Albania: Concluding Statement of the Staff Visit
September 27, 2013
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.
Economic weakness and elevated macroeconomic imbalances pose significant policy challenges. Foremost, public debt has reached a level hitherto not known in Albania, in part because of the accumulation of unpaid government bills and arrears. A return to debt sustainability would require a firm commitment to sustained fiscal consolidation over the medium term, beginning with a 2014 budget underpinned by tangible policies and structural reforms that address the root causes of high deficits. However, weak cyclical conditions put an upper limit on the degree of upfront adjustment Albania can undertake without having adverse economic and social consequences. Revival of credit will depend on the repayment of arrears and unpaid bills, and clean up of bank and corporate balance sheets.
1. The economy is sluggish because of weak domestic demand. Growth is expected to remain low in 2013, at 1.7 percent as stagnating credit, troubled corporate balance sheets, and declining remittances are a drag on domestic demand, while the rise in arrears has aggravated liquidity constraints in the private sector. Significant import compression and one-off improvement in the energy trade balance—thanks to strong hydroelectricity production and exports—are driving a moderate external current account adjustment. Growth could increase modestly in 2014, provided the authorities initiate much needed policy and structural reforms. With output below potential, and unemployment above trend in 2013–14, the mission expects inflation to be muted.
2. Domestic imbalances have worsened significantly. Fiscal slippages in the first half of 2013—emanating largely from poor tax revenue performance, together with the accumulation of a large stock of unpaid bills and arrears (over the past two years or so) are expected to push public debt to 70 percent of GDP by end-2013, compared to 59 percent in 2010. The budget has high financing need—including because of short maturity structure of domestic debt. Government bond yields have declined in 2013 despite the deterioration in public finances, reflecting the easing of monetary policy, low inflation and risk averse domestic banks that have opted to buy government paper rather than lend to the private sector. NPLs have continued to rise to nearly 24 percent of all loans, while the banking sector remains vulnerable to shocks emanating from parent banks abroad, including changes in their regulatory environment.
3. Policy inaction would pose serious risks to macroeconomic stability. Without the necessary policy and structural reforms, public debt would continue on its upward trend and could adversely impact growth, particularly if interest rates start rising and begin to crowd out private investment over the medium term. Deterioration in the domestic bond market’s perception of sovereign risk could affect its appetite and willingness to finance government debt, resulting in rising yields and, possibly, a disorderly fiscal adjustment.
Reduce the risks to fiscal and debt sustainability
4. To start lowering vulnerabilities associated with high debt and rebuild fiscal buffers against shocks the authorities should commit to a credibly low medium term debt target. To anchor expectations, the mission recommends the authorities to commit to an ambitious but feasible ten year target of 40 percent of GDP, and an interim target that sees debt declining close to 60 percent of GDP within 5 years. Achieving the interim target would require sustained fiscal consolidation over the medium term. The mission recommends the authorities to commit to achieving a decline in the public debt-GDP ratio in 2015, as a credible first step in a sustained medium term adjustment effort.
5. The 2014 budget should initiate the process of fiscal consolidation while being cognizant of the weak economy. Reversing the upward trend in public debt in 2014, or even maintaining it at the same level, in relation to GDP, as in 2013 would require an excessively large fiscal adjustment. With output expected to remain below potential in 2014, the extent of fiscal adjustment would need to be tempered against avoiding negative effects on growth and social outcomes. Nevertheless, fiscal adjustment of about 1½ of GDP would be needed in 2014 to signal the authorities’ seriousness in moving toward debt sustainability.
6. Specific and tangible measures would have to underpin the 2014 budget. A comprehensive approach to tax reform is needed, and the mission discussed possible options, including the authorities’ plan to introduce a progressive personal income tax, modifications to the profit tax, and excise tax reform. Forceful action is needed to improve tax administration, though such measures are likely to yield benefits only over the medium term. The mission recommends that relief measures to help the poor should take the form of direct and targeted budget support rather than tax relief that distorts the revenue system and does not necessarily benefit the poor. The IMF stands ready to provide further advice and technical assistance.
7. To establish credibility, the authorities should also announce their intention to implement ambitious fiscal reforms over the medium term. The mission sees reform of the social insurance system and the energy sector as essential. The pension system is currently in deficit, and with the projected dramatic aging of the population over the coming decades, it will be unable to cope with increasing demands for pensions. The mission encourages the authorities to develop a reform plan that envisages, among other things, bringing rural workers into the net, removing disincentives for participation by high income earners and raising the retirement age. Similarly, energy reform is critical for the sector’s sustainability and ensuring it does not continue to be a fiscal risk. Fiscal reforms, including those related to tax revenues and public financial management would also be key.
8. Addressing the problem of unpaid bills and arrears would enhance the government’s credibility and boost liquidity and confidence. Clearance of these liabilities would strengthen private sector balance sheets, facilitate the resumption of credit growth by helping lower nonperforming loans (NPLs) and support domestic demand. While the precise level of outstanding unpaid bills and arrears of the central government would not be known till a comprehensive exercise is undertaken, the mission’s preliminary estimate suggests they could amount to around 4 percent of GDP. The mission suggests a three-pronged approach that should be implemented to address the problem: i) solicit private sector to submit their claims within a reasonable time; establish the true amount of these liabilities following proper audit (preferably by an external entity), and include them in the government’s public debt statistics; ii) announce a timetable to extinguish this liability promptly and begin implementation; and iii) simultaneously undertake tangible public financial management reforms to prevent a recurrence of the problem.
Facilitate cleanup of balance sheets to boost credit growth
9. A strong rebound in credit would be contingent on progress in restructuring troubled corporate balance sheets. The high NPLs are indicative of the state of disrepair of corporate balance sheets, and partly explain banks’ high risk aversion in lending; credit would continue to be weak till there is improvement on this front. The mission welcomes the authorities’ recent efforts to prevent delays in court cases and facilitate collateral execution, but encourages them to pursue additional measures to support the cleanup of bank balance sheets, including loan restructurings, removal of tax distortions, and facilitating out-of-court settlement.
10. Continued supervisory vigilance is essential, given the high NPL level and weak profitability. Strict monitoring of NPLs, enforcement of loan provisioning, and ensuring that banks respond promptly to capital shortfalls are essential. The mission welcomed the authorities’ intention to participate in the Financial Sector Assessment Program (FSAP).
The mission thanks the authorities and other counterparts for the open and constructive discussions.