## EXECUTIVE SUMMARY ## Source details **Canonical URL:** [EXECUTIVE SUMMARY](https://www.imf.org/-/media/files/publications/cr/2018/cr18123.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18123.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18123.pdf.json) --- ### Context - Albania’s economic recovery remains strong, benefiting from a favorable domestic and external environment. - Growth drivers: strong domestic demand, energy-related foreign direct investment (FDI), and exports of services. - Key vulnerabilities: high public debt, non-performing loans (NPLs) in the financial sector, and institutional weaknesses, notably public financial management and the rule of law. - Reform priorities: judicial reform as a precondition for opening EU accession negotiations; increasing investments; improving public administration efficiency. ### Recent economic developments - Real GDP growth: 3.8 percent (yoy) during 2017. - Current account deficit: narrowed to 6.9 percent of GDP in 2017; predominantly funded by concessional borrowing and large FDI inflows. - Gross international reserves: covering more than 6 months of imports; reserves reported as comfortable. - Inflation: 1.8 percent (below target); core inflation 1 percent. - Exchange rate: nominal LEK/EUR appreciation of 4 percent (yoy). - Fiscal outcomes 2017: - General government primary surplus: 0.1 percent of GDP (deteriorated from 0.2 percent in 2016 and 0.4 percent in the revised budget). - General government deficit: 2 percent of GDP. - General government debt: 71.8 percent of GDP. - New arrears: around 0.9 percent of GDP accumulated in 2017 (primarily VAT refunds and central government investments). - 2018 budget: overall deficit target of 2 percent of GDP; fiscal stance expected to remain broadly neutral. - Banking sector (end-2017): - Private credit growth: nominal 0.2 percent (3.4 percent after adjusting for write-offs). - Average capital adequacy ratio: 16.6 percent. - NPL ratio: 13.2 percent of total loan portfolio (declining due to write-offs and restructurings). - Lending composition: household and SME lending expanding; loans to large corporates declining. - As of 2017 Q2: corporate NPL ratio 19.5 percent vs household ratio 9 percent; NPLs in FX-denominated loans 17.6 percent vs Lek-denominated loans 11-12 percent. ### Outlook and risks - Short- to medium-term outlook: - 2018: GDP growth expected to ease slightly as large energy projects wind down. - Medium-term growth projected: increase to 4 percent, driven by strong domestic demand, EU accession-related reforms, and recovery in trading partners. - Inflation: expected to edge up, stabilizing around the 3 percent target by late 2019. - Current account deficit: expected to narrow to around 6½ percent of GDP. - Selected baseline scenario indicators: - Real GDP Growth (percent): 2016 3.4, 2017 3.8, 2018 3.6, 2019 3.7, 2020 3.9, 2021 3.9, 2022 4.0, 2023 4.0 - Inflation (avg., percent): 2016 1.3, 2017 2.0, 2018 2.5, 2019 2.8, 2020 3.0, 2021 3.0, 2022 3.0, 2023 3.0 - Current account (percent of GDP): 2016 -7.6, 2017 -6.9, 2018 -6.8, 2019 -6.6, 2020 -6.1, 2021 -5.9, 2022 -5.8, 2023 -5.9 - Reserves (months of Imports): 2016 6.5, 2017 6.3, 2018 6.6, 2019 6.0, 2020 5.9, 2021 5.6, 2022 5.3, 2023 5.0 - Fiscal overall balance (percent of GDP): 2016 -2.3, 2017 -2.0, 2018 -2.1, 2019 -2.0, 2020 -1.9, 2021 -1.8 - Primary balance (percent of GDP): 2016 0.2, 2017 0.1, 2018 0.1, 2019 0.3, 2020 0.4, 2021 0.3 - Government debt (percent of GDP): 2016 73.2, 2017 71.8, 2018 72.2, 2019 69.5, 2020 66.6, 2021 63.9 - Downside risks (RAM, Annex I): - Delays in fiscal consolidation and reform agenda may reduce investor confidence and donor/capital inflows. - Adverse weather could affect electricity generation, creating quasi-fiscal risks. - External risks: rapid tightening of financial conditions, banking stress spillovers, weaker-than-expected Euro area growth affecting exports, remittances, and FDI. - Upside possibility: progress in EU accession could raise investment and growth. ### Capacity to repay the Fund - Fund credit outstanding: 3.1 percent of GDP (document reports 3 percent in main text and 3.1 percent in earlier paragraph) or 12 percent of gross international reserves in 2017. - FX reserves: 26 percent of GDP or almost 6⅓ months of imports. - Fund credit outstanding: 213 percent of quota at end-2017; expected to remain above 200 percent of quota until November 2019. - Debt service to the Fund: expected to peak in 2022 at 1.8 percent of reserves and around 0.4 percent of GDP under baseline; under an adverse scenario peak at around 0.5 percent of GDP or 2.2 percent of reserves. - External position: - Net international investment position (NIIP) increasingly negative; external liabilities reached 110 percent of GDP in 2017. - Composition of external liabilities: half FDI, one third sovereign external debt (a large share held by donors). - External debt to GDP: 63 percent in 2017. - Reserves adequacy: international reserves at 181 percent of ARA metric at end-2017. - Public sector debt vulnerabilities (DSA, Annex III): - Public debt: 71.8 percent of GDP in 2017. - Stress test: combined macro-fiscal shock could push public debt to 80 percent of GDP by 2020. - Key vulnerabilities: - High rollover needs: 20 percent of GDP in 2018 as about two-fifths of central government domestic debt was short-term at end-2017. - Rising net FX exposure from replacing short-term domestic debt with longer-term external borrowing. - Sovereign-banking nexus: concentration of debt holdings in a few large domestic banks; high exposure of banks to government bonds (25 percent of total assets). - Mitigating factors: - Domestic debt maturity lengthened from 1.7 to 2.2 years between 2014 and 2017. - Gross financing needs declined from a peak of 37 percent of GDP in 2014. - Authorities considering a Eurobond issuance in the last quarter of 2018 to build buffers, pre-finance external debt payments including the €450 million 2020 Eurobond, and mitigate domestic financing pressures. ### Policy discussions and recommendations - Overall focus: mitigate risks in fiscal and financial sectors; improve resilience to shocks; raise growth prospects through structural reforms. - Fiscal policy recommendations: - Implement larger up-front fiscal consolidation via stronger revenues. - Reduce debt vulnerabilities backed by sound fiscal institutions, including public finance management and SOE governance. - Staff recommended a more ambitious near-term fiscal adjustment of around 1.2 percent of GDP over 2018-19 to reduce public debt more rapidly. - Medium-term fiscal path comparisons (percent of GDP): - Overall balance: IMF baseline: -2.3 (2016), -2.0 (2017), -2.1 (2018), -2.0 (2019), -1.9 (2020), -1.8 (2021); IMF recommended path: -2.3, -2.0, -1.8, -0.8, -0.7, -0.6; Authorities MTBF*: -2.0, -2.0, -1.7, -1.2, -0.5. - Primary balance: IMF baseline: 0.2, 0.1, 0.1, 0.3, 0.4, 0.3; IMF recommended path: 0.2, 0.1, 0.4, 1.5, 1.5, 1.5; Authorities MTBF*: 0.4, 0.6, 1.0, 1.5, 2.2. - Structural primary balance: IMF baseline: 0.4, 0.2, 0.2, 0.4, 0.5, 0.3; IMF recommended path: 0.4, 0.2, 0.5, 1.6, 1.6, 1.5; Authorities MTBF*: 0.2, 0.7, 1.1, 1.5, 2.2. - Public debt: IMF baseline: 73.2 (2016), 71.8 (2017), 72.2 (2018), 69.5 (2019), 66.6 (2020), 63.9 (2021); IMF recommended path: 73.2, 71.8, 71.9, 68.0, 64.0, 60.3; Authorities MTBF*: 71.5, 68.7, 66.4, 63.5, 59.9. - *MTBF as of December 2017 (authorities' definitions exclude some energy sector support from deficit and omit PPPs and arrears in debt statistics). - Financial sector recommendations: - Strengthen institutional framework for resolving NPLs. - Enhance bank supervision and regulation aligned with EU standards to manage risks of systemic banks and related-party transactions. - Address sovereign-banking nexus by deepening financial markets and diversifying investor base. - Structural reforms: - Improve the business climate, secure energy supplies, reduce informality, increase human capital, and deepen financial markets. - Other fiscal risks to monitor: contingent liabilities from SOEs and PPPs, court disputes on tax and other obligations, and local government liabilities. ### Fiscal rule, consolidation, and operational target - Staff recommended adopting a primary balance (excluding one-offs) of 1.5 percent of GDP as an operational target from 2019. - Staff advised closely monitoring debt indicators and continuing further consolidation should debt deviate significantly from its medium-term target. - Given difficulties in operationalizing the debt target and the lack of a quantitative target under the existing fiscal rule, the primary-balance target was proposed to enhance accountability and transparency of public finances. ### Tax policy measures and revenue mobilization - Fiscal consolidation should be underpinned by additional tax revenue measures; with limited room for expenditure savings, staff recommended continued efforts in improving tax policy and administration. - Specific recommendations: - Indexation of excise rates to inflation. - Environmental taxes. - Broadening the tax base and reducing informality. - Further preparatory efforts for value-based property taxation and the fiscal cadaster to ensure proper implementation. - Avoid new measures that erode the tax base. - Implement the authorities’ proposal for reverse VAT schemes cautiously to minimize fraud and prevent undermining tax administration efforts. - Extracted numerical measures (percent of GDP) and time horizon labels (2018 2019 2020 2021) as presented: - Measures already/being taken by the government: 0.20 0.06 0.05 0.05 - Harmonize cigarette excise towards EU standards: 0.12 0.06 0.05 0.05 - Increase the base for social security contributions: 0.09 --- - Lower VAT rate for tourism-related activities: 0.00 --- - Other exemptions (IT, high-tech): -0.01 --- - Permanent tax measures assumed in the baseline: 0.12 0.10 0.18 0.01 - Ad valorem transfer duty and pilot property tax: 0.12 0.10 -0.10 - - Value-based property tax: -- 0.28 0.01 - Recommended permanent tax measures: 0.32 0.78 0.14 0.13 - Index specific excises/national taxes on observed inflation (e.g., fuel excise, carbon tax, circulation tax, car registration, etc.): 0.05 0.11 0.11 0.10 - Broaden the VAT base (drugs, machineries, new residential property sales, education, advertisement, tourism): 0.03 0.16 0.03 0.03 - Reintroduce small business income tax: 0.15 -- - Reduce the zero-tax threshold to the minimum wage level: 0.19 --- - Environment and health-related excises: 0.06 0.36 -- ### Fiscal institutions, public investment, PPPs, and arrears - Public investment management and PPPs: - Significant infrastructure gaps relative to regional peers; shortcomings in project management (including in local governments and SOEs) need to be addressed before scaling up public investment. - All projects, including PPPs, should require prioritization with adequate funding available within the medium-term budgetary framework. - Fragmented decision making in PPPs and public investment spending remains a key shortcoming. - MOF has tightened oversight of PPPs, but further strengthening of budgeting, accounting, and risk assessment is needed given large contingent liabilities frequently embedded in PPP contracts. - The practice of unsolicited proposals should be eliminated. - Budgetary controls and arrears: - Strengthening budgetary and commitment controls, Treasury IT system, and cash management is crucial to prevent buildup of new arrears and expedite clearance of current stock. - Arrears represent unrecorded fiscal deficits; strengthen registration of budget commitments and record unpaid bills. - At the end of 2017, the total stock of arrears stood at 1.7 percent of GDP, of which VAT refund arrears amounted 0.7 percent of GDP. - Around 80 percent of total VAT arrears are related to three large taxpayers. - Arrears table excerpts (as presented; Lek million % of GDP Lek million % of GDP Lek million % of GDP (Stock / Flow / 2016 / 2017 / 2017)): - Total 13,121 0.89 26,662 1.7 13,541 0.9 - Central Government 3,680 0.25 17,405 1.1 13,725 0.9 - VAT refund arrears 1,908 0.13 11,705 0.7 9,797 0.6 - Other 1,772 0.12 5,700 0.4 3,928 0.25 - Local Government 9,441 0.6 9,257 0.6 (184) -0.01 Box: Public-Private Partnerships in Albania - By mid-2017, more than 200 PPP contracts had been signed, with estimated total investment equivalent to 36 percent of GDP. - The €1 Billion Program launched in January 2017 comprises nine new PPP projects with an estimated investment cost of about 7 percent of GDP (likely procured as government-funded projects by 2021). - Current PPP framework is poorly designed and lacks proper recording and risk analysis; integration into public investment process and quantification of risks over project lifetimes are lacking. - MOF legislative threshold: annual payments not exceeding 5 percent of the previous year fiscal revenues, but estimates mix mandatory, expected, and worst-case payments and are not reliable without quantified potential risks. - Recommended measures: - Full-scale assessment of PPP-associated risks and their impact on the medium-term budget framework and debt sustainability. - Introduction of accrual accounting, preferably based on IPSAS, aligned with GFSM and ESA. - Develop disclosure and analysis of fiscal risks related to PPPs in the Fiscal Risk Statement. ### Debt management - Domestic debt market is underdeveloped, with a lack of long-term institutional investors, contributing to potential sovereign yield volatility and higher government borrowing cost if cash management is inadequate and communication with the market is poor. - Debt management capacity at the MoF requires further strengthening. - Close coordination between the MoF and BOA and the markets is needed, given high bank exposure to the public sector. - Authorities embarked on developing a primary dealers’ system to help deepen secondary market liquidity. - Staff recommended diversifying sources of financing with a combination of long-term issuance, debt buyback, and foreign concessional financing. ### Authorities’ views on fiscal policy and structural reforms - Authorities emphasized commitment to continue fiscal consolidation, but at a slower pace than recommended by staff. - They plan to closely monitor budget execution and revenue collection and undertake compensatory measures as needed to achieve the overall deficit target of 2 percent of GDP in 2018. - Authorities view further tax policy changes beyond what is in the 2018 budget as difficult to implement and potentially undermining compliance. - They considered the 60 percent of GDP medium-term debt target ambitious and believed a slightly higher debt level should be acceptable given high public investment needs. - Structural reform commitments: - Restructuring a state-owned oil and petroleum company expected to increase royalty revenues. - Committed to clearing outstanding stock of arrears and developing a payment schedule for large taxpayers aiming to repay all outstanding arrears by September 2019. - Efforts towards implementation of the Third Energy Package advancing to improve tariff setting, governance reform, and loss reduction. - Options for private investment in energy companies under consideration; reforms in water supply have started. - On PPPs, projects are high priority; risks are contained within the MTBF; unsolicited projects practice discontinued from 2021. ### Banking sector: stability, NPLs, and supervision - Banking system is stable but faces structural challenges and crisis legacy issues weighing on bank balance sheets. - Banks’ funding base remains very stable with a loan to deposit ratio of around 52 percent. - Deposits continued to grow moderately, particularly in foreign currency. - Credit to the private sector remains weak due to an overhang of NPLs, lack of creditworthy borrowers, and deleveraging by EU-owned banks. - Banks continue to invest heavily in Albanian sovereign bonds and foreign placements, including through non-resident lending. - NPL resolution: - Addressing the NPL resolution framework is crucial for revitalizing bank lending. - Staff emphasized the need to accelerate reforms, including measures related to collateral execution (e.g., success fees for bailiffs) and regulation of out-of-court restructuring agreements. - While private credit is expected to recover in 2018, authorities should monitor risks related to large corporate exposures and growth in the construction sector. - EU bank deleveraging and consolidation: - Several EU banks have announced intentions to sell Albanian subsidiaries. - Market share of EU-owned banks declined from 67 percent in 2013 to 52 percent at end-2017. - Interest from investors with banking experience remains limited; ensuring new entrants meet fit and proper criteria is critical. - An abrupt exit or large portfolio shift by a large bank could pose risks for FX and T-bill markets. - Staff underscored the need for close communication with EU-owned banks, parent banks, and peer supervisors for smooth bank consolidation. - Supervision and regulation: - Enhanced bank supervision and regulation aligned with EU standards would provide the BOA with tools to manage risks of systemic banks and build capital buffers. - Domestic banks expected to align with the IFRS9 framework by the end of 2018. - Monitoring of systemic banks should be strengthened to contain risk of large borrowers and related-party lending. - Staff suggested considering a special external diagnostic, possibly with a peer supervision authority, to assess high-risk portfolios and identify gaps in risk management focusing on large exposures. - BOA should progressively converge towards Basel III implementation and implement new D-SIB capital surcharges on a risk-based, bank-by-bank approach. ### Non-banking sector and market infrastructure - Risks from the non-banking sector include investment funds. - AFSA progress: adoption of new liquidity management framework for funds; regulations on transactions with related parties; central securities depository regulation. - Critical to complete the crisis management framework for investment funds in coordination with BOA and MOF. - Introduction of new instruments on the newly licensed stock exchange should be strictly regulated given current gaps in governance and market standards; current trading limited to sovereign securities. ### Monetary policy, de-euroization, and exchange rate regime - BOA policy rate: 1.25 percent (historical minimum). - Staff supported BOA forward guidance that monetary tightening will not take place until early 2019 given subdued core inflation, limited wage pressures, a stable exchange rate, and low inflation in the euro area. - BOA inflation target: 3 percent. - Output gap estimate for 2018: 0.5 percent. - De-euroization strategy: - Shares of total deposits and loans denominated in foreign currency: 52.7 and 56.4 percent, respectively. - 26 percent of credit to the private sector represent unhedged FX-borrowers. - De-euroization should be implemented gradually to mitigate risks of financial disintermediation. - Exchange rate policy: - The flexible exchange rate regime serves as an efficient shock absorber. - BOA has been intervening to build up FX reserve buffers per a pre-announced calendar. - Central bank interventions to build FX reserve buffers should remain fully transparent and consistent with achieving the inflation target. ### Safeguards assessment - The BoA has implemented all safeguards recommendations except for legal amendments of the central bank law to enhance central bank governance and autonomy in line with international practices. - The BOA and MoF are committed to the de-euroization strategy and concur that current conditions call for a supportive monetary policy, not expecting normalization before Q2 2019 depending on data. ### Staff appraisal — macroeconomic assessment and policy priorities - Growth and structural reform: - Albania is enjoying strong economic growth, but it may not last without a significant push for structural reforms. - Critical to use the good times to push the reform agenda to lift potential growth and position the country to benefit from EU accession prospects. - Key challenges: - Public debt remains high. - NPLs, while declining, continue to affect overall credit growth, particularly in the corporate sector. - State-owned electricity sector needs financial restructuring and governance reform. - Fiscal policy and debt management: - Address fiscal risks posed by high public debt—requires more fiscal adjustment preferably in the near term. - Public debt management should focus on lengthening maturity and diversifying investor base while avoiding excessive non-concessional FX borrowing. - Revenue mobilization and tax policy: - Improve tax compliance and administration; proceed carefully with value-based property taxation. - Refrain from lowering tax rates or granting new tax exemptions that could complicate the tax system. - Fiscal institutions and PPPs: - Strengthen fiscal institutions, enhance credibility of the MTBF, and improve public investment prioritization, appraisal and monitoring. - MoF should strengthen fiscal recording and analysis of PPP projects. - Arrears, VAT refunds, and public financial management: - Institutional improvements needed to tackle arrears; expand Treasury IT system to local governments and register unbudgeted commitments. - NPLs: - Accelerate legislative and institutional measures to resolve high NPL ratios, improve collateral execution and out-of-court restructuring frameworks. ### Further alignment of financial sector regulation with EU standards - Key recommendations: - Gradually align financial sector regulation with EU standards, including advancing convergence with Basel III. - Implement capital requirements using a risk-based, bank-specific methodology. - Continue and expand targeted regulations to mitigate risks from related party transactions and cross-border flows. - Finalize and operationalize the crisis management framework for non-bank financial institutions. ### Risk Assessment Matrix (highlights) - Weaker-than-expected global growth: Relative Likelihood: High; Impact if Realized: High. Policy advice: diversify export markets; improve domestic policy environment. - Tighter global financial conditions: Relative Likelihood: High; Impact if Realized: Medium. Policy advice: persist with fiscal consolidation; lengthen debt maturity. - Disruption of credit intermediation: Relative Likelihood: Medium; Impact if Realized: Low. Policy advice: share information with parent banks, enforce fit-and-proper rules, align with EBA. - Adverse weather conditions: Relative Likelihood: Medium; Impact if Realized: Medium. Policy advice: reinvigorate electricity sector reform; diversify domestic electricity sources. - Poorly designed PPPs: Relative Likelihood: Medium; Impact if Realized: Medium. Policy advice: fully implement PPP law; upgrade Fiscal Risk Unit capacity. - Rollover of public debt: Relative Likelihood: Low; Impact if Realized: High. Policy advice: lengthen maturity, diversify holder base, improve market communication. - Domestic political instability: Relative Likelihood: Low; Impact if Realized: High. Policy advice: continue reforms to improve business environment. - Lower energy prices: Relative Likelihood: Low; Impact if Realized: Medium. Policy advice: implement additional fiscal measures as needed. ### Adverse scenario — summary and selected projections - Assumptions: - Delays in reforms reduce real GDP growth to 3 percent over the medium-term (vs 4 percent baseline). - Government unable to issue new Eurobonds, increasing domestic issuances and domestic borrowing costs by 200 basis points versus baseline. - Reduced access to foreign financing triggers a depreciation 3 percent more than baseline during 2018-19. - Main outcome: - Government debt stabilizes at about 74 percent of GDP and reserves decline to 4.5 months of imports by 2023; capacity to repay the Fund remains. - Debt service to the Fund peaks at around 0.5 percent of GDP or 2.2 percent of reserves under the adverse scenario. - Selected indicators: Adverse Scenario (highlights) - Real GDP Growth (percent): 2016 3.4, 2017 3.8, 2018 3.6, 2019 3.0, 2020 3.0, 2021 3.0, 2022 3.1, 2023 3.1 - Inflation (avg., percent): 2016 1.3, 2017 2.0, 2018 2.5, 2019 2.8, 2020 3.2, 2021 3.1, 2022 2.9, 2023 2.9 - Current account (percent of GDP): 2016 -7.6, 2017 -6.9, 2018 -6.9, 2019 -5.9, 2020 -4.7, 2021 -3.8, 2022 -3.4, 2023 -3.3 - Reserves (months of Imports): 2016 6.5, 2017 6.3, 2018 5.7, 2019 5.6, 2020 5.0, 2021 4.9, 2022 4.7, 2023 4.5 - Fiscal overall balance (percent of GDP): 2016 -2.3, 2017 -2.0, 2018 -2.2, 2019 -3.1, 2020 -3.4, 2021 -3.7, 2022 -4.1, 2023 -3.5 - Primary balance (percent of GDP): 2016 0.2, 2017 0.1, 2018 0.0, 2019 0.0, 2020 0.0, 2021 -0.3, 2022 -0.4, 2023 -0.2 - Government debt (percent of GDP): 2016 73.2, 2017 71.8, 2018 72.3, 2019 72.8, 2020 73.7, 2021 73.7, 2022 74.2, 2023 74.3 - Indicators of Capacity to Repay to the Fund, 2013-23: Adverse Scenario (selected time series) - Fund repurchases and charges (In millions of SDRs): 2013 6.9, 2014 6.1, 2015 5.3, 2016 5.4, 2017 6.8, 2018 9.5, 2019 20.9, 2020 33.2, 2021 48.9, 2022 52.7, 2023 51.8 - Fund repurchases and charges (In millions of euro): 2013 7.7, 2014 7.2, 2015 6.8, 2016 6.9, 2017 8.1, 2018 11.1, 2019 24.3, 2020 38.4, 2021 56.4, 2022 60.8, 2023 59.6 - Fund repurchases and charges (In percent of gross international reserves): 2013 0.4, 2014 0.3, 2015 0.2, 2016 0.2, 2017 0.3, 2018 0.4, 2019 0.9, 2020 1.5, 2021 2.1, 2022 2.2, 2023 2.2 - Fund credit outstanding (end of period) (In millions of SDRs): 2013 16.4, 2014 57.7, 2015 129.3, 2016 241.5, 2017 296.8, 2018 291.7, 2019 277.3, 2020 249.6, 2021 205.1, 2022 155.9, 2023 106.7 - Fund credit outstanding (end of period) (In percent of gross international reserves): 2013 0.9, 2014 3.1, 2015 5.7, 2016 10.5, 2017 11.8, 2018 12.1, 2019 11.3, 2020 11.0, 2021 8.9, 2022 6.6, 2023 4.5 - Memorandum items (selected): Gross international reserves: 1795, 1855, 2261, 2305, 2506, 2405, 2447, 2262, 2309, 2345, 2389; Exports of goods and services: 2479, 2381, 2197, 2432, 3054, 3407, 3669, 3903, 4148, 4420, 4721; GDP (as presented): 8575, 8437, 8057, 8405, 9606, 9683, 1040, 1105, 6810, 6411, 0951, 11492, 12055; External public debt (as presented): 2351, 2458, 2692, 2925, 3215, 3433, 3586, 3493, 3524, 3535, 3542; Quota (as presented): 60.0, 60.0, 60.0, 139.3, 139.3, 139.3, 139.3, 139.3, 139.3, 139.3, 139.3. ### Debt Sustainability Analysis — key points (Annex III) - Background: - Public debt declined in 2017 for a second consecutive year but remained nearly 72 percent of GDP at end-2017. - Public debt rose by around 13 percentage points of GDP between 2010 and 2013; fiscal consolidation since 2014 slowed accumulation and reversed it in 2016. - Macroeconomic assumptions: Real growth gradually recovers to around 4 percent; inflation expectations anchored by 3 percent target; fiscal consolidation over 2014–16 and primary balance rising to 0.4 percent in medium term. - Debt maturity: average weighted maturity of domestic public debt now exceeds two years; shift toward long-term external financing including donors. - Public DSA results — baseline and risks: - Baseline nominal gross public debt (percent of GDP): 2016 62.6; 2017 73.2; 2018 71.8; 2019 72.2; 2020 69.5; 2021 66.6; 2022 63.9; 2023 60.4. - Public gross financing needs (percent of GDP): 2016 39.1; 2017 28.3; 2018 25.0; 2019 21.2; 2020 19.1; 2021 22.7; 2022 19.1; 2023 21.6. - Real GDP growth (percent): 2016 3.3; 2017 3.4; 2018 3.8; 2019 3.6; 2020 3.7; 2021 3.9; 2022 3.9; 2023 4.0. - Vulnerabilities: high rollover needs, heavy reliance on domestic banking sector (banks held 60 percent of domestic public debt end-2017), concentration in a few local banks, public gross financing needs above 15 percent of GDP early warning threshold. - Stress tests: combined macro-fiscal shock could push debt-to-GDP to around 80 percent in 2019-20; historical-scenario outcome: debt around 73 percent of GDP by 2023. - External debt sustainability: - External debt peaked around 63 percent of GDP in 2017 and expected to decline to 49 percent by 2023. - Most external debt held by multilateral creditors and bilateral development agencies; most foreign public debt denominated in euros followed by SDRs. - External public and private debt service expected to rise to 11 percent of GDP in 2020 as the €450 million 2015 Eurobond is amortized. - External stress tests: 30 percent exchange rate depreciation shock would peak external debt at 90 percent of GDP in 2018 before declining to 72 percent by 2023. - Policy recommendations: - Continue fiscal consolidation and structural reforms to improve debt dynamics. - Strengthen debt management capacity, lengthen maturities, and diversify investor base. - Consider pre-financing strategies to mitigate Eurobond rollover and interest rate risk. - Risks to monitor: high rollover requirements, concentration of domestic holdings in the banking sector, potential sharp increases in interest rates, and adverse growth or exchange rate shocks. *International Monetary Fund. Executive Summary, Albania Article IV Consultation and Selected Issues — May 3, 2018.* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Context - Albania’s economic recovery remains strong, benefiting from a favorable domestic and external environment. - Growth drivers: strong domestic demand, energy-related foreign direct investment (FDI), and exports of services. - Key vulnerabilities: high public debt, non-performing loans (NPLs) in the financial sector, and institutional weaknesses, notably public financial management and the rule of law. - Reform priorities emphasized: judicial reform as a precondition for opening EU accession negotiations; increasing investments; improving public administration efficiency. ### Recent economic developments - Real GDP growth: 3.8 percent (yoy) during 2017. - Current account deficit: narrowed to 6.9 percent of GDP in 2017; predominantly funded by concessional borrowing and large FDI inflows. - Gross international reserves: covering more than 6 months of imports; reserves reported as comfortable. - Inflation: 1.8 percent (below target); core inflation 1 percent. - Exchange rate: nominal LEK/EUR appreciation of 4 percent (yoy). - Fiscal outcomes 2017: - General government primary surplus: 0.1 percent of GDP (deteriorated from 0.2 percent in 2016 and 0.4 percent in the revised budget). - General government deficit: 2 percent of GDP. - General government debt: 71.8 percent of GDP. - New arrears: around 0.9 percent of GDP accumulated in 2017 (primarily VAT refunds and central government investments). - 2018 budget: overall deficit target of 2 percent of GDP; fiscal stance expected to remain broadly neutral. - Banking sector (end-2017): - Private credit growth: nominal 0.2 percent (3.4 percent after adjusting for write-offs). - Average capital adequacy ratio: 16.6 percent. - NPL ratio: 13.2 percent of total loan portfolio (declining due to write-offs and restructurings). - Lending composition: household and SME lending expanding; loans to large corporates declining. - As of 2017 Q2: corporate NPL ratio 19.5 percent vs household ratio 9 percent; NPLs in FX-denominated loans 17.6 percent vs Lek-denominated loans 11-12 percent. ### Outlook and risks - Short- to medium-term outlook: - 2018: GDP growth expected to ease slightly as large energy projects wind down. - Medium-term growth projected: increase to 4 percent, driven by strong domestic demand, EU accession-related reforms, and recovery in trading partners. - Inflation: expected to edge up, stabilizing around the 3 percent target by late 2019. - Current account deficit: expected to narrow to around 6½ percent of GDP. - Selected baseline scenario indicators: - Real GDP Growth (percent): 2016 3.4, 2017 3.8, 2018 3.6, 2019 3.7, 2020 3.9, 2021 3.9, 2022 4.0, 2023 4.0 - Inflation (avg., percent): 2016 1.3, 2017 2.0, 2018 2.5, 2019 2.8, 2020 3.0, 2021 3.0, 2022 3.0, 2023 3.0 - Current account (percent of GDP): 2016 -7.6, 2017 -6.9, 2018 -6.8, 2019 -6.6, 2020 -6.1, 2021 -5.9, 2022 -5.8, 2023 -5.9 - Reserves (months of Imports): 2016 6.5, 2017 6.3, 2018 6.6, 2019 6.0, 2020 5.9, 2021 5.6, 2022 5.3, 2023 5.0 - Fiscal overall balance (percent of GDP): 2016 -2.3, 2017 -2.0, 2018 -2.1, 2019 -2.0, 2020 -1.9, 2021 -1.8 - Primary balance (percent of GDP): 2016 0.2, 2017 0.1, 2018 0.1, 2019 0.3, 2020 0.4, 2021 0.3 - Government debt (percent of GDP): 2016 73.2, 2017 71.8, 2018 72.2, 2019 69.5, 2020 66.6, 2021 63.9 - Downside risks (RAM, Annex I): - Delays in fiscal consolidation and reform agenda may reduce investor confidence and donor/capital inflows. - Adverse weather could affect electricity generation, creating quasi-fiscal risks. - External risks: rapid tightening of financial conditions, banking stress spillovers, weaker-than-expected Euro area growth affecting exports, remittances, and FDI. - Upside possibility: progress in EU accession could raise investment and growth. ### Capacity to repay the Fund - Fund credit outstanding: 3.1 percent of GDP (document reports 3 percent in main text and 3.1 percent in earlier paragraph) or 12 percent of gross international reserves in 2017. (Both figures appear in source.) - FX reserves: 26 percent of GDP or almost 6⅓ months of imports. - Fund credit outstanding: 213 percent of quota at end-2017; expected to remain above 200 percent of quota until November 2019. - Debt service to the Fund: expected to peak in 2022 at 1.8 percent of reserves and around 0.4 percent of GDP under baseline; under an adverse scenario peak at around 0.5 percent of GDP or 2.2 percent of reserves. - External position: - Net international investment position (NIIP) increasingly negative; external liabilities reached 110 percent of GDP in 2017. - Composition of external liabilities: half FDI, one third sovereign external debt (a large share held by donors). - External debt to GDP: 63 percent in 2017. - Reserves adequacy: international reserves at 181 percent of ARA metric at end-2017. - Public sector debt vulnerabilities (DSA, Annex III): - Public debt: 71.8 percent of GDP in 2017. - Stress test: combined macro-fiscal shock could push public debt to 80 percent of GDP by 2020. - Key vulnerabilities: - High rollover needs: 20 percent of GDP in 2018 as about two-fifths of central government domestic debt was short-term at end-2017. - Rising net FX exposure from replacing short-term domestic debt with longer-term external borrowing. - Sovereign-banking nexus: concentration of debt holdings in a few large domestic banks; high exposure of banks to government bonds (25 percent of total assets). - Mitigating factors: - Domestic debt maturity lengthened from 1.7 to 2.2 years between 2014 and 2017. - Gross financing needs declined from a peak of 37 percent of GDP in 2014. - Authorities considering a Eurobond issuance in the last quarter of 2018 to build buffers, pre-finance external debt payments including the €450 million 2020 Eurobond, and mitigate domestic financing pressures. ### Policy discussions and recommendations - Overall focus: mitigate risks in fiscal and financial sectors; improve resilience to shocks; raise growth prospects through structural reforms. - Fiscal policy recommendations: - Implement larger up-front fiscal consolidation via stronger revenues. - Reduce debt vulnerabilities backed by sound fiscal institutions, including public finance management and state-owned enterprise (SOE) governance. - Staff recommended a more ambitious near-term fiscal adjustment of around 1.2 percent of GDP over 2018-19 to reduce public debt more rapidly. - Observations on medium-term fiscal paths (percent of GDP): - Overall balance: - IMF baseline: -2.3 (2016), -2.0 (2017), -2.1 (2018), -2.0 (2019), -1.9 (2020), -1.8 (2021) - IMF recommended path: -2.3, -2.0, -1.8, -0.8, -0.7, -0.6 - Authorities MTBF*: -2.0, -2.0, -1.7, -1.2, -0.5 - Primary balance: - IMF baseline: 0.2, 0.1, 0.1, 0.3, 0.4, 0.3 - IMF recommended path: 0.2, 0.1, 0.4, 1.5, 1.5, 1.5 - Authorities MTBF*: 0.4, 0.6, 1.0, 1.5, 2.2 - Structural primary balance: - IMF baseline: 0.4, 0.2, 0.2, 0.4, 0.5, 0.3 - IMF recommended path: 0.4, 0.2, 0.5, 1.6, 1.6, 1.5 - Authorities MTBF*: 0.2, 0.7, 1.1, 1.5, 2.2 - Public debt: - IMF baseline: 73.2 (2016), 71.8 (2017), 72.2 (2018), 69.5 (2019), 66.6 (2020), 63.9 (2021) - IMF recommended path: 73.2, 71.8, 71.9, 68.0, 64.0, 60.3 - Authorities MTBF*: 71.5, 68.7, 66.4, 63.5, 59.9 - *MTBF as of December 2017 (authorities' definitions exclude some energy sector support from deficit and omit PPPs and arrears in debt statistics). - Financial sector recommendations: - Strengthen institutional framework for resolving NPLs. - Enhance bank supervision and regulation aligned with EU standards to manage risks of systemic banks and related-party transactions. - Address sovereign-banking nexus by deepening financial markets and diversifying investor base. - Structural reforms: - Further reforms to raise competitiveness and growth potential, including improving the business climate, securing energy supplies, reducing informality, increasing human capital, and deepening financial markets. - Other fiscal risks to monitor: contingent liabilities from SOEs and PPPs, court disputes on tax and other obligations, and local government liabilities. *International Monetary Fund. Executive Summary, Albania Article IV Consultation and Selected Issues — May 3, 2018.* ### 15. Staff also called for a more operational fiscal rule to pin down the fiscal path and ### 15. Staff also called for a more operational fiscal rule to pin down the fiscal path and ### Fiscal rule, consolidation, and operational target - Staff recommended adopting a primary balance (excluding one-offs) of 1.5 percent of GDP as an operational target from 2019. - Staff advised closely monitoring debt indicators and continuing further consolidation should debt deviate significantly from its medium-term target. - Given difficulties in operationalizing the debt target and the lack of a quantitative target under the existing fiscal rule, the primary-balance target was proposed to enhance accountability and transparency of public finances. ### Tax policy measures and revenue mobilization - Fiscal consolidation should be underpinned by additional tax revenue measures; with limited room for expenditure savings, staff recommended continued efforts in improving tax policy and administration. - Specific recommendations: - Indexation of excise rates to inflation. - Environmental taxes. - Broadening the tax base and reducing informality. - Further preparatory efforts for value-based property taxation and the fiscal cadaster to ensure proper implementation. - Avoid new measures that erode the tax base. - Implement the authorities’ proposal for reverse VAT schemes cautiously to minimize fraud and prevent undermining tax administration efforts. - Extracted numerical measures (percent of GDP) as presented: - Measures already/being taken by the government: 0.20 0.06 0.05 0.05 - Harmonize cigarette excise towards EU standards: 0.12 0.06 0.05 0.05 - Increase the base for social security contributions: 0.09 --- - Lower VAT rate for tourism-related activities: 0.00 --- - Other exemptions (IT, high-tech): -0.01 --- - Permanent tax measures assumed in the baseline: 0.12 0.10 0.18 0.01 - Ad valorem transfer duty and pilot property tax: 0.12 0.10 -0.10 - - Value-based property tax: -- 0.28 0.01 - Recommended permanent tax measures: 0.32 0.78 0.14 0.13 - Index specific excises/national taxes on observed inflation (e.g., fuel excise, carbon tax, circulation tax, car registration, etc.): 0.05 0.11 0.11 0.10 - Broaden the VAT base (drugs, machineries, new residential property sales, education, advertisement, tourism): 0.03 0.16 0.03 0.03 - Reintroduce small business income tax: 0.15 -- - Reduce the zero-tax threshold to the minimum wage level: 0.19 --- - Environment and health-related excises: 0.06 0.36 -- - Time horizon labels associated with the table: 2018 2019 2020 2021 ### Fiscal institutions, public investment, PPPs, and arrears - Public investment management and PPPs: - Albania faces significant infrastructure gaps relative to regional peers; before scaling up public investment, shortcomings in project management (including in local governments and SOEs) need to be addressed. - All projects, including PPPs, should require prioritization with adequate funding available within the medium-term budgetary framework. - Fragmented decision making in PPPs and public investment spending remains a key shortcoming. - MOF has tightened oversight of PPPs, but further strengthening of budgeting, accounting, and risk assessment is needed given large contingent liabilities frequently embedded in PPP contracts. - The practice of unsolicited proposals should be eliminated. - Budgetary controls and arrears: - Strengthening budgetary and commitment controls, Treasury IT system, and cash management is crucial to prevent buildup of new arrears and expedite clearance of current stock. - Arrears represent unrecorded fiscal deficits; strengthen registration of budget commitments and record unpaid bills. - At the end of 2017, the total stock of arrears stood at 1.7 percent of GDP, of which VAT refund arrears amounted 0.7 percent of GDP. - Around 80 percent of total VAT arrears are related to three large taxpayers. - Arrears table excerpts (as presented): - Total 13,121 0.89 26,662 1.7 13,541 0.9 - Central Government 3,680 0.25 17,405 1.1 13,725 0.9 - VAT refund arrears 1,908 0.13 11,705 0.7 9,797 0.6 - Other 1,772 0.12 5,700 0.4 3,928 0.25 - Local Government 9,441 0.6 9,257 0.6 (184) -0.01 - Labels shown in table: Lek million % of GDP Lek million % of GDP Lek million % of GDP (Stock / Flow / 2016 / 2017 / 2017) Box: Public-Private Partnerships in Albania - By mid-2017, more than 200 PPP contracts had been signed, with estimated total investment equivalent to 36 percent of GDP. - A new program (the €1 Billion Program) launched in January 2017 comprises nine new PPP projects with an estimated investment cost of about 7 percent of GDP (likely procured as government-funded projects by 2021). - The current PPP framework is poorly designed and lacks proper recording and risk analysis of investment projects; integration into the public investment process, identification and allocation of explicit and implicit liabilities and risks, and quantification of potential risks over project lifetimes are lacking. - MOF is guided by a legislative threshold of annual payments not exceeding 5 percent of the previous year fiscal revenues, but these estimates mix mandatory payments, expected payments and worst-case estimates if guarantees are triggered and are not reliable without quantified potential risks. - Recommended measures: - Full-scale assessment of PPP-associated risks and their impact on the medium-term budget framework and debt sustainability. - Introduction of accrual accounting, preferably based on IPSAS, aligned with GFSM and ESA. - Develop disclosure and analysis of fiscal risks related to PPPs in the Fiscal Risk Statement, providing a comprehensive overview of contracts and mitigation policy. ### Debt management - Domestic debt market is underdeveloped, with a lack of long-term institutional investors, contributing to potential sovereign yield volatility and higher government borrowing cost if cash management is inadequate and communication with the market is poor. - Debt management capacity at the MoF requires further strengthening. - Close coordination between the MoF and BOA and the markets is needed, given high bank exposure to the public sector. - Authorities embarked on developing a primary dealers’ system to help deepen secondary market liquidity. - Staff recommended diversifying sources of financing with a combination of long-term issuance, debt buyback, and foreign concessional financing. ### Authorities’ views on fiscal policy and structural reforms - Authorities emphasized commitment to continue fiscal consolidation, but at a slower pace than recommended by staff. - They plan to closely monitor budget execution and revenue collection and undertake compensatory measures as needed to achieve the overall deficit target of 2 percent of GDP in 2018. - Authorities view further tax policy changes beyond what is in the 2018 budget as difficult to implement and potentially undermining compliance. - They considered the 60 percent of GDP medium-term debt target ambitious and believed a slightly higher debt level should be acceptable given high public investment needs. - Structural reform commitments: - Restructuring a state-owned oil and petroleum company expected to increase royalty revenues. - Committed to clearing outstanding stock of arrears and developing a payment schedule for large taxpayers aiming to repay all outstanding arrears by September 2019. - Efforts towards implementation of the Third Energy Package advancing to improve tariff setting, governance reform, and loss reduction. - Options for private investment in energy companies under consideration; reforms in water supply have started. - On PPPs, projects are high priority; risks are contained within the MTBF; unsolicited projects practice discontinued from 2021. ### Banking sector: stability, NPLs, and supervision - Banking system is stable but faces structural challenges and crisis legacy issues weighing on bank balance sheets. - Banks’ funding base remains very stable with a loan to deposit ratio of around 52 percent. - Deposits continued to grow moderately, particularly in foreign currency. - Credit to the private sector remains weak due to an overhang of NPLs, lack of creditworthy borrowers, and deleveraging by EU-owned banks. - Banks continue to invest heavily in Albanian sovereign bonds and foreign placements, including through non-resident lending. - Authorities have mitigated cross-border lending risks via exchange of information and joint inspections with host regulators. - NPL resolution: - Addressing the NPL resolution framework is crucial for revitalizing bank lending. - Staff emphasized the need to accelerate reforms, including measures related to collateral execution (e.g., success fees for bailiffs) and regulation of out-of-court restructuring agreements. - While private credit is expected to recover in 2018, authorities should monitor risks related to large corporate exposures and growth in the construction sector. - EU bank deleveraging and consolidation: - Several EU banks have announced intentions to sell Albanian subsidiaries. - Market share of EU-owned banks declined from 67 percent in 2013 to 52 percent at end-2017. - Interest from investors with banking experience remains limited; ensuring new entrants meet fit and proper criteria is critical. - An abrupt exit or large portfolio shift by a large bank could pose risks for FX and T-bill markets. - Staff underscored the need for close communication with EU-owned banks, parent banks, and peer supervisors for smooth bank consolidation. - Supervision and regulation: - Enhanced bank supervision and regulation aligned with EU standards would provide the BOA with tools to manage risks of systemic banks and build capital buffers. - Domestic banks expected to align with the IFRS9 framework by the end of 2018. - Monitoring of systemic banks should be strengthened to contain risk of large borrowers and related-party lending. - Staff suggested considering a special external diagnostic, possibly with a peer supervision authority, to assess high-risk portfolios and identify gaps in risk management focusing on large exposures. - BOA should progressively converge towards Basel III implementation and implement new D-SIB capital surcharges on a risk-based, bank-by-bank approach. ### Non-banking sector and market infrastructure - Risks from the non-banking sector include investment funds. - AFSA progress: adoption of new liquidity management framework for funds; regulations on transactions with related parties; central securities depository regulation. - Critical to complete the crisis management framework for investment funds in coordination with BOA and MOF. - Introduction of new instruments on the newly licensed stock exchange should be strictly regulated given current gaps in governance and market standards; current trading limited to sovereign securities. ### Monetary policy, de-euroization, and exchange rate regime - Bank of Albania’s policy rate remains at a historical minimum of 1.25 percent. - Staff supported BOA forward guidance that monetary tightening will not take place until early 2019 given subdued core inflation, limited wage pressures, a stable exchange rate, and low inflation in the euro area. - BOA inflation target: 3 percent. - Output gap estimate for 2018: 0.5 percent. - Any change in the policy rate should be data dependent, pending evidence of sustained rise in underlying inflationary pressures. - De-euroization strategy: - Implementation should strengthen monetary policy implementation and help limit risks from FX lending. - Shares of total deposits and loans denominated in foreign currency: 52.7 and 56.4 percent, respectively. - 26 percent of credit to the private sector represent unhedged FX-borrowers, exposing banks to indirect credit risks from FX depreciations. - De-euroization should be implemented gradually to mitigate risks of financial disintermediation in an economy with high informality. - Exchange rate policy: - The flexible exchange rate regime serves as an efficient shock absorber. - BOA has been intervening to build up FX reserve buffers per a pre-announced calendar. - Central bank interventions to build FX reserve buffers should remain fully transparent, consistent with achieving the inflation target, and any unscheduled FX interventions should be limited to preventing disorderly market conditions. *Source: IMF staff estimates.* ### 29. Safeguards assessment. The BoA has implemented all safeguards recommendations ### 29. Safeguards assessment. The BoA has implemented all safeguards recommendations ### Safeguards assessment - The BoA has implemented all safeguards recommendations except for legal amendments of the central bank law to enhance central bank governance and autonomy in line with international practices. ### Authorities’ views - The authorities agreed with the staff assessment of the monetary policy stance as well as risks stemming from excessive FX lending. - The BOA agrees that current conditions call for a supportive monetary policy, and do not expect the normalization to begin before the second quarter of 2019, depending on outcomes in the data. - The BOA and MoF are committed to adhere to de-euroization strategy, and concur that it should help limit risks from FX lending. ### Staff appraisal — macroeconomic assessment and policy priorities - Growth and structural reform - Albania is enjoying strong economic growth, but it may not last without a significant push for structural reforms. - The country is yet to take full advantage of its low labor costs and proximity with the EU due to a difficult business environment that deters investment. - It is critical that the government uses the good times to push the reform agenda to lift potential growth and position the country to benefit from potential EU accession. - Key challenges - Public debt remains high. - NPLs, while declining, continue to affect overall credit growth, particularly in the corporate sector. - The state-owned electricity sector needs to be put on a sustainable financial footing and growth-enhancing structural measures need to continue with more vigor. - Efforts to address these challenges should be redoubled to enhance the country’s resilience to shocks and mitigate vulnerabilities. - Fiscal policy and debt management - Addressing fiscal risks posed by the high level of public debt and the related financing needs remains a high priority. - This requires more fiscal adjustment, preferably in the near term. - Public debt management should focus on lengthening the maturity of public debt and diversifying the investor base, while avoiding risks posed by excessive non-concessional FX borrowing. - Debt management capacity needs to be strengthened. - Revenue mobilization and tax policy - Improving tax compliance and administration is crucial. - Progress towards value-based property taxation is welcome, but its implementation needs careful preparation. - The authorities should consider additional revenue measures, including broadening the tax base. - The authorities should refrain from lowering tax rates or granting any new tax exemptions or preferential tax treatments that could complicate the tax system and distort resource allocation. - Fiscal institutions and PPPs - Strengthening fiscal institutions and assessment of fiscal risks is a priority. - Stronger efforts are needed to enhance the credibility of the medium-term budgetary framework. - Public investment prioritization, project appraisal and monitoring are key. - The MoF should enhance the fiscal recording, and legal, financial and economic analysis of PPP projects and ensure proper implementation of the PPP framework. - The impact of PPPs on the fiscal medium-term budget framework and debt sustainability should be carefully assessed. - Arrears, VAT refunds, and public financial management - Institutional improvements are needed to tackle arrears, including in VAT refunds and unbudgeted investment projects. - The authorities should improve the VAT refund process and strengthen commitment controls, expand the Treasury’s IT system to local governments and register all unbudgeted commitments and record unpaid bills. - Measures such as reverse VAT to limit refunds should be exercised with caution. - State-owned electricity sector - Reforms in governance and financial restructuring of the state-owned electricity sector need to continue. - The endemic issues of arrears accumulation and intracompany debt should be addressed. - These measures should be backed by acceleration of institutional and market design reforms. - Monetary policy and financial stability - The current monetary policy stance is appropriate. - The policy rate is currently at a historical low rate, consistent with low inflation and external conditions. - Measures to reduce euroization and deepen domestic financial markets are welcome. - The flexible exchange rate has been an important stabilizer for the economy and the Bank of Albania has been building a comfortable buffer of foreign reserves to address external shocks. - Nonperforming loans (NPLs) - The push for legislative and institutional measures to resolve high NPL ratios needs to continue. - While NPL ratios have declined, the authorities need to accelerate measures to deal with cumbersome and inefficient collateral execution and out-of-court restructuring frameworks, which continue to impede credit growth. *Source: cr18123 - 29. Safeguards assessment. The BoA has implemented all safeguards recommendations* ### 40. Further alignment of financial sector regulation with EU standards is needed. ### 40. Further alignment of financial sector regulation with EU standards is needed. ### Key findings and rationale - Gradual convergence with the Basel III framework is warranted. - Capital requirements should be imposed on a risk-based, bank-specific approach to tackle risks within certain banks. - Recent efforts of the authorities to implement targeted regulations to address risks from related party transactions and cross-border flows are welcome. - The crisis management framework for non-bank financial institutions needs to be finalized to enhance system’s resilience to shocks and mitigate financial stability risk. ### Policy recommendations - Gradually align financial sector regulation with EU standards, including advancing convergence with Basel III. - Implement capital requirements using a risk-based, bank-specific methodology to address idiosyncratic risks in banks. - Continue and expand targeted regulations to mitigate risks from related party transactions and cross-border flows. - Finalize and operationalize the crisis management framework for non-bank financial institutions to strengthen the system’s resilience to shocks and reduce financial stability risks. *Source: cr18123 - 40. Further alignment of financial sector regulation with EU standards is needed.* ### Annex I. Risk Assessment Matrix ### Annex I. Risk Assessment Matrix ### Major Risks, Likelihood, Impact, and Policy Advice - Weaker-than-expected global growth - Relative Likelihood: High - Impact if Realized: High - Description: Structurally weak growth in key advanced economies. Weaker than anticipated growth (particularly in Greece and Italy, the main export destinations and sources of remittances) might spill over to Albania and test the authorities’ perseverance with reforms. - Policy Advice: - Continue to diversify export markets. - Improve the domestic policy environment to support growth in domestic consumption and investment. - Financial conditions: Tighter global financial conditions - Relative Likelihood: High - Impact if Realized: Medium - Description: Tapering by the ECB could raise interest rates in Albania and stress-test public debt service. Faster-than-expected Fed normalization could lead to dollar appreciation against the euro, pushing up Albania’s public-debt-to-GDP ratio. - Policy Advice: - Persist with fiscal consolidation and further lengthen the maturity of public debt. - Target improvements in public debt management which would make the debt stock less sensitive to fluctuations in the euro-dollar exchange rate. - Disruption of credit intermediation - Relative Likelihood: Medium - Impact if Realized: Low - Description: Financial turmoil in Greece or Western Europe could weigh on investor confidence. A potential abrupt and disorderly exit of a large foreign bank could stress the domestic banking system and create pressures on the market for domestic public debt. - Policy Advice: - Continue sharing information with parent banks and their regulators, strengthen contingency plans, and closely monitor capital and liquidity positions. - In the event of a change of ownership, ensure that fit-and-proper rules are enforced. - Fully align Albanian bank regulation with EBA. - Adverse weather conditions - Relative Likelihood: Medium - Impact if Realized: Medium - Description: Continued drought conditions could affect electricity generation in 2018. Power shortages could damage growth. Electricity imports could pose quasi-fiscal risks for the budget. - Policy Advice: - Reinvigorate the implementation of the electricity sector reform. - Diversify domestic sources of electricity. - Poorly designed PPPs - Relative Likelihood: Medium - Impact if Realized: Medium - Description: A rush to sign poorly designed PPP contracts for infrastructure investment could create large contingent liabilities, the realization of which could undermine fiscal and debt sustainability and impede efficiency of public investment. - Policy Advice: - Fully implement the PPP law to ensure PPP contracts are well-designed and will not create significant contingent liabilities on the public balance sheet. - Upgrade the capacity of Fiscal Risk Unit to undertake financial analysis of new PPP contracts. - Rollover of public debt - Relative Likelihood: Low - Impact if Realized: High - Description: Concerns about debt sustainability may make banks reluctant to roll over government debt, a significant part of which is short-term. - Policy Advice: - Further lengthen the maturity of public debt and diversify the holder base. - Improve market communication. - Continue fiscal adjustment and debt reduction. - Domestic political instability - Relative Likelihood: Low - Impact if Realized: High - Description: Volatile domestic politics could hinder the implementation of the authorities’ structural reform and fiscal consolidation agenda. Reforms improving the business environment are key for medium-term growth prospects. Failure to advance in these areas would undermine medium-term debt sustainability. - Policy Advice: - Continue reforms improving the business environment to support medium-term growth and debt sustainability. - Lower energy prices - Relative Likelihood: Low - Impact if Realized: Medium - Description: A decline in oil prices could hurt fiscal revenues and growth, by forcing a scale-back in investment and domestic production. On the upside, since Albania is a net oil importer, low prices could boost domestic demand. - Policy Advice: - Implement additional fiscal measures, as needed, to meet fiscal targets. ### Adverse Scenario — Summary and Key Assumptions - Scenario description: - Delays in reforms result in: - a decline of real GDP growth to 3 percent over the medium-term (compared to 4 percent in the baseline), - the government being unable to issue new Eurobonds and thereby increasing domestic issuances, resulting in an increase in domestic borrowing costs by 200 basis points compared to the baseline, - reduced access to foreign financing triggers a depreciation that is 3 percent more than that in the baseline during 2018-19. - Main outcome: - Despite the adverse scenario, the government debt stabilizes at about 74 percent of GDP and reserves decline to a still adequate level of 4.5 month of imports by 2023, indicating that Albania will still have enough capacity to repay the Fund. - Even under this adverse scenario, debt service to the Fund is expected to peak at around 0.5 percent of GDP or 2.2 percent of reserves. ### Selected Indicators: Adverse Scenario (highlights and projections) - Real GDP Growth (percent) - 2016: 3.4 - 2017: 3.8 - 2018: 3.6 - 2019: 3.0 - 2020: 3.0 - 2021: 3.0 - 2022: 3.1 - 2023: 3.1 - Inflation (avg., percent) - 2016: 1.3 - 2017: 2.0 - 2018: 2.5 - 2019: 2.8 - 2020: 3.2 - 2021: 3.1 - 2022: 2.9 - 2023: 2.9 - Current account (percent of GDP) - 2016: -7.6 - 2017: -6.9 - 2018: -6.9 - 2019: -5.9 - 2020: -4.7 - 2021: -3.8 - 2022: -3.4 - 2023: -3.3 - Reserves (months of Imports) - 2016: 6.5 - 2017: 6.3 - 2018: 5.7 - 2019: 5.6 - 2020: 5.0 - 2021: 4.9 - 2022: 4.7 - 2023: 4.5 - Fiscal overall balance (percent of GDP) - 2016: -2.3 - 2017: -2.0 - 2018: -2.2 - 2019: -3.1 - 2020: -3.4 - 2021: -3.7 - 2022: -4.1 - 2023: -3.5 - Primary balance (percent of GDP) - 2016: 0.2 - 2017: 0.1 - 2018: 0.0 - 2019: 0.0 - 2020: 0.0 - 2021: -0.3 - 2022: -0.4 - 2023: -0.2 - Government debt (percent of GDP) - 2016: 73.2 - 2017: 71.8 - 2018: 72.3 - 2019: 72.8 - 2020: 73.7 - 2021: 73.7 - 2022: 74.2 - 2023: 74.3 ### Indicators of Capacity to Repay to the Fund, 2013-23: Adverse Scenario (selected time series) - Fund repurchases and charges (In millions of SDRs) - 2013: 6.9 - 2014: 6.1 - 2015: 5.3 - 2016: 5.4 - 2017: 6.8 - 2018: 9.5 - 2019: 20.9 - 2020: 33.2 - 2021: 48.9 - 2022: 52.7 - 2023: 51.8 - Fund repurchases and charges (In millions of euro) - 2013: 7.7 - 2014: 7.2 - 2015: 6.8 - 2016: 6.9 - 2017: 8.1 - 2018: 11.1 - 2019: 24.3 - 2020: 38.4 - 2021: 56.4 - 2022: 60.8 - 2023: 59.6 - Fund repurchases and charges (In percent of gross international reserves) - 2013: 0.4 - 2014: 0.3 - 2015: 0.2 - 2016: 0.2 - 2017: 0.3 - 2018: 0.4 - 2019: 0.9 - 2020: 1.5 - 2021: 2.1 - 2022: 2.2 - 2023: 2.2 - Fund credit outstanding (end of period) (In millions of SDRs) - 2013: 16.4 - 2014: 57.7 - 2015: 129.3 - 2016: 241.5 - 2017: 296.8 - 2018: 291.7 - 2019: 277.3 - 2020: 249.6 - 2021: 205.1 - 2022: 155.9 - 2023: 106.7 - Fund credit outstanding (end of period) (In percent of gross international reserves) - 2013: 0.9 - 2014: 3.1 - 2015: 5.7 - 2016: 10.5 - 2017: 11.8 - 2018: 12.1 - 2019: 11.3 - 2020: 11.0 - 2021: 8.9 - 2022: 6.6 - 2023: 4.5 - Memorandum items (selected) - Gross international reserves: 1795, 1855, 2261, 2305, 2506, 2405, 2447, 2262, 2309, 2345, 2389 - Exports of goods and services: 2479, 2381, 2197, 2432, 3054, 3407, 3669, 3903, 4148, 4420, 4721 - GDP: 8575, 8437, 8057, 8405, 9606, 9683, 1040, 1105, 6810, 6411, 0951, 11492, 12055 (as presented) - External public debt: 2351, 2458, 2692, 2925, 3215, 3433, 3586, 3493, 3524, 3535, 3542 (as presented) - Quota: 60.0, 60.0, 60.0, 139.3, 139.3, 139.3, 139.3, 139.3, 139.3, 139.3, 139.3 (as presented) *Source: Fund staff estimates.* ### Annex III. Debt Sustainability Analysis (DSA) ### Annex III. Debt Sustainability Analysis (DSA) ### A. Background - Following rapid growth, public debt declined in 2017 for a second consecutive year, but remained high at nearly 72 percent of GDP at end-2017. - Public debt rose by around 13 percentage points of GDP between 2010 and 2013 due to high primary deficits and slowing growth; fiscal consolidation since 2014 slowed accumulation and reversed it in 2016. - Macroeconomic assumptions: - Real growth gradually recovers to around 4 percent over the medium term. - Inflation expectations anchored by the central bank’s 3 percent target. - Fiscal consolidation: a consolidation of over 2 percent of GDP in 2014–16; primary balance rising from 0.1 percent of GDP to 0.4 percent in the medium term. - Debt maturity profile: - Average weighted maturity of domestic public debt has more than doubled since 2011 and now exceeds two years. - Shift from short-term domestic to long-term external financing, including from donors. ### B. Public DSA Results — Baseline and Risks - Baseline outlook: - Public debt will decline gradually but remain at elevated levels of above 60 percent of GDP until 2023. - Baseline nominal gross public debt (in percent of GDP): 2016: 62.6; 2017: 73.2; 2018: 71.8; 2019: 72.2; 2020: 69.5; 2021: 66.6; 2022: 63.9; 2023: 60.4. - Public gross financing needs (in percent of GDP): 2016: 39.1; 2017: 28.3; 2018: 25.0; 2019: 21.2; 2020: 19.1; 2021: 22.7; 2022: 19.1; 2023: 21.6. - Real GDP growth (in percent): 2016: 3.3; 2017: 3.4; 2018: 3.8; 2019: 3.6; 2020: 3.7; 2021: 3.9; 2022: 3.9; 2023: 4.0. - Inflation (GDP deflator, in percent): 2016: 2.4; 2017: -0.5; 2018: 1.4; 2019: 2.0; 2020: 2.4; 2021: 2.7; 2022: 2.8; 2023: 2.7. - Effective interest rate (in percent): 2016: 5.6; 2017: 3.6; 2018: 3.1; 2019: 3.4; 2020: 3.4; 2021: 3.7; 2022: 3.8; 2023: 4.4. - Vulnerabilities and risks: - High rollover needs and vulnerability to macroeconomic shocks from slow growth, low inflation, and volatility in interest rates and terms of trade. - Heavy reliance on the banking sector: banks held 60 percent of domestic public debt at end-2017; concentration of domestic debt holdings in a few local banks exacerbates rollover risk. - About two-fifths of central government domestic direct debt was short-term at end-2017 (ratio expected to decline as international issuances take place). - Public gross financing needs projected to remain well above the 15 percent of GDP early warning threshold associated with past debt crises. - Interest rate risk expected to increase with lengthening maturities; mitigating factors include limited secondary market liquidity, banks’ preference to hold to maturity, and increasing share of external donor financing. - Exchange rate risk will rise with expanding foreign-currency debt, but Albania’s comfortable international reserves should limit disorderly depreciation risk and help cover external debt service. - Alternative scenarios and stress tests: - Historical-scenario outcome: by 2023 public debt would be around 73 percent of GDP; gross financing needs stabilize at about 20 percent of GDP in 2023. - Combined macro-fiscal shock (worst among stress tests): debt-to-GDP increases to around 80 percent in 2019-20, then gradually declines to around 76 percent by 2023; gross financing needs increase to 29 percent of GDP by the end of the forecast horizon. - Growth shock (real GDP growth negative shock of one standard deviation in 2018–19): public debt would be just under 65 percent of GDP in 2023. - Fan-chart simulation results: - Under a symmetric distribution, an 80 percent confidence interval for the debt stock in 2023 ranges between 51 and 68 percent of GDP. - Under a restricted distribution (precluding positive shocks to the primary balance), debt could be above 66 percent of GDP by 2023 with a probability of almost 25 percent, relative to the baseline scenario of 59 percent of GDP. - Assessment of baseline realism: - Historical scenario has limited validity given the policy break since 2014. - Authorities committed to gradual debt reduction and growth acceleration via structural reforms. - Forecast track record: growth forecasts do not show large systematic bias; primary balance forecasts have been too pessimistic (percentile rank 89 percent); inflation forecasts have been too optimistic (percentile rank 15 percent). - Medium-term growth projections considered realistic given low per capita income, high FDI inflows, potential launch of EU accession negotiations, and authorities’ reform record. ### C. External Debt Sustainability - External debt levels and composition: - External debt estimated to have peaked at around 63 percent of GDP in 2017 and is expected to decline to 49 percent by 2023. - Most external debt is held by multilateral creditors and bilateral development agencies. - Most foreign public debt denominated in euros (inter-government loans and the Eurobond), followed by SDRs (IMF loans). - External private borrowing expected to fall from about 27 percent of GDP to 19 percent of GDP by 2023; FDI-related debt liabilities remain the largest component of private external debt. - External debt service and financing: - Public and private external debt service expected to rise through the medium term, increasing to 11 percent of GDP in 2020 as the €450 million 2015 Eurobond issuance is amortized. - Authorities expect to roll over the Eurobond and are considering pre-financing options through a new Eurobond issuance to mitigate rollover and interest rate risk. - External stress tests: - 30 percent exchange rate depreciation shock: external debt would peak at 90 percent of GDP in 2018 before declining to 72 percent by 2023 as commercial debt amortizes. - Current-account shock (half a standard deviation, around 2½ percent of GDP): external debt would peak at 63 percent of GDP in 2019 and decline to 57 percent by 2023. - Bound tests and additional scenarios indicate vulnerability under historical and combined shocks; example scenario outcomes cited: - Historical scenario external debt projection peak 81 percent (historical), baseline 49 percent (presented in figure notes). - Combined shock and CA shock scenarios show higher external debt trajectories (figures referenced). - Selected external-debt table highlights (Table 1): - Baseline external debt (in percent of GDP): 2013: 60.5; 2014: 56.1; 2015: 63.0; 2016: 61.9; 2017: 63.2; 2018: 63.1; 2019: 61.5; 2020: 59.1; 2021: 55.7; 2022: 52.4; 2023: 49.5. - Change in external debt (in percent of GDP): 2013: 8.8; 2014: -4.4; 2015: 7.0; 2016: -1.2; 2017: 1.3; 2018: -0.1; 2019: -1.5; 2020: -2.4; 2021: -3.4; 2022: -3.4; 2023: -2.9. - Gross external financing need (in percent of GDP): 2013: 12.7; 2014: 16.7; 2015: 19.6; 2016: 13.4; 2017: 12.7; 2018: 10.9; 2019: 10.6; 2020: 13.4 (in billions of US dollars figures also reported). - Scenario with key variables at historical averages projects external debt rising (examples in table). ### D. Conclusion and Policy Recommendations - Overall assessment: - Despite significant fiscal adjustment since 2014, Albania’s debt remains high and poses significant risks. - Standardized heat map: debt and gross financing needs are above relevant thresholds under the baseline (highlighted in red); the share of short-term debt has been declining (green), but key indicators remain above lower risk-assessment benchmarks (yellow). - Risks are partially mitigated by a significant share of public debt held by external donors. - Policy priorities and recommendations: - Continue fiscal consolidation to reduce debt vulnerabilities and support macroeconomic stability. - Steadfast implementation of structural reforms to accelerate growth and improve debt dynamics. - Strengthen debt management capacity and lengthen debt maturity to mitigate rollover, interest rate, and concentration risks. - Consider options to mitigate Eurobond-related rollover and interest rate risk, including pre-financing strategies. - Risks to monitor: - High rollover requirements, concentration of domestic holdings in the banking sector, potential sharp increases in interest rates, and adverse growth or exchange rate shocks. *Source: IMF staff, Annex III. Debt Sustainability Analysis (DSA).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18123.pdf_