## ALBANIA

## Source details

**Canonical URL:** [ALBANIA](https://www.imf.org/-/media/files/publications/cr/2019/1albea2019003.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/cr/2019/1albea2019003.pdf.md)
- [Structured JSON version](/-/media/files/publications/cr/2019/1albea2019003.pdf.json)

---

### CONTEXT
- Two years after the end of the last IMF-supported program, Albania faces pressing policy challenges despite robust economic growth.
- Key vulnerabilities: climatic conditions, adverse demographic developments, external spillovers.
- Structural reforms have slowed since program completion; reforms should focus on reducing vulnerabilities in economic growth and public finances, and on improving governance and productivity to raise living standards and reduce emigration.
- Political uncertainty increased since February 2019 with opposition renunciations of parliamentary seats and a dispute over local elections after the President cancelled end-June polls (President’s decision on June 10).

### RECENT DEVELOPMENTS AND OUTLOOK
- Growth and composition
  - Real GDP grew by 4.1 percent in 2018—the highest rate since the global financial crisis.
  - Largest single contribution to 2018 growth was record-high hydropower production, contributing 0.9 percentage point.
  - Demand-side driver: consumption.
  - Current account deficit narrowed to 6.8 percent of GDP in 2018.
- Inflation and monetary policy
  - Headline inflation: 1.4 percent in April 2019, below the Bank of Albania’s (BOA) 3 percent target.
  - Core inflation: remained below 1 percent over the last six months.
  - Policy rate: historic-low 1 percent since the June-2018 rate cut.
  - Central bank FX interventions ceased in fall 2018 after earlier spot-market purchases beginning June 2018.
  - Monetary stance: very accommodative; normalization should be data-driven.
  - Inflation outlook: expected to converge slowly toward 3 percent by 2021; BOA expected inflation to reach 3 percent in 2020.
- Fiscal developments
  - Fiscal deficit declined to 1.6 percent of GDP in 2018 (down 0.4 percentage points from 2017).
  - Public debt declined to 69.9 percent of GDP (including arrears) from 71.9 percent in 2017.
  - Domestic government arrears: 1.8 percent of GDP as of end-2018.
- Outlook
  - 2019 growth expected to slow to 3.5 percent due to base effects from 2018 power generation and slower growth in partner countries.
  - Medium-term GDP growth projected to converge to its 4 percent potential rate.
  - Drivers of medium-term growth: pickup in EU growth, increasing labor market participation, strengthening exports including tourism, investments to close infrastructure gap.
  - Current account deficit projected to narrow over the medium term supported by strong export growth and planned fiscal consolidation.
- Authorities’ views
  - Ministry of Finance expected GDP growth to exceed 4 percent in 2019, citing construction surge and a record-high tourist season.
  - BOA prepared to take measures as needed to attain inflation objectives.

### CAPACITY TO REPAY THE FUND
- Fund exposure and reserves
  - Fund credit outstanding: 2.8 percent of GDP or 10.4 percent of gross international reserves in 2018.
  - FX reserves: 26 percent of GDP or 6½ months of imports in 2018.
  - Fund credit-outstanding: 209.4 percent of quota at end-2018; expected to remain above 200 percent of quota until November-2019 (PPM threshold: 200 percent of quota).
  - Debt service to the Fund: expected to peak in 2022 at around 0.4 percent of GDP and 1.5 percent of reserves.
  - Reserve coverage: 189 percent of the ARA metric at end-2018 and more than nine times Fund credit outstanding.
- Assessment
  - Baseline assessment: Albania’s capacity to repay is adequate under the baseline.
  - Albania’s strong record of repaying the Fund and relative macroeconomic stability suggest repayment risks are contained.
- Public debt and fiscal vulnerabilities
  - Under the baseline, public debt is envisaged to decline to 56.8 percent of GDP by 2024.
  - Debt remains high and is sensitive to shocks—individual stress tests show particular sensitivity to GDP growth and interest rate shocks.
  - Combined macro-fiscal shock scenario would bring debt close to 72 percent of GDP as of 2020.
  - All scenarios exclude contingent liabilities from increasing PPP-financed investment and from energy sector losses.
  - Domestic debt concentration: around 60 percent of domestic debt is held by the domestic banking system, concentrated in a few large banks.
- Financing needs and risks
  - Gross public financing needs declined from 37 percent of GDP in 2014 to about 19 percent of GDP in 2019.
  - Gross public financing needs are projected to remain above the 15 percent threshold (in the DSA) through the entire projection period.
  - Main sources of borrowing have been concessional (bilateral and multilateral donors); authorities increasingly using external commercial borrowing.
  - Main vulnerabilities: rollover risk, concentration risk due to limited long-term institutional investors, and exchange rate risk—especially if external financing conditions tighten.
- Mitigating factors
  - Robust reserve coverage and a flexible exchange rate provide important shock absorption.
  - Access to donor-funded concessional and longer-term financing also mitigates near-term foreign exchange availability risks.

### RISKS AND POLICY DISCUSSIONS (key risks and policy implications)
- Risks to growth
  - Dependence on hydropower and climatic variability introduces volatility to growth (e.g., 2018 hydropower surge).
  - External spillovers from partner country slowdowns could lower growth (2019 baseline growth slowed to 3.5 percent).
- Risks to public finances
  - High public debt and large gross public financing needs pose rollover and concentration risks.
  - Increasing reliance on external commercial borrowing raises exchange rate and rollover vulnerabilities.
  - Large contingent liabilities from PPPs and energy sector losses are not fully captured in baseline scenarios.
- Financial sector risks
  - High concentration of domestic debt in a few large banks increases systemic vulnerability (around 60 percent held by domestic banking system).
- Policy priorities (as implied by staff analysis)
  - Continue fiscal consolidation to reduce public debt vulnerabilities while protecting investment in infrastructure.
  - Strengthen debt management to reduce rollover and concentration risks and to diversify investor base and maturities.
  - Maintain accommodative, data-driven monetary policy until inflation sustainably converges to target.
  - Advance structural reforms to improve governance, productivity, and resilience to climate and demographic risks.

### EXTERNAL SECTOR ASSESSMENT HIGHLIGHTS
- The External Sector Assessment presented in the January 2019 Staff Report for the 2018 Article IV Consultation remains valid.
- Successful allocation of Eurobonds and a buyback operation in 2018 helped improve the profile and maturity of public debt.
- Near-term growth shocks (including the impact of draught and political uncertainties) appear less likely to have a material impact on capacity to repay.

### RISKS TO GROWTH — SPECIFICS
- Supply-side contributors to growth: electricity production, services, and construction — all prone to external and domestic risks.
- Demand-side: net exports have been the most volatile contributor to growth.
- External risks: slowdown among Albania’s main trading partners could reduce exports, remittance inflows and FDI.
- Domestic vulnerabilities:
  - Working age population declined by 0.6 percent over 2015-‘19.
  - Population above 65 years increased by 12 percent during 2015-‘19.
  - A severe draught shock as occurred in 2017 could worsen the trade balance by about 0.6 percent of GDP (assuming a generation shortfall of 2000 Gwh and an import price of 40 Euros per Mwh), with a similar potential impact on the public finances.
- Policy emphasis:
  - Improve management and financial viability of the energy sector.
  - Improve quality of human capital.
  - Lift exports and tourism by leveraging low labor cost and proximity to the EU, requiring improvements in economic governance, transportation infrastructure, and the investment environment.

### PUBLIC FINANCES — RISKS AND STAFF RECOMMENDATIONS
- Fiscal outcomes and projections:
  - Fiscal deficit declined to 1.6 percent in 2018.
  - Absent further measures, projected to widen to 2.5 percent of GDP in 2019 (including guarantees for new loans to the energy sector of 0.4 percent of GDP).
- Drivers of widening deficit:
  - Planned repayment of government arrears.
  - Recent tax measures that erode the tax base.
  - Risks of further revenue shortfalls and expected losses in the energy sector due to lower hydropower production.
  - Rising contingent liabilities and potential higher financing costs from tightening financial conditions in the euro area.
- Staff recommendations:
  - Use favorable environment to strengthen the revenue base.
  - Front-load fiscal adjustment to bring the primary surplus to 1.5 percent of GDP by 2021 to build fiscal buffers and ensure faster convergence of debt towards the 45 percent objective in the organic budget law.
  - Achieve adjustment through higher revenues rather than expenditure cuts.
  - Bolster the fiscal rule, including by putting a cap on annual fiscal deficits (with an escape clause for severe downturns).
- Tax system specifics (headline rates as of May 2019):
  - standard VAT rate is 20 percent
  - standard CIT rate is 15 percent
  - top personal income tax rate is 23 percent
- Staff advice on tax policy and arrears:
  - Reverse measures that fragment and weaken the tax base and level the playing field across businesses.
  - Develop a medium-term revenue strategy (MTRS) covering tax policy and administration.
  - Ensure full and timely payment of all validated new VAT refund requests from now on, disconnecting them from corresponding revenue flows.
  - Strengthen commitment controls for investment projects to end government payment arrears, in particular by the road fund.
- Authorities’ view:
  - Expected to meet their 1.9 percent of GDP deficit target for 2019, having identified sufficient buffers on the spending side to offset expected revenue shortfalls.
  - Planned to prevent creation of new VAT refund arrears and to settle existing arrears on an accelerated schedule (mostly within 2019).
  - Preparing a broad diagnosis of the revenue system and a medium-term roadmap for reform.
  - Agreed to maintain three-month Treasury instruments to support financial market development.

### VAT EFFECTIVENESS AND ARREARS
- VAT C-efficiency: 0.54.
- Stock of VAT refund arrears: 1.2 percent of GDP at end-2018.
- Staff proposals:
  - Structural changes to reduce new refund claims (e.g., reverse-charge mechanism for the TAP project) and a gradual repayment schedule based on consultations with the private sector.
  - Expand the VAT base and eliminate preferential reduced rates; reconsider recent lowering of VAT registration threshold from ALL 5 to ALL 2 million.
- Staff welcomed authorities’ plans to repay VAT refund arrears mostly within 2019.

### DEBT MANAGEMENT AND DOMESTIC DEBT MARKET
- Staff recommendations:
  - Resume issuance of short-term (three-months and six months) T-bills to support cost-efficient cash-flow management, development of secondary and hedging markets, and BOA liquidity management.
  - Strengthen MOFE’s debt management capacity and ensure good coordination with the BOA.
- Rationale:
  - Building a robust and liquid domestic debt market mobilizes domestic savings and reduces currency and rollover risks.

### PPPs, AIC, AND PUBLIC INVESTMENT MANAGEMENT
- Current PPP usage and risks:
  - More than 200 PPP projects contracted (31 percent of GDP), with about 15 percent of GDP in the pipeline (based on 2019 budget documentation).
  - Projected annual budget payments for government-funded PPPs approaching legislated ceiling: 5 percent of the previous year’s fiscal revenues.
  - Power generation projects account for about 23 percent of GDP and are covered by power purchase agreements with little apparent residual fiscal risk; most other projects relate to infrastructure and are in planning or construction phases, with fiscal risks likely materializing over medium to longer term.
- Staff advice:
  - Use proposed PPP law amendments to limit PPP-related contingent liabilities and ensure consistent public investment management.
  - Ensure MOFE, as gatekeeper for PPPs, has capacity to assess risks and costs, particularly in pre-feasibility stage, with access to all contractual information from line-ministries (including existing projects).
  - Reverse fragmentation of decision making in public investment management and abolish unsolicited proposals for PPPs.
- Albania Investment Corporation (AIC):
  - Staff strongly advised revisiting AIC proposals to avoid budget and public investment management risks:
    - Draft law risks making AIC an off-budget spending tool and eroding fiscal discipline.
    - Framework should ensure AIC operates on a commercial basis and at arm’s length from government.
    - Law should affirm operational independence, limit explicit government financial contributions, and make AIC subject to the Public Procurement Law.
- Authorities’ view:
  - Preparing MOFE’s role as gatekeeper for PPPs, upgrading risk management with TA from World Bank and the Fund.
  - Considering IFI feedback on AIC plans.
  - Financial recovery plan for the power sector recently adopted.

### ENERGY SECTOR VULNERABILITIES
- Sector issues:
  - Energy sector is financially weak and struggling with endemic arrears, with dependence on rainfall exacerbating financial vulnerability and creating risks for the government budget.
- Staff encouraged implementation of the restructuring plan for the sector prepared with World Bank advice to put the sector on a sustainable financial footing.

### Box 2 — Albania’s Power Sector: Challenges and Solutions (summary)
- Sector structure and recent developments:
  - Sector consists of three major SOEs—for generation (KESH), transmission (OST), and distribution (OSHEE)—and more than one-hundred small private and concession-type hydropower plants (HPPs).
  - KESH generates about two-thirds of the total electricity production from three hydro-powerplants on the Drin cascade.
  - The country’s only thermal power plant is currently non-operational.
  - The Trans-Adriatic Pipeline (TAP) construction is expected to finish in 2019.
- Key challenges:
  - Heavy reliance on hydropower creates significant weather-related vulnerabilities, with escalating import needs in years of drought.
  - Persistent governance problems have left the sector with sizeable intra-company and intra-sector arrears.
  - Underlying problems include lack of accountability and transparency, and distortions in intra-company pricing mechanisms.
- Authorities’ strategy and planned solutions (financial recovery plan aims at):
  - (i) Improving the governance of the power companies, cleaning their balance sheets, and establishing rules for clearing intra-company and intra-sector arrears,
  - (ii) establishing targets and controls for loss reduction,
  - (iii) establishing clear borrowing rules, including for bank overdrafts,
  - (iv) improving transparency and accountability concerning investment plans, and
  - (v) the unbundling of OSHEE and finalizing the sector’s liberalization.

### ANNEX I — RISK ASSESSMENT MATRIX (selected entries)
- International Macroeconomic Environment
  - Relative Likelihood: High
  - Impact if Realized: High
  - Findings: Growing global uncertainties and further weakening of growth across Europe might spill over to Albania resulting in lower demand for exports and a decline in remittances.
  - Policy Advice: Continue to diversify export markets; accelerate fiscal consolidation to build buffers; resolve structural bottlenecks to credit growth; if a significant external shock materializes, allow automatic stabilizers to operate while strengthening the debt anchor.
- International Financial Conditions
  - Relative Likelihood: Medium
  - Impact if Realized: Medium
  - Findings: An increase in the risk premium could raise interest rates for Albania and reduce international investor appetite for Albanian securities.
  - Policy Advice: Persist with fiscal consolidation and further lengthen the maturity of public debt; optimize the foreign debt portfolio based on risk-return tradeoff analysis.
- Domestic risks — Financial disintermediation
  - Relative Likelihood: Medium
  - Impact if Realized: Medium
  - Findings: An 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; conduct strict fit and proper assessment of new entrants; continue to align bank regulations with European standards.
- Domestic risks — Poorly designed PPPs & increased contingent liabilities
  - Relative Likelihood: High
  - Impact if Realized: Medium
  - Findings: Poorly designed PPP contracts could impede efficiency of public investment and create large contingent liabilities.
  - Policy Advice: Strengthen governance and transparency in PPP implementation; upgrade MOFE capacity for financial analysis of new PPP contracts.
- Domestic risks — Adverse weather conditions
  - Relative Likelihood: Medium
  - Impact if Realized: Medium
  - Findings: Drought conditions could affect electricity generation, damage growth, and create quasi-fiscal risks from electricity imports.
  - Policy Advice: Reinvigorate electricity sector reform; finalize financial restructuring plans; prepare a backup power supply plan.
- Domestic risks — Domestic political instability
  - Relative Likelihood: Low
  - Impact if Realized: High
  - Findings: Volatile domestic politics and social tensions could hinder implementation of structural reforms and fiscal consolidation.
  - Policy Advice: Ensure reforms are grounded in careful policy analysis and a consultative preparation process.

### STRESS TESTS AND DSA HIGHLIGHTS
- Stress test headline results
  - Under a 30 percent exchange rate depreciation shock, external debt would peak at 82 percent of GDP in 2020 before declining to 67 percent by 2024.
  - A shock to the current account of half a standard deviation (around 2 percent of GDP) would cause external debt to peak at 54 percent of GDP in 2020 and gradually decline to 52 percent by 2023.
- Baseline public sector debt projections (selected indicators; nominal gross public debt in percent of GDP and other series)
  - Nominal gross public debt: 2017: 64.8; 2018: 71.9; 2019: 69.9; 2020: 66.3; 2021: 64.6; 2022: 61.6; 2023: 59.7; 2024: 57.1; 56.8
  - Public gross financing needs: 2017: 36.8; 2018: 25.0; 2019: 22.0; 2020: 19.2; 2021: 16.5; 2022: 15.5; 2023: 16.1; 2024: 15.1; 15.8
  - Real GDP growth: 2017: 3.0; 2018: 3.8; 2019: 4.1; 2020: 3.5; 2021: 4.0; 2022: 4.0; 2023: 4.0; 2024: 4.0; 4.0
  - Inflation (GDP deflator): 2017: 1.8; 2018: 1.5; 2019: 0.7; 2020: 2.0; 2021: 2.4; 2022: 2.8; 2023: 3.0; 2024: 3.0; 3.0
  - Nominal GDP growth: 2017: 4.8; 2018: 5.4; 2019: 4.8; 2020: 5.6; 2021: 6.5; 2022: 6.9; 2023: 7.1; 2024: 7.1; 7.1
  - Effective interest rate: 2017: 5.4; 2018: 3.1; 2019: 3.4; 2020: 3.5; 2021: 2.8; 2022: 2.9; 2023: 3.0; 2024: 3.5; 3.9
- Debt dynamics drivers (selected contributions)
  - Change in gross public sector debt: 2017: 2.2; 2018: -1.5; 2019: -1.9; 2020: -3.6; 2021: -1.7; 2022: -3.0; 2023: -1.9; 2024: -2.6; cumulative: -0.3; cumulative over projection horizon: -13.1
  - Identified debt-creating flows: 2017: 2.8; 2018: -2.1; 2019: -1.8; 2020: -2.5; 2021: -1.6; 2022: -2.9; 2023: -1.9; 2024: -2.6; cumulative: -1.3; cumulative over projection horizon: -12.8
  - Primary deficit: 2017: 1.5; 2018: -0.1; 2019: -0.6; 2020: 0.5; 2021: 0.0; 2022: -0.2; 2023: -0.2; 2024: -0.4; cumulative: -0.4; cumulative over projection horizon: -0.7
  - Automatic debt dynamics: 2017: 1.3; 2018: -3.3; 2019: -3.0; 2020: -1.3; 2021: -2.2; 2022: -2.3; 2023: -2.2; 2024: -1.9; cumulative: -1.0; cumulative over projection horizon: -10.9
  - Exchange rate depreciation contribution: 2017: 0.8; 2018: -1.7; 2019: -2.1
- Alternative scenarios and stress-test variants (selected outcomes)
  - Historical scenario: Historical: 77
  - Baseline scenario: Baseline: 45
  - Current account (CA) shock (half standard deviation, ~2 percent of GDP): CA shock: 52
  - Combined shock (permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance): Combined shock: 49
  - Real depreciation shock (one-time real depreciation of 30 percent occurs in 2010 in illustrative historical test): Real depreciation shock: 67
- Risk assessment highlights (2018 reference values where provided)
  - Bond spread (bp): 203
  - External financing requirement: 12 (in percent of GDP)
  - Public debt held by non-residents: 44 percent (of total)
  - Public debt in foreign currency: 12 percent (of total)

*International Monetary Fund. June 13, 2019.*

### 2.8 percent of GDP or 10.4 percent of gross international reserves in 2018. Albania’s

### ALBANIA

### CONTEXT
- Two years after the end of the last IMF-supported program, Albania faces pressing policy challenges despite robust economic growth.
- Key vulnerabilities: climatic conditions, adverse demographic developments, external spillovers.
- Structural reforms have slowed since program completion; reforms should focus on reducing vulnerabilities in economic growth and public finances, and on improving governance and productivity to raise living standards and reduce emigration.
- Political uncertainty increased since February 2019 with opposition renunciations of parliamentary seats and a dispute over local elections after the President cancelled end-June polls (President’s decision on June 10).

### RECENT DEVELOPMENTS AND OUTLOOK
- Growth and composition
  - Real GDP grew by 4.1 percent in 2018—the highest rate since the global financial crisis.
  - The largest single contribution to 2018 growth was record-high hydropower production, contributing 0.9 percentage point.
  - Demand-side driver: consumption.
  - Current account deficit narrowed to 6.8 percent of GDP in 2018.
- Inflation and monetary policy
  - Headline inflation: 1.4 percent in April 2019, below the Bank of Albania’s (BOA) 3 percent target.
  - Core inflation: remained below 1 percent over the last six months.
  - Policy rate: historic-low 1 percent since the June-2018 rate cut.
  - Central bank FX interventions ceased in fall 2018 after earlier spot-market purchases beginning June 2018.
  - Monetary stance: very accommodative; normalization should be data-driven.
  - Inflation outlook: expected to converge slowly toward 3 percent by 2021; BOA expected inflation to reach 3 percent in 2020.
- Fiscal developments
  - Fiscal deficit declined to 1.6 percent of GDP in 2018 (down 0.4 percentage points from 2017).
  - Public debt declined to 69.9 percent of GDP (including arrears) from 71.9 percent in 2017.
  - Domestic government arrears: 1.8 percent of GDP as of end-2018.
- Outlook
  - 2019 growth expected to slow to 3.5 percent due to base effects from 2018 power generation and slower growth in partner countries.
  - Medium-term GDP growth projected to converge to its 4 percent potential rate.
  - Drivers of medium-term growth: pickup in EU growth, increasing labor market participation, strengthening exports including tourism, investments to close infrastructure gap.
  - Current account deficit projected to narrow over the medium term supported by strong export growth and planned fiscal consolidation.
- Authorities’ views
  - Ministry of Finance expected GDP growth to exceed 4 percent in 2019, citing construction surge and a record-high tourist season.
  - BOA prepared to take measures as needed to attain inflation objectives.

### CAPACITY TO REPAY THE FUND
- Fund exposure and reserves
  - Fund credit outstanding: 2.8 percent of GDP or 10.4 percent of gross international reserves in 2018.
  - FX reserves: 26 percent of GDP or 6½ months of imports in 2018.
  - Fund credit-outstanding: 209.4 percent of quota at end-2018; expected to remain above 200 percent of quota until November-2019 (PPM threshold: 200 percent of quota).
  - Debt service to the Fund: expected to peak in 2022 at around 0.4 percent of GDP and 1.5 percent of reserves.
  - Reserve coverage: 189 percent of the ARA metric at end-2018 and more than nine times Fund credit outstanding.
- Assessment
  - Baseline assessment: Albania’s capacity to repay is adequate under the baseline.
  - Albania’s strong record of repaying the Fund and relative macroeconomic stability suggest repayment risks are contained.
- Public debt and fiscal vulnerabilities
  - Under the baseline, public debt is envisaged to decline to 56.8 percent of GDP by 2024.
  - Debt remains high and is sensitive to shocks—individual stress tests show particular sensitivity to GDP growth and interest rate shocks.
  - Combined macro-fiscal shock scenario would bring debt close to 72 percent of GDP as of 2020.
  - All scenarios exclude contingent liabilities from increasing PPP-financed investment and from energy sector losses.
  - Domestic debt concentration: around 60 percent of domestic debt is held by the domestic banking system, concentrated in a few large banks.
- Financing needs and risks
  - Gross public financing needs declined from 37 percent of GDP in 2014 to about 19 percent of GDP in 2019.
  - Gross public financing needs are projected to remain above the 15 percent threshold (in the DSA) through the entire projection period.
  - Main sources of borrowing have been concessional (bilateral and multilateral donors); authorities increasingly using external commercial borrowing.
  - Main vulnerabilities: rollover risk, concentration risk due to limited long-term institutional investors, and exchange rate risk—especially if external financing conditions tighten.
- Mitigating factors
  - Robust reserve coverage and a flexible exchange rate provide important shock absorption.
  - Access to donor-funded concessional and longer-term financing also mitigates near-term foreign exchange availability risks.

### RISKS AND POLICY DISCUSSIONS (summary of key risks and policy implications)
- Risks to growth
  - Dependence on hydropower and climatic variability introduces volatility to growth (e.g., 2018 hydropower surge).
  - External spillovers from partner country slowdowns could lower growth (2019 baseline growth slowed to 3.5 percent).
- Risks to public finances
  - High public debt and large gross public financing needs pose rollover and concentration risks.
  - Increasing reliance on external commercial borrowing raises exchange rate and rollover vulnerabilities.
  - Large contingent liabilities from PPPs and energy sector losses are not fully captured in baseline scenarios.
- Financial sector risks
  - High concentration of domestic debt in a few large banks increases systemic vulnerability (around 60 percent held by domestic banking system).
- Policy priorities (as implied by staff analysis)
  - Continue fiscal consolidation to reduce public debt vulnerabilities while protecting investment in infrastructure.
  - Strengthen debt management to reduce rollover and concentration risks and to diversify investor base and maturities.
  - Maintain accommodative, data-driven monetary policy until inflation sustainably converges to target.
  - Advance structural reforms to improve governance, productivity, and resilience to climate and demographic risks.

*International Monetary Fund. June 13, 2019.*

### 2.2 years at end 2018, with this debt being almost fully denominated in domestic currency.

### 2.2 years at end 2018, with this debt being almost fully denominated in domestic currency.

### External sector assessment
- The External Sector Assessment presented in the January 2019 Staff Report for the 2018 Article IV Consultation remains valid.
- Successful allocation of Eurobonds and a buyback operation in 2018 helped improve the profile and maturity of public debt.
- On balance, the impact of potential realization of macro-fiscal risks on Albania’s capacity to repay seems contained, with larger risks relating to prospects for economic development and the build-up of public sector contingent liabilities that are not immediate but pose concerns beyond the horizon of outstanding debt obligations.
- Near-term growth shocks (including the impact of draught and political uncertainties) appear less likely to have a material impact on capacity to repay.

### Risks to Growth
- Albania’s growth is vulnerable to shocks and faster income convergence hinges on ongoing structural reforms.
- Main supply-side contributors to growth: electricity production, services, and construction — all prone to external and domestic risks.
- On the demand side, net exports have been the most volatile contributor to growth.
- External risks: a continued or sharper economic slowdown among Albania’s main trading partners could reduce exports, remittance inflows and FDI.
- Domestic vulnerabilities:
  - Aging population and emigration:
    - Working age population declined by 0.6 percent over 2015-‘19.
    - Population above 65 years increased by 12 percent during 2015-‘19.
  - Dependence on weather conditions:
    - A severe draught shock as occurred in 2017 could worsen the trade balance by about 0.6 percent of GDP (assuming a generation shortfall of 2000 Gwh and an import price of 40 Euros per Mwh), with a similar potential impact on the public finances.
- Policy emphasis:
  - Improve management and financial viability of the energy sector.
  - Improve quality of human capital.
  - Lift exports and tourism by leveraging low labor cost and proximity to the EU, requiring improvements in economic governance, transportation infrastructure, and the investment environment.
- Authorities’ view:
  - Broad concurrence with staff on risks to growth.
  - Ongoing commitment to structural reforms to promote tourism, enhance coordination within the energy sector, and enhance road and airport infrastructure.

### Risks to the Public Finances
- Fiscal outcomes and projections:
  - Fiscal deficit declined to 1.6 percent in 2018.
  - Absent further measures, projected to widen to 2.5 percent of GDP in 2019 (including guarantees for new loans to the energy sector of 0.4 percent of GDP).
- Drivers of widening deficit:
  - Planned repayment of government arrears.
  - Recent tax measures that erode the tax base.
  - Risks of further revenue shortfalls and expected losses in the energy sector due to lower hydropower production.
  - Rising contingent liabilities and potential higher financing costs from tightening financial conditions in the euro area.
- Staff recommendations:
  - Use favorable environment to strengthen the revenue base.
  - Front-load fiscal adjustment to bring the primary surplus to 1.5 percent of GDP by 2021 to build fiscal buffers and ensure faster convergence of debt towards the 45 percent objective in the organic budget law.
  - Achieve adjustment through higher revenues rather than expenditure cuts.
  - Bolster the fiscal rule, including by putting a cap on annual fiscal deficits (with an escape clause for severe downturns).
- Tax system specifics:
  - Headline rates as of May 2019: standard VAT rate is 20 percent, standard CIT rate is 15 percent, top personal income tax rate is 23 percent.
  - Revenue performance lags regional peers, partly due to tax base-narrowing measures and low compliance.
  - Recent policy measures in 2018 and 2019 expanded VAT exemptions, introduced preferential treatment for sectors (reduced VAT and corporate tax rates), and raised the turnover-based corporate tax threshold from ALL 8 to ALL 14 million.
- Staff advised:
  - Reverse measures that fragment and weaken the tax base and level the playing field across businesses.
  - Develop a medium-term revenue strategy (MTRS) covering tax policy and administration.
  - Ensure full and timely payment of all validated new VAT refund requests from now on, disconnecting them from corresponding revenue flows.
  - Strengthen commitment controls for investment projects to end government payment arrears, in particular by the road fund.
- Authorities’ view:
  - Expected to meet their 1.9 percent of GDP deficit target for 2019, having identified sufficient buffers on the spending side to offset expected revenue shortfalls.
  - Planned to prevent creation of new VAT refund arrears and to settle existing arrears on an accelerated schedule (mostly within 2019).
  - Preparing a broad diagnosis of the revenue system and a medium-term roadmap for reform.
  - Agreed to maintain three-month Treasury instruments to support financial market development.

### VAT effectiveness and arrears
- VAT C-efficiency:
  - Albania’s VAT C-efficiency is 0.54, one of the lowest in the comparator group.
- Stock of VAT refund arrears: 1.2 percent of GDP at end-2018.
- Staff proposals:
  - Two complementary streams: structural changes to reduce new refund claims (e.g., reverse-charge mechanism for the TAP project) and a gradual repayment schedule based on consultations with the private sector.
  - Expand the VAT base and eliminate preferential reduced rates; reconsider recent lowering of VAT registration threshold from ALL 5 to ALL 2 million.
- Urgent action needed to curtail persistent public sector arrears:
  - Arrears undermine business climate and voluntary compliance.
  - Staff welcomed authorities’ plans to repay VAT refund arrears mostly within 2019.

### Debt management and domestic debt market
- Staff recommendations:
  - Resume issuance of short-term (three-months and six months) T-bills to support cost-efficient cash-flow management, development of secondary and hedging markets, and BOA liquidity management.
  - Strengthen MOFE’s debt management capacity and ensure good coordination with the BOA.
- Rationale:
  - Increased reliance on Eurobond issuances may be beneficial in favorable times, but building a robust and liquid domestic debt market mobilizes domestic savings and reduces currency and rollover risks.

### PPPs, AIC, and public investment management
- Current PPP usage and risks:
  - More than 200 PPP projects contracted (31 percent of GDP), with about 15 percent of GDP in the pipeline (based on 2019 budget documentation).
  - PPPs not well integrated into public investment management; separate feasibility, affordability and risk assessment processes for PPPs.
  - Projected annual budget payments for government-funded PPPs approaching legislated ceiling: 5 percent of the previous year’s fiscal revenues.
  - Power generation projects account for about 23 percent of GDP and are covered by power purchase agreements with little apparent residual fiscal risk; most other projects relate to infrastructure and are in planning or construction phases, with fiscal risks likely materializing over medium to longer term.
- Staff advice:
  - Use proposed PPP law amendments to limit PPP-related contingent liabilities and ensure consistent public investment management.
  - Ensure MOFE, as gatekeeper for PPPs, has capacity to assess risks and costs, particularly in pre-feasibility stage, with access to all contractual information from line-ministries (including existing projects).
  - Reverse fragmentation of decision making in public investment management and abolish unsolicited proposals for PPPs.
- Albania Investment Corporation (AIC):
  - Authorities considering establishment of the AIC to exploit state assets and prepare/implement investment projects using IFI and other funding.
  - Staff strongly advised revisiting AIC proposals to avoid budget and public investment management risks:
    - Draft law risks making AIC an off-budget spending tool and eroding fiscal discipline.
    - Framework should ensure AIC operates on a commercial basis and at arm’s length from government.
    - Law should affirm operational independence, limit explicit government financial contributions, and make AIC subject to the Public Procurement Law.
- Authorities’ view:
  - Preparing MOFE’s role as gatekeeper for PPPs, upgrading risk management with TA from World Bank and the Fund.
  - Considering IFI feedback on AIC plans.
  - Financial recovery plan for the power sector recently adopted.

### Energy sector vulnerabilities
- The energy sector is financially weak and struggling with endemic arrears, with dependence on rainfall exacerbating financial vulnerability and creating risks for the government budget.
- Staff encouraged implementation of the restructuring plan for the sector prepared with World Bank advice to put the sector on a sustainable financial footing.

*Italic: IMF staff report text (excerpt).*

### Box 2. Albania’s Power Sector: Challenges and Solutions

### Box 2. Albania’s Power Sector: Challenges and Solutions

### Sector structure and recent developments
- The sector consists of three major SOEs—for generation (KESH), transmission (OST), and distribution (OSHEE)—and more than one-hundred small private and concession-type hydropower plants (HPPs).
- KESH generates about two-thirds of the total electricity production from three hydro-powerplants on the Drin cascade.
- The country’s only thermal power plant is currently non-operational.
- The Trans-Adriatic Pipeline (TAP), which will deliver Central Asian gas through Greece and Albania to Europe, is expected to increase demand for gas-fired energy and manufacturing investments in Albania. Its construction is expected to finish in 2019.

### Key challenges
- Heavy reliance on hydropower creates significant weather-related vulnerabilities, with escalating (and expensive) import needs in years of drought.
- Persistent governance problems have left the sector with sizeable intra-company and intra-sector arrears.
- Underlying problems include a lack of accountability and transparency, and distortions in intra-company pricing mechanisms throughout the sector.
- The sector has relied on repeated public support.

### Authorities’ strategy and planned solutions
- Going forward the authorities are determined to implement a financial recovery plan for the sector, supported by the World Bank.
- The plan aims at:
  - (i) Improving the governance of the power companies, cleaning their balance sheets, and establishing rules for clearing intra-company and intra-sector arrears,
  - (ii) establishing targets and controls for loss reduction,
  - (iii) establishing clear borrowing rules, including for bank overdrafts,
  - (iv) improving transparency and accountability concerning investment plans, and
  - (v) the unbundling of OSHEE and finalizing the sector’s liberalization.

*Source: Box 2. Albania’s Power Sector: Challenges and Solutions (from the provided IMF content).*

### Annex I. Risk Assessment Matrix

### Annex I. Risk Assessment Matrix

### International Macroeconomic Environment
- Relative Likelihood: High
- Impact if Realized: High
- Findings:
  - Growing global uncertainties and further weakening of growth across Europe (particularly in the main export destinations and sources of remittances) might spill over to Albania resulting in lower demand for exports and a decline in remittances.
- Policy Advice:
  - Continue to diversify export markets.
  - Accelerate fiscal consolidation to build buffers.
  - Resolve structural bottlenecks to credit growth.
  - If a significant external shock were to materialize, allow automatic stabilizers to operate, while strengthening the debt anchor.

### International Financial Conditions
- Relative Likelihood: Medium
- Impact if Realized: Medium
- Findings:
  - An increase in the risk premium could raise interest rates for Albania and reduce international investor appetite for Albanian securities.
  - Ample external reserves mitigate this risk.
- Policy Advice:
  - Persist with fiscal consolidation and further lengthen the maturity of public debt.
  - Optimize the foreign debt portfolio based on risk-return tradeoff analysis.

### Domestic risks — Financial disintermediation
- Relative Likelihood: Medium
- Impact if Realized: Medium
- Findings:
  - An 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.
  - The new bank resolution adopted by the BoA should mitigate this risk.
- Policy Advice:
  - Continue sharing information with parent banks and their regulators.
  - Strengthen contingency plans, and closely monitor capital and liquidity positions.
  - Conduct strict fit and proper assessment of new entrants, especially those with limited banking experience.
  - Continue to align bank regulations with European standards.

### Domestic risks — Poorly designed PPPs & increased contingent liabilities
- Relative Likelihood: High
- Impact if Realized: Medium
- Findings:
  - Engaging in poorly designed PPP contracts for infrastructure investment could impede the efficiency of public investment, and create large contingent liabilities, the realization of which could undermine fiscal and debt sustainability.
- Policy Advice:
  - Strengthen governance and transparency in PPP implementation.
  - Upgrade the capacity of the Ministry of Finance to undertake financial analysis of new PPP contracts.

### Domestic risks — Adverse weather conditions
- Relative Likelihood: Medium
- Impact if Realized: Medium
- Findings:
  - Drought conditions could affect electricity generation.
  - 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.
  - Finalize financial restructuring plans to restore the financial viability of public electricity companies.
  - Prepare a backup power supply plan.

### Domestic risks — Rollover of public debt
- Relative Likelihood: Low
- Impact if Realized: Medium
- Findings:
  - Concerns about debt sustainability may make banks reluctant to roll over government debt, a significant part of which is short-term.
- Policy Advice:
  - Diversify the debt holders base.
  - Improve market communication and coordination with the central bank.
  - Continue fiscal adjustment and debt reduction.

### Domestic risks — Domestic political instability
- Relative Likelihood: Low
- Impact if Realized: High
- Findings:
  - Volatile domestic politics and social tensions could hinder the implementation of the structural reforms and fiscal consolidation agenda.
  - Reforms, including those to strengthen the rule of law are key for medium-term growth and prospects for EU accession talks.
- Policy Advice:
  - Ensure that reforms are grounded in careful policy analysis and a consultative preparation process.

*The RAM shows events that could materially alter the baseline scenario (the scenario most likely to materialize in staff’s view). The relative likelihood of risks listed is staff’s subjective assessment of the risks surrounding the baseline.*

### 12.      Stress test results. Under a 30 percent exchange rate depreciation shock, external debt

### 1albea2019003 - 12.      Stress test results. Under a 30 percent exchange rate depreciation shock, external debt

### Stress test headline results
- Under a 30 percent exchange rate depreciation shock, external debt would peak at 82 percent of GDP in 2020 before declining to 67 percent by 2024.
- A shock to the current account of half a standard deviation (around 2 percent of GDP) would cause external debt to peak at 54 percent of GDP in 2020 and gradually decline to 52 percent by 2023.
- Depreciation shocks are likely to have added significance for debt dynamics in view of increased external commercial borrowing, although Albania’s ample reserve buffers should help mitigate disorderly foreign exchange market conditions.

### Baseline public sector debt projections (selected indicators)
- Nominal gross public debt (in percent of GDP): 2017: 64.8; 2018: 71.9; 2019: 69.9; 2020: 66.3; 2021: 64.6; 2022: 61.6; 2023: 59.7; 2024: 57.1; 56.8
- Public gross financing needs (in percent of GDP): 2017: 36.8; 2018: 25.0; 2019: 22.0; 2020: 19.2; 2021: 16.5; 2022: 15.5; 2023: 16.1; 2024: 15.1; 15.8
- Real GDP growth (in percent): 2017: 3.0; 2018: 3.8; 2019: 4.1; 2020: 3.5; 2021: 4.0; 2022: 4.0; 2023: 4.0; 2024: 4.0; 4.0
- Inflation (GDP deflator, in percent): 2017: 1.8; 2018: 1.5; 2019: 0.7; 2020: 2.0; 2021: 2.4; 2022: 2.8; 2023: 3.0; 2024: 3.0; 3.0
- Nominal GDP growth (in percent): 2017: 4.8; 2018: 5.4; 2019: 4.8; 2020: 5.6; 2021: 6.5; 2022: 6.9; 2023: 7.1; 2024: 7.1; 7.1
- Effective interest rate (in percent): 2017: 5.4; 2018: 3.1; 2019: 3.4; 2020: 3.5; 2021: 2.8; 2022: 2.9; 2023: 3.0; 2024: 3.5; 3.9

### Debt dynamics drivers (selected contributions)
- Change in gross public sector debt (in percent of GDP): 2017: 2.2; 2018: -1.5; 2019: -1.9; 2020: -3.6; 2021: -1.7; 2022: -3.0; 2023: -1.9; 2024: -2.6; cumulative: -0.3; cumulative over projection horizon: -13.1
- Identified debt-creating flows (in percent of GDP): 2017: 2.8; 2018: -2.1; 2019: -1.8; 2020: -2.5; 2021: -1.6; 2022: -2.9; 2023: -1.9; 2024: -2.6; cumulative: -1.3; cumulative over projection horizon: -12.8
- Primary deficit (in percent of GDP): 2017: 1.5; 2018: -0.1; 2019: -0.6; 2020: 0.5; 2021: 0.0; 2022: -0.2; 2023: -0.2; 2024: -0.4; cumulative: -0.4; cumulative over projection horizon: -0.7
- Automatic debt dynamics (in percent of GDP): 2017: 1.3; 2018: -3.3; 2019: -3.0; 2020: -1.3; 2021: -2.2; 2022: -2.3; 2023: -2.2; 2024: -1.9; cumulative: -1.0; cumulative over projection horizon: -10.9
- Exchange rate depreciation contribution (in percent of GDP): 2017: 0.8; 2018: -1.7; 2019: -2.1

### Alternative scenarios and stress-test variants (selected outcomes)
- Historical scenario: external debt in figure box shows Historical: 77 (presumably peak under historical scenario).
- Baseline scenario: Baseline: 45 (external debt in percent of GDP under baseline shown in figure box).
- Current account (CA) shock (half standard deviation, ~2 percent of GDP): CA shock: 52 (external debt in percent of GDP shown in figure box).
- Combined shock (permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance): Combined shock: 49 (external debt in percent of GDP shown in figure box).
- Real depreciation shock (one-time real depreciation of 30 percent occurs in 2010 in illustrative historical test): Real depreciation shock: 67 (external debt in percent of GDP shown in figure box).
- Interest rate shock scenarios and growth shocks are included in the DSA stress test suite; individual shocks are permanent one-half standard deviation shocks unless noted.

### Risk assessment highlights
- Gross financing needs benchmark used: 15% of GDP; cells in the heat map highlight whether this benchmark or other debt burden benchmarks (70% of GDP) are exceeded under baseline or shocks.
- Key risk indicators shown (2018 reference values where provided):
  - Bond spread (bp): 203
  - External financing requirement (in percent of GDP): 12
  - Public debt held by non-residents (in percent of total): 44%
  - Public debt in foreign currency (in percent of total): 12

_Italic: Source: IMF staff (from Albania: Public Sector Debt Sustainability Analysis (DSA), as presented in the provided chapter)._

---


_Source: https://www.imf.org/-/media/files/publications/cr/2019/1albea2019003.pdf_