Albania: Staff Concluding Statement of the 2018 Article IV Mission
IMF News, November 20, 2018
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- Published: November 20, 2018
A mostly positive outlook: growth, inflation, external position, and financing
- Economic growth has trended upward; a temporary push from electricity generation owing to favorable weather conditions is expected to boost growth to 4 percent this year, and to dampen it somewhat in 2019, to 3.7 percent.
- Over the medium term, growth is projected to stay close to 4 percent, supported by buoyant exports, including tourism, and investments in infrastructure.
- Inflation is expected to rise very gradually to reach its 3 percent target by 2021.
- In October, the authorities successfully issued a €500 million Eurobond with a seven-year maturity, at a favorable rate of 3.50 percent.
- As large energy projects with import-intensive components taper off, the current account deficit is foreseen to narrow to around 6 percent of GDP over the medium term.
- Although the banking system is well-capitalized and liquid, credit provision to support business investments remains weak.
- Non-performing loans (NPLs) have declined by more than 10 percentage points since 2014, but remain high in some banks.
- Risks are tilted to the downside: Albania is strongly exposed to increasing risks to growth in Europe; a downturn in main trading partners could reduce exports, remittances, and FDI. Expected tightening in global financial conditions would raise Albania’s cost of financing. Domestic risks include insufficient structural reforms and adverse weather affecting electricity generation.
Fiscal risks, public investment, and public debt dynamics
- Fiscal consolidation should be accelerated to create buffers; limited space for fiscal stimulus if adverse risks materialize.
- Without additional measures, government deficit projected to remain close to 2 percent of GDP in 2018 and beyond, resulting in a continued declining path of public debt, although with slower reduction than recommended — to 62.3 percent of GDP by 2021 (including projected general government arrears of 0.6 percent of GDP).
- This debt path assumes maintaining a prudent reserve buffer in the single treasury account, equal to 1 percent of GDP.
- To achieve the authorities’ objective of reducing public debt to 60 percent of GDP by 2021 in a sustainable manner, further fiscal adjustment will be needed; failure to meet this target could undermine market confidence.
- For 2019, the mission advises an additional reduction in the deficit by more than 0.5 percent of GDP, achievable through a mix of excise-rate indexation, environmental taxation, and further broadening of the tax base.
- Strengthening the fiscal rule is recommended: set targets for the annual (primary or overall) fiscal balance to underpin the legislated target of reducing debt to no more than 45 percent of GDP.
- Authorities are urged to refrain from introducing ad-hoc tax cuts, exemptions, or preferential treatments and consider rolling back those already implemented.
- Progress is noted on revenue administration improvements, including a new system for data integration being established in GDT, and progress in property tax reform with the expected launch of the fiscal cadaster in January 2019.
- Spending priorities: strengthen efficiency without eroding spending in priority areas (education, health care, infrastructure). Spending on education remains low; skills shortages constrain productivity and growth.
Public-Private Partnerships (PPPs), arrears, and fiscal risk assessment
- Rapid increase in PPPs has raised fiscal risks; essential to strengthen investment planning and execution at all levels, and to obtain value-for-money.
- Documents accompanying the 2019 budget foresee an existing stock of PPPs of 31 percent of GDP (of which concessions in energy of more than 23 percent) and a pipeline of potential new PPPs capped at 15 percentage points.
- Current efforts to bolster the role of the Ministry of Finance and Economy as gatekeeper are welcomed; advise halting acceptance of unsolicited PPP proposals to promote competitive bidding.
- Projected PPP-related spending remains below the legal limit of 5 percent of tax revenues, leaving little room for additional government-funded PPP projects.
- Budgetary arrears increased in 2017 and should be addressed without delay; arrears are estimated at 1.5 percent of GDP as of end-September 2108 (including local governments).
- Prevention and control of arrears require strengthening revenue forecasting, cash management, and commitment controls (notably by the Road Authority). Prompt payment of VAT refunds is important for trust in the VAT system.
- Inclusion of a fiscal risk assessment in recent budgets is welcome, but its depth and coverage need enhancement, including a more granular analysis of large contingent liabilities (including PPP contracts) and presentation of mitigation measures.
Electricity sector reforms
- Planned reforms guided by a five-year financial recovery plan (prepared with World Bank support) foresee clearance of arrears, further reduction of distribution losses, and better targeting of investments.
- Completing reform requires timely decisions on governance of public energy sector companies, pricing that ensures cost recovery throughout the production chain, and contingencies to deal with droughts.
Monetary policy, exchange rate, and monetary transmission
- Current accommodative monetary policy stance remains appropriate until inflation approaches the target, but structural bottlenecks mute policy effectiveness.
- Lowering of the policy interest rate to a historical minimum has been transmitted to financial markets, but the upward effect on headline inflation remains to be seen.
- Monetary transmission is constrained by extensive use of euros and cash (rather than lek deposits) and structural weaknesses in credit provision, including continued high NPLs, weaknesses in property rights and insolvency regimes, high informality, banks’ deleveraging and risk aversion.
- Addressing these bottlenecks would support credit growth and money creation and enhance monetary policy transmission.
- Within the flexible exchange rate regime, authorities have intervened to dampen strong appreciation pressures: since June-2018, the Bank of Albania (BOA) has conducted unscheduled interventions in the foreign exchange market focused on preventing disorderly market conditions and dampening downward pass-through effects on inflation.
- The mission encourages phasing out these operations as disinflation risks recede; exchange rate flexibility has mitigated shock impacts.
Financial system: supervision, NPL resolution, markets, and de-euroization
- NPL reduction: authorities’ approach (notably write-offs) has been effective; further reduction calls for: (i) strong enforcement of the new Bankruptcy Law, (ii) enactment of the regulatory framework for out-of-court settlement agreements to resolve NPLs, (iii) resolving deadlock around more efficient operations of private bailiffs, and (iv) rules to accelerate loan write-offs further.
- Supporting banking system quality: as ownership shifts toward domestic and non-EU conglomerates, supervision must contain risks from related-party lending, cross-border lending, and large exposures. Supervisory department of BOA should be adequately staffed for more frequent on-site inspections of higher-risk banks.
- Developing financial markets: commit to predictable issuance of short-term T-bills; balance reduction of debt-service costs with developing domestic capital markets. Developing second- and third-pillar private pension plans would enhance the social safety net through new savings vehicles. Enhance financial literacy to mitigate risks and stimulate financial inclusion.
- De-euroization strategy: introduction in July of differentiated reserve requirements for foreign currency deposits was a useful step, in line with the de-euroization plan. Next phase: prepare specific actions to discourage pricing and payment of domestic transactions in foreign currency.
- AML/CFT: ongoing steps to bolster the AML/CFT framework will be needed to address vulnerabilities and safeguard financial integrity.
Enhancing the business climate, rule of law, and structural reforms
- Determined efforts needed to improve the business climate to promote faster and more inclusive growth, stronger regional integration, and to blunt the appeal of emigration.
- Priorities include:
- Vigorous implementation of judicial sector reform, enforcement of the rule of law, and the anti-corruption strategy.
- Strengthening framework for property and contractual rights to foster private sector credit growth and facilitate FDI.
- Improving quality of health care and education to address skilled labor shortages.
- Closing infrastructure gaps with regional peers.
- Aligning rules and standards with the EU to foster participation in global value chains.
Source: Albania: Staff Concluding Statement of the 2018 Article IV Mission (November 20, 2018).