## _cr0588

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---

### Context and overview
- Since 1991 Albania moved from isolationist rule to market-based reforms but "remains one of the poorest countries in the region" with "considerable shortcomings in the governance and institutional frameworks and with enormous infrastructure needs."
- Albania "remains vulnerable to domestic political and regional instability." Parliamentary elections scheduled for mid-2005 are likely to influence policy making.
- Albania has been engaged in Fund-supported programs for "110 out of 148 months during September 1992–December 2004."

### History of Fund-supported arrangements (highlights)
- SBA (8/26/1992–8/25/1993): Access 20.00; Amount Drawn 13.30; Percent Drawn 66.5. "All quantitative performance criteria through March 1993 were met. Program was cancelled in July 1993, one month ahead of expiration, upon approval of ESAF arrangement."
- ESAF (7/14/1993–7/13/1996): Access 42.36; Amount Drawn 31.06; Percent Drawn 73.3. "The first and second year arrangements were completed successfully. Understanding could not be reached on the third-year program, and the ESAF commitment period expired in July 1996."
- Emergency Post-Conflict Assistance (10/31/1997–3/31/1998): Access 8.85; Amount Drawn 8.85; Percent Drawn 100.0. "Assistance was made available in one tranche, upon Board approval."
- ESAF/PRGF (5/13/1998–7/31/2001): Access 45.04; Amount Drawn 45.04; Percent Drawn 100.0. "All scheduled reviews were completed and drawings made."
- PRGF (6/21/2002–6/20/2005): Access 28.00; Amount Drawn 20.00; Percent Drawn 71.4. "Adoption of the new program was delayed owing to political uncertainties. Four scheduled reviews completed thus far."
- Note: PRGF arrangement "will expire in June 2005."

### Phases of economic developments
- Phase 1 (1991–95): "Post-transition slump and restoration of macroeconomic stability."
  - By 1992: "output had contracted by one third from its 1990 level," "inflation had risen to triple digits," and "the external current account deficit was equivalent to almost 40 percent of GDP."
  - Recovery 1993–95: "real GDP growing by around 9 percent annually during 1993–95." By 1995: "annual inflation had fallen to single digits," external current account deficit reduced to "6½ percent of GDP," and foreign reserves rebuilt to "the equivalent of almost three months of imports from about one month in 1992."
  - Reform actions: fiscal tightening; elimination of almost all price controls; liberalization of exchange and trade systems; introduction of a modern tax system; a two-tier banking system; basic legal framework for a market economy.
- Phase 2 (1996–mid 1997): "Faltering policies and a severe economic fallout from the collapse of the pyramid schemes."
  - 1996: politically motivated tax rate reductions and weaker tax enforcement resulted in "considerable revenue loss."
  - Pyramid schemes: "nominal liabilities of these schemes are estimated to have reached nearly 50 percent of GDP by end-1996."
  - Early 1997: collapse triggered "near civil war-like situation"; lek depreciated "by over 40 percent during the first half of the year"; remittances declined and foreign aid virtually ceased; inflation soared.
- Phase 3 (mid 1997–2004): "Post-conflict stabilization and renewed reform."
  - Macroeconomic stability restored; "real GDP growth settled at around 7 percent in 2000–01."
  - Severe energy shortages and floods slowed activity in 2002; growth recovered in 2003.
  - Inflation generally in the "2–4 percent range since late-2002."
  - External current account deficit fluctuated "in the 7–8 percent of GDP range during 1998–2004."
  - Tax reform: October 1997 package increased VAT "from 12½ percent to 20 percent."

### Macroeconomic outcomes, growth, inflation, reserves, and debt (selected exact values)
- Real GDP (percent change) by year: 1992 -7.2; 1993 9.6; 1994 9.4; 1995 8.9; 1996 9.1; 1997 -10.2; 1998 12.7; 1999 10.1; 2000 7.3; 2001 7.2; 2002 3.4; 2003 6.0; 2004 5.9 (Est.).
- Retail prices (annual average): 1992 226.0; 1993 85.0; 1994 22.6; 1995 7.8; 1996 12.7; 1997 32,1; 1998 20.9; 1999 0.4; 2000 0.0; 2001 3.1; 2002 5.2; 2003 2.4; 2004 2.9.
- Gross international reserves (millions of U.S. dollars): 1992 72; 1993 147; 1994 204; 1995 240; 1996 275; 1997 306; 1998 388; 1999 485; 2000 608; 2001 737; 2002 860; 2003 1,026; 2004 1,335.
  - Reserves (in months of next year's imports): 1992 1.1; 1993 2.3; 1994 2.9; 1995 2.7; 1996 4.0; 1997 3.8; 1998 3.7; 1999 3.8; 2000 4.1; 2001 4.3; 2002 4.0; 2003 4.0; 2004 4.0.
- External debt (millions of U.S. dollars): 1992 900; 1993 1,011; 1994 1,103; 1995 787; 1996 844; 1997 877; 1998 1,007; 1999 1,108; 2000 1,173; 2001 1,200; 2002 1,180; 2003 1,420; 2004 1,644.
  - External debt (percent of GDP): 1992 155.4; 1993 71.1; 1994 50.1; 1995 29.0; 1996 28.1; 1997 40.8; 1998 34.5; 1999 31.6; 2000 31.8; 2001 27.8; 2002 25.1; 2003 21.7; 2004 19.5.
- External debt as ratio to GDP declined by one half from the time of the 1997 crisis to 20 percent of GDP at end-2004.
- Public sector debt fell by over one fourth to 56 percent of GDP over the same period.

### Fiscal policy implementation, composition, and outcomes
- Budget deficit (including grants) declined from about 19 percent of GDP in 1992 to 5¼ percent of GDP in 2004.
- Cash Balance (including grants) as percent of GDP: 1992: -19.2; 1993: -13.5; 1994: -11.9; 1995: -9.3; 1996: -10.8; 1997: -13.1; 1998: -10.3; 1999: -9.4; 2000: -8.2; 2001: -7.9; 2002: -6.6; 2003: -4.4; 2004 (Est.): -5.3.
- Primary balance (including grants, percent of GDP): 1992 -18.1; 1993 -11.4; 1994 -9.8; 1995 -7.3; 1996 -8.0; 1997 -7.3; 1998 -1.6; 1999 -1.9; 2000 -2.4; 2001 -3.6; 2002 -2.6; 2003 -0.2; 2004 -1.6.
- Revenue and grants (percent of GDP): 1992 20.1; 1993 22.3; 1994 20.8; 1995 21.3; 1996 16.3; 1997 18.3; 1998 24.2; 1999 25.5; 2000 23.8; 2001 23.6; 2002 24.5; 2003 24.0; 2004 23.6.
- Expenditure (percent of GDP): 1992 39.3; 1993 35.8; 1994 32.7; 1995 30.6; 1996 27.1; 1997 31.4; 1998 34.5; 1999 34.9; 2000 31.9; 2001 31.5; 2002 31.1; 2003 28.5; 2004 28.8.
- Fiscal consolidation 1992–95 relied on compression of current expenditures (personnel cuts in 1993, subsidy reductions, cuts to operations and maintenance).
- Since 1998 (post-October 1997 tax package), budget deficit dropped by 5 percentage points of GDP, but increases in priority spending did not materialize as intended—expenditure cuts and shortfalls in foreign-financed capital expenditure explain much of the consolidation.
- In four out of the six revenue shortfall years during 1998–2004, the shortfall exceeded 1 percent of GDP.
- Profit transfers from the central bank to the budget fell from a peak of 4 percent of GDP in 1998 to about 1¼ percent of GDP in 2003.

### Private remittances and external financing
- Private remittances (millions of U.S. dollars): 1992 148.0; 1993 230; 1994 264.4; 1995 300.0; 1996 425.0; 1997 250.1; 1998 440.0; 1999 326.7; 2000 438.5; 2001 542.6; 2002 597.0; 2003 782.4; 2004 1,048.
  - Private remittances (percent of GDP): 1992 18.6; 1993 16.7; 1994 11.9; 1995 11.1; 1996 14.1; 1997 11.4; 1998 16.1; 1999 9.5; 2000 11.9; 2001 13.2; 2002 13.3; 2003 13.7; 2004 13.9.
- Private remittance inflows were "virtually always larger than projected" in Fund-supported programs; risks to fiscal and external sustainability "have turned out to be more moderate than assessed by the Fund staff when setting the fiscal deficit targets."

### Revenue administration, targets, and technical assistance findings
- Since mid-1999, tax collections were monitored by quarterly indicative floors; these benchmarks were typically not met except in 2000.
- Revenue shortfalls concentrated in VAT, customs duties, and excise taxes.
- Fund staff attributed shortfalls to weaknesses in customs and tax administration—delays in reform, frequent managerial changes, and political uncertainties.
- Tax experts providing TA in 2002–03 judged revenue gains assumed in budgets as overly optimistic:
  - Example: 2002 budget assumed a 10–14 percent increase in revenue from tax administration improvements; tax experts believed a 5 percent gain could be reasonably expected absent extraordinary circumstances.
- Evidence of perverse incentive effects from ambitious revenue targets: incentives in Customs Houses led to clearing goods at the border to meet revenue targets rather than transiting goods inland for clearance.
- Recommended mitigations for harassment and incentive problems: computerizing tax administration; centralizing the information base; establishing an effectively functioning appeals court.

### Monetary framework and Bank of Albania operations
- BoA used an eclectic approach within a flexible exchange rate regime, guided by a monetary program drawn up in consultation with Fund staff.
- BoA publicly announced an informal inflation target of 2–4 percent to anchor expectations.
- Since early 2002 there has been little cumulative appreciation vis-à-vis the euro and on a nominal effective basis; the real effective exchange rate has moved in line with the nominal effective exchange rate.
- Monetary operations: after mid–2000 BoA switched to indirect tools; repo auctions became the key policy instrument and floors on deposit rates were removed.
- Because monetary transmission is poorly understood (absence of a meaningful credit channel and widespread dollarization), inflation control remains supported by indirect targets for net domestic assets and net international reserves.
- BoA aims to move to formal inflation targeting over the medium term and has initiated steps to strengthen analytical capacities with Fund technical assistance.

### Financial sector, enterprise reform, and electricity sector developments
- Pyramid scheme crisis (early 1997) was the most costly policy failure; warnings by Fund staff and management in 1996 were not heeded.
- Banking reform outcomes:
  - Comprehensive strategy began in early 1995.
  - State-owned banks insolvent by end-1996; Rural Commercial Bank liquidated March 1998; NCB transferred to foreign investors November 2000; Savings Bank privatized in early 2004 (after delays).
  - Savings Bank held about 72 percent of the outstanding stock of treasury bills at the time of review.
- Enterprise privatization proceeded slowly; mass privatization introduced in 1995, halted in 1996, reactivated in 1998 but missed targets. Privatization of fixed-lines telecommunications and the oil sector experienced significant delays and "still remains outstanding."
- Electricity sector:
  - Illegal use, nonpayment, and below-cost prices led to suspension of World Bank credit in 1998; power supply deteriorated from 2000.
  - Rolling action plan for restructuring in 2001; quarterly targets for reducing non-technical losses and improving bill collection met consistently.
  - Annual tariff adjustments since 2002 restored electricity company profitability in 2004; planned elimination of subsidy for electricity imports from 2005.

### Business climate, governance, and statistical weaknesses
- 2002 BEEPS found little improvement in corruption and judicial standards since 1999.
- 2004 Transparency International CPI: Albania ranked 108th out of 145 countries with a score of 2.5—unchanged from previous two years.
- EU (March 2004 annual report and SAA negotiations) expressed concern about insufficient progress in law enforcement and the fight against organized crime and corruption.
- Growth concentrated in construction and services supported by remittances; industry and tradable sectors underperforming.
- Property restitution law approved July 2004 expected to help land market development.
- Data weaknesses: "Data on national accounts and other economic activity indicators in Albania are weak," complicating monitoring and policy formulation. Priority statistical improvements recommended: national accounts and real activity indicators; balance of payments elements (remittances, financial account transactions, foreign investment); monitoring of foreign assistance and external debt.

### Program ownership, conditionality, technical assistance, and implementation capacity
- Ownership of program agenda was a key factor in successful implementation; except during 1996–mid 1997, authorities stayed committed to taming inflation, maintaining price stability, and safeguarding fiscal and external sustainability.
- Program conditionality: detailed and extensive; about one fourth of structural measures were required as prior actions.
- Performance record:
  - Standard quantitative performance criteria and benchmarks were always met.
  - Quarterly indicative revenue targets persistently missed except in 2000.
  - Structural benchmarks record weaker, with delays notably in tax and customs administration and privatization.
- TA and capacity constraints:
  - Fund TA provided conceptual advice and resident advisors; skill transfer in central banking and financial sector regulation occurred effectively.
  - In tax and customs projects, limited staffing impeded pace; foreign advisors sometimes stepped in as managers, aiding implementation but limiting skill transfer.
  - Conflicting advice from multiple TA providers on legal reform created implementation difficulties.

### Risks, medium-term program considerations, and eligibility context
- Key macro and fiscal risks ahead:
  - Expansion of bank lending after Savings Bank privatization could put upward pressure on treasury bill interest rates and government debt service costs; competition could risk credit portfolio quality.
  - EU Stabilization and Association Agreement will involve further tariff reduction and revenue loss; compensating fiscal measures required.
  - Albania’s per capita income (US$1,740) is estimated at almost twice the cutoff level for IDA eligibility (US$895); availability of concessional external financing is expected to decline, increasing reliance on non-concessional borrowing for infrastructure.
  - External sector structure remains weak: private remittances are the largest source of foreign exchange earnings, significantly exceeding merchandise exports and tourism receipts.
- Program design and exit considerations:
  - A Fund-supported program would need a medium-term dimension; a precautionary arrangement with low access is one possibility given limited prospective BOP needs, but concerns exist about incentive strength.
  - Eligibility issues: anticipated removal from PRGF eligibility list after current arrangement expires or coverage by PRGF/EFF blends; decision likely needed before PRGF expiry in June 2005.
  - No indication that prolonged Fund engagement caused reform fatigue; continued program-based engagement recommended until institution and capacity building advance sufficiently.

### Policy recommendations and priorities (enumerated)
- Maintain an appropriately tight fiscal stance to create room for private credit growth and safeguard fiscal and external sustainability; set parameters based on realistic assessment of private saving prospects—particularly private remittances—and external financing availability.
- Increase efforts to:
  - Enhance tax and customs administration, particularly audit and enforcement for direct and indirect taxes.
  - Integrate social insurance collections with tax administration.
  - Enlarge the tax base.
  - Strengthen capacities of directorates of taxation and customs to implement reform agenda.
  - Base budget revenue projections on realistic assumptions of revenue gains from improved tax administration.
- Improve expenditure prioritization and management to preserve spending on priority areas:
  - Minimize wage drift in the budgetary sector.
  - Follow through on public administration and expenditure management reforms.
  - Improve aid coordination and properly reflect aid flows in the budget.
  - Focus on selective wage increases to attract/retain highly-qualified staff and avoid across-the-board pay increases.
  - Consider introducing within-title steps in the civil service salary scale and use promotion as the primary means of linking pay to performance.
- Strengthen all aspects of debt management and debt budgeting.
- Continue strengthening supervisory and prudential oversight of banks; Financial Sector Assessment Program in early 2005 to identify additional measures.
- Make concerted efforts to establish a business-friendly environment to attract investment:
  - Emphasize implementation aspects.
  - Independent judiciary and more effective prosecuting institutions and enforcement machinery are key.
  - Address supply-side constraints: reduce administrative barriers, complete privatization in strategic enterprises, upgrade and modernize infrastructure.
- Improve quality, coverage, and timeliness of economic statistics, focusing on national accounts, selected balance of payments elements, and monitoring of foreign assistance and external debt.

### Conclusions from the EPA review
- Fund engagement helped establish and maintain macroeconomic stability and provided a blueprint for structural reforms; implementation of structural measures within the Fund’s mandate was uneven but satisfactory overall.
- Albania’s structural reform agenda remains unfinished due to poor starting conditions, administrative capacity constraints, divisive politics, and weak governance.
- Program forecasting tended to be optimistic on tax revenues and foreign-financed capital expenditure; unrealistic targets and inadequate staffing likely detracted from effective tax administration reform.
- Continued program-based engagement by the Fund is suggested to preserve fiscal and external sustainability while creating room for private sector credit growth and to support a sustained multi-pronged structural reform agenda in close collaboration with the World Bank.

*Source: IMF staff report text as provided in the content unit.*

### 1. Selected Economic Indicators, 1992–2004............................................................................7

### _cr0588 - 1. Selected Economic Indicators, 1992–2004............................................................................7

### Context and overview
- Since 1991 Albania moved from isolationist rule to market-based reforms but "remains one of the poorest countries in the region" with "considerable shortcomings in the governance and institutional frameworks and with enormous infrastructure needs."
- Albania "remains vulnerable to domestic political and regional instability." Parliamentary elections scheduled for mid-2005 are likely to influence policy making.
- Albania has been engaged in Fund-supported programs for "110 out of 148 months during September 1992–December 2004."

### History of Fund-supported arrangements (Table 1 highlights)
- SBA (8/26/1992–8/25/1993): Access 20.00; Amount Drawn 13.30; Percent Drawn 66.5. "All quantitative performance criteria through March 1993 were met. Program was cancelled in July 1993, one month ahead of expiration, upon approval of ESAF arrangement."
- ESAF (7/14/1993–7/13/1996): Access 42.36; Amount Drawn 31.06; Percent Drawn 73.3. "The first and second year arrangements were completed successfully. Understanding could not be reached on the third-year program, and the ESAF commitment period expired in July 1996."
- Emergency Post-Conflict Assistance (10/31/1997–3/31/1998): Access 8.85; Amount Drawn 8.85; Percent Drawn 100.0. "Assistance was made available in one tranche, upon Board approval."
- ESAF/PRGF (5/13/1998–7/31/2001): Access 45.04; Amount Drawn 45.04; Percent Drawn 100.0. "All scheduled reviews were completed and drawings made."
- PRGF (6/21/2002–6/20/2005): Access 28.00; Amount Drawn 20.00; Percent Drawn 71.4. "Adoption of the new program was delayed owing to political uncertainties. Four scheduled reviews completed thus far."
- Note: PRGF arrangement "will expire in June 2005."

### Phases of economic developments (II)
- Phase 1 (1991–95): "Post-transition slump and restoration of macroeconomic stability."
  - By 1992: "output had contracted by one third from its 1990 level," "inflation had risen to triple digits," and "the external current account deficit was equivalent to almost 40 percent of GDP."
  - Recovery 1993–95: "real GDP growing by around 9 percent annually during 1993–95." By 1995: "annual inflation had fallen to single digits," external current account deficit reduced to "6½ percent of GDP," and foreign reserves rebuilt to "the equivalent of almost three months of imports from about one month in 1992."
  - Reform actions included fiscal tightening, elimination of almost all price controls, liberalization of exchange and trade systems, introduction of a modern tax system, a two-tier banking system, and basic legal framework for a market economy.
- Phase 2 (1996–mid 1997): "Faltering policies and a severe economic fallout from the collapse of the pyramid schemes."
  - 1996: Politically motivated tax rate reductions and weaker tax enforcement resulted in "considerable revenue loss."
  - Pyramid schemes: "nominal liabilities of these schemes are estimated to have reached nearly 50 percent of GDP by end-1996."
  - Early 1997: Collapse of schemes triggered "near civil war-like situation"; widespread destruction of public facilities and loss of government authority; "GDP growth remained rapid" in 1996 despite mounting instability; lek depreciated "by over 40 percent during the first half of the year"; remittances declined and foreign aid virtually ceased; inflation soared.
- Phase 3 (mid 1997–2004): "Post-conflict stabilization and renewed reform."
  - Macroeconomic stability restored; "real GDP growth settled at around 7 percent in 2000–01."
  - Severe energy shortages and floods slowed activity in 2002; growth recovered in 2003.
  - Inflation declined from the 1997 peak and "has generally remained in the 2–4 percent range since late-2002."
  - External current account deficit fluctuated "in the 7–8 percent of GDP range during 1998–2004."
  - Tax reform: October 1997 package increased VAT "from 12½ percent to 20 percent," strengthening the fiscal framework.
  - Structural reforms: liquidation of pyramid schemes; tax and customs administration strengthening; civil service efficiency measures; public expenditure management improvements; privatization of state-owned banks; foundations for a modern financial sector; enterprise privatization; land market creation; addressing governance weaknesses.

### Key indicators and trends (selected figures from Table 2 and text)
- Real GDP (percent change): 1992 -7.2; 1993 9.6; 1994 9.4; 1995 8.9; 1996 9.1; 1997 -10.2; 1998 12.7; 1999 10.1; 2000 7.3; 2001 7.2; 2002 3.4; 2003 6.0; 2004 5.9 (Est.).
- Retail prices (annual average): 1992 226.0; 1993 85.0; 1994 22.6; 1995 7.8; 1996 12.7; 1997 32,1; 1998 20.9; 1999 0.4; 2000 0.0; 2001 3.1; 2002 5.2; 2003 2.4; 2004 2.9.
- Revenue and grants (percent of GDP): 1992 20.1; 1993 22.3; 1994 20.8; 1995 21.3; 1996 16.3; 1997 18.3; 1998 24.2; 1999 25.5; 2000 23.8; 2001 23.6; 2002 24.5; 2003 24.0; 2004 23.6.
- Expenditure (percent of GDP): 1992 39.3; 1993 35.8; 1994 32.7; 1995 30.6; 1996 27.1; 1997 31.4; 1998 34.5; 1999 34.9; 2000 31.9; 2001 31.5; 2002 31.1; 2003 28.5; 2004 28.8.
- Overall balance (including grants, percent of GDP): 1992 -19.2; 1993 -13.5; 1994 -11.9; 1995 -9.3; 1996 -10.8; 1997 -13.1; 1998 -10.3; 1999 -9.4; 2000 -8.2; 2001 -7.9; 2002 -6.6; 2003 -4.4; 2004 -5.3.
- Primary balance (including grants, percent of GDP): 1992 -18.1; 1993 -11.4; 1994 -9.8; 1995 -7.3; 1996 -8.0; 1997 -7.3; 1998 -1.6; 1999 -1.9; 2000 -2.4; 2001 -3.6; 2002 -2.6; 2003 -0.2; 2004 -1.6.
- Private remittances (millions of U.S. dollars): 1992 148.0; 1993 230; 1994 264.4; 1995 300.0; 1996 425.0; 1997 250.1; 1998 440.0; 1999 326.7; 2000 438.5; 2001 542.6; 2002 597.0; 2003 782.4; 2004 1,048.
  - Private remittances (percent of GDP): 1992 18.6; 1993 16.7; 1994 11.9; 1995 11.1; 1996 14.1; 1997 11.4; 1998 16.1; 1999 9.5; 2000 11.9; 2001 13.2; 2002 13.3; 2003 13.7; 2004 13.9.
- Gross international reserves (millions of U.S. dollars): 1992 72; 1993 147; 1994 204; 1995 240; 1996 275; 1997 306; 1998 388; 1999 485; 2000 608; 2001 737; 2002 860; 2003 1,026; 2004 1,335.
  - Reserves (in months of next year's imports): 1992 1.1; 1993 2.3; 1994 2.9; 1995 2.7; 1996 4.0; 1997 3.8; 1998 3.7; 1999 3.8; 2000 4.1; 2001 4.3; 2002 4.0; 2003 4.0; 2004 4.0.
- External debt (millions of U.S. dollars): 1992 900; 1993 1,011; 1994 1,103; 1995 787; 1996 844; 1997 877; 1998 1,007; 1999 1,108; 2000 1,173; 2001 1,200; 2002 1,180; 2003 1,420; 2004 1,644.
  - External debt (percent of GDP): 1992 155.4; 1993 71.1; 1994 50.1; 1995 29.0; 1996 28.1; 1997 40.8; 1998 34.5; 1999 31.6; 2000 31.8; 2001 27.8; 2002 25.1; 2003 21.7; 2004 19.5.

### Role of the Fund and program design (III.A)
- Fund-supported programs adapted objectives as circumstances evolved:
  - SBA (1992) and post-conflict emergency assistance (second half of 1997) prioritized financial stabilization and arresting economic decline, while also taking initial structural reform steps.
  - ESAF-supported programs focused on consolidating stabilization and laying foundations for sustained growth through broad structural reforms.
  - From 2000, emphasis expanded to "inclusive growth and poverty reduction," reorienting government spending toward priority areas for poverty reduction while ensuring fiscal sustainability, and improving governance and the business climate.

### Achievements and continuing challenges (III)
- Achievements:
  - Rapid rebound in output during 1993–95 and sustained growth in many subsequent years, including strong recovery after the 1997 crisis.
  - Stabilization of inflation and restoration of confidence in the lek.
  - Rebuilt reserves (from about one month to almost three months of imports by 1995) and improved external position relative to the early transition years.
  - Strengthened fiscal framework after October 1997 tax package (VAT raised to 20 percent).
  - Progress on structural fronts: liquidation of pyramid schemes, privatization of banks, foundation for modern financial sector, enterprise privatization, and land market creation.
- Continuing challenges:
  - Weak governance and institutional frameworks; "enormous infrastructure needs."
  - Episodes of political uncertainty and social instability that hinder policy making and implementation (notably 1996–97, September 1998, Kosovo crisis March 1999, and political divisions post-2001).
  - Data weaknesses: "Data on national accounts and other economic activity indicators in Albania are weak," with large agricultural and informal sectors complicating measurement.

*Source: IMF staff report text as provided in the content unit.*

### 14.      The macroeconomic objectives of the Fund-supported programs were generally

### 14.      The macroeconomic objectives of the Fund-supported programs were generally achieved

### Macroeconomic outcomes and debt dynamics
- Financial policies were decisively implemented, fostering macroeconomic stability and growth.
- In most years, inflation and external current account deficit outturn were lower than projected under the programs, and growth performance was in line with program expectations.
- Inflation has been brought down to the levels of Albania’s main trading partners in the European Union.
- Albania’s initial post-transition slump was steeper than that in other transition countries in central and eastern Europe, but Albania caught up with other transition countries in the cumulative increase in real GDP since the beginning of the transition process.
- External debt as ratio to GDP declined by one half from the time of the 1997 crisis to 20 percent of GDP at end-2004.
- Public sector debt fell by over one fourth to 56 percent of GDP over the same period.

### Structural reforms and institutional capacity
- Implementation of structural reforms proceeded at an uneven pace but was satisfactory overall.
- Measures with immediate stabilization impact were generally implemented timely; medium-term measures faced delays.
- Substantial (though still incomplete) progress in building institutional foundations for sound macroeconomic policies.
- Public administration rationalized; government’s role in production reduced sharply; commercial banking sector entirely in private hands.
- Implementation weaknesses remained in areas outside the Fund’s mandate and not covered by conditionality (for example, law enforcement and fight against corruption).

### Fragility and social outcomes
- Achievements remain fragile due to pervasive poverty, administrative capacity weaknesses, divisive politics, and slow governance improvements.
- The pyramid scheme crisis of early 1997 highlighted potential fragility.
- 2002 Living Standard Measurement Survey: one fourth of the Albanian population lived below the absolute poverty line; non-income dimensions of poverty were also high.
- Concerns exist about the quality and sustainability of the strong growth performance in the context of governance weaknesses.

### Program ownership and conditionality
- Ownership of the program agenda was a key factor in successful implementation; except during 1996–mid 1997, authorities stayed committed to taming inflation, maintaining price stability, and safeguarding fiscal and external sustainability.
- During the Kosovo crisis authorities pursued cautious financial policies though structural reforms suffered.
- Program design and conditionality were detailed, hard-nosed, and increasingly complemented by capacity building and technical assistance.
- Given limited capacity, programs used very detailed conditionality as a blueprint for reforms; key structural measures were often implemented as prior actions when uncertainties were high.
- Interruptions in program-based engagement were triggered by faltering policies or uncertainties about program ownership:
  - 1996: understandings could not be reached on the third-year ESAF program because of election-related policy slippage, culminating in the pyramid scheme crisis in early 1997.
  - 2001–02: final understandings on the current PRGF arrangement were kept pending for almost one year because of elections and political feuds that led to three changes in government; interim understandings covered the period and there was no macroeconomic deterioration though structural reform progress was stifled.
- The Fund re-engaged in program mode after both interruptions once political climate stabilized and authorities showed credible commitment.

### Fiscal policy implementation: overview
- Fiscal consolidation has been the centerpiece of authorities’ economic policies since the beginning of transition.
- Budget deficit (including grants) declined from about 19 percent of GDP in 1992 to 5¼ percent of GDP in 2004.
- Domestic borrowing by the budget was consistently in line with programmed limits.
- Overall deficit outturn always was lower than envisaged under the program, owing to shortfalls in foreign-financing.
- Budget formulation process was weak and the objective of higher pro-poor spending was not met.

### Fiscal adjustment, composition, and priority spending
- The budget deficit fell by 10 percentage points of GDP during 1992–95; fiscal position deteriorated during 1996–97.
- Since 1998, following the full-year effect of the October 1997 tax package, the budget deficit dropped by 5 percentage points of GDP.
- Fiscal consolidation during 1992–95 relied on compression of current expenditures: personnel cost cutback in 1993, progressive reduction in subsidies to enterprises, and cuts to operations and maintenance expenditure.
- PRGF-era fiscal strategy since 1998 envisaged consolidation through higher revenue mobilization (via tax administration improvements) while creating room for higher spending on priority areas for poverty reduction (health, education, social safety nets).
- That strategy did not materialize:
  - Reduction in overall budget deficit since 1998 explained by decreases in expenditure, both current and capital.
  - Tax revenue did increase gradually, but from 2000 onward these gains were almost entirely offset by declining non-tax revenue.
  - Expenditure on priority areas did not increase as a ratio to GDP and fell short of the budgeted level.

### Revenue performance and capital expenditure shortfalls
- Since mid-1999, tax collections were monitored under Fund-supported programs by quarterly indicative floors; these benchmarks were typically not met except in 2000.
- In four out of the six revenue shortfall years during 1998–2004, the shortfall exceeded 1 percent of GDP.
- Shortfalls concentrated in VAT, customs duties, and excise taxes.
- Governments typically cut operations and maintenance expenditures and investment to remain within domestic financing limits.
- Contingency reserves were included in budgets but proved insufficient; ad hoc expenditure cuts and shortfalls in foreign financing were main reasons spending on priority sectors fell short of budgeted levels.
- Shortfalls in foreign-financed capital expenditure were explained in Fund staff reports by optimistic projections by the authorities, inadequate donor coordination, and procurement delays.

### Tax administration, technical assistance findings, and incentive effects
- Fund staff reports attributed tax revenue shortfalls to weaknesses in customs and tax administration—delays in reform, frequent managerial changes, and political uncertainties.
- Tax experts providing technical assistance in 2002–03 partially disagreed:
  - Further improvements in revenue administration were key to increasing tax collections sustainably.
  - Revenue gains from improved administrative efficiency built into the budget projections were overly optimistic.
    - Example: 2002 budget assumed a 10–14 percent increase in revenue from tax administration improvements; tax experts believed a 5 percent gain could be reasonably expected absent extraordinary circumstances.
  - Albania’s low revenue effort was overstated because of its large agricultural sector; when expressed as ratio to nonagricultural GDP, revenue performance of indirect taxes in Albania was comparable with several central and east European transition countries (see Table 5).
- Authorities set ambitious revenue targets believing this would raise collections by incenting tax collectors; while collections increased over time, tax experts argued unrealistic targets detracted from necessary reform efforts and caused excessive pressure on a small base of regular taxpayers.
- Evidence cited of perverse impacts from revenue targets:
  - Incentives distributed down to Customs Houses led to clearing goods at the border to meet revenue targets rather than transiting goods inland for clearance.
- Harassment problems from aggressive collection can be mitigated by:
  - Computerizing tax administration
  - Centralizing the information base
  - Establishing an effectively functioning appeals court
- These complementary organizational requirements were not fully in place in Albania when the incentive system for tax collection was introduced in 2000.

### Key fiscal and revenue figures (selected exact values from source)
- Budget deficit (including grants): about 19 percent of GDP in 1992; 5¼ percent of GDP in 2004.
- External debt: 20 percent of GDP at end-2004.
- Public sector debt: 56 percent of GDP at end-2004.
- In four out of six revenue shortfall years during 1998–2004, shortfall exceeded 1 percent of GDP.
- Profit transfers from the central bank to the budget fell from a peak of 4 percent of GDP in 1998 to about 1¼ percent of GDP in 2003.
- Examples from Table 3 (Total Revenue and Grants as percent of GDP): 1992: 20.1; 1993: 22.3; 1994: 20.8; 1995: 21.3; 1996: 16.3; 1997: 18.3; 1998: 24.2; 1999: 25.5; 2000: 23.8; 2001: 23.6; 2002: 24.6; 2003: 24.1; 2004 (Est.): 23.6.
- Cash Balance (including grants) as percent of GDP: 1992: -19.2; 1993: -13.5; 1994: -11.9; 1995: -9.3; 1996: -10.8; 1997: -13.1; 1998: -10.3; 1999: -9.4; 2000: -8.2; 2001: -7.9; 2002: -6.6; 2003: -4.4; 2004 (Est.): -5.3.
- Table 4 deviations in tax collections from budgeted levels (1998–2004) example deviations as percent of GDP: Total tax revenue: -1.8, -1.8, 0.1, -0.5, -1.6, -1.2, -0.6 (periods 1998–2004 respectively).

*Source: _cr0588 - 14.      The macroeconomic objectives of the Fund-supported programs were generally achieved*

### 26.      As the Fund staff team for Albania became aware of the considerations noted by

### _cr0588 - 26.      As the Fund staff team for Albania became aware of the considerations noted by

### Revenue projections and fiscal management
- Fund staff proposed more realistic revenue projections in the 2002–04 budgets and called for specific supporting measures, but projections "were clearly not scaled back sufficiently" and underperformance continued.
- In preparing the 2005 budget, Fund staff strongly reiterated the desirability of realistic budget revenue projections because authorities were reluctant to scale back ambitious targets for fear of parliamentary rejection due to spending implications.
- Private remittance inflows were "virtually always larger than projected" in all Fund-supported programs; risks to fiscal and external sustainability "have turned out to be more moderate than assessed by the Fund staff when setting the fiscal deficit targets."
- Data weaknesses hampered staff monitoring, macroeconomic projections, and policy formulation; fiscal deficit, though declining, "was running at a fairly high level for much of the period."

Key statistics on private remittances (selected, from Table 8):
- 1993: private remittances 230 (in millions of U.S. dollars); 16.7 percent of GDP.
- 2003: private remittances 782 (in millions of U.S. dollars); 13.7 percent of GDP.

### Expenditure prioritization and public expenditure management
- With limited prospects for revenue gains from tax administration enhancements, expenditure prioritization and improved expenditure management were deemed "crucial requirements for preserving spending on priority areas."
- Progress and trends:
  - Personnel costs in the budget declined from 9 percent of GDP in 1992 to about 6½ percent of GDP in 2004.
  - Staffing levels in budgetary institutions fell "by about one half overall during 1992–2003," creating room for wage increases and greater salary differentiation.
  - Average real wages in the budgetary sector increased three fold during 1993–2003 and nearly doubled during 1998–2003.
  - By 2002, salaries of those in the civil service, including sector chiefs and specialists, "had come up to par with salaries of their private sector comparators."
- Weaknesses and reform needs:
  - Progress in computerizing treasury operations and debt management "has been slow," with many tasks still performed manually.
  - Efforts to modernize the financial management system have been constrained by government absorptive capacity; such efforts "perhaps should have started earlier."
  - Early-stage efforts are underway to enhance accountability of budgetary institutions and strengthen line ministries and the ministry of finance for strategic planning and management of public investment, including externally-financed projects.
  - Synchronizing the annual budget, the Medium-Term Budget Program, and the National Strategy for Socio-Economic Development "still [has] some way to go."
  - Policy coherence and coordination among lead agencies involved in the reform process are ongoing challenges.

### Fiscal stance and counterfactual assessment
- With better-than-expected macroeconomic performance (see paragraph 14 in source) and larger-than-projected private remittances, Fund-supported programs might, with hindsight, have accommodated a more relaxed fiscal stance to provide more domestic resources for anti-poverty spending; the text concludes "the answer appears to be yes" while noting the understandable caution given data weaknesses and a still fairly high fiscal deficit for much of the period.

### The monetary framework
- The Bank of Albania (BoA) has used an eclectic approach within a flexible exchange rate regime, guided by a monetary program drawn up in consultation with Fund staff.
- The BoA publicly announced an informal inflation target of 2–4 percent to anchor expectations and encourage policy discipline; this approach helped bring down inflation and build BoA credibility.
- Flexible exchange rate adoption was influenced by lack of reserve cushion and transition uncertainties; the regime preserved foreign exchange reserves during the pyramid scheme crisis.
- Since early 2002 there has been little cumulative appreciation vis-à-vis the euro and on a nominal effective basis; the real effective exchange rate has moved in line with the nominal effective exchange rate.
- Fund staff analysis in the 2002 Article IV consultation concluded the effect of exchange rate appreciation on exports "has likely been limited" and export performance "has likely been impaired by non-price factors."
- Monetary operations developments:
  - During the 1990s BoA relied on bank-by-bank credit ceilings and minimum deposit rates.
  - After Fund technical assistance the BoA switched to indirect tools in mid–2000; repo auctions became the key policy instrument for controlling bank liquidity and floors on deposit rates were removed.
  - Because monetary transmission is poorly understood (absence of a meaningful credit channel and widespread dollarization), inflation control remains supported by indirect targets for net domestic assets and net international reserves.
  - BoA aims to move to formal inflation targeting over the medium term and has initiated steps to strengthen analytical capacities with Fund technical assistance.

### Financial sector reform
- The pyramid scheme crisis in early 1997 was the most costly policy failure and highlighted weaknesses in Fund surveillance and domestic reforms; warnings by Fund staff and management in 1996 were not heeded.
- Banking system reform chronology and outcomes:
  - A comprehensive strategy to reform commercial banking began in early 1995.
  - State-owned banks had severe problems; more than one fourth of all credit since mid–1992 was non-performing by end-1994.
  - At end-1996, all three state-owned banks were insolvent.
  - The Rural Commercial Bank was liquidated in March 1998.
  - The National Commercial Bank (NCB) was transferred to foreign investors in November 2000.
  - After an unsuccessful attempt in the first half of 2002, the Savings Bank was privatized in early 2004—"four years past the target date first specified as a structural benchmark under a PRGF arrangement."
- Delays in privatization were driven by difficult conditions (e.g., Kosovo crisis, weak global markets); authorities placed banks under foreign advisors and restricted new lending while awaiting privatization, and strengthened bank supervision and regulatory framework in parallel.

### Enterprise sector reform and electricity sector
- Enterprise privatization proceeded more slowly than expected but "has been largely completed, except for a few strategic companies."
  - Mass privatization introduced in 1995 halted in 1996; reactivated in 1998 but implementation missed targets set under Fund-supported programs.
  - Causes of delays: domestic political tensions, poor coordination among ministries, unresolved financial and legal disputes, Kosovo crisis uncertainties, and lack of investor interest.
  - Privatization of fixed-lines telecommunications and the oil sector experienced significant delays—the original deadlines were end-1998 and end-2000, respectively—and "still remains outstanding."
  - Large state-owned enterprises accumulated a huge stock of inter-enterprise arrears; at end-2001 these arrears amounted to the equivalent of 3.2 percent of GDP.
- Electricity sector:
  - Failure to address illegal use, nonpayment, and below-cost prices led to suspension of World Bank credit and donor support for power projects in 1998; power supply deteriorated from 2000 due to poor hydrological conditions.
  - Increased electricity imports and budget subsidies of about ¼–½ percent of GDP annually were required.
  - Authorities implemented a rolling action plan for electricity sector restructuring in 2001; donors resumed support once commitment was visible.
  - Action plan quarterly targets for reducing non-technical losses and improving bill collection rates have been consistently met—reflecting progress in installing meters, enforcing disconnection of nonpayers, and organizational improvements.
  - Annual tariff adjustments since 2002 restored the electricity company to profitability in 2004, facilitating the planned elimination of subsidy for electricity imports from 2005.
  - Close oversight by an inter-ministerial committee and coordinated donor support were important factors in electricity sector progress.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### 39.      Progress in improving the overall business climate has been slow. The 2002

### _cr0588 - 39.      Progress in improving the overall business climate has been slow. The 2002

### Business climate, governance, and rule of law
- 2002 Business Environment and Enterprise Performance Survey (BEEPS) found little improvement in reducing corruption and improving standards of the judiciary since the first BEEPS in 1999.
- In 2004, Albania ranked 108th out of 145 countries in the Transparency International Corruption Perceptions Index with a score of 2.5—on a scale of 0 (highly corrupt) to 10 (highly clean)—unchanged from the score received in the previous two years.
- The European Union (March 2004 annual report and in Stability and Association Agreement negotiations) expressed concern about insufficient progress in law enforcement and the fight against organized crime and corruption.
- World Bank governance operations focused on: legal and judicial reforms; depoliticizing personnel management; limiting discretion to reduce corruption; ensuring clear and consistent regulations; and requiring declaration of assets and financial holdings by public and elected officials.

### Growth pattern and structural constraints
- Recent growth concentrated in construction and services, supported by large inflows of private remittances; industry and other tradable sectors have not yet taken off.
- Initial agricultural growth was not sustained due to frequent absence of secure tenure or clear property titles, hampering development of a functioning land market and investment; the property restitution law approved by Parliament in July 2004 is expected to remove this obstacle.
- FIAS (2003) highlighted administrative barriers—reflecting weaknesses in governance and law enforcement and abuse of power by government officials—as hindering domestic and foreign investment in tradable sectors.

### Benefits of Fund support, conditionality, and Bank-Fund collaboration
- Fund arrangements provided policy framework and financing and catalyzed financial support from other multilateral agencies and donors; the share of Fund resources in Albania’s total financing requirements declined over time, especially under the current PRGF arrangement.
- Fund-supported programs provided the basis for significant balance of payments support from other multilateral and bilateral sources and for three Paris Club reschedulings.
- Structural conditionality under Fund arrangements was extensive and addressed areas critical for program objectives; even after 2002 streamlining, the number of conditions remained large due to the extensive structural agenda.
- Main categories of conditionality: fiscal management and control; payments discipline; budgetary implications of enterprise reforms; financial sector reform; privatization; and—in early transition years—price and trade liberalization.
- Since mid-2003, Fund-supported programs included conditions supporting governance strengthening, particularly relating to fiscal policy.
- About one fourth of structural measures were required as prior actions for program approval or completion of program review.
- Close cooperation between the Fund and World Bank: Bank led dialogue on financial sector, power, social sector and pension reforms, public expenditure management, and public administration reforms; measures agreed with the Bank were incorporated selectively into Fund programs.
- Streamlining conditionality (post-2002) reduced overlap and did not adversely affect macroeconomic adjustment; examples: conditionality on land market reform and employment in budgetary institutions were dropped from Fund programs; public expenditure management conditionality limited to budget control of foreign-financed projects and state-owned enterprises.
- Record on meeting program conditionality: standard quantitative performance criteria (PCs) and benchmarks were always met; quarterly indicative targets on revenue collection were persistently missed except in 2000. Measures subject to prior actions and structural PCs were implemented timely for the most part. Structural benchmarks record weaker, with delays notably in tax and customs administration and privatization.
- Delays in satisfying structural conditionality were often due to organizational capacity constraints and overambitious timetables rather than solely political uncertainties; FAD TA reports identified inadequate staffing at headquarters of tax and customs departments and limited officials working directly on reform projects.
- In some TA-supported fiscal projects, foreign advisors stepped in as managers to compensate for administrative capacity weaknesses; while this aided implementation, skill transfer was limited or slow and risked creating dependence on transitional capacities.
- Multiple TA providers on legal reform led to laws modeled on different jurisdictions (continental and Anglo-American), contributing to difficulties in interpretation and implementation.

### Technical assistance and implementation capacity
- Extensive Fund technical assistance (TA) has been provided to strengthen policy design, implementation capacity, and statistical compilation; implementation record of recommendations is relatively positive, but further institutional development is required across virtually every sector.
- In fiscal, monetary, and financial sectors, Fund TA provided conceptual advice implemented by authorities often with long-term resident advisors; skill transfer in central banking operations and financial sector regulation and supervision occurred effectively.
- In tax and customs administration projects, limited staffing impeded reform pace; structural benchmarks were established on recruiting additional staff under the current PRGF arrangement, but job training and skill upgrading remain major needs.
- Conflicting advice from multiple TA providers in some fiscal projects caused delays in implementation.

### Considerations for future program engagement
- Present conditions do not seem ripe for the Fund to exit program mode with Albania due to unfavorable starting conditions, extensive structural agenda, and deep administrative capacity constraints.
- No indication that prolonged Fund engagement led to reform fatigue; authorities have been receptive and program ownership solid overall.
- Continued capacity building required in budget formulation, revenue mobilization, expenditure management, and governance; risk exists that authorities may not effectively formulate and implement policy frameworks on their own.
- Key macroeconomic challenges ahead:
  - Monetary management and financial supervision will face new demands as scope for bank credit to the private sector expands with recent privatization of the Savings Bank; following privatization, the Savings Bank is no longer restricted from new lending and is likely to diversify away from government securities toward loans to enterprises and households.
  - The Savings Bank currently holds about 72 percent of the outstanding stock of treasury bills.
  - Expansion of bank lending and greater use of open market operations could put upward pressure on interest rate on treasury bills, with implications for government debt service costs, and growing competition could risk deterioration in credit portfolios.
  - Moving forward with the Stabilization and Association Agreement with the European Union (EU) will involve further reduction of tariffs and consequent loss of budgetary revenues; compensating fiscal measures will be needed to avoid widening the fiscal deficit.
  - Albania’s current per capita income (US$1,740) is estimated at almost twice the cutoff level for IDA eligibility (US$895); availability of concessional external financing is expected to decline, so non-concessional borrowing for infrastructure must not endanger fiscal and external viability. Accessing international financial markets will expose Albania to market sentiment vagaries.
  - External sector structure remains weak: private remittances are the largest source of foreign exchange earnings, significantly exceeding the sum of merchandise exports and tourism receipts; remittances are vulnerable to social and political crises and the export base is relatively low and undiversified.
- Political risks: Albania’s politics has been divisive and confrontational and likely to remain so, creating uncertainty about government composition after mid-2005 parliamentary elections.
- Other multilaterals likely to seek a Fund arrangement to complement their operations; World Bank staff indicated that program-based Fund engagement will be important for the Bank’s next four-year Country Assistance Strategy; European Commission macroeconomic financial assistance for 2005 will be disbursed in two tranches (March and September/October) and will be subject to a Fund arrangement being in place.

### Policy recommendations and priorities
- Maintain an appropriately tight fiscal stance to create room for private credit growth and safeguard fiscal and external sustainability; set parameters based on realistic assessment of private national saving prospects—particularly private remittances—and external financing availability.
- Increase efforts to:
  - Enhance tax and customs administration, particularly audit and enforcement for direct and indirect taxes;
  - Integrate social insurance collections with tax administration;
  - Enlarge the tax base.
  - Priority: strengthen capacities of directorates of taxation and customs to implement reform agenda; FAD TA reports consider the reform program comprehensive and generally well designed and note that tax rates were comparable to regional levels.
  - Base budget revenue projections on realistic assumptions of revenue gains from improved tax administration.
- Improve expenditure prioritization and management to find resources for priority spending and poverty reduction within the overall fiscal envelope:
  - Minimize wage drift in the budgetary sector;
  - Follow through on public administration and expenditure management reforms;
  - Improve aid coordination and properly reflect aid flows in the budget;
  - Focus on selective wage increases to attract/retain highly-qualified staff and avoid across-the-board pay increases;
  - Consider introducing within-title steps in the civil service salary scale and use promotion as the primary means of linking pay to performance.
- Strengthen all aspects of debt management and debt budgeting.
- Continue strengthening supervisory and prudential oversight of banks to guard against banking sector stresses; the forthcoming Financial Sector Assessment Program in early 2005 will help identify specific additional measures beyond current World Bank initiatives.
- Make concerted efforts to establish a business-friendly environment to attract foreign and domestic investment and boost potential output and exports:
  - Emphasize implementation aspects;
  - An independent judiciary and more effective prosecuting institutions and enforcement machinery are key to improving governance and rule of law;
  - Address supply-side constraints: reduce administrative barriers to investment, complete privatization in strategic enterprises, and upgrade and modernize infrastructure.
- Improve quality, coverage, and timeliness of economic statistics, focusing on national accounts and real activity indicators, and selected elements of balance of payments statistics—notably remittances, financial account transactions, and foreign investment; improve monitoring of foreign assistance and external debt.

*Source: Staff reports.*

### 52.      Given the extensive structural reform agenda and nature of the tasks, a program

### _cr0588 - 52.      Given the extensive structural reform agenda and nature of the tasks, a program

### Medium-term nature of a Fund-supported program
- A program supported by the Fund would need to have a medium term dimension.
- Determination of the appropriate type of arrangement is beyond the scope of the EPA review.
- Given that prospective balance of payments needs appear to be limited, a precautionary arrangement is one possibility.
- Concerns about a precautionary arrangement:
  - It may not provide sufficient incentive for maintaining policy discipline and mustering political support for appropriate policies.
  - It might be deemed not sufficiently commensurate with the magnitude of the required reform efforts.
- Drawings from the Fund upon meeting program conditionality could serve as an important signal for establishing credibility, domestically and externally, in the authorities’ commitment to reforms.
- These considerations argue in favor of a Fund arrangement with low access.
- Eligibility context and timing:
  - In earlier Board papers, it was anticipated that Albania would be removed from the PRGF eligibility list after the current arrangement expired or would be covered by PRGF/EFF blends, given that Albania’s per capita income is nearly twice the IDA eligibility threshold.
  - A final decision in this regard will likely need to be made before the current PRGF arrangement expires in June 2005.
  - The World Bank will be reviewing Albania’s IDA eligibility and creditworthiness to borrow on market terms in the next few months.
- Irrespective of the type of a possible successor arrangement, it would be important to have incentives in place that foster the institutionalization of the participatory process in public policy making and sustain the focus on poverty reduction efforts.

### Bank-Fund collaboration and scope of conditionality
- Effective Bank-Fund collaboration would be essential, since many required reforms are in areas in which the World Bank has taken the lead.
- Given the heightened role expected of the budget formulation process and expenditure management in meeting fiscal objectives, measures in these areas and civil service reform might have to be incorporated into conditionality under a Fund arrangement to a greater extent than in the past.
- Conditionality should also:
  - Cover key recommendations of the forthcoming FSAP on financial sector reform.
  - Include aspects of law enforcement that affect revenue collection and loan recovery by banks, testing progress in governance.
- Early coordination between Bank and Fund staff on the pace of reform implementation is necessary.
- Conditionality principles:
  - Conditionality should be pointed and strike at the core of the problem.
  - Develop appropriate performance indicators on implementation aspects of reform for specifying structural conditionality and monitoring progress.
  - The Fund should not hesitate to interrupt drawings under an arrangement if overall performance in the structural area turns out to be unsatisfactory.

### Exit considerations for Fund engagement
- Question: When would it be appropriate for the Fund to exit from a program-based relationship with Albania?
- Experience from other transition countries:
  - Proximity of EU accession is sometimes seen as an alternative anchor for policy discipline.
  - Stabilization and Association Agreement with the EU and access to international capital markets do not necessarily guarantee sufficient anchors for policy discipline and institution building.
- Albania’s situation:
  - Albania is a long way from joining the EU.
  - Despite long program engagement, there does not seem any overwhelming reason why the Fund should not continue a program-based engagement for some time—assuming programs are appropriately strong and authorities implement them well—until institution and capacity building is sufficiently advanced or until appropriate anchors in support of prudent policies are in place.
  - The appropriate timing of the transition to a surveillance-only relationship could be assessed toward the end of the next Fund arrangement with Albania.

### Conclusions (EPA team)
- The Fund’s longer-term engagement in Albania occurred within the context of generally successful programs:
  - Implementation of financial policies in line with the Fund’s advice was instrumental in establishing and maintaining macroeconomic stability.
  - The Fund also played an important role in providing a blueprint for structural reforms.
  - Judging by the record on meeting conditionality, implementation of structural measures in areas within the mandate of the Fund was uneven, but satisfactory overall.
- Albania’s structural reform agenda remains unfinished:
  - Reflects the enormity and complexity of reforms due to Albania’s extremely poor starting conditions and administrative capacity constraints.
  - Divisive politics and weak governance hindered the pace of reform.
  - The Fund staff took adequately into account political economy factors; when sufficient ownership was not forthcoming in 1996 and when political uncertainties were mounting in 2001–02, the Fund disengaged from a program mode and delayed the start of the arrangement, respectively.
- Financial pyramid scheme crisis:
  - The crisis in early 1997 was a watershed, revealing fundamental problems in governance.
  - Following the crisis and with the change in government, reforms became more broad-based and commitment strengthened; financial sector reforms received a boost.
- Program forecasting and fiscal management lessons:
  - Programs showed a consistent trend of over optimism with regard to projections for tax revenues and foreign-financed capital expenditure.
  - Focus on unrealistic tax revenue targets, together with inadequate staffing, likely detracted attention from pursuing tax administration reform efforts.
  - Revenue and foreign financing shortfalls triggered expenditure cuts, some in priority areas such as health and education.
  - This experience suggests that expenditure prioritization and management as well as donor coordination of aid and technical assistance should have been addressed early in the reform process.
- Role of structural conditionality:
  - Detailed structural conditionality likely played a useful role in coordinating domestic policies.
  - On the whole, the coverage of conditionality was appropriate, and significant reliance on prior actions strengthened implementation.
  - In some areas—especially privatization—the timetable may have been ambitious and did not take due account of the prevailing difficult market environment.
- Forward-looking program design:
  - Continued program-based engagement by the Fund is suggested by macroeconomic challenges and the unfinished reform agenda.
  - A new program should contain measures to preserve fiscal and external sustainability while creating room for private sector credit growth.
  - Sustained commitment to a multi-pronged structural reform agenda is warranted, including:
    - Strengthening bank supervision.
    - Further upgrading tax and customs administration.
    - Enhancing public expenditure management.
    - Improving the overall business environment through addressing governance weaknesses and infrastructure needs.
  - Focusing on policy implementation will be vital and will require effective upstream collaboration with the World Bank to ensure consensus on coverage and prioritization of key structural measures.

*Source: EPA review text as provided in the content unit.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr0588.pdf_