0%) and the public debt to GDP ratio increased by 10 percentage points to 77.2 per cent. Amidst high uncertainty over the course of the pandemic and rising energy prices, the government has maintained an expansionary stance, through repeated budget revisions in response to growing social and capital expenditure needs, leaving the projected deficit almost unchanged for 2021.

The authorities concur with staff that the use of normative acts to revise the budget in the course of the fiscal year should be reserved exclusively to emergency circumstances and reaffirm their commitment to the ordinary parliamentary process going forward. They are also committed to bringing the primary balance into equilibrium by 2024 and keeping it unchanged thereafter, as established by the Organic Budget Law; as a result, the public debt to GDP ratio would decline steadily over time. To this end, the 2022 budget foresees a reduction of the primary deficit to 2.7 per cent, supported by both rising revenues as the economy firms up and a gradual tapering of economic support measures and capital expenditure.

The authorities strongly believe that a more front-loaded fiscal adjustment, as recommended by staff, might weaken the robust but highly uncertain economic momentum, and unduly restrict their ability to support the vulnerable population, strengthen social protection, and close the still large infrastructure gaps. They believe that the envisaged Eurobond issuance for 700 million euro by the end of the year will provide ample fiscal buffers for next year. Thet also intend to use the 2021 SDR allocation for contingent spending.

At the same time, the authorities agree with staff on the need to continue strengthening revenue mobilization and improving the efficiency of spending; they are keen to advance the necessary fiscal reforms swiftly and decisively by leveraging on past and ongoing Fund’s technical assistance. They highlight the recent progress in cash debt management, most notably the operationalization of an improved reporting system for arrears and the clearance of those related to VAT refunds by the end of 2021, as testament to their determination to advancing fiscal reforms notwithstanding limited resources and challenging conditions.

A comprehensive Medium Term Revenue Strategy (MTRS) is being developed with Fund’s assistance with the aim of raising additional revenue of up to 3 per cent of GDP over four years. The MTRS will strive to remove current loopholes and distortions, while creating a tax system more conducive to business and, in particular, SMEs development. The authorities are equally committed to: a) strengthening public investment management by implementing the outstanding recommendations from the 2016 Public Investment Management Assessment (PIMA); and b) managing the fiscal risks from Public Private Partnerships (PPP), which have been covered by an annual PPP monitoring report since 2019. Finally, further reforms would improve fiscal transparency and accountability, following the establishment of the public registry of beneficial ownership and the publication of the Supreme Audit Institution’s (SAI) audit of earthquake and pandemic-related spending.

III. Monetary and Financial Sector Policies

The Bank of Albania (BOA) has maintained a highly accommodative monetary stance since the outbreak of the pandemic, keeping the policy interest rate at the historical low level of 0.5 per cent and providing unlimited liquidity to banks. While the unlimited liquidity provision is envisaged to end in the first quarter of 2022, reflecting lower banks refinancing needs, the BOA intends to pursue its accommodative monetary policy stance as long as inflationary pressures remain subdued and inflation expectations well anchored.

The BOA strongly supports the flexibility of the lek and adequate foreign reserves as key shock absorbers. The BOA will intervene in the foreign exchange market only to contain excessive volatility and build the needed reserves. It will also continue to promote the de-euroization of the credits and deposits to further improve the effectiveness of its monetary policy.

The banking system is supporting the economic recovery by supplying credit both to businesses and households, while remaining adequately capitalized and liquid, and with no discernible impact on non-performing loans (NPLs). As financial vulnerabilities might materialize only after the emergency regulatory measures expire, the BOA will closely monitor banks’ asset quality; it stands ready to conduct thorough asset quality reviews on a case-by-case basis and take remedial action to restore adequate capital buffers, if needed.

IV. Post Financing Assessment and the Way Ahead

The authorities welcome and fully share staff’s assessment that Albania’s capacity to repay the Fund remains adequate and that risks are contained and manageable. They are determined to build on the favorable economic and political momentum to advance their structural reform agenda focused on completing the judicial reform, strengthening the anticorruption and the AML/CFT frameworks, and improving business conditions, thereby fostering confidence and trust among official partners and investors and meeting Albania’s development needs.

The financial authorities are fully aware that exiting the FATF’s grey list is of utmost importance to safeguard financial stability and integrity within and beyond the banking sector, including the nascent virtual assets industry. To this end, they are making significant progress in strengthening and enforcing the AML/CFT framework, as also acknowledged by the latest MONEYVAL report.

The authorities wish to thank Fund’s staff for the constructive engagement during the safeguard assessment of the BOA’s institutional set-up and practices, conducted in November 2021.