## _cr1478

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### Context and recent macroeconomic performance
- Albania "successfully avoided recession in the aftermath of the global crisis" and "suffered a milder growth shock than neighboring countries."
- Inflation "was kept low and stable."
- Banking sector "maintained adequate capital and liquidity."
- Strong early policy response: "an early fiscal stimulus, effective monetary policy, and macroprudential actions."

### Growth outlook and near- to medium-term projections
- Near term:
  - Real growth could be around 2 percent in 2014.
  - Growth drivers: dissipation of election-related uncertainty; confidence boost from fiscal risk reduction, tackling high NPLs, monetary easing, and arrears clearance.
  - External demand expected sluggish; remittances continue to weaken.
  - Current account deficit: will increase to 10 percent of GDP (compared to 9 in 2013).
  - Gross reserves cover: expected to remain near 4½ months of imports.
- Medium term:
  - Economic growth expected to gradually reach about 4½ percent.
  - Output gap: output will remain below potential by 2.1 percent in 2014, closing in 2019.
  - Major investment drivers: Trans Adriatic Pipeline (TAP) and foreign investment in new hydropower amounting in total to about 15 percent of 2013 GDP (fiscal impact not factored in).

### Fiscal position, objectives, and recommended framework
- Recent deterioration and objectives:
  - Fiscal position "deteriorated substantially in 2013" with public debt "to over 71 percent of GDP" (staff table: public debt series 70.5, 71.7, 71.2, 68.8, 65.4, 61.4, 57.1 for 2013–2019).
  - Authorities should aim to reduce public debt to about 60 percent of GDP over the medium term and 40 percent of GDP over the longer term; staff recommends inscribing the debt target in law and adopting a binding medium-term budget framework.
  - Staff recommends beginning to lower the debt-GDP ratio in 2015 (lowering in 2014 would require a "3 percent of GDP" structural adjustment).
- Staff fiscal projections (2013–2019):
  - New measures (Percent of GDP) 2014–2019: 1.1, 1.2, 1.3, 1.1, 0.9, 0.6.
  - Overall balance: -6.2, -6.7, -4.8, -3.4, -1.3, -0.5, 0.0.
  - Primary balance: -2.9, -3.4, -0.7, 0.8, 2.8, 3.4, 3.2.
  - Structural primary balance: -2.4, -0.5, 0.8, 1.9, 2.6, 3.1, 3.2.
  - Change in SPB: -1.9, 1.9, 1.2, 1.1, 0.7, 0.5, 0.1.
- Fiscal multipliers and arrears:
  - Fiscal multiplier estimates: range 0.4–0.7; multiplier of 0.5 used in the DSA (Annex II).
  - Arrears clearance multiplier: 0.1–0.2.
- Recommended fiscal measures:
  - Emphasize revenue measures (given limited scope for spending cuts), some spending restraint, pension reform, and targeted relief measures to protect vulnerable groups.
  - Inscribe medium- and long-term debt targets in law; adopt binding medium-term budget framework.
  - Lengthen debt maturities, diversify holders, deepen public debt market.

### Arrears prevention and clearance (APCS) and PFM
- APCS features and limits:
  - APCS (prior action) to be published quarterly on the MoF website.
  - Clearance bands: arrears cleared limited to 11.7 billion lek by June 2014 and 35 billion lek by December 2014; authorities to consult Fund staff should clearance exceed bands.
  - Authorities expect arrears cleared not to exceed 0.9 percent of GDP by June and 2.6 percent by December (MEFP ¶23).
- Operational PFM measures and reporting:
  - Contract external auditor to conduct ex-post risk-based audits (structural benchmark, End May/June 2014).
  - Quarterly arrears surveys starting 2014:Q1 for selected ministries; consolidated survey report to IMF 45 days after quarter end.
  - Multi-year commitment limits to be introduced in the 2015 budget (structural benchmark, End December, 2014).
  - MoF operational steps (dates preserved): issue budget instructions by January, 2014; record signed procurement orders for contracts > $300,000 a year (January 2014); roll out Treasury commitment module and reporting enhancements by June/2014.

### Financial sector, NPLs, and stability vulnerabilities
- Banking system status:
  - Banking sector "well-capitalized" but NPLs "high compared to regional peers, and still rising."
  - NPL ratio: 24.2 percent of gross loans (end-November 2013, unchanged from September).
  - Provisions: September provision coverage reached 62.3 percent of NPLs and 15.2 percent of total loans.
  - Credit growth: private credit growth declined by 3.0 percent (2013, annual); credit to private sector declined by 2.6 percent (yoy) in November.
  - System highly euroized: foreign currency loans amount to two-thirds of all loans; half of foreign currency loans are unhedged (staff finding).
- Key vulnerabilities:
  - High euroization, strong bank–sovereign links, concentrated loan portfolios, and large holdings of government securities with limited secondary market.
  - BoA limited capacity to act as lender of last resort in foreign currency.
- Policy recommendations to strengthen stability:
  - Adopt FSAP recommendations and prepare an action plan.
  - Forceful approach to NPLs: resolve tax treatment for loan write-offs, improve collateral execution, reform bankruptcy laws, encourage NPL sales and voluntary restructuring.
  - Internalize euroization risks: increase liquidity requirements on foreign currency deposits; disallow new unhedged foreign currency lending; require higher loan-to-value ratios where appropriate.
  - Strengthen nonbank supervision: reform AFSA to ensure independence; introduce liquidity and capital adequacy requirements and mark-to-market accounting for investment funds; require contingency arrangements and disclosure for investment funds.

### Monetary policy and exchange rate policy
- Inflation-targeting framework:
  - BoA target: headline CPI 3 percent with tolerance band +/-1 percentage point (3±1 percent).
  - December inflation: 1.9 percent; core inflation: 0.3 percent.
- Policy rates and measures:
  - One-week reverse repo rate cut cumulatively by 225 basis points since mid-2011 to 3.0 percent.
  - Lek lending and deposit rates declined; euro loan rates largely unchanged.
- Scope and caveats for easing:
  - Low inflation and weak domestic demand provide scope for further modest easing, but effectiveness constrained by impaired corporate balance sheets, high NPLs, and banks' risk aversion.
  - Further moderate easing could help if inflation and exchange pressures remain muted, but must be weighed against high unhedged foreign currency exposure.
- Exchange restrictions and Article VIII issues:
  - Staff identified two exchange restrictions inconsistent with Article VIII, Sections 2(a) and 3:
    - (i) requirement for residents and nonresidents to submit a tax certificate certifying no outstanding taxes prior to transferring foreign exchange for certain current transactions (including payment of moderate amounts for amortization of loans, certain insurance premiums, transfer of profits and dividends);
    - (ii) requirement to provide customs clearance documents for advance import payments prior to making payments for unrelated foreign exchange transactions.
  - Authorities committed to remove one restriction (item (i)) and are discussing removal of the other.

### Structural reform priorities to boost medium-term growth
- Binding constraints and recommended reforms:
  - Improve investment climate: prioritize land titling, property rights, judicial effectiveness, reduce arbitrary tax enforcement, expand SME access to finance.
  - Electricity sector reform: comprehensive plan with World Bank; near-term measures to limit subsidized prices to low-income consumers, open commercial user price setting, reduce power losses, tackle electricity theft, restructure market participants’ balance sheets, and attract private capital.
  - Public administration reform: adopt new civil service law to improve efficiency and professionalize hiring; limit public administration size (staffing cap for 2014: number of employees will not exceed 87,700).
  - Local government reform: improve transparency, accountability, and reporting; local government revenues fell to 0.7 percent of GDP in 2013 from 1.4 in 2005.
  - Statistics: strengthen national accounts, shorten publication lags, and enhance INSTAT independence; revise annual GDP numbers for 2008–2011 in Q2:2014.

### Program design, modalities, monitoring, and conditionality
- Arrangement and financing:
  - Staff proposes a 36-month EFF with access equivalent to SDR 295.42 million (about 492.4 percent of quota) for 2014–16.
  - Albania faces a moderate BOP financing gap in 2014–16 of about 7.1 percent of GDP (2.5 percent of GDP in 2014).
  - Fund arrangement expected to unlock about €145 million in World Bank budget support in 2014; remainder of 2014 gap requires about 94.2 million SDR (157 percent of quota).
  - Program disbursements to be direct budget support.
- Monitoring and conditionality:
  - Performance monitored via quarterly quantitative performance criteria and extensive structural conditionality.
  - Quantitative PC and indicative targets cover NIR, fiscal deficit, accumulation of external arrears, ceiling on BoA lending to government, domestic arrears accumulation, payment of existing arrears, and inflation consultation.
  - First-year structural benchmarks emphasize arrears clearance, multi-year commitment limits, tax administration reforms, AFSA law amendments, and nonbank supervision strengthening.
  - Program reviews: initially quarterly (first five reviews), subsequently semi-annual if performance strong.
- Safeguards and capacity:
  - A safeguards assessment of BoA to be conducted by FIN prior to first review.
  - Authorities to sign MoU with BoA on modalities for repayment to the Fund.

### Debt sustainability, DSA results, and alternative scenarios
- Public debt status and dynamics:
  - Public debt at end-2013: 70.5 percent of GDP (includes arrears/unpaid bills of 5.3 percent of GDP).
  - Most public debt is domestic (about 62 percent of total) and short term (about 30 percent).
- Baseline and projections:
  - Baseline: debt expected to decline gradually and cross below 60 percent of GDP only by end-2019.
  - Staff projection public debt path (table): 70.5 (2013), 71.7, 71.2, 68.8, 65.4, 61.4, 57.1 (2013–2019).
- Alternative scenarios and stress tests (selected outcomes):
  - Historical scenario: public debt slightly above 70 percent of GDP by 2019.
  - Constant primary balance scenario: public debt about 83 percent of GDP by 2019.
  - Combined macro–fiscal shock: debt rises to about 80 percent of GDP by 2016, then declines to about 70 percent by 2019; gross financing needs higher by more than 6 percentage points of GDP relative to baseline.
  - Real GDP growth shock: debt to 75 percent of GDP by 2016, about 65 percent by 2019.
  - Customized financial-sector shock (withdrawal of foreign banks’ exposure): public debt could rise to about 85 percent of GDP and gross financing needs to about 35 percent of GDP by end of projection period.
  - Fan-chart symmetric range for debt by 2019: between 40 and 70 percent of GDP; restricted distribution max up to about 85 percent of GDP.
- DSA conclusion:
  - Albania’s public debt is high and requires urgent fiscal consolidation; key risks include rollover risk, rising interest rates, and financial-sector exposures.

### Key quantitative facts and indicators (preserved exactly)
- Public debt: "over 71 percent of GDP." Staff table: public debt series 70.5, 71.7, 71.2, 68.8, 65.4, 61.4, 57.1 (2013–2019).
- Reserve increase in 2013 (up to November): "EUR 30 mln increase in foreign reserves."
- Growth turning negative: "Q3, 2013" real GDP growth negative (output fell below potential in 2013).
- Arrears accumulation: "particularly in 2013H1."
- EU candidacy decision postponed "till mid 2014."
- 2013 real GDP growth: 0.7 percent.
- Current account (including official transfers) 2013: -9.0 percent of GDP; excluding official transfers: -10.4 percent of GDP.
- Gross international reserves 2013: 2.0 (in billions of Euros); reserves in months of imports: 4.8.
- NPL ratio at end-November 2013: 24.2 percent of gross loans.
- Provision coverage (September): 62.3 percent of NPLs and 15.2 percent of total loans.
- Fiscal deficit (staff estimate) 2013: -6.2 percent of GDP (preliminary update: -4.8 percent of GDP).
- Stock of arrears (IMF staff estimate end-2013): 5.3 percent of GDP.
- Extended Arrangement request: SDR 295.42 million (492.4 percent of quota).
- Program access detail: disbursement immediate of SDR 23.55 million upon approval (Executive Board action noted).
- Exchange rates (as of November 30, 2013): lek 140.25 = €1; lek 103.17 = $1; lek 158.05 = SDR 1.
- Estimated external financing need: up to 7.1 percent of GDP during the three-year program.
- External debt peak projection: about 43 percent of GDP in 2014 before declining thereafter.
- Fiscal targets and reform measures noted in the 2014 budget:
  - Increase CIT rate from 10 to 15 percent.
  - Increase fuel pump prices by about 6.6 percent (circulation tax).
  - Introduce progressive PIT rates 0, 13 and 23 percent corresponding to monthly salaries up to lek 30, 130, and in excess of 130 thousand respectively.
- Quantitative program indicators (reported table excerpts preserved exactly where presented):
  - I. Quantitative Performance Criteria — Floor on net international reserves of the BoA (EUR million) 1289128912891289 (table formatting preserved as in source).
  - III. Inflation Consultation bands — Upper outer band 5.0 5.0 5.0 5.0; Actual/center point 1.9 3.0 3.0 3.0.
  - IV. Indicative Targets — Floor on clearance of general government domestic arrears 0.0 0.0 0.0 14.2.

*Italic: Source — _cr1478 (IMF staff report excerpts and related appendices provided).*

### 1. Implementation Recommendations of the 2012 Article IV Consultation _______________________ 27

### _cr1478 - 1. Implementation Recommendations of the 2012 Article IV Consultation _______________________ 27

### Context and recent macroeconomic performance
- Albania was not directly affected by the recent crisis and avoided recession; it “successfully avoided recession in the aftermath of the global crisis” and “suffered a milder growth shock than neighboring countries.”
- Inflation “was kept low and stable.”
- The banking sector “maintained adequate capital and liquidity.”
- Strong early policy response attributed to this performance: “an early fiscal stimulus, effective monetary policy, and macroprudential actions.”

### Worsening dynamics and macroeconomic imbalances
- Since 2011 the economy “has shown signs of protracted weakness and macroeconomic imbalances have widened,” linked in part to “policy indiscipline.”
- Public debt and financing needs have risen—“among the highest regionally and heavily dependent on banks”—due to “fiscal slippage and accumulation of sizable arrears, particularly in 2013H1,” which undermined investor confidence and contributed to slowdown.
- Output: “Economic growth has been low since 2011, turning negative in Q3, 2013, largely because of election-related uncertainty,” causing output to fall below potential in 2013.
- External sector: the current account deficit “has narrowed on the back of an improved trade balance,” but the improvement is “not on a sustained basis” as it is driven mainly by oil exports; FDI and remittances “continue to be the main sources of external financing.”
- Reserve developments: foreign reserves increased by “EUR 30 mln (up to November)” in 2013, tied to privatization receipts and higher FDI.

### Fiscal developments and challenges
- Fiscal position “deteriorated substantially in 2013” and deterioration was “partly because of election-related revenue shortfalls.”
- Public debt rose sharply, “to over 71 percent of GDP,” cited as “one of the highest levels in the region.”
- Revenue and spending ratios are low and tax efficiency is low: “Albania’s revenue- and spending-to-GDP ratios are low... as is tax efficiency.”
- Realistic budgeting has been a challenge; 2013 saw sizable deviations of realized fiscal revenues from budgeted amounts.

### Financial sector and credit conditions
- The banking sector remains “well-capitalized,” but nonperforming loans (NPLs) are “high compared to regional peers, and still rising.”
- The banking system is “highly euroized” and credit growth has started to contract, reflecting “banks’ risk aversion.”
- Banks’ low reliance on parent funding is noted as a buffer against external deleveraging pressures; banks have increased their foreign assets.
- Monetary stance: inflation within Bank of Albania’s target range has “slowed since 2012,” providing “scope for further monetary easing,” which has helped lower market interest rates and reduce costs on domestic public debt.
- Exchange rate: “The exchange rate has remained stable and BoA/MoF’s interventions minimal,” with interventions in 2013 focused on purchasing EUR.

### Implementation of prior recommendations and governance
- Implementation of the 2012 Article IV recommendations “has been mixed.” Specifics:
  - Progress: authorities “have strengthened financial sector supervision and stretched the maturity profile of public debt” in line with 2012 recommendations.
  - Limited progress: “there was little progress on fiscal consolidation” following the 2012 recommendations.
- Institutional quality: “Quality of public institutions has worsened in recent years,” with weaknesses in “rule of law” and corruption concerns; the judicial system is “weak, especially in protecting property rights.”
- Public finance administration: “Tax administration needs major improvement,” and “other areas of fiscal management” including public investment efficiency require strengthening.

### Political context and reform outlook
- The new government (post-2013 elections) is described as “committed to economic and structural reforms” and having “a stronger than usual electoral majority in the 2013 elections,” enabling difficult public finance and structural reforms required for EU accession.
- EU process: the EU “has acknowledged progress, it has recently postponed the candidacy decision till mid 2014, citing the need for a sustained record of judiciary, parliament and public administration reforms.”
- Policy implication: “A strong reform push that improves perceptions about EU accession prospects would help boost business confidence, FDI and growth.”

### External risks and resilience indicators
- External risks are characterized as “high” despite conventional metrics showing foreign reserve cover as adequate.
- Remittances and FDI remain principal external financing sources; Greece and Italy are noted as the biggest sources of remittances.
- Reserve adequacy noted using a “New Reserve Adequacy Metric” described in the source (components and weights provided in the original text).

### Key quantitative facts and indicators (as stated)
- Public debt: “over 71 percent of GDP.”
- Reserve increase in 2013 (up to November): “EUR 30 mln increase in foreign reserves.”
- Growth turning negative: “Q3, 2013” real GDP growth negative.
- Arrears accumulation: “particularly in 2013H1.”
- EU candidacy decision postponed “till mid 2014.”

*Source: _cr1478 - 1. Implementation Recommendations of the 2012 Article IV Consultation (IMF PDF content provided)*

### 5.      Growth is expected to rebound in 2014 (Table 1). Real growth could be around 2 percent,

### _cr1478 - 5.      Growth is expected to rebound in 2014 (Table 1). Real growth could be around 2 percent,

### Growth outlook and near-term projections
- Real growth could be around 2 percent in 2014, spurred by:
  - dissipation of uncertainties related to elections, change of government and bureaucracy and future policies;
  - confidence boost from reducing underlying risks notably in the fiscal area, tackling of high NPLs, monetary easing, and arrears clearance.
- External demand expected to remain sluggish and remittances continue to weaken (given close links to Greece and Italy).
- Current account deficit will increase to 10 percent of GDP (compared to 9 in 2013) on account of release of import compression.
- Gross reserves cover is expected to remain near 4½ months of imports.

### Medium-term outlook
- Economic growth is expected to gradually reach about 4½ percent over the medium term, though remaining below the more than 5½ percent achieved in the 4 years prior to the crisis.
- Output will remain below its potential by 2.1 percent in 2014, with the gap narrowing to close in 2019.
- Recovery drivers:
  - implementation of policies to correct domestic imbalances and ambitious structural reforms to boost total factor productivity;
  - EU accession-related reforms improving investment prospects;
  - significant energy-related investments—the Trans Adriatic Pipeline (TAP), and foreign investment in new hydropower—amounting in total to about 15 percent of 2013 GDP (fiscal impact not factored in due to lack of data).
- Underlying external imbalances would improve modestly; reserves cover would remain comfortable at about 4 months of imports.

### Downside risks to the baseline
- Protracted slower European growth could spill over via trade and remittances, hurting growth and external and financial sector stability.
- Insufficient fiscal consolidation could undermine investor confidence and increase rollover risks.
- Lack of progress on structural reforms could lead to a protracted period of slower growth.

### Fiscal policy: objectives and context
- Fiscal consolidation objective: reduce the public debt ratio to mitigate risks and strengthen resilience.
- Authorities should aim to reduce public debt to about 60 percent of GDP over the medium term and 40 percent of GDP over the longer term; staff recommends adopting the debt target in law and improving credibility via a binding medium-term budget framework.
- Public debt trajectory and fiscal balances (IMF staff estimates and projections):
  - Public debt: 70.5, 71.7, 71.2, 68.8, 65.4, 61.4, 57.1 (years shown in source table corresponding to 2013–2019).
  - New measures (Percent of GDP): 1.1, 1.2, 1.3, 1.1, 0.9, 0.6 (years 2014–2019 as in source table).
  - Overall balance: -6.2, -6.7, -4.8, -3.4, -1.3, -0.5, 0.0 (2013–2019).
  - Primary balance: -2.9, -3.4, -0.7, 0.8, 2.8, 3.4, 3.2 (2013–2019).
  - Structural primary balance: -2.4, -0.5, 0.8, 1.9, 2.6, 3.1, 3.2 (2013–2019).
  - Change in SPB: -1.9, 1.9, 1.2, 1.1, 0.7, 0.5, 0.1 (2013–2019).
- Staff recommendation: begin lowering the debt-GDP ratio in 2015; doing so in 2014 or maintaining 2013 level would require an excessively large adjustment (3 percent of GDP in the structural primary balance).
- Over the medium term, further improvement in the structural balance of about 3.8 percent will be needed to reduce debt to near 60 percent of GDP by 2019.
- Fiscal multipliers and arrears:
  - Fiscal multiplier estimates for Albania are in the range of 0.4–0.7, with a multiplier of 0.5 used in the DSA (Annex II).
  - Arrears clearance expected to have a lower multiplier in the range of 0.1–0.2 due to large balance sheet improvement from arrears clearance (about one quarter to one third of the regular multiplier).
- Fiscal background and drivers of deficits:
  - 2007–08 tax reform lowered PIT and CIT rates to a 10 percent flat rate (from PIT rates 5, 10, 15, 25, and 30 percent, and a 20 percent flat tax on profits).
  - Intake from these taxes fell from 3.7 percent of GDP in 2007 to 3.4 in 2012.
  - Excise and property tax rates and other fees unchanged for years; PIT exemption threshold increase in 2013 now close to average private sector wage.
  - Use of multi-year commitments without regard to appropriations resulted in arrears in excess of 5 percent of GDP.
  - Overall public spending-GDP ratio is relatively low; wages, transfers, and interest claim more than ¾ of revenues.
  - Pensions: social insurance system deficit rose to 5 percent of GDP in 2013.
  - Pension system features discouraging contributions: highest contributions can be as much as five times lowest, while highest benefits at most twice minimum; minimum pension about 50 percent of average rural income vs 35 percent in urban areas.

### Fiscal policy recommendations (policy advice)
- Commit to medium and long-term public debt targets (about 60 percent of GDP medium term; 40 percent longer term); inscribe target in organic budget law and adopt a binding medium-term budget framework.
- Implement sizable fiscal adjustment while avoiding excessive consolidation that would harm growth—begin lowering debt-GDP ratio in 2015 rather than 2014.
- Implement tax and spending policy reforms to address root causes of high deficits:
  - Emphasis on revenue measures (given limited scope for spending cuts), some spending restraint, and pension reform.
  - Support targeted relief measures to protect vulnerable groups.
- Clear arrears comprehensively and transparently:
  - Stocktake and verify outstanding arrears; adopt a clearance strategy approved at highest level and made publicly available.
  - Make amounts cleared public regularly and employ an external auditor for verification.
  - Authorities expect arrears cleared to not exceed 0.9 percent of GDP by June and 2.6 percent by December (MEFP ¶23).
- Prevent future arrears through credible measures:
  - Rationalize revenue projections at budget time; improve procurement reporting; introduce multiyear commitment limits; require key ministries to report if current obligations are being met.
- Implement extensive spending reforms:
  - Ensure investment project approvals consistent with budget space; enhance local government financial planning; condition transfers on revenue and PFM reforms; discourage external borrowing by local governments; reform disability benefit system.
- Strengthen tax administration:
  - Build capacity at the General Directorate; develop corporate strategy for medium and long-term reforms; ensure proper adoption of new IT system; streamline VAT refunds by making the Treasury responsible for payments.
- Prepare pension reform strategy in consultation with the World Bank and IMF:
  - Establish Pension Reform commission; priorities: raise retirement age for men and women; upgrade social transfers and separate from social insurance; align benefit and contribution ceilings; limit pension benefits by keeping public sector wage and pension increases in line with inflation; emphasize up-front announcements to anchor expectations.
- Manage debt rollover risks:
  - Lengthen maturity structure of debt; diversify securities holders; deepen public debt market and secondary market development.

### Authorities’ views (summary)
- Authorities commit to medium-term fiscal and debt sustainability; view 60 percent debt-GDP target as feasible but cautious about 40 percent by 2024.
- Caution on adopting an explicit long-term target across electoral cycles; comprehensive medium-term fiscal framework or fiscal rule would require time.
- Agree with staff path and level of medium-term adjustment and 2014 adjustment level, but stress need for flexibility if economic conditions worsen.
- Tax policy reform in 2014 budget: increases in rates of CIT, fuel circulation tax, and property tax; imposition of various excise duties and road tolls; PIT made progressive.
- Arrears payment strategy: stocktaking and verification; clear criteria for order of settlement; scheduling and monitoring of payment process; external auditor to conduct risk-based audits.
- Arrears clearance preference: accelerated pace to release liquidity drag, but ensure due diligence—expect arrears cleared not to exceed 0.9 percent of GDP by June and 2.6 percent by December.
- Measures to prevent future arrears: control commitments; enhance procurement reporting and approval; central government to avoid new arrears; quarterly survey of main ministries to monitor obligations.
- Tax administration strengthening: develop corporate strategy; improve compliance and reduce fraud; complete new IT system by year end; IMF technical assistance expected to continue.
- Pension reform: establish pension reform commission; complete reform strategy by end-2014 after stakeholder consultation.
- Rollover risks deemed manageable given current strong bank demand for government paper and expected decline in public debt under the program.

### Monetary policy: assessment and recommendations
- Objective: use modest monetary easing to support weak economy provided inflation and exchange market pressures stay muted; key to reviving credit is reducing NPLs.
- Inflation framework performance:
  - Inflation-targeting has yielded low and stable inflation within the 3±1 percent annual target range.
  - December inflation amounted to 1.9 percent; core inflation was 0.3 percent.
- Monetary easing and credit:
  - Bank of Albania has lowered policy rate—the one-week reverse repo rate was cut by a cumulative 225 basis points since mid-2011 to 3.0 percent.
  - Lek lending and deposit rates declined somewhat; credit to private sector continued to slow, declining by 2.6 percent (yoy) in November.
  - Euro loan rates have not changed much.
  - Weakness in credit largely due to tightened lending standards and rise in troubled loans.
- Financial stability constraints:
  - Heavy euroization: foreign currency loans amount to two-thirds of all loans.
  - Aggressive easing risks exchange market pressures and fallout on unhedged foreign currency borrowers.
- Monetary policy advice:
  - Further moderate easing could help with credit if inflation and exchange pressures remain muted; easing can help borrowers as rates on existing loans reset and potentially improve loan servicing and bank risk aversion.
  - Easing must be weighed against unhedged foreign currency exposure and high NPLs.
  - Key to accelerating credit is tackling the large stock of NPLs; monetary easing alone is unlikely to have strong impact given weak demand and supply constraints.
- Exchange rate assessment and restrictions:
  - Exchange rate broadly in line with fundamentals; standard assessment points to slight overvaluation but stable FDI and imports imply higher current account deficit norm.
  - Inflation-targeting framework and flexible wage setting should help avoid currency misalignment; structural reforms to improve business environment and expand export base would improve competitiveness.
  - Staff identified two exchange restrictions inconsistent with Article VIII, Sections 2(a) and 3:
    - requirement for residents and nonresidents to submit a tax certificate certifying no outstanding taxes prior to transferring foreign exchange for certain current transactions (including payment of moderate amounts for amortization of loans, payment of certain insurance premium, transfer of profits and dividends);
    - requirement to provide customs clearance documents for advance import payments prior to making payments for unrelated foreign exchange transactions.
  - Since these exchange restrictions are not BoP-relevant, staff does not recommend approval of temporary retention of these measures.

*Source: _cr1478 (excerpt).*

### 34.      Low inflation and weak domestic demand provide scope for some further modest

### 34.      Low inflation and weak domestic demand provide scope for some further modest

### Monetary policy, credit conditions, and NPLs
- Low inflation and weak domestic demand provide scope for some further modest easing, but:
  - Impact likely constrained by impaired corporate balance sheets and increased risk aversion by banks.
  - Authorities concerned about risks of aggressive monetary easing, particularly on the exchange rate.
- NPL reduction is critical for credit growth; staff and authorities concur that credit supply rather than demand is currently the binding constraint.
- Authorities expressed concern some banks may repatriate funds to parent banks instead of re-lending improved repayments associated with arrears clearance.
- Macroprudential measures to boost credit have been largely ineffective.
- Note on NPL dynamics: "The reduction in NPLs following the commencement of arrears clearance could take time as banks typically require clients to maintain an improved repayment record before the associated loan is re-classified as performing." According to the BoA, the NPL ratio could eventually decline by 5–6 percentage points.

### Exchange rate and external positions
- Staff exchange rate assessment is broadly appropriate.
- Authorities view recent exchange rate stability as reflecting a lack of strong market forces for major adjustment; they are firmly committed to a free floating exchange rate regime and intend to refrain from market interventions.
- Authorities expect Albania’s FDI potential (noted gas pipeline and hydropower projects) and import substitution to improve external balances over the medium run.
- Authorities believe current international reserves cover level appropriately reflects elevated external risks.
- Authorities have been notified of new findings on exchange restrictions; they are committed to removing one (item (i) above) and are discussing removal of the other.

### Maintaining financial stability — background and vulnerabilities
- Systemic vulnerabilities:
  - Profitability pressures and potential deleveraging in a system dominated by subsidiaries of foreign banks.
  - High euroization and strong financial links between banks and the government complicate financial management.
  - Emergence of investment funds indicates financial deepening but highlights gaps in supervisory infrastructure.
- Specific findings:
  - Risk of direct inward financial spillovers is contained: large share of foreign banks (Austria, Greece, Italy, Turkey) but banking system relies almost exclusively on domestic deposits; loan-to-deposit ratio is merely 50 percent.
  - Banks have strong solvency ratios and stringent provisioning rules.
  - High financial euroization risks: (i) half of loans in foreign currency are unhedged; (ii) large maturity mismatches; (iii) credit risk for euro loans may be underpriced. BoA has limited capacity to act as lender of last resort in foreign currency.
  - NPL increase driven by cyclical and structural factors: government arrears, adverse tax treatment of write-offs, long and unpredictable legal collateral execution process.
  - High NPL-related provisioning hurts bank profits and pressures capitalization; deleveraging risks likely to remain elevated while NPLs remain high.
  - Strong bank–sovereign links create systemic risk through exposure to longer-term debt securities and government reliance on bank rollover.
  - Investment funds hold mostly illiquid government bonds; lack of a functioning secondary market constrains liquidity management and raises systemic liquidity risks.

### Policy advice to strengthen financial stability
- Implement recent FSAP mission recommendations; prepare an action plan guiding reforms in financial market supervision, financial market deepening, contingency planning, and AML/CFT enforcement.
- Adopt a comprehensive and forceful approach to address NPLs:
  - Resolve tax treatment for loan write-offs.
  - Improve collateral execution.
  - Review and reform competition policy and bankruptcy laws.
  - Clearance of government arrears may contribute to NPL reduction.
- Internalize risks associated with euroization:
  - Increase liquidity requirement on foreign currency deposits.
  - Ensure banks require higher loan-to-value ratios if appropriate.
  - Disallow new unhedged foreign currency lending.
  - Implement robust consumer education and borrower protection.
- Lengthen maturities and diversify government debt holders; reduce public debt to lower rollover risks and systemic bank–sovereign links.
- Strengthen nonbank supervision:
  - Reform the Albanian Financial Regulatory Authority (AFSA) to ensure financial and operational independence.
  - Introduce liquidity and capital adequacy requirements and mark-to-market accounting for investment funds.
  - Ensure investment funds have adequate liquidity contingency arrangements with banks and transparently disclose lack of deposit insurance coverage.

### Authorities’ views on financial stability measures
- Authorities plan to implement FSAP recommendations and will prepare a strategy in the coming months.
- Tangible actions for NPLs include:
  - Resolving adverse tax treatment of loan write-offs and facilitating legal collateral execution.
  - Corporate restructuring, review of competition policy, modifications in bankruptcy laws.
  - Monitoring system for corporate and household indebtedness.
  - Revamped framework for loan restructuring and collateral repossession.
  - Recognition that arrears clearance would lower outstanding contractor obligations to banks.
- Authorities consider financial euroization structural and a cushion due to strong links to the euro area; monetary policy decisions will be planned to avoid exchange market pressures affecting bank balance sheets.
- AFSA law will be amended and investment fund regulatory framework revised to introduce liquidity, capital, and valuation requirements; strengthening nonbank regulation and supervision will require time.

### Structural reforms to boost medium-term growth
- Background constraints:
  - Deceleration of structural reforms has coincided with declining potential growth, limited productive base broadening, persistent informality, and export concentration.
  - Business environment weaknesses: poor property rights, corruption, weak contract enforcement, inefficient judicial system, and weak access to finance for SMEs.
  - Electricity sector problems: poor collection, electricity theft, low quality grid; state producer has run down reservoirs or imported electricity via state guarantees or budget support; lack of payment discipline discourages investment in new generation.
  - Public administration inefficiencies and politicization; high turnover around political transitions has undermined administration (deterioration in tax administration during change of government noted).
  - Weak local government structures: local government revenues down to 0.7 percent of GDP in 2013, from 1.4 in 2005; PFM weak, lacks transparency, and suffers from corruption.
  - National statistics weaknesses: annual national accounts based on limited information; expenditure-basis data not published since 2007; quarterly GDP subject to significant revisions.
- Policy recommendations:
  - Forcefully pursue targeted reforms to improve the investment climate:
    - Prioritize legal framework and judicial effectiveness related to land titling and property rights.
    - Reduce arbitrary tax enforcement and expand access to finance, including for SMEs.
  - Initiate energy reform with a comprehensive reform plan for the electricity sector (in consultation with the World Bank) to reduce fiscal risk and improve sustainability; near-term measures include:
    - Limit subsidized prices to low-income consumers.
    - Open commercial user price setting to market competition.
    - Lower power losses (including preventing electricity thefts).
    - Reform market structure, restructure main participants’ balance sheets, attract private capital into distribution.
  - Public administration reform underpinned by a new civil service reform law to improve efficiency and professionalism; cooperate with EU and World Bank.
  - Develop local government reform agenda to improve transparency, accountability, and capacity; fuller reporting of local governments’ new procurement orders recommended.
  - Improve quality of statistics: continue national accounts and balance of payments improvements, strengthen statistical agency independence, and set up inter-government data-exchange scheme for macroeconomic statistics.

### Authorities’ views on reforms and implementation
- Prompt implementation of ambitious reforms is a high priority; government plans to address business environment constraints and politically difficult problems of property rights and judicial enforcement.
- Energy sector: a Prime Minister-led task force will address inter-company debts, short-term investment needs, and negotiations with the energy distribution parent company; authorities will finalize a reform action plan by early 2014 in collaboration with the World Bank and take near-term measures such as enforcement of bill payments and tariff reforms.
- Public administration: reducing the size of public administration is a priority; authorities commit to hiring new staff in compliance with a forthcoming civil service law.
- Local government: near-term instruction to local governments to report all new procurement orders to the ministry of finance; administrative and territorial reform to be completed before the 2015 local elections.
- Statistics: authorities committed to creating a professional and transparent statistical agency and to use IMF TA to further improve statistics.

### Program modalities and risks
- Staff proposes a three-year extended arrangement under the extended fund facility (EFF) with access equivalent to SDR 295.42 million (492.4 percent of quota) for 2014-16 to address a balance of payments need.
- Rationale and objectives:
  - Large current account deficit reflects low domestic savings stemming from large fiscal deficit and underperforming non-energy export sector.
  - Repayment of government arrears would require a large fiscal and current account adjustment in 2014; external support under the EFF allows phasing of adjustment over several years while progressing on structural reforms to improve productive capacity, particularly in export-oriented sectors.
  - Arrangement would support efforts to increase public savings to repay arrears and put public debt on a sustainable medium-term trajectory, address structural constraints on growth, buttress confidence, and help unlock financing from other multilateral institutions.
- Disbursement modality:
  - Program disbursements will be in the form of direct budget support because:
    - Albania has limited access to international capital markets.
    - Financing the fiscal deficit and arrears through domestic securities would strain the market and aggravate rollover risks.
    - Very limited provision of direct credit by the central bank to the government has been important for BoA’s operational independence.
  - Direct budget support expected to contribute to medium-term fiscal consolidation, ease risks associated with high public debt, smooth short-run economic adjustment, and help reduce the external current account deficit.
- Expected program outcome by end of the three-year period:
  - The fiscal position would shift into primary surplus, with substantially lower financing and rollover needs, reduced reliance on domestic bank financing and improved access to global financial markets.

*Source: IMF staff report excerpt on Albania (content unit CR1478).*

### 69.      Performance under the program will be monitored through quarterly quantitative

### _cr1478 - 69.      Performance under the program will be monitored through quarterly quantitative

### Program monitoring, conditionality, and focus areas
- Performance will be monitored through quarterly quantitative performance criteria and extensive structural conditionality.
- 2014 structural conditions and prior actions focus on PFM, revenue administration and financial reforms, the latter based on the recent FSAP update (Box 6 and MEFP Table 2).
- Quantitative Performance Criteria and Indicative Targets cover:
  - NIR
  - fiscal deficit
  - accumulation of external arrears
  - ceiling on central bank lending to government
  - domestic arrears accumulation
  - payment of existing arrears
  - inflation consultation
  (Elaborated in Box 6 and MEFP Table 1.)
- Over the program period emphasis: PFM, arrears prevention, addressing shortcomings of the pension system, and putting the energy sector on a sustainable footing.
- Program risks are substantial given the complexity, scale, and scope of reforms and the need for strong political commitment (Box 6).

### Staff appraisal — macroeconomic conditions and outlook
- The economy is slowing amid elevated macroeconomic imbalances.
  - Domestic demand increasingly sluggish due to sharp increase in public debt, worsening NPLs, and credit contraction.
  - Ongoing weak external demand, particularly from Greece and Italy, remains a headwind.
- The authorities’ economic program, supported by the proposed extended arrangement under the EFF, aims to:
  - reverse the upward trend in public debt and lay the ground for sustained reduction;
  - bring down NPLs and restore banks’ confidence in lending;
  - reduce structural constraints on growth via ambitious structural reforms.

### Fiscal stance, targets, and recommended framework
- Sizable further fiscal adjustment is needed over the medium term to correct domestic imbalances and put public debt on a sustainable footing.
- Fiscal policy will target a reduction in public debt in 2015, with the objective of further reducing it to 60 percent of GDP by 2019.
- Authorities should consider building a bipartisan consensus around adopting a longer term debt target of 40 percent of GDP and underpin it through an effective medium term budget framework.
- Tax and expenditure reforms are needed to tackle underlying causes of high fiscal deficits:
  - The burden of adjustment should fall primarily on revenues due to development needs, low share of revenues in GDP, and embedded expenditure inflexibility.
  - Pension and energy reform should be part of medium-term adjustment.

### Arrears strategy and public financial management (PFM)
- Reducing the outstanding stock of arrears and establishing mechanisms to prevent recurrence is critical for fiscal sustainability.
- Announced measures, if implemented properly, should:
  - re-establish government credibility,
  - aid fiscal sustainability,
  - re-inject liquidity into the private sector.
- Authorities should proceed cautiously with payments and employ an external auditor promptly to begin conducting ex-post risk-based audits.
- Ambitious PFM reform program, supported by IMF TA, will help prevent recurrence, but tangible results will take time.
- Restoration of spending discipline is necessary to prevent ad hoc cuts in capital spending.

### Monetary policy and financial sector recommendations
- In the absence of fiscal buffers, monetary policy can support recovery, but caution is warranted.
  - Further moderate easing could help if inflation expectations and financial stability remain well anchored.
  - Caveats:
    - Sluggish credit demand and bank risk aversion likely limit effectiveness of conventional easing.
    - High unhedged foreign currency exposure and rising NPLs require caution.
  - Measures to reduce the large stock of NPLs will aid in restoring credit growth.
- Continued vigilance needed to maintain financial stability:
  - Rising NPLs require prompt and comprehensive action.
  - Recommended reforms: remove structural distortions in collateral execution and bankruptcy laws; revamp loan restructuring and NPL sales framework; clear arrears.
  - Strengthen regulation and supervision of the nonbank financial system, in line with FSAP recommendations.

### Structural reform agenda and growth prospects
- Sustained medium-term growth hinges on implementing an ambitious structural reform program covering:
  - pensions, energy, local government, public administration, and business environment.
- If implemented properly, reforms will strengthen ability to attract investment, reduce fiscal risks, and improve debt sustainability.

### Program risks and policy support
- Risks to the program are significant: strong political commitment is required by a largely untested new government; key risk is delayed or challenged implementation, especially given reform complexity.
- Authorities’ commitment to broad-based reforms and upfront commitments should help mitigate risks.
- Staff supports the authorities’ request for an Extended Arrangement in an amount equivalent to SDR 295.42 million.
- Recommendation: next Article IV consultation be held on the 24-month cycle, subject to Decision No. 14747, as amended.

### Box 3 — Possible Tax and Expenditure Measures, 2014–16 (selected measures and estimated yields)
- Revenue measures (direct yields):
  - Raise CIT rate: Increase in the profit tax rate from 10 to 15 percent. Yield: 0.5 (percent of GDP)
  - Increase in excises: Increase in the excise tax on cigarettes, wine, beer, alcoholic beverages, energy drinks, tobacco, and grease. Yield: 0.4
  - Increase in Property Tax: Doubling of property tax for commercial purposes. Yield: 0.1
  - Circulation tax (environmental tax): Increase in fuel prices at the pump by about 6.5%. Yield: 0.4
  - Simplified profit tax on small businesses: Levy a tax of 7.5 percent on businesses with turnover between lek 2-8 million. Yield: 0.1
  - Health care contributions: Remove ceiling on health care contributions. Yield: 0.1
- Expenditure measures (selected yields):
  - Freeze on nominal wages: Maintain nominal level of public sector wages (except police) at the 2013 level. Yield: 0.1
  - Pensions: Limit pension increases to inflation. Yield: 0.04
- Other potential measures (S, M, L denote short-, medium-, and long-term measures respectively) include widening VAT base, tolls on the highway to Kosovo, increasing fees and taxes on vehicles, introducing VAT on incoming telephone calls, introducing a foreign visit tax, widening property tax base, introducing annual vehicle license fee, tax on luxury goods, increasing withholding tax on capital incomes (from 10% to 12%), reducing network loss in electricity distribution, reforming wage setting in the public sector, and increasing retirement age to 67 for men and 65 for women.
- Note: Missing yield means technical estimates are not available. Measures marked "2/" have been incorporated in Table 2.

### Box 4 — Exchange Rate Assessment (summary)
- Exchange rate remained relatively stable in 2013; higher energy exports aided an increase in Albania's global export share.
- Current account balance continued to improve in 2013 despite deteriorating fiscal imbalance, helped by strong energy export performance and weaker goods imports.
- Three methodologies used: ERER, Macroeconomic Balance (MB), External Sustainability (ES).
  - ERER: real exchange rate level broadly in line with fundamentals; ERER approach points to a relatively small difference of about 3 percent between the REER and the estimated equilibrium real exchange rate.
  - MB and ES: moderately overvalued; these approaches suggest a gap between the projected 2019 current account deficit and estimated norm of about 3.5–4.0 percentage points of GDP.
- Important caveat: MB and ES approaches do not fully account for stable and large FDI flows (notably Trans Adriatic Pipeline (TAP) and foreign investment in new hydropower production), amounting in total to about 15 percent of 2013 GDP, which imply higher import needs without raising external sustainability concerns.
- Table (selected numbers as presented):
  - MB Approach: Current Account -7.4; Current Account Norm -4.0; Real Exchange Rate Overvaluation -15.5
  - ERER Approach: Real Effective Exchange Rate 91.0; Equilibrium Real Exchange Rate 88.0; Real Exchange Rate Overvaluation 3.0
  - ES Approach: Current Account -7.4; Current Account Norm -3.5; Real Exchange Rate Overvaluation -17.7
- Source comment: Current account elasticity with respect to the real effective exchange rate is estimated to be -0.22.

### Box 5 — Conclusions of the 2013 FSAP (key findings and recommendations)
- Key vulnerabilities in the banking sector:
  - High euroization, strong financial links between banks and the government, and dominance of foreign bank subsidiaries.
  - High and rising NPLs and resulting decline in bank profitability.
- Stress test findings:
  - Banks are vulnerable to shocks; in severe macro scenarios at least 6 banks (representing 21 percent of banking system assets) become undercapitalized.
  - Aggregate additional capital requirement is relatively modest.
  - Liquidity stress tests show banks are amply liquid and able to confront large deposit withdrawals.
  - Sensitivity tests show high vulnerability to lek depreciation due to large share of unhedged foreign currency lending; credit risk exacerbated by concentrated loan portfolios.
- Priority actions:
  - Reduce large stock of existing NPLs via legal and prudential measures to support voluntary restructuring, encourage NPL sales, resolve tax ambiguities, and reform insolvency and collateral execution regimes.
  - Strengthen financial reporting requirements, expand definition of related parties, and conduct an asset quality review.
  - Enhance risk-based supervision focused on credit policy and underwriting quality.
- Sovereign–bank linkages:
  - Large holdings of government securities create systemic risks and liquidity challenges given the lack of a secondary market.
  - Emergence of investment funds diversifies government security ownership but introduces liquidity and systemic risks that require careful management.
- Nonbank regulation:
  - Strengthen the capacity, independence, and resources of AFSA to regulate insurance and investment funds effectively.
- Macroprudential and crisis-preparedness framework:
  - Generally strong but needs refinement: expand consolidated supervision, formalize cooperation with home supervisors, increase supervision staff and legal protection, and refine ELA contingency planning and reporting guidelines.

*Source: IMF staff report excerpts as provided in the supplied content.*

### Box 6. Albania: Program Modalities and Risks

### Box 6. Albania: Program Modalities and Risks

### Access and Phasing
- Albania faces a moderate balance of payments financing gap in 2014–16—about 7.1 percent of GDP (2.5 percent of GDP in 2014).
- Staff proposes a 36-month extended arrangement under Extended Fund Facility (EFF) with total access equivalent to SDR 295.42 million (about 492.4 percent of quota) to support Albania’s BOP need and the authorities’ policy and structural reforms.
- Upon approval, the Fund arrangement will unlock about €145 million in World Bank budget support in 2014—the World Bank will support the reform program through a series of Development Policy Loans (DPLs) focused in the fiscal and financial area, but also incorporating energy and pension reform measures.
- Filling the remainder of the gap in 2014 will require about 94.2 million SDR, or 157 percent of quota from the Fund.
- The EU will provide support, but in 2016.
- The Fund-supported program is expected to be fully financed in the first year.
- Phasing over three years under the program has been determined after accounting for the support expected from other multilateral partners.
- Given the independence of the central bank and budget financing constraints, the authorities intend to use the domestic currency equivalent of Fund resources for budgetary financing.
- A government–BoA MoU establishing a framework on the modalities for the repayment to the Fund has been prepared.
- A safeguards assessment of the BoA will be conducted by FIN prior to the time of the first review.

### Conditionality and Monitoring
- Program entails structural reforms to:
  - strengthen PFM,
  - arrears prevention,
  - address shortcomings of the pension system,
  - put the energy sector on a sustainable footing.
- Financial sector reforms would be based on recent FSAP recommendations.
- Program reviews:
  - initially on a quarterly basis (for the first five reviews),
  - subsequently on a semi-annual basis, conditional on strong program performance in the first year.
- Quantitative targets (performance criteria) on:
  - the overall deficit,
  - net international reserves,
  - accumulation of external arrears.
- Monetary conditionality will be embedded in the inflation consultation clause (given the well functioning inflation targeting framework).
- Indicative targets on:
  - BoA credit to the general government,
  - accumulation and payment of central government domestic arrears (MEFP Table 1).
- Structural benchmarks in the first year (prominent focus on arrears clearance and prevention) include:
  - contracting of an external auditor to conduct risk–based audit of arrears payments,
  - publication of report on arrears payment,
  - quarterly surveys on new arrears accumulation in key ministries,
  - introduction of multi-year commitment limits.
- Financial sector measures will address the NPL problem and strengthen nonbank supervision (MEFP Table 2).

### Capacity to Repay the Fund
- Albania is expected to meet its repayment obligations to the Fund.
- By the end of the proposed extended arrangement, Fund credit outstanding is projected to be 3.1 percent of GDP, or 16 percent of gross reserves.
- External debt dynamics:
  - After peaking at 43.1 percent of GDP in 2014, external debt will decline to 32 percent of GDP by 2019.
  - External public debt falling from 30.9 to 21.1 percent of GDP.
- Albania has a strong record of repaying the Fund.

### Risks
- Political climate remains contentious.
- Implementation risks arise because of the complexity of reforms.
- Authorities are committed to launching a broad based reform agenda and will make up front announcements on planned measures.
- If economic growth does not evolve as expected:
  - fiscal objectives, including the envisaged reduction in public debt, could be undermined,
  - there could be further pressure on bank asset quality, profitability and capitalization.
- In that event, staff will consider easing, in subsequent reviews, the nominal deficit targets to allow automatic stabilizers to work consistently with a broadly unchanged structural balance.

*Source: Box 6. Albania: Program Modalities and Risks (IMF staff).*

### Appendix I. Letter of Intent

### Appendix I. Letter of Intent

### Request for IMF Support and Program Overview
- Albania requests a three year extended arrangement under the Extended Fund Facility in an amount equivalent to SDR 295.42 million (about EUR 331.1 million, and 492.4 percent of quota).
- Estimated external financing need: up to 7.1 percent of GDP during the duration of the three-year program.
- Arrangement to be complemented by support from the World Bank and the European Commission to close the financing gap.
- Monitoring and review framework:
  - 5 quarterly reviews and 3 bi-annual reviews under the arrangement.
  - Progress monitored through reviews, quantitative performance criteria and indicative targets, and structural benchmarks per the attached MEFP and Technical Memorandum of Understanding (TMU).
- Government commitments:
  - Stand ready to take additional measures if required; will consult the Fund before revisions.
  - Provide the IMF with requested information to monitor progress.
  - Authorize publication of this letter, the MEFP, the TMU, and the IMF staff report subject to Executive Board approval.

### Recent Economic Developments and Outlook
- Growth and demand:
  - Real GDP growth projected to slow to around 0.7 percent in 2013, the lowest level since 1997.
  - Growth expected to recover to 2.1 percent of GDP as confidence is restored and domestic demand recovers.
  - Output slowdown since 2012 driven by weak credit growth, rising government payment arrears, and election-related uncertainty.
  - External demand has been the primary growth driver but constrained by euro zone weakness and a narrow export base.
- External sector and debt:
  - Current account deficit: reached 14 percent of GDP in 2009; declined to 9.5 percent in 2012 and projected to be 9 percent in 2013.
  - External debt: nearly doubled since 2004 to around 40 percent of GDP in 2012, with the largest part reflecting external public debt.
  - Recent FDI prospects: agreed gas pipeline and hydropower projects amounting to a projected $1.5 billion.
- Inflation and monetary policy:
  - Headline CPI inflation fluctuated around the lower band of the target range during 2012 and first three quarters of 2013.
  - The BoA reduced its policy interest rate by 225 basis points over the past 24 months to 3.0 percent.
- Financial sector:
  - Banking system largely foreign-owned but financed mainly by local deposits.
  - Nonperforming loans (NPLs): reached 24 percent of gross loans at end-November 2013.
  - Provisions: in September reached 62.3 percent of NPLs and 15.2 percent of total loans.
  - Annual credit growth turned negative in September 2013, declining by 3 percent (year-on-year).
- Fiscal position:
  - Fiscal deficit widened in 2013: government increased deficit projection to about 6 percent of GDP from 3.5 percent planned initially.
  - Public debt (including arrears) will exceed 70 percent of GDP by end 2013.
  - Preliminary IMF staff estimate of total stock of arrears: 5.3 percent of GDP at the end of 2013.

### Fiscal Consolidation Strategy and Measures
- Objectives and targets:
  - Begin fiscal consolidation in 2014 to achieve a reduction in public debt in 2015.
  - Medium-term target: public debt down to 69 percent of GDP by the end of the program with the IMF in 2016 and to well below 60 percent by 2019.
  - Target fiscal deficit for 2014: about 4.0 percent of GDP, excluding spending on the repayment of arrears (down from near 6 percent estimated for 2013).
  - Approval of the 2014 budget in line with IMF staff agreement is a prior action under the program.
- 2014 budget revenue measures:
  - Increase corporate income tax (CIT) rate from 10 to 15 percent.
  - Increase excise tax rates on cigarettes, tobacco, beer, energy drinks, wine, alcoholic drinks and industrial lubricants (grease).
  - Increase circulation tax equivalent to an increase in gasoline and diesel fuel prices of about 6.6 percent.
  - Increase property tax rates paid by businesses (local tax).
- 2014 budget spending and social measures:
  - Refrain from increasing public sector salaries in 2014, except a structural increase for police officers.
  - Limit pension increases to cost of living adjustments per the pension law.
  - Introduce progressive income tax on salaries with rates of 0, 13 and 23 percent corresponding to monthly salaries up to lek 30, 130, and in excess of 130 thousand respectively.
  - Abolish the small business tax (local tax) and reduce the simple tax on profit for small businesses to half the corporate tax rate.
  - Provide targeted support to vulnerable groups:
    - Half of the VAT paid for some basic food products will be subsidized.
    - Half of the VAT paid for electricity will be subsidized for those who have difficulties paying electricity bills.
  - Refund VAT partially paid on agricultural inputs by April 1, 2014.
  - Exempt medicines and medical services from VAT, in line with EU regulations.
- Budget flexibility and contingencies:
  - 2014 budget includes a contingency for revenue shortfalls; appropriations saved unless revenues over-perform.
  - Decisions to release contingency funds made in consultation with IMF staff via a supplementary budget request in the second half of the year.
  - Fiscal adjustment to be calibrated in consultation with IMF staff based on economic conditions.
- Tax administration and compliance reforms:
  - Complete introduction of a new IT system by end-2014.
  - Contracted a foreign consultant to assist customs in tax collection.
  - Tax administration to establish committees (prior action) and develop a new corporate strategy for medium and long term capacity building by end-June (structural benchmark, June 2014).
  - Treasury responsible for making payments on all new VAT refund claims after approval by the Tax Administration beginning in January 2014.
  - Implement lotteries on sales receipts by June, 2014.
  - Check tax payment records and net out tax debt from arrears payments to businesses to which the government owes arrears.
  - Launch a public awareness campaign beginning in June, 2014 on the importance of paying taxes.
  - Strengthen verification of VAT and CIT refund claims; in 2015 change the verification process to link directly to businesses’ online tax payment records.
- Property tax and public administration reforms:
  - Prepare to move to a valuation-based property tax by 2015; commence geospatial imaging and reinforcement of the land registry by end of 2014.
  - Public administration review in 2014 to increase efficiency and cut costs.
  - Public administration staffing cap for 2014: number of employees will not exceed the current level of 87,700.
  - Implement new Civil Service Law by April, 2014 for merit-based hiring.
- Pension and local government reform:
  - Establish a new Reform Commission by March, 2014 (structural benchmark) to review the pension system with the World Bank and present a medium-term reform strategy to the Council of Ministers for approval by December, 2014 (structural benchmark).
  - Review existing benefit structure and reform the disability system to prevent abuse; prosecute abuses.
  - Streamline property compensation program and tackle fraud with the Social Assistance Scheme of the World Bank.
  - Launch comprehensive local government reform to be completed before the 2015 local elections.

### Prevention and Clearance of Government Arrears
- Policy priority: meet government payment obligations and avoid recurrence of new arrears.
- Rationale:
  - Accumulation of public sector arrears has contributed to the slowdown in economic activity and created negative payment chains affecting corporate and bank balance sheets.
  - Prompt clearance of obligations intended to restore confidence and alleviate private sector liquidity constraints.
- Immediate actions and objectives (programmatic):
  - Implement measures to prevent new arrears and clear existing arrears as a core component of restoring macroeconomic stability and supporting recovery.

*Appendix I. Letter of Intent (Tirana, February 5, 2014).*

### 23. Arrears repayment will be guided by a comprehensive and transparent prevention and

### 23. Arrears repayment will be guided by a comprehensive and transparent prevention and

### Arrears Prevention and Clearance Strategy (APCS)
- The APCS (prior action) will be published quarterly on the MoF website.
- APCS will:
  - Address weaknesses in the system that generated the arrears problem.
  - Lay out the structure of the clearance process, including the Arrears Committee.
- Verification and audits:
  - Arrears will be paid without delay upon verification.
  - The High State Audit will be involved in verification and monitoring of adherence to the APCS.
  - An external auditor will perform an ex-post risk-based audit of randomly chosen cases (structural benchmark, June 2014).
  - The breakdown of individually cleared arrears, by amount, and result of the external auditor’s findings will be published quarterly on the Ministry of Finance website (continuous structural benchmark).
- Expected clearance bands:
  - Amount of arrears cleared limited to 11.7 billion lek by June 2014 and 35 billion lek by December 2014.
  - Government will consult with Fund staff should arrears clearance exceed these clearance bands.
- Financing:
  - External financing from the IMF and the World Bank is expected to enable timely clearance without overstretching domestic financial markets.

### Strengthening commitment management and procurement controls
- Extension of Treasury System and institutional reporting:
  - Inclusion of the Albanian Roads Authority in pilot rollout in November 2012; five institutions are responsible to register contract commitments and pre-commitments.
  - All new procurement orders (goods, works and services) must be sent to MoF for clearance prior to starting the bidding process.
  - Submission to Parliament of legislation to clearly define expenditure arrears and payment terms is a prior action under the program, for January 2014.
- Reporting and approval procedures (operational steps, with dates preserved):
  - MoF will issue budget instructions by January, 2014 to all central government entities to report all proposed new procurement orders for MoF clearance, and suspend issuing any new multi-year procurement orders until outer-year commitment ceilings are approved by the Council of Ministers (CoM) (prior action).
  - MoF will start clearing in-year procurement orders based on appropriations and sign on each cleared procurement order (January 2014).
  - MoF will record signed procurement orders for all investment contracts and for all current expenditures of higher than $300,000 a year in a designated database. (January 2014)
  - MoF will issue instructions to all local governments to report all new procurement orders to MoF starting September 2014 (structural benchmark, March 2014).
  - MoF will submit to CoM proposals for outer-year commitment limits and get them approved (March 2014).
  - Government entities will be allowed to resume issuing multi-year procurement orders and start reporting them to MoF, including their disbursement schedules by year (March 2014).
  - MoF will start clearing multi-year procurement orders based on annual appropriations and outer-year commitment ceilings (March 2014).
- Transition goal:
  - Reporting and clearance procedures to remain in place until the Treasury System is reconfigured to fulfill the same functions for key ministries and coverage is extended to 60 percent of the state budget and Tirana Municipality by end-2014.

### Public financial management (PFM) improvements and commitment limits
- Planned PFM measures in 2014:
  - Modify the commitment module in the treasury system to disaggregate multi-year commitments by individual year allocations by June, 2014.
  - Require registration in the Treasury system of all invoices received, regardless of cash availability, within 5 days of acceptance by June 2014.
  - Strengthen timeliness and flow of tax and revenue information so gross transactions and values of collections and refunds are captured in the treasury system on weekly bases using the interface between Tax Information System and Treasury System by 2015.
  - Treasury granted authority and responsibility to execute tax refund payment transactions starting January 2014.
  - IPA-financed twinning project providing technical assistance on Public Financial Management reforms, including comprehensive review of primary and secondary legislation.
- Commitment limits:
  - Plan to introduce commitment limits with the 2015 budget (structural benchmark, December 2014).
  - Commitment limits will specify, for every line item, amounts of commitments that can be made in the current year and for each outer-year.
  - Sum of commitment limits will be lower than cash ceilings for outer-years.
  - Relevant laws will be amended in 2014 to legally enforce commitment limits.
  - Public campaigns will inform the business community of the reform measures.

### Arrears monitoring, surveys, and institutional capacity
- Quarterly arrears survey:
  - MoF to carry out a quarterly survey of arrears accumulation among selected parts of central government starting in the first quarter of 2014 (Ministries of Transportation, Health, Education, Justice, and Defense, and the GDT) to collect information on all unpaid obligations (structural benchmark, April, 2014).
  - Coverage to be gradually expanded (structural benchmark, October, 2014).
  - A new unit within MoF will conduct surveys and consolidate results; the unit will collect and monitor arrears data.
  - Consolidated survey report to be sent to the IMF for review, 45 days after the end of each quarter.
  - Financial reporting training for line ministries to gradually extend the survey.
  - By the end of 2014, survey expected to cover the 10 ministries with the highest existing arrears stocks.

### Monetary and exchange rate policy (BoA)
- Inflation-targeting framework:
  - BoA aims to achieve a headline average CPI inflation target of 3 percent over the medium term, with a tolerance band of +/-1percentage points.
  - Monetary policy decision-making guided by deviation of forecasted inflation from this objective; BoA targets headline inflation and monitors core inflation.
  - Inflation performance monitored through an inflation consultation clause (see TMU).
- Exchange rate and external restrictions:
  - BoA committed to a free floating exchange rate regime.
  - Reserve coverage is currently well above the level prescribed by most standard reserve metrics.
  - For the duration of the program, without Fund approval BoA will not introduce or intensify restrictions on payments and transfers for current international transactions, nor introduce/modify multiple currency practices or bilateral payments agreements inconsistent with Article VIII, nor introduce or intensify import restrictions for BOP reasons.
- Operational framework:
  - Main tool: one week repo rate.
  - Monetary operations to aim for adequate liquidity so interbank short-term rates are close to policy rate.
  - BoA to improve operational framework, transparency, communication strategy, and anchor inflation expectations.

### Safeguarding financial sector stability
- Bank monitoring and capital/liquidity:
  - BoA will monitor bank capitalization and liquidity; may apply higher minimum required levels of risk weighted capital and liquidity ratios according to risk profiles.
  - Regular top-down and bottom-up solvency and liquidity stress tests will continue using scenarios with persistent uncertainties and increased macroeconomic volatility.
- Nonperforming loans and legal/insolvency reforms:
  - NPL reduction is a priority; BoA to improve regulatory framework by February 2014 to strengthen credit standards and provide guidance on NPL management.
  - BoA and MoF, with Ministry of Justice, other agencies, and Albanian Banking Association, submitted legal amendment of the Tax Law to Parliament to remove issues impeding loan write-offs within January 2014.
  - With IFC assistance, prepare changes in the Civil Code and other laws to improve insolvency requirements, set payment to bailiffs in line with success rate, and restrict judicial discretion on postponing borrowers’ payments or determining priority in collateral claims.
  - Arrears clearance will also help NPL reduction.
- Bankruptcy Law review:
  - Joint project with IFC to start in February to review bankruptcy legal framework.
- Macroprudential framework and FSAG:
  - Gather information on interlinkages between banking and nonbank financial institutions and strengthen financial crisis preparedness by end 2014, including Emergency Liquidity Assistance (ELA) framework alignment with FSAP recommendations.
  - Ensure Financial Stability Advisory Group (FSAG) meetings take place quarterly and focus on financial stability and systemic risk management.
  - Introduce monthly technical-level meetings by end of March 2014 (structural benchmark, March 2014).
  - Authorities to cooperate under FSAG to strengthen legal support for prevention and management of systemic financial crisis.
- Collateral and market development:
  - To mitigate risks from lack of a secondary public debt market, BoA plans to issue a regulation by March 2014 applying the same collateral standards to all monetary operations and expanding collateral eligibility to all negotiable securities issued by the government of Albania (structural benchmark, March 2014).
- Stress-testing toolkit and market infrastructure:
  - BoA will streamline procedures by September 2014 to ensure macro-model and satellite models are used for macro scenarios in stress-testing.
  - During 2014, measures to facilitate development of the secondary market for government securities, including fully automating clearing and registration of government securities transactions to reduce settlement, liquidity and legal risks and foster repo market development.
- Nonbank financial sector regulation:
  - Amend law governing Albanian Financial Supervisory Authority (AFSA) to strengthen operational and financial independence, and amend insurance law in line with FSAP recommendations (structural benchmark, June 2014).
  - Revise regulatory framework for investment funds to introduce liquidity and capital requirements (structural benchmark, June 2014) and require net asset value on a mark to market basis (structural benchmark, June 2014).
  - Requested technical assistance to determine market value methodology given lack of secondary market; implementation based on technical assistance outcome.
  - Strengthen requirements for funds’ disclosure and consumer protection by September 2014.

### Improving coordination of macroeconomic policies
- Institutional mechanisms:
  - National Economic Council (NEC) established as roundtable forum chaired by the Prime Minister to coordinate government policies with business community and donors.
  - New Inter-Ministerial Commission for Economic Development Policies to provide integrated governmental responses on key economic issues.
  - A tax council (consultative body of the Ministry of Finance) will engage with the business community.

### Structural reforms — Business climate
- Overall strategy:
  - Address short- and medium-term issues, including arrears resolution, National Economic Council engagement, and procedural reforms published on Ministry of Economic Development website.
  - Review of VAT legislation underway; measures to improve revenue administration, including hiring a consultant.
- Regulatory assessment and EBRD engagement:
  - Comprehensive assessment of regulatory framework planned to provide basis for medium-term agenda.
  - MoETDE to seek input from local business community; move on an EBRD project on business climate reform by the second half of 2014.
  - MoU likely to be signed during official visit to EBRD headquarters on February 24.
- Business procedure reforms:
  - Questionnaire to business community on most harmful/time-consuming procedures; competition held December 6, 2013–January 6, 2014 identified 19 procedures and has been reopened.
  - Review of existing concessions for elements of exclusivity that result in monopolies, consistent with applicable laws.
- Business registration and tourism sector:
  - Comprehensive review of National Registration Office by beginning of 2015, including legislation review, launch of online applications and online financial tables.
  - Reform regulatory framework of tourism sector by the beginning of the second half of 2014.

### Structural reforms — Agriculture
- Agricultural land reform:
  - Goal to distribute 70 percent of land titles by 2015.
  - Improve coordination among institutions for licensing, certification and ownership titles to create integrated information on farmers and land.
- Farm Accountancy Data Network:
  - Establish Farm Accountancy Data Network by 2017 containing individual accounts for all farmers to improve access to lending and markets.
- Institutional and infrastructure improvements:
  - MoARDWA to improve irrigation infrastructure and food safety via capacity building.
  - Decentralize management of Rural Development funds by 2016 and align organizational structure closer to EU requirements.

*Source: IMF staff report (chapter on arrears repayment, APCS, procurement and public financial management, monetary policy, and financial sector reforms).*

### 44. On social protection, the government seeks to improve equity and efficacy of the

### _cr1478 - 44. On social protection, the government seeks to improve equity and efficacy of the

### Social protection: objectives and measures
- Objective: improve equity and efficacy of the social protection system through “de-institutionalize” social services by combining direct monetary transfers with provided services.
- World Bank TA: a new TA project will modernize the social assistance scheme and produce a unified formula for evaluating all applicants for Economic Aid and the Special Needs Pension.
- Data sharing and fraud reduction:
  - Introduce a database that will allow different government agencies to exchange publicly held data on individuals by April 2014.
  - Expected outcome: reduce fraudulent claims and reduce the number of recipients by 20 percent by 2016.
- Active labor market measures:
  - Complement social benefits with vocational training.
  - A portion of economic aid recipients will be offered a small payment instead of the aid and engaged in community work; this policy will be in place by year 2015.
  - Plan to expand an incentive system to provide financial compensation to companies for employing these individuals.

### Energy sector: reform strategy and timelines
- Task Force mandate and legislative reform:
  - Develop a medium-term strategy in cooperation with the World Bank.
  - Changes in all laws regulating the power sector: Law “On power sector” by the end of June, and the Law on Renewable and Law on Efficiency by December 31, 2014.
  - Revised market model including necessary sublegal acts and regulations ready by December 31, 2014.
- Metering, billing, and tariffs:
  - Ministry of Energy to design a plan by first quarter of 2014 to increase billing in regions with informal consumption.
  - Increase correct billing first through average expenses based on consumption, then with measures that account for energy before it reaches the consumer.
  - Review tariff system by end of June, 2014 to bring prices closer to market prices.
  - Revise prices for feed-in energy produced by small private hydro-electric companies (HEC) plants by December 31, 2014.
  - Review by end of June, 2014 and clearly distinguish customer types that require electricity subsidies.
  - Strategy expected to be presented to Parliament in December.
- Administrative enforcement and asset maintenance:
  - Task force with law enforcement to identify illegal consumers, cut illegal connections, and provide assistance to re-connect legally; publish quarterly reports on progress one month after the end of each quarter.
  - Task Force to identify immediate needs for meter repairs and grid maintenance and propose an investment plan by first quarter of 2014.
- Inter-company debts and sector financial stability:
  - Task Force and Ministry of Energy to devise a plan by first quarter of 2014 to resolve inter-company debts that accumulated due to heavy network losses and low collection rates.
  - Amicable resolution with the distribution company is an immediate priority.
- Infrastructure upgrades and projects:
  - Upgrade distribution grid, install smart meters and a smart grid as a partial pilot application by end 2014.
  - Improve transmission grid and complete construction of the interconnection line Tirane–Prishtine by the end of 2014.
  - Elbasan–Bitola: study completed but no construction deadline specified.
  - Long-term objective: initiate generation projects such as Skavica HEC; analyze feasibility of Interconnection project with Italy and prepare Master Plan for gasification given TAP Project possibilities.
  - World Bank to support reforms through an investment operation in coordination with other IFIs.

### Education and health reform priorities
- Education:
  - Increase investment in early child education to expand access and enrollment in pre-school education.
  - Overhaul long-term budgeting process for education.
  - Higher education: allocate resources to public universities based on quality and cost performance.
  - Professional education: comprehensive review of poor performance; plan to increase number of professional education and training institutions, improve skills quality, reduce skill mismatches, engage business community in curriculum design, and establish apprentice arrangements with companies.
- Health:
  - Create a new National Agency for Medicines and Medical Materials to improve procurement of pharmaceuticals and other medical materials.

### EU integration and statistics
- EU integration:
  - Launch a complete review of the legal framework for European integration in line with the 2013 Progress Report of the European Commission.
  - Update national coordinating structures and increase public awareness of integration issues.
- Statistics and inter-agency data sharing:
  - Introduce by the end of 2014 a more systemic way to share administrative data (INSTAT and Bank of Albania) in line with the European Statistics Code of Practice and the IMF Data Quality Assessment Framework to reduce duplications and streamline business information requests.

### Program monitoring: review schedule and key procedural items
- Review schedule:
  - Quarterly reviews for the first five reviews and semiannual reviews thereafter.
  - Anticipated first four review dates: June 28, 2014; September 15, 2014; December 15, 2014; and March 27, 2015.
  - Reviews require observance of conditionality for end-March 2014, end-June 2014, end-September 2014, and end-December 2014, respectively.
- Exchange rates used for the program (as of November 30, 2013):
  - lek 140.25 = €1
  - lek 103.17 = $1
  - lek 158.05 = SDR 1
- Privatization adjuster:
  - Ceiling on overall cash deficit will be adjusted by 50 percent of privatization receipts, up to total privatization receipts of lek 14 billion in a given year.
  - Programmed amount of privatization receipts in 2014 is Lek 400 million.

### Quantitative and performance targets (as reported)
- Table excerpts (reported values preserved exactly as in source):
  - I. Quantitative Performance Criteria
    - 1. Floor on net international reserves of the BoA (EUR million) 1289128912891289
    - 2. Ceiling on general government overall cash deficit excluding arrears payment (cumulative)83.616.026.633.456.8
  - III. Inflation Consultation (12-month percent change in consumer prices)
    - Upper outer band5.05.05.05.0
    - Upper inner band4.04.04.04.0
    - Actual/center point1.93.03.03.03.0
    - Lower inner band2.02.02.02.0
    - Lower outer band1.01.01.01.0
  - IV. Indicative Targets
    - 7. Floor on clearance of general government domestic arrears0.00.00.014.2

### Selected structural benchmarks and prior actions (high-level)
- Prior actions include:
  - Parliament to pass the 2014 budget that includes measures needed to meet the fiscal objective.
  - GDT to establish management committees for reform issues, daily business operations, and taxpayer compliance improvements.
  - Working Group of BoA and MoF, in agreement with the Tax Authority, to submit to parliament legislation providing clear and consistent tax treatment of NPL write-offs.
  - Publish a comprehensive arrears prevention and clearance strategy (APCS) on MoF website.
  - Submit amended Law for Payment of Arrears on Contractual Obligations to define expenditure arrears and payment terms.
  - MoF to issue budget instructions to central government entities to report procurement orders for MoF clearance and suspend new multi-year procurement orders until outer-year ceilings are approved.
- Selected structural benchmarks and deadlines:
  - Contract an external auditor with mandate to conduct risk-based audits of arrears payments. End May, 2014
  - Publish a report on arrears paid (on a quarterly basis) on the MoF website (starting in June, 2014). Continuous
  - MoF to issue instructions to all local governments to report all new procurement orders to MoF starting September, 2014. End March, 2014
  - MoF to report quarterly survey results on new arrears accumulation (starting January, 2014) among 5 key ministries and GDT (starting in April, 2014). Continuous
  - Introduce multi-year commitment limits in the 2015 budget and change Procurement Law, Financial Management and Control Law, and Budget Law accordingly. End December, 2014
  - GDT to develop a corporate strategy for medium to long term capacity building. End December, 2014
  - Establish a Pension Reform Commission. End March, 2014
  - Council of Ministers to approve a pension reform strategy. End December, 2014
  - Several financial sector and regulatory amendments with End March, 2014 and End June, 2014 deadlines.

*Source: Albanian authorities; and Fund staff estimates and projections, as provided in the IMF document.*

### 14.      Under the definition of debt set out above, arrears, penalties, and judicially awarded

### _cr1478 - 14.      Under the definition of debt set out above, arrears, penalties, and judicially awarded

### Definition of debt and external arrears
- Arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt.
- Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.
- External payments arrears: arrears of external debt obligations (principal and interest) falling due after the due date and grace period, as specified in the contract, has passed.
- Exclusion: Arrears resulting from nonpayment of debt service for which a clearance framework has been agreed or rescheduling agreement is being sought are excluded.
- The external arrears of the general government will be calculated based on the schedule of external payments obligations reported by the MoF; data will be reconciled with relevant creditors and adjustments incorporated in targets as they occur.
- This performance criterion does not cover arrears on trade credits.
- The performance criterion will apply on a continuous basis.

### Reporting on external arrears
- The MoF will provide final data on the external arrears of the general government to the Fund, with a lag of not more than two weeks after the test date.

### Inflation consultation mechanism
- Quarterly consultation bands apply to the 12-month rate of inflation in consumer prices (headline CPI published by INSTAT).
- If the observed year-on-year rate of CPI inflation (quarterly average) falls outside the outer bands, the authorities will complete a consultation with the IMF on their proposed policy response before requesting further purchases under the program.
- The BoA will conduct discussions with IMF staff should the observed year-on-year rate of CPI inflation (quarterly average) fall outside the inner bands specified for the end of each quarter.

### Indicative targets — Ceiling on accumulation of central government domestic arrears
- Definitions:
  - Domestic expenditure arrears: payments to residents determined by contractual agreements that remain unpaid 30 days after the due date specified by the contract or by the law.
  - Domestic tax refund arrears: obligations on tax refunds in accordance with tax legislation that remain unpaid 30 days after the due date.
  - Due date: the date domestic debt payments are due according to relevant contractual agreement or legislation, taking into account contractual grace periods.
- Monitoring:
  - Accumulation of domestic arrears monitored through MoF’s quarterly survey on arrears accumulation, covering: General Directorate of Taxation, Ministries of Transportation, Health, Education, Defense, Justice and their subordinate agencies starting 2014:Q1; extended to cover Ministries of Interior, Agriculture, Finance, Economy, and Social Welfare by 2014:Q4.
  - All Ministries included in the survey from 2015:Q2.
  - Recording of invoices and tax refund claims should be cumulative starting 2014:Q1 and include unpaid items from previous quarters.
  - MoF should verify reported invoices/refund claims are not already included in the arrears clearance database.
- Reporting:
  - MoF to send consolidated data from the survey to the Fund with a lag of no more than 40 days after each quarter.

### Clearance of general government domestic arrears — definitions and reporting
- Definitions reiterate clauses in the indicative targets: domestic expenditure arrears and tax refund arrears defined as unpaid 30 days after due date; general government domestic arrears include arrears on domestic general government direct debt, suppliers, all recurrent and capital expenditure commitments, and all tax refund arrears.
- Limit: the clearance limit consists of a floor for the amount of arrears payment.
- Data collection: through payments identified as made via the Treasury system under the arrears clearance strategy.
- Reporting: Data provided by the MoF to the Fund with a lag of no more than four weeks after the test date.

### Cumulative ceiling on increase of Bank of Albania credit to general government
- Definition: Credit of the central bank to the general government is outstanding claims of the Bank of Albania on the general government, including overdrafts, direct credit, and holdings of government securities excluding repo operations.
- Reporting: Data will be provided by the BoA to the Fund on a quarterly basis with a lag of no more than fifteen days.

### Structural benchmarks (selected measures)
- Publish a comprehensive arrears prevention and clearance strategy including plan, prioritization criteria for liquidation of arrears, and measures for arrears prevention; draft to be sent to the Fund for review before submission to the Council of Ministers.
- Contract an external auditor with mandate to conduct risk-based audits of arrears payments; MoF to submit Terms of Reference for IMF review before tendering.
- Introduce multi-year commitment limits in the 2015 budget; change Procurement Law, Financial Management and Control Law, and Budget Law accordingly. Commitment limits specify amounts that can be committed in the current year for both the current year and each outer-year per line item; the sum of the commitment limits for an outer-year should be lower than the cash spending ceiling for that year.
- GDT to develop a corporate strategy for medium to long term capacity building in consultation with IMF TA.
- Amend regulatory framework for investment funds (in agreement with BoA and AFSA) to:
  1. Require calculation of unit value to represent proportionate share of aggregate market value of underlying assets;
  2. Introduce capital adequacy requirements aligned with relevant E.U. regulations;
  3. Introduce liquidity requirements consistent with recent E.U. regulatory developments and current level of development of Albanian market.
- Parliament to pass an amended AFSA law, a new insurance law, and amendments to Civil Servant Law and Law on Salaries of Independent Institutions to:
  1. Abolish requirement for AFSA organizational structure approval by Parliament;
  2. Remove AFSA from government employee compensation and benefits structure;
  3. Give AFSA’s Board and staff legal protection from bona fide discharge of governmental, regulatory and administrative functions and powers.

### Monitoring and reporting requirements (monthly unless noted)
- Bank of Albania will supply:
  (i) Balance sheets of the Bank of Albania;
  (ii) Consolidated accounts of, separately, the commercial banks, and the Savings and Loan Institutions (SLIs);
  (iii) The monetary survey;
  (iv) Banking sector prudential indicators;
  (v) Net foreign assets of the Bank of Albania and their components;
  (vi) Comprehensive information on reserve assets that are pledged, collateralized, or otherwise encumbered;
  (vii) Foreign exchange cash flow of the Bank of Albania, including the level of NIR;
  (viii) Daily average exchange rates;
  (ix) Quarterly balance of payments data and updates of balance of payments estimates;
  (x) Inflation forecast on a monthly basis.
- Albanian Financial Supervisory Agency will supply:
  (i) Consolidated accounts of nonbank financial institutions;
  (2) Nonbanking sector prudential indicators.
- Ministry of Finance will supply:
  (i) Summary fiscal table, including the overall budget deficit, on a modified cash basis;
  (ii) Issuance of treasury bills by the MOF, including gross value and cash received;
  (iii) Privatization receipts;
  (iv) Information on contracting and guaranteeing of new debt;
  (v) Information on the stock of short-, medium- and long-term debt;
  (vi) Information on official grants for projects or budget support purposes;
  (vii) Information on the stock of expenditure arrears identified in the Arrears Prevention and Clearance Strategy and progress in arrears repayment;
  (viii) Information on the accumulation of new arrears in central government ministries;
  (ix) Information on the implementation of stronger procurement and commitment controls.
- General Directorate of Customs will supply:
  (i) Detailed monthly data on customs revenues collected.
- General Directorate of Taxation will supply:
  (i) Detailed monthly data on tax revenues collected;
  (ii) Information on progress in implementing business restructuring and IT reforms;
  (iii) Information on the stock of VAT refunds claimed, refund arrears, and refunds paid out every month within one month of the end of the reporting period.
- INSTAT will supply:
  (i) CPI at aggregated level and for each individual item in the basket;
  (ii) Producer price index;
  (iii) Construction cost index;
  (iv) All short term indicators as they become available as defined in INSTAT’s quarterly publication “Conjoncture”;
  (v) Preliminary estimates for Quarterly GDP on a regular basis and preliminary estimates for annual GDP disaggregated by 22 sectors distinguishing between observed and non-observed economy, communicated as early as possible.

### Risk Assessment Matrix — selected risks and staff judgments
- Surges in global financial market volatility:
  - Overall Level of Concern: High
  - Relative Likelihood: Medium
  - Impact if Realized: Medium
  - Notes: Higher long-term rates could trigger capital outflows, depreciation and/or interest rate pressures. Mitigating factors: limited short-term financial transmission channels, little nonresident participation, banks fully funded by local deposits, BoA international reserves are adequate. Deterioration could complicate rollover of Albania’s Eurobond maturing in late 2015. Policy response: plan financing needs well in advance.
- Reemergence of financial stress in the euro area and/or exit of a foreign bank from the market:
  - Overall Level of Concern: Medium
  - Relative Likelihood: High
  - Impact if Realized: High
  - Notes: Stress in European parent banks could reduce ability to re-capitalize Albanian subsidiaries. Mitigating factors: high capital adequacy, banks funded by domestic deposits. Policy response: closely monitor capital shortfalls and require prompt bank responses.
- Protracted period of slower European growth:
  - Overall Level of Concern: High
  - Relative Likelihood: Medium
  - Impact if Realized: Medium
  - Notes: Could weaken exports, tourism, remittances, and FDI. Mitigating factors: share of exports in GDP remains low; bank capitalization is healthy. Policy response: fiscal targets could be adjusted.
- Insufficient implementation of structural reforms:
  - Overall Level of Concern: High
  - Relative Likelihood: High
  - Impact if Realized: High
  - Notes: Political and social tensions could hinder reforms; failure to advance reforms would undermine medium-term debt sustainability.
- Rollover of government debt:
  - Overall Level of Concern: Medium
  - Relative Likelihood: High
  - Impact if Realized: High
  - Notes: Uncertainty and concerns about debt sustainability may make banks hesitant to rollover government debt, much of which is short term. Policy response: avoid disorderly fiscal adjustment.

### Annex II — Debt Sustainability Analysis (DSA) — key results and background
- Summary assessment:
  - Albania’s public debt is high and requires urgent action to bring back toward a sustainable level.
  - Over the medium term, substantial further fiscal consolidation will be needed to put debt on a downward trajectory and mitigate risks to debt sustainability.
  - Key risks include rollover risk and exposure to shocks.
- I. Background:
  - Public debt at end 2013: 70.5 percent of GDP (includes outstanding arrears and unpaid bills of 5.3 percent of GDP).
  - Most public debt is domestic (about 62 percent of the total) and short term (about 30 percent).
  - Includes guaranteed debt (about 5 percent of the total).
  - Local government debt is negligible (0.04 percent of the total).
  - Most domestic debt is held by commercial banks and increasingly by nonbanks.
  - External debt owed to multilateral creditors (about 51 percent), official bilateral creditors (28 percent), and private creditors (21 percent).
- Public debt dynamics:
  - Since 2008, public debt as a percent of GDP increased by more than 10 percentage points, resulting in breach and removal of the 60 percent of GDP debt ceiling in 2012.
  - Albania is treated as a higher scrutiny case because: i) current (and projected) public debt exceeding 60 percent of GDP, ii) gross financing needs (25 percent of GDP in 2013) exceeding 10 percent of GDP.
- Macroeconomic assumptions:
  - Gradual recovery of growth to about 4.7 percent in the medium term.
  - Inflation expectations remain anchored within central bank’s 3±1 percent annual target range.
  - Overall fiscal balance expected to decline from an estimated deficit of 6.2 percent of GDP in 2013 to a balanced position in 2019.
- II. DSA results:
  - Under the baseline scenario, debt is expected to decline gradually but remain high; debt expected to decline below 60 percent of GDP only at end-2019.
  - Remaining risks: i) high rollover need, ii) rising interest rates, iii) close links to financial sector, iv) vulnerability to terms of trade shocks.
  - Financing profile risk: short term debt expected to decline over time, but public gross financing needs will remain elevated in near term, above the 20 percent of GDP early warning benchmark.
  - Interest rate risk expected to increase with lengthening maturities; lack of secondary market limits valuation impact.
  - Foreign currency debt expected to increase over medium term due to external financing under the program and efforts to contract longer maturities; exchange rate risk will therefore increase, but Albania’s comfortable level of reserves would help mitigate this risk.
  - Creditor base currently heavily weighted toward banks; expected medium-term diversification toward other institutions (e.g., investment funds).

*Italic: Source — _cr1478 - 14.      Under the definition of debt set out above, arrears, penalties, and judicially awarded*

### 7.      Alternative scenarios underscore risks associated with the baseline scenario. Two

### _cr1478 - 7.      Alternative scenarios underscore risks associated with the baseline scenario. Two

### Alternative scenarios: summary findings
- Historical scenario: public debt will remain slightly above 70 percent of GDP by 2019.
- Constant primary balance scenario: public debt increases to about 83 percent of GDP by 2019.
- Rationale for not adjusting baseline:
  - The historical period used is short (covers data since 2006) and not representative of the current environment.
  - High growth during the historical period led to pro-cyclical fiscal policy and easy financing, disincentivizing adjustment.
  - Maintaining the primary balance at its 2014 projected level (constant primary balance scenario) would entail significant risks for macroeconomic stability and growth and may not be feasible given financing constraints.

### Stress tests: projected impacts of shocks
- Combined macro–fiscal shock (incorporates largest effects of individual shocks on all variables):
  - Public debt would increase to about 80 percent of GDP by 2016, then decline to about 70 percent by 2019.
  - Gross financing needs are higher by more than 6 percentage points of GDP relative to the baseline.
- Real GDP growth shock (reduction in real GDP growth by one standard deviation for two consecutive years):
  - Public debt increases to 75 percent of GDP by 2016, then declines to about 65 percent by 2019.
- Customized financial-sector shock (substantial withdrawal of foreign banks’ exposure):
  - Could reduce credit supply, raise government borrowing costs, depreciate the exchange rate, raise inflation and the monetary policy rate, and reduce growth and fiscal revenues.
  - Under the illustrative customized scenario, public debt would rise steadily to about 85 percent of GDP and gross financing needs to about 35 percent of GDP by the end of the projection period.
  - At such high debt and large rollover needs, multiple-equilibrium risks increase substantially and the risk of a “bad equilibrium” (loss of domestic market access) is plausible.

### Probabilistic simulations and fan charts
- Symmetric distribution (fan chart): debt stock could range between 40 and 70 percent of GDP by 2019.
- Restricted distribution (precludes a positive shock to the primary balance): debt could increase up to about 85 percent of GDP by 2019 relative to the baseline.
- Overall assessment: risks are likely to be on the upside.

### Macroeconomic and fiscal context
- Planned fiscal consolidation is ambitious:
  - The proposed fiscal consolidation, measured by the three-year adjustment in the structural primary balance, is among the largest for high debt countries (those with debt exceeding 60 percent of GDP).
  - The level of the three-year average cyclically adjusted primary balance is broadly typical of other countries’ adjustment experience.
- Forecast performance:
  - The track record of projecting growth, primary balance, and inflation does not reveal systematic one-sided biases; forecast errors were generally within the 25–75 inter-quartile range.
  - Projections for the primary balance have been rather conservative in recent years.

### Risks and implications for stability
- Shock scenarios push Albania’s debt and gross financing needs above relevant benchmarks:
  - Albania’s debt exceeds the 70 percent debt benchmark under the baseline and various shocks.
  - Gross financing needs exceed 15 percent of GDP under the baseline and specific shocks.
  - Changes in the debt profile pose moderate risks, except changes in short-term debt which pose low risks.
- High debt consequences:
  - Associated with lower growth and may prolong recession.
  - Increases vulnerability to shocks.
  - Stabilizing debt at a high level requires large primary surpluses for many years, which may be politically difficult to sustain.
  - High debt implies high rollover requirements, increasing vulnerability to sudden reversals in market perceptions.

### Key scenario numbers and projections (selected)
- Historical scenario public debt by 2019: slightly above 70 percent of GDP.
- Constant primary balance scenario public debt by 2019: about 83 percent of GDP.
- Combined macro–fiscal shock: debt about 80 percent of GDP by 2016, declining to about 70 percent by 2019.
- Real GDP growth shock: debt to 75 percent of GDP by 2016, about 65 percent by 2019.
- Customized financial-sector shock: public debt about 85 percent of GDP and gross financing needs about 35 percent of GDP by the end of the projection period.
- Fan-chart symmetric range for debt by 2019: between 40 and 70 percent of GDP.
- Fan-chart restricted distribution maximum for debt by 2019: about 85 percent of GDP.
- Gross financing needs under combined macro–fiscal shock: higher by more than 6 percentage points of GDP relative to the baseline.

### Policy implications and priorities
- Addressing high-debt risks is critical for macroeconomic stability:
  - Sustain credible fiscal consolidation to lower debt risks and rollover vulnerabilities.
  - Reduce exposure to contingent and financial-sector risks that could trigger large depreciation, higher interest rates, and loss of market access.
  - Strengthen measures to preserve financing access and investor confidence, given that high debt and large rollover needs can lead to multiple-equilibrium dynamics.
- Recognize feasibility constraints:
  - Maintaining constant primary balance at 2014 levels would pose significant macroeconomic risks and may be infeasible given financing constraints.
  - Political economy considerations matter: large, sustained primary surpluses required to stabilize debt at high levels may be difficult to sustain.

*Source: IMF staff.*

### Annex III. External Debt Sustainability

### Annex III. External Debt Sustainability

### Fund Relations — Membership, Resources, and Financial Arrangements
- Membership Status: Joined October 15, 1991; Article XIV.
- General Resources Account (SDR Million / Percent Quota):
  - Quota 60.00 100.00
  - Fund Holdings of Currency 59.51 99.18
  - Reserve Position 6.18 10.30
- SDR Department (SDR Million / Percent Allocation):
  - Net cumulative allocation 46.45 100.00
  - Holdings 66.98 144.19
- Outstanding Purchases and Loans (SDR Million / Percent Quota):
  - Extended Arrangement 5.68 9.47
  - ECF Arrangements 10.70 17.83
- Financial Arrangements — Approval / Expiration / Amount Approved / Amount Drawn (SDR Million):
  - ECF1: 2/01/2006 — 1/31/2009 — 8.52 — 8.52
  - EFF: 2/01/2006 — 1/31/2009 — 8.52 — 8.52
  - ECF1: 6/21/2002 — 11/20/2005 — 28.00 — 28.00
  - 1 Formerly PRGF.
- Projected Obligations to Fund (SDR Million; based on existing use of resources and present holdings of SDRs):
  - Forthcoming Principal by year: 2014 5.80; 2015 4.32; 2016 2.90; 2017 2.01
  - Charges/Interest by year: 2014 0.06; 2015 0.05; 2016 0.03; 2017 0.01
  - Total by year: 2014 5.86; 2015 4.38; 2016 2.93; 2017 2.01
- Safeguards assessments:
  - A safeguards assessment mission scheduled for February 2014; assessment to be issued soon after.
  - Last assessment (July 14, 2006) identified weaknesses: external audit quality, lack of audit committee oversight, internal controls, controls over Fund data reporting.
  - Post-assessment improvements: external audit quality improved by adding a cosignatory; data reporting process modified. Internal audit vulnerabilities remain; audit committee not yet established.
- Exchange rate arrangement:
  - De jure system: free floating (adopted July 1, 1992).
  - De facto arrangement: floating with occasional monetary authority interventions to avoid excessive short-term disruptions and to accumulate reserves.
  - Outstanding exchange restrictions under Article XIV related to outstanding debit balances on inoperative bilateral payment agreements (nonconvertible/formerly nonconvertible currencies).
  - Two additional exchange restrictions inconsistent with Article VIII, Sections 2(a) and 3:
    - Requirement to submit a tax certificate showing no outstanding taxes prior to transferring foreign exchange for certain current transactions (including moderate amortization of loans, certain insurance premiums, and profit/dividend transfers).
    - Requirement to provide customs clearance documents for advance import payments prior to unrelated foreign exchange transactions.
  - Exchange rate: lek 103.17 per U.S. dollar on November 30, 2013.
- Article IV Consultation: 2012 Article IV consultation concluded on December 3, 2012 (IMF Country Report No. 13/7).
- FSAP and ROSCs:
  - Most recent FSAP: November 2013 (Board date February 28, 2014).
  - Data module ROSC published June 2000; fiscal ROSC June 2003.
  - Participates in GDDS; GDDS metadata posted on Fund’s Dissemination Standards Bulletin Board.
  - Data module ROSC reassessment using DQAF conducted March 2006.
  - ROSC on FATF AML/CFT conducted November 2010; report published July 2011.

### Fund Technical Assistance and Capacity Building (since FY2008)
- Overview: Extensive TA by the Fund and donors across fiscal, legal, monetary, banking supervision, and statistics areas. Multiple missions per subject.
- Selected TA items and dates (Department / Purpose / Date):
  - FAD: Cash Management and Public Finance Strategy — May 2008
  - FAD: Cash Forecasting and Management — October 2012
  - FAD: Revenue Administration — October/November 2008
  - FAD: Advice on IT Strategy and Business Process Reengineering — April 2009; March 2010
  - FAD: Capacity Building in Taxpayer Compliance and Information Technology — November 2011
  - FAD: Tax Administration — April 2009; March 2010; April 2011; April 2012; November 2013; January 2014
  - FAD: Arrears Clearance and Prevention — November 2013
  - LEGAL: Review of the Albanian AML/CFT law — August 2007
  - LEGAL: TA on Repurchase Transactions Law — March 2008
  - LEGAL: Banking Seminar for Judges and Bank Regulators — November 2008
  - MCM: Monetary Policy — 25 visits between June 2007 and April 2010; Management — June, July 2007
  - MCM/Banking Supervision: Credit Registry, Modeling and Forecasting, Banking Supervision visits, Treasury Bill Registry, Stress testing, Contingency planning, Basel II implementation — various dates from 2007 to 2013
  - STATISTICS: Balance of Payments, GDDS consultation, CPI/PPI, Government Finance Statistics, National Accounts statistics visits — various dates from 2007 to 2013

### World Bank Group Relations and Joint Bank-Fund Coordination
- World Bank (WBG) support since 1991:
  - 72 IDA, IBRD and GEF projects totaling US $1.4 billion.
  - IFC investments of US$621 million.
  - MIGA guarantees totaling US$8.6 million.
- National Strategy for Development and Integration (NSDI) 2007–2013 objectives:
  - (i) EU integration, strengthening rule of law and democratization;
  - (iii) achieving rapid and sustainable economic and social development.
- Progress and indicators:
  - Joined NATO in 2008; EU membership application submitted in 2009.
  - November 2010: European Commission recommended opening negotiations once compliance degree achieved.
  - GDP growth continued through global financial crisis; poverty declined.
  - Doing Business 2014 ranking: 90th position (decline).
- NSDI 2014–2020 (draft, consultative; expected finalization by September 2014):
  - Three overarching goals: (i) prepare Albania for full EU membership; (ii) foster strong and sustained economic growth; (iii) transform growth into improved well-being in a fair and cohesive society.
  - Four key areas: (i) good governance, democracy and rule of law; (ii) growth through fiscal stability and increased competitiveness (Pillar I); (iii) sustainable growth through efficient use of resources (Pillar II); (iv) investing in people and social cohesion (Pillar III).
- Current Bank Group CPS for 2011–14 supports NSDI with three strategic objectives:
  - (i) supporting Albania’s economic recovery and growth in a crisis-affected Europe;
  - (ii) broadening and sustaining social gains;
  - (iii) reducing vulnerability to climate change and natural disasters.
  - CPS adjustments: IBRD financing envelope increased from around US$300 million to US$575 million to strengthen financial stability, macroeconomic management, and growth.
- Lending and portfolio performance:
  - 2010 CAS proposed lending range of US$ 75–US$ 196 million.
  - Current portfolio (as of FY13): five projects totaling US$200 million in IDA credits and IBRD loans.
  - Portfolio consolidation: from 18 projects at end-FY09 to five projects by FY13.
  - Disbursement rates: FY11 22 percent; FY12 24 percent; FY13 17 percent (affected by new projects and deteriorating macro-fiscal performance leading to expenditure cuts and project arrears).
  - Steps taken: portfolio simplification, restructuring problem projects, regular portfolio performance reviews.
- Albania: Bank-Fund Joint Management Action Plan Matrix (As of January 2014) — mutual information on work programs and joint missions (provisional mission timing and expected delivery dates listed for various World Bank and Fund products; examples include Environmental Services Project, Energy Sector Recovery Project, Program reviews and EFF arrangement reviews, technical assistance areas such as monetary and financial sector, safeguard assessment, fiscal sector, tax compliance, PFM).

### Statistical Issues — Data Adequacy, Gaps, and Plans
- Overall assessment: Data provision has some shortcomings, but is broadly adequate for surveillance. Main obstacles are in real sector statistics.
- National Accounts:
  - Weaknesses mainly due to poor source data; insufficient information to compile reliable estimates, especially on unobserved economy.
  - Long lag in handling source data (e.g., Structural Business Survey) — timeliness of annual GDP publication around 13 months after the year.
  - INSTAT considering partial electronic survey reporting; would require considerable resources.
  - Improvements via TA (Fund and EU) on methodology, data sources, private sector coverage.
  - Labor Force Survey incorporated into unobserved economy estimates; Household Budget Survey used to develop new benchmark private consumption estimate.
  - New methodology for gross fixed capital formation (commodity flow approach) developed.
  - Resource constraints slow improvements; INSTAT working on adopting ESA95 methodology.
  - Plan: revise annual GDP numbers for 2008–2011 using new methodology in Q2:2014.
  - Quarterly GDP published with lag >90 days using indirect method; large discrepancies between aggregated quarterly GDPs and annual GDP estimates.
- Labor statistics:
  - Labor Force Survey quality insufficient; remote areas undersurveyed.
  - Treatment of agricultural employment needs improvement — currently all landowners considered self-employed.
  - Shortcomings lead to lack of variation in employment/unemployment data.
- Price statistics:
  - Compilation generally follows international standards.
  - Imputed rent estimation in CPI improved in 2003.
  - December 2007: CPI weights updated using national-level HBS (Oct 2006–Sep 2007).
  - PPI published quarterly due to financial constraints; weights derived from Structural Business Survey two years earlier.
- Government finance statistics:
  - Fiscal source data sufficiently adequate for a broad presentation in line with GFSM 2001.
  - Transition to GFSM 2001 requires further improvements: more detail on accounts (National Taxes, Income of Budgetary Institutions, Property Compensation, Compensation for Electricity), separate reporting of local governments, breakdown of Net Acquisition of Nonfinancial assets into GFSM 2001 subcategories, and breakdown of financing into net acquisition of financial assets and liabilities with instruments.
- Monetary statistics:
  - Framework conforms to MFSM 2000 methodology.
  - Depository corporations’ survey covers Bank of Albania (BoA) and other deposit-taking institutions (commercial banks and SLAs).
  - SLAs accounts (except loans) produced on cash basis — deviation from MFSM accrual accounting recommendation.
  - BoA’s and commercial banks’ holdings of nontradable long-term securities recorded at book value — deviation from MFSM.
- External sector statistics:
  - Balance of payments compiled by BoA with lag <90 days; methodologically sound but some estimates need refinement (service transactions, remittances, monitoring of financial account transactions, foreign assistance, external debt).
  - Estimation methods for transactions outside banking system (remittances and nonresident investments) require improvement; remittances increasingly channeled through banking system.
  - BoA to conduct household survey in 2014 to improve remittance estimates.
  - External debt database ensures timely and accurate reporting of external government debt (including state-owned enterprise commitments).
  - Collection of external grants (EG) not timely and covers only central government; BoA revising EG numbers.
  - IIP compiled annually by BoA; timeliness currently 15 months after year, plan to shorten to 9 months in 2014.
- Data Standards and Quality:
  - Albania participates in the General Data Dissemination System (GDDS).
  - Data ROSC published in October 2006.
- Selected fiscal and balance sheet figures (Table 1. Albania: Statement of Operations–General Government, 2009–19; Billions of leks; projections):
  - Revenue series (2009–2019): 299.03; 319.63; 330.43; 330.43; 325.83; 360.83; 379.54; 405.64; 435.44; 466.95; 502.4
  - Taxes (2009–2019): 221.02; 235.02; 247.32; 243.42; 233.82; 267.22; 283.03; 302.53; 324.83; 348.73; 375.6
  - Social contributions (2009–2019): 49.85; 53.85; 56.65; 57.46; 60.06; 63.86; 67.67; 72.47; 77.78; 83.48; 89.8
  - Grants (2009–2019): 4.4; 4.6; 3.8; 5.6; 7.9; 8.5; 6.5; 6.7; 7.1; 7.1; 7.1
  - Other revenue (2009–2019): 23.7; 26.2; 22.7; 24.0; 24.1; 21.2; 22.4; 24.0; 25.8; 27.7; 29.8
  - Expenditure series (2009–2019): 385.3; 371.5; 376.2; 374.2; 409.4; 420.1; 449.5; 482.0; 515.7; 551.0; 588.8
  - Expense (2009–2019): 283.9; 299.9; 305.6; 312.6; 332.1; 353.5; 379.4; 407.0; 435.2; 464.5; 495.7
  - Compensation of employees (2009–2019): 62.4; 65.8; 67.4; 69.4; 71.6; 74.0; 78.4; 83.9; 90.1; 96.7; 104.1
  - Interest (2009–2019): 36.3; 41.6; 41.1; 41.5; 43.9; 46.0; 62.3; 67.2; 70.6; 72.8; 74.2
  - Social benefits (2009–2019): 117.6; 124.9; 132.6; 140.6; 151.4; 159.2; 168.7; 180.8; 194.0; 208.7; 224.7
  - Net acquisition of nonfinancial assets (2009–2019): 101.4; 71.6; 70.6; 61.7; 77.3; 66.7; 70.1; 75.0; 80.6; 86.5; 93.1
  - Net lending/borrowing (2009–2019): -86.3; -51.8; -45.7; -43.9; -83.6; -59.4; -52.3; -37.4; -22.7; -9.9; -0.7
  - Net incurrence of liabilities (2009–2019): 58.8; 41.7; 45.3; 44.6; 67.7; 59.0; 52.3; 37.4; 22.7; 9.9; 0.7
  - Foreign component of net incurrence of liabilities (2009–2019): 42.4; 25.4; 20.9; 15.6; 13.6; 52.2; 47.6; 30.2; -17.7; -29.8; -26.2
  - Sources: Albanian authorities; and IMF staff estimates and projections.
- Table of Common Indicators Required for Surveillance (As of January 31, 2014) — data frequency and last observation notes for key series (Exchange Rates, International Reserve Assets, Reserve/Base Money, Broad Money, Central Bank Balance Sheet, Consolidated Banking System Balance Sheet, Interest Rates, CPI, Revenue/Expenditure/Balance, Stocks of Central Government Debt, External Current Account Balance, Exports and Imports, GDP/GNP, Gross External Debt, International Investment Position). Specific timeliness and data quality assessments referenced (e.g., O, LO, LNO, NO) and footnotes regarding definitions and coverage.

*Statement by the IMF Staff Representative on Albania — February 28, 2014*

### 1.      This statement provides information that has become available since the issuance of

### _cr1478 - 1.      This statement provides information that has become available since the issuance of

### Update since Staff Report
- The information presented has become available since the issuance of the Staff Report and "does not alter the thrust of the staff appraisal."
- Preliminary data for 2013 indicate that the fiscal deficit was 4.8 percent of GDP, compared to 6.2 percent of GDP in the staff report (Table 1).
- The improved fiscal outturn was primarily the result of lower than expected capital expenditure (foreign–financed).
- Tax revenues were higher than envisaged, particularly VAT.
- The improved revenue collection, absent a clear sign of a pickup in economic activity, is likely to have been from better administration—following resolution of uncertainty associated with elections and change of government.
- The good revenue performance was partially offset by lower than expected nontax revenues and grants.

### Fiscal and General Government Operations (Table 1, percent of GDP)
- 2012 (SR; Prel.):
  - Total revenue and grants: 24.9 24.0 24.2
  - Tax revenue: 22.7 21.6 22.2
    - Of which: VAT: 8.8 8.0 8.3
    - Profit tax: 1.3 1.1 1.1
    - Excise tax: 2.7 2.7 2.8
    - Personal income tax: 2.1 2.1 2.2
    - Social insurance contributions: 4.3 4.4 4.4
  - Non-tax revenue: 1.8 1.8 1.6
  - Grants: 0.5 0.6 0.4
  - Total expenditure: 28.4 30.1 29.0
    - Current expenditure: 23.7 24.5 24.2
    - Capital expenditure: 4.7 5.7 4.8
      - Of which: foreign financed: 2.7 2.9 2.1
  - Lending minus repayment: 0.0 0.0 0.0
  - Overall balance: -3.5 -6.2 -4.8
  - Financing: 3.5 6.2 4.8
    - Domestic: 2.3 5.4 4.0
    - Foreign: 1.2 1.0 1.1
    - Accumulation of Arrears: 0.0 -0.3 -0.3
- Sources indicated: "Albanian authorities; and IMF staff estimates and projections."
- Table title: "Table 1. Albania: General Government Operations, 2012–13 (Percent of GDP)"

### Banking and Financial Soundness
- Credit to the economy declined by 2.6 percent in November (y-o-y), unchanged from September.
- The profitability of the banking system remains weak, but provisioning has increased slightly relative to September.
- Financial soundness data for November indicate that the NPL ratio was unchanged at 24.2 percent of gross loans, the same level as in September.
- The nominal stock of NPLs fell slightly on a month-on-month basis.

### IMF Decisions, Support, and Executive Board Statements
- The Executive Board approved a 36-month SDR 295.42 million (about €330.9 million, or about US$457.1 million; 492.4 percent of country’s quota in the Fund) arrangement under the Extended-Fund Facility (EFF) for Albania.
- The approval allows for immediate disbursement of SDR 23.55 million (about €26.4 million, or about US$36.4 million).
- The World Bank and the EU are also likely to provide assistance to the authorities’ reform program.

David Lipton, First Deputy Managing Director and Acting Chair, stated:
- Albania’s economic outlook is expected to improve in 2014, spurred by the planned reduction of underlying risks in the fiscal area, clearance of arrears, tackling of high nonperforming loans (NPLs), and the launch of structural reforms.
- However, risks are significant and refinancing needs are large. The EFF will help Albania meet its external financing needs while providing the necessary support to strengthen fiscal and debt sustainability, lower public financing risks, and put the economy on a sustained medium-term growth path.
- Albania’s high public indebtedness calls for fiscal consolidation that aims to lower the public debt ratio to below 60 percent of GDP in the medium term. This will require significant tax and expenditure policy measures, supported by extensive public financial management and tax administration reforms. Lowering the outstanding stock of arrears and putting in place mechanisms to prevent their recurrence will also be critical.
- Further moderate easing of monetary policy could help to support economic recovery, provided inflation expectations and financial stability remain well anchored; this would need to be carefully balanced against risks posed by high unhedged foreign currency exposure.
- Preserving financial stability while promoting access to credit is necessary to facilitate a durable recovery. Reducing NPLs will safeguard financial stability and may help release credit supply constraints by lowering bank risk aversion.
- Steadfast implementation of the recent Financial Sector Assessment Program recommendations, including those related to lowering risks in the non-bank financial sector, will be important.
- The authorities’ plans to reform pensions, energy, local government finances, public administration, and the business environment are welcome; if implemented properly, these reforms should strengthen Albania’s ability to attract investment, improve prospects for sustained medium-term growth, and reduce fiscal risks.

### IMF Article IV Consultation (concluding note)
- On February 28, 2014, the Executive Board concluded the 2013 Article IV Consultation with Albania.
- The economy "successfully avoided recession in the aftermath of the global crisis and suffered a milder growth shock than neighboring countries."
- Recently, the economy has shown signs of protracted weakness and macroeconomic imbalances have widened.
- Weak investor confidence, bank risk aversion, as well as incomplete investment climate reforms, have amplified the slowdown.
- "Real GDP growth is expected to decline to" (text truncates at this point in the supplied content).

*Sources: Albanian authorities; and IMF staff estimates and projections.*

### 0.7 percent in 2013, the lowest in more than a decade. Inflation has remained low, largely

### _cr1478 - 0.7 percent in 2013, the lowest in more than a decade. Inflation has remained low, largely

### Macroeconomic outlook and growth
- Real GDP growth:
  - 2013: 0.7 percent (the lowest level since 1997)
  - Recent trend: slowdown from 3.3 (2009) → 3.8 (2010) → 3.1 (2011) → 1.3 (2012) → 0.7 (2013)
- Inflation:
  - Consumer Price Index (avg.) 2013: 1.9
  - Inflation has remained low, largely within the central bank’s 2–4 percent target range, reflecting the negative output gap.
- External sector and reserves:
  - Current account balance (including official transfers) 2013: -9.0 percent of GDP
  - Current account balance (excluding official transfers) 2013: -10.4 percent of GDP
  - Gross international reserves 2013: 2.0 (in billions of Euros)
  - Reserves in months of imports of goods and services 2013: 4.8
  - Positive financial account contribution from direct investments: around 8 percent of GDP (stable)
  - External debt could reach about 43 percent of GDP in 2014 before declining thereafter
- Output gap:
  - 2013: -1.5 percent

### Fiscal position and public debt
- Fiscal deterioration in 2013:
  - Public Debt: 70.5 percent of GDP in 2013 (historical peak)
  - Unpaid bills and arrears: about 5.3 (percent of GDP) noted in table; narrative states about 5 percent of GDP linked to contracts
  - Estimated deficit for 2013: 4.8 percent of GDP (narrative)
- Fiscal targets and program objectives:
  - Program seeks to reverse upward trend in public debt and lay ground for sustained reduction.
  - Authorities commit to reducing debt ratio to 69 percent of GDP by end-2016 (end of proposed EFF program) and to well below 60 percent by 2019.
  - Fiscal deficit target for 2014: about 4 percent of GDP, excluding the repayment of arrears.
- Fiscal measures (2014 budget and medium term):
  - Corporate income tax (CIT) rate increase: from 10 to 15 percent.
  - Increases in excise tax rates, fuel tax and property tax rates.
  - No increase in public sector salaries in 2014 (except police officers).
  - Pension increases limited to cost of living adjustments.
  - Introduction of progressive income tax; reduce simple tax on profit for small businesses to half the corporate tax rate.
  - Commitment to public financial management and tax administration reforms, including engaging a foreign consultant to assist customs and establishing management committees for taxpayer compliance.
- Arrears strategy:
  - Comprehensive arrears prevention and clearance strategy (APCS) published by Ministry of Finance.
  - Amended Law for Payment of Arrears on Contractual Obligations submitted to Parliament.
  - External auditor to be contracted to conduct risk-based audits of arrears payments.
  - New procurement clearance and reporting procedures; suspension of new multi-year procurement orders until outer-year commitment ceilings approved.
  - Introduction of commitment limits with the 2015 budget.

### Monetary policy and inflation targeting
- BoA stance and objectives:
  - BoA has kept inflation low and relatively stable under the inflation-targeting framework.
  - Most Directors saw scope for moderate monetary policy easing to support recovery, provided inflation expectations and financial stability remain anchored.
  - Authorities view monetary stance could be moderately expansive, given low inflation and weak demand, while avoiding excessive financial stability strains.
- Policy rates and indicators (2013 figures from table):
  - Interest rate (3-mth T-bills, end-period) 2013: 3.3
  - BoA repo rate 2013: 3.0
  - Broad money growth 2013: 2.9 percent
  - Private credit growth 2013: -3.0 percent
- Operational improvements:
  - BoA will improve operational framework and communication strategy to increase transmission efficiency and promote money market development.
- Cautions:
  - Further easing could increase risks due to high unhedged foreign currency exposure and limited effectiveness because of sluggish credit demand and bank risk aversion.
  - Directors encouraged removal of exchange restrictions as soon as possible.

### Banking and financial sector stability
- Banking system strengths:
  - Relies almost exclusively on domestic deposits; branches of foreign banks fully funded by domestic deposits.
  - Strong solvency ratios and stringent provisioning rules support resilience to eurozone stress.
  - Banking sector described as well-capitalized and liquid.
- Non-performing loans (NPLs) and profitability:
  - NPLs have increased considerably, constraining credit growth and putting pressure on bank profitability.
  - Program objectives include bringing down NPLs to restore banks’ confidence in lending.
- Measures to address NPLs and legal constraints:
  - Legal amendment of the Tax Law submitted to Parliament to remove impediments to loan write-offs from banks’ balance sheets.
  - Regulatory framework to strengthen credit standards will be improved.
  - Amendments to Civil Code and other laws to improve insolvency requirements, set bailiff payment in line with success rate, and restrict judicial discretion in postponing borrowers’ payments.
  - Removal of impediments to collateral execution and loan restructuring encouraged.
  - Clearing arrears expected to contribute to NPL reduction.
- Nonbank financial sector:
  - Strengthen regulation and supervision of nonbank financial system in line with FSAP recommendations.
  - Improve operational and financial independence of the Albanian Financial Supervisory Authority (AFSA).
  - Revise regulatory framework for investment funds to introduce liquidity and capital requirements and require calculation of net asset value on a mark to market basis.
- Macroprudential framework:
  - BoA will further improve its macro-prudential framework.

### Extended Fund Facility (EFF) program request and external financing
- Authorities requested a three-year program under the Extended Fund Facility (EFF).
- Estimated external financing need: about 7.1 percent of GDP in 2014-16.
- Program modalities:
  - Direct budget support chosen due to limited domestic market capacity and limited access to international capital markets.
  - Program expected to catalyze external financing and increase confidence.
- Program aims:
  - Significantly reduce public debt.
  - Bring down NPLs to restore bank lending.
  - Undertake ambitious structural reforms (pensions, energy, public administration, business environment) to promote long-term growth.
  - Achieve gradual fiscal adjustment.

### Structural reforms and growth-supporting measures
- Pensions:
  - Medium-term pension reform to be adopted.
  - Reform Commission to be established by end of next March and present medium-term strategy for Council of Ministers approval by December 2014.
- Energy sector:
  - Task Force to develop medium-term strategy in cooperation with World Bank.
  - By Q1 2014 plan to increase billing in regions with high informal sectors.
  - Plan to address inter-company debt in energy sector.
  - By first half of 2014 tariff system to be reviewed to bring prices closer to market prices.
- Business environment and public administration:
  - Assessment of regulatory framework for business and reform of business registration procedures to improve transparency and reduce time for firms.
  - Use meritocratic criteria in hiring new public employees in compliance with new Civil Service Law.
  - Review of legal framework to address European Commission issues related to future EU integration.
- Agriculture and rural development:
  - Land reform to distribute 70 percent of land titles by 2015.
  - Improve irrigation infrastructure and food safety through capacity building by Rural Development and Water administration.
- Social protection and labor:
  - TA project with World Bank to modernize social assistance scheme.
  - New database to be introduced by April 2014 for inter-agency exchange of information on individuals.
  - Increase investment in early child education, review professional education system, and establish apprentice arrangements with companies.
- Statistics:
  - Improve statistics through better inter-agency data sharing.

### Executive Board assessment and policy guidance
- Directors commended authorities for measures to restore fiscal sustainability, safeguard financial stability, and improve investment climate.
- Debt reduction objective:
  - Directors recommended fiscal consolidation to lower public debt ratio to below 60 percent of GDP in the medium term.
  - Significant further tax and expenditure policy measures required, supported by public financial management and tax administration reforms.
  - Adoption of a medium-term budget framework or fiscal rule recommended to anchor commitment to debt target.
- Distribution of adjustment:
  - Directors generally agreed burden of fiscal adjustment should fall primarily on revenues.
  - Pension and energy reforms emphasized as key parts of medium-term adjustment.
- Arrears and audits:
  - Reduce outstanding stock of arrears and put in place mechanisms to prevent recurrence.
  - Proceed cautiously with payments and employ an external auditor promptly to conduct ex post risk-based audits.
- Financial stability:
  - Prompt and comprehensive action to address rising NPLs encouraged, including removing impediments to collateral execution and loan restructuring, and clearing arrears.
  - Strengthen regulation and supervision of nonbank financial system per FSAP recommendations.
- Structural reforms:
  - Ambitious structural reforms (pensions, energy, local government, public administration, business environment) are critical to attract investment, reduce fiscal risks, and strengthen debt sustainability.
- Monetary policy guidance:
  - Scope for moderate monetary easing if inflation expectations and financial stability are anchored, but caution urged given foreign currency exposure and weak credit demand.

### Key fiscal and macroeconomic statistics (selected table figures)
- Real GDP growth rates: 2009: 3.3; 2010: 3.8; 2011: 3.1; 2012: 1.3; 2013 (Est.): 0.7
- Consumer Price Index (avg.): 2009: 2.3; 2010: 3.5; 2011: 3.4; 2012: 2.0; 2013: 1.9
- Foreign savings (Percent of GDP): 2009: 14.1; 2010: 10.0; 2011: 9.6; 2012: 9.3; 2013: 9.0
- National savings (Percent of GDP): 2009: 16.2; 2010: 16.9; 2011: 16.2; 2012: 15.0; 2013: 15.2
- Investment (Percent of GDP): 2009: 30.3; 2010: 26.9; 2011: 25.8; 2012: 24.3; 2013: 24.2
- Revenues and grants (Percent of GDP): 2009: 26.0; 2010: 26.1; 2011: 25.8; 2012: 24.9; 2013: 24.0
- Expenditures (Percent of GDP): 2009: 33.5; 2010: 29.9; 2011: 29.3; 2012: 28.4; 2013: 30.1
- Overall balance (Percent of GDP): 2009: -7.4; 2010: -3.8; 2011: -3.6; 2012: -3.5; 2013: -6.2
- Primary balance (Percent of GDP): 2009: -4.3; 2010: -0.4; 2011: -0.4; 2012: -0.3; 2013: -2.9
- Net domestic financing (Percent of GDP): 2009: 3.3; 2010: 1.4; 2011: 1.9; 2012: 2.3; 2013: 5.4
- Public Debt (Percent of GDP): 2009: 59.5; 2010: 58.5; 2011: 60.3; 2012: 62.4; 2013: 70.5
  - Domestic: 2009: 36.1; 2010: 33.3; 2011: 34.2; 2012: 35.5; 2013: 43.7
  - External (including publicly guaranteed): 2009: 23.3; 2010: 25.2; 2011: 26.0; 2012: 27.0; 2013: 26.8
- Broad money growth: 2009: 6.8; 2010: 12.5; 2011: 9.1; 2012: 5.0; 2013: 2.9
- Private credit growth: 2009: 10.3; 2010: 10.1; 2011: 10.4; 2012: 1.4; 2013: -3.0
- BoA repo rate (in percent): 2009: 5.3; 2010: 5.0; 2011: 4.8; 2012: 4.0; 2013: 3.0
- Trade balance (goods and services, Percent of GDP): 2009: -24.7; 2010: -20.9; 2011: -23.1; 2012: -19.0; 2013: -17.1
- Official transfers (Percent of GDP): 2009: 0.7; 2010: 2.1; 2011: 2.9; 2012: 1.7; 2013: 1.4
- Gross international reserves (in billions of Euros): 2009: 1.6; 2010: 1.9; 2011: 1.9; 2012: 2.0; 2013: 2.0
- Reserves relative to external debt service: 2009: 2.4; 2010: 3.4; 2011: 8.4; 2012: 7.9; 2013: 5.8
- Nominal GDP (in billions of lek): 2009: 1148.1; 2010: 1222.5; 2011: 1282.3; 2012: 1326.5; 2013: 1357.9

*Source: IMF staff report and statements contained in the provided document.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1478.pdf_