Albania-Concluding Statement of the 2012 Article IV Consultation Mission
October 1, 2012
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Since the onset of the global crisis in 2008, Albania has avoided a sharp fall in output and maintained banking system stability, thanks to a fiscal stimulus, sound monetary policy and effective macroprudential actions. Growth is now slowing and persistent macroeconomic imbalances need to be addressed. Key priorities in the period ahead are: ensuring debt sustainability, strengthening the banking system’s resilience, and advancing growth-enhancing structural reforms. The mission thanks the authorities for open and constructive discussions.
1. After showing resilience over the last two years, Albania’s economy is now beginning to slow down. Output fell by 0.2 percent in the first quarter of 2012 because of the impact of the Euro area crisis, weak domestic demand, and largely supply side bottlenecks related to a harsh winter. While economic activity could recover in the second half of the year, growth is expected to be sluggish in 2012—at about 0.5 percent—primarily because of continued weak consumer and business confidence, a sharp decline in credit growth, the effects of rising stock of unpaid government bills and VAT refunds, and sluggishness in Albania’s main external partners, Greece and Italy. The economy will operate below potential in 2012 (of about 3.5 percent growth), but would still grow broadly in line with other countries in the region.
2. The ongoing euro area crisis will continue to create economic headwinds in the near term, and risks to the outlook are mostly to the downside. In 2013, economic growth could recover slowly to 1.3 percent, because of sluggish domestic demand and weak external environment. Inflation would remain within the central bank’s 3±1 percent target range. However, if the euro area crisis were to worsen, this would further affect the outlook. Another risk to the outlook is the worsening trend of loan performance, which if not arrested, could exacerbate negative feedback to the economy. Structural impediments in the electricity sector are a source of fiscal risk, and unless dealt with urgently, could result in supply constraints, further affecting the economy.
3. Unchanged fiscal policies will not tackle underlying vulnerabilities. Public debt is elevated and fiscal financing needs are the highest in the region primarily because of high rollover—while economic rebalancing is incomplete, including a large external current account deficit that persists in double digits. Despite the attempts to control budget spending, public debt could breach the 60 percent statutory debt limit this year, and is not expected to decline much over the medium term, even if the budget registers small primary surpluses.
4. With an elevated public debt, Albania faces substantial risks. The large share of short term public debt translates to high fiscal financing risks. In the medium term, rising public debt could also hamper growth prospects by crowding out private sector credit and affecting the government’s ability to finance crucial development projects.
Advancing fiscal sustainability through a credible anchor
5. With buffers depleted, new fiscal stimulus to support the weak economy is not an option; instead, fiscal consolidation is needed to lower risks from elevated debt. Setting an ambitious but feasible long term debt target to anchor fiscal policy—reducing the debt-GDP ratio to 40 percent by 2022—would strengthen the economy’s resilience to shocks, while allowing for a more gradual adjustment to accommodate development needs. For 2013, the government’s immediate priority should be arresting the upward trend in public debt, by committing to a budget that maintains debt-GDP ratio at around the 2012 level—an adjustment of the fiscal deficit by about 0.6 percentage points of GDP. This would strike an appropriate balance between signaling the government’s commitment to debt sustainability, and limiting the adverse impact of fiscal consolidation on the weak economy, financial sector stability, and social outcomes. Fiscal prudence in the run up to elections is needed to preserve market confidence. To achieve the medium term debt target (consistent with about 53 percent debt-GDP ratio in 2017), a cumulative fiscal consolidation of about 3.1 percentage points of GDP would be needed.
6. Tax and expenditure reforms would be needed to achieve the long-term debt target while supporting growth. With large components of expenditure already pre-committed, lowering the fiscal deficit will require higher revenues over a sustained period of time. Achieving this through tax administration efforts alone will likely not suffice, and some changes in tax policy, including the income tax rates, may be needed. Yet, because the scope for additional revenues through adjusting tax rates also has limits, spending control would also be required—staff views social security reform and keeping public wage growth in line with inflation as essential. These reforms will also create fiscal space for government to undertake higher capital spending to ease infrastructure constraints and boost growth and preserve social spending targeted to the poor and vulnerable. Discontinuing the practice of programming optimistic budget revenues and then having to face budget stress once revenue outturn is lower than expected would help avoid the accumulation of unpaid bills.
7. Privatization receipts should be utilized in a balanced manner, to reduce debt and clear unpaid bills. To the extent that the natural resource wealth being privatized belongs to current and future generations of Albanians, the bulk of privatization receipts should therefore be used to retire debt, which is necessary to reduce the economy's vulnerabilities (given the high debt stock and short maturity structure), secure debt sustainability, and rebuild buffers to protect against future shocks. Given the weak state of the economy today, and the recent buildup of unpaid bills and VAT refunds, part of the receipts should also be used to clear the backlog, which will support growth in the near term.
Safeguarding monetary and banking stability
8. Monetary policy has been an anchor of macrofinancial stability, but it has limits. Albania’s flexible exchange rate and inflation targeting regime have successfully maintained low and stable inflation, which, in turn, has provided the market comfort about the authorities’ ability to maintain macroeconomic stability. If domestic demand were to weaken further and credit to contract, then the authorities could consider further monetary easing, provided inflation expectations remain well anchored. However, the effectiveness of such a policy would be limited by sluggish credit demand and bank risk aversion in a weak economy, and could result in exchange market pressures.
9. Despite the preponderance of European bank subsidiaries, the banking system has proved resilient, and has not required public support. The high share of European banks in the system and persistent banking troubles in Europe raise the specter of spillovers to Albania’s banking system. A relatively low reliance on external funding has ameliorated the risks, while recent Bank of Albania (BoA) actions—converting foreign branches to subsidiaries, tightening capital and liquidity requirements, and enforcing prudential and provisioning limits—have also helped. Banks today have high liquidity and capital ratios.
10. Nonetheless, supervisory vigilance is essential in the period ahead. Significant unhedged foreign currency lending exposes bank balance sheets to exchange rate risk, while sizable holdings of government bonds could potentially become a source of future vulnerability if adequate measures to reduce public debt are not implemented. Stress tests should continue to guide decisions on capital and liquidity buffers. The close cooperation that BoA has established with parents banks’ supervisors is key to mitigating cross-border risks.
11. The rising level of non-performing loans is a concern and requires prompt action. NPLs—mainly in trade, construction and manufacturing—have risen faster than in other countries in the region, largely because of the economic slowdown, government’s nonpayment of suppliers’ bills, and continued delays in collateral execution. This has affected the profitability of banks and their ability to extend credit to the economy. Concrete actions, such as easing collateral execution—allowing property prices to adjust to market forces by facilitating foreclosure sales (including, by removing the regulated price floor), increasing efficiency of private bailiff offices, and limiting inconsistent application of the law—and clearing unpaid government bills and VAT refunds would help.
Structural reforms for sustainable growth
12. Business environment weaknesses are an obstacle to investment and hence medium term growth. Continued weaknesses in the legal framework, notably in property rights and contract enforcement, continue to be major problems. Arbitrariness of tax collection undermines the effectiveness of Albania’s low tax rates. Widespread informal sector employment calls for making formal employment more flexible. Improving data accuracy, particularly in national and external accounts, and timeliness will contribute toward better surveillance and policymaking.