Mission Concluding Statement 

Albania: Staff Concluding Statement of the 2016 Article IV Mission and the Seventh Review Under the Extended Arrangement

March 24, 2016

Over the past few years, Albania has successfully maintained macroeconomic stability amidst a turbulent external environment. However, growth remains sluggish due to a weak Euro Area recovery, risk-averse banks, and, more recently, a decline in oil production. The policy mix focuses on fiscal adjustment, while supporting growth through gradual monetary easing. The key policy priorities are to lower fiscal vulnerabilities through continued consolidation, revive private sector credit by cleaning up bank balance sheets, and continue implementing growth-friendly structural reforms. Faster implementation of structural reforms is critical to strengthen competitiveness, improve the investment climate, and catalyze stronger growth. The authorities’ Fund-supported program provides a further opportunity to advance these reforms in the coming year. The program remains broadly on track and the IMF mission and the authorities have reached staff level agreement on the policies needed for completion of the seventh review under the Extended Arrangement.

Economic recovery is underway and reforms are progressing

1. Albania is gradually recovering from a protracted growth slowdown. Despite weathering the global financial crisis well, economic difficulties in key Euro Area trading partners (Italy and Greece) and stagnant bank lending have weighed on economic activity in the post-crisis period. The economic recovery is now slowly gathering pace, supported by prudent policies and a gradual restoration of consumer confidence. Increased FDI in large energy-related projects is also expected to boost growth in the near-term. GDP growth is projected to accelerate to 3.4 percent in 2016, from 2.6 percent in 2015. The current account deficit is expected to widen and remain elevated as import-intensive investment pick up. Headline inflation is low and will likely remain subdued in the near future, due to imported disinflation and slack in domestic demand.

2. Reforms are progressing well. Since the approval of the Extended Arrangement in early 2014, the authorities have made good progress with strengthening public finances and implementing structural reforms in the power sector. A sizable fiscal consolidation is underway and public debt is projected to have peaked in 2015. These achievements have led to a successful Eurobond issuance and a recent credit rating upgrade. However, other reforms critical for improving the business environment—including those related to property rights, NPL resolution, the judiciary, and governance—are lagging.

3. The medium-term outlook remains favorable, provided the reform momentum is maintained. Growth is expected to rise to around 4 percent over the medium term, reflecting higher investment from a stronger credit recovery, continued FDI, and structural reforms as Albania advances through the EU accession process. Risks to the outlook are on the downside. They arise from a potential scaleback in investment from the impact of the oil price decline and spillovers from weaker economic conditions in Euro Area trading partners. Further delays in structural reforms critical for improving the business climate would also hinder growth prospects.

Advance fiscal sustainability and implement structural fiscal reforms

4. Fiscal consolidation should continue to lower fiscal vulnerabilities and ensure debt sustainability. The primary balance is expected to improve by around 2¼ percent of GDP in 2014-16, reaching a primary surplus this year. Thereafter, the authorities should persist with their target of lowering public debt below 60 percent of GDP by 2019, which requires measures of around 1 percent of GDP each year. To anchor long-term expectations, the authorities should adopt a fiscal rule underpinned by an independent fiscal council. Furthermore, debt management should further lengthen the maturity of public debt and diversify the investor base, thereby lowering the risks arising from financing needs which remain elevated.

5. Given the relatively low level of public spending, the fiscal adjustment should focus mainly on the revenue side. Given the need for greater spending in areas such as infrastructure and education as well as relatively low and declining tax efficiency in Albania, the consolidation strategy should focus on broadening the tax base and on strengthening compliance and revenue administration. The authorities should accelerate work on a fiscal cadastre, with the goal of introducing a valuation-based property tax by end-2017. They should refrain from granting any further tax exemptions or preferential tax treatments, and should strive to remove existing ones.

6. Persistence with structural fiscal reforms is needed to reduce fiscal risks.

• Tax administration: The focus should be on the timely implementation of the tax administration’s corporate strategy, which includes a wholesale restructuring of the General Directorate of Taxes as well as the adoption of modern compliance risk management tools. The tax and customs administrations should coordinate more closely on risk assessment and maintain the momentum of the campaign against informality, which has already yielded a large increase in the number of registered small businesses and employees.
• Public investment management and PPPs: Strengthening public investment management and boosting the credibility of the authorities’ medium term budgetary framework is crucial in order to reduce the risk of unfunded commitments and arrears. In particular, the authorities should review all outstanding unbudgeted investment projects and identify projects that will be cancelled, based on transparent criteria. All PPP proposals should be subject to detailed feasibility study and cost-benefit analysis, which should be evaluated by the Ministry of Finance before approval. The impact of any new PPPs on the fiscal accounts should be reflected transparently and in line with international norms.
• Commitment control and arrears clearance: The authorities have successfully cleared a substantial stock of central government arrears. To prevent recurrence of new arrears, multi-year commitment limits and the rollout of a new treasury IT system should be implemented urgently. Approval of the Organic Budget Law is a priority. A recent survey of local government finances undertaken by the Ministry of State for Local Government has also uncovered potential arrears of around 0.6 percent of GDP as of mid-2015. The authorities should require local government units to conduct formal audits and formulate action plans to resolve these arrears, with external auditors ensuring the integrity of the process. To mitigate fiscal risks from the ongoing fiscal decentralization and improve reporting and monitoring, the review of the local public finance law should be expedited.

7. Continued progress on power sector reforms would also mitigate fiscal risks. The early results from these reforms are impressive, including sustained increases in bill collections, reductions in distribution losses, and stronger finances of the state-owned electricity companies. To ensure that these gains are cemented, steadfast implementation of the reform agenda would be critical, especially given the history of failed past attempts. In advancing reforms, the focus should be on further liberalizing the electricity market, investing prudently in meters and grid infrastructure, and strengthening corporate governance in the sector.

Continue with gradual monetary easing and revive the flow of credit to the private sector

8. The accommodative monetary policy stance remains appropriate. There remains ample space under the conventional monetary policy framework for further easing. Greater exchange rate flexibility would support the inflation-targeting monetary policy framework, but should be weighed against financial stability risks emanating from unhedged exposures. To continue to rebuild its credibility and safeguard its independence, the BoA should take further steps to improve its operations and governance, including through amendments to the central bank law.

9. High bank risk aversion due to difficulties in NPL resolution continues to thwart credit recovery. Mandatory writeoffs have led to a sizable decline in the NPL ratio and there is welcome progress in addressing the NPLs from large borrowers. Nevertheless, credit growth remains weak, reflecting the still high level of NPLs. Speedy implementation of the authorities’ comprehensive NPL strategy is critical, in particular in simplifying the legal framework for insolvency, as well as facilitating collateral execution and out-of-court restructuring.

10. The authorities continued efforts to strengthen financial supervision and regulation are welcome. The banking system remains well-capitalized and liquid. BoA’s microprudential tools should focus on the fastest-growing and systemically important segments of the banking system. The BoA should seek to reduce euroization in the banking system, including by appropriate macroprudential measures to reduce the share of unhedged borrowers in foreign currency. It should also maintain consistency with international standards and ensure healthy capitalization levels in the banking system by unwinding reduced risk weights for new credit. Given the growing presence of investment funds and non-bank financial institutions, the authorities should urgently strengthen the non-bank financial regulator’s capacity and its ability to attract and retain skilled staff.

Advance structural reforms to achieve sustainable high growth

11. Competitiveness indicators suggest need for further improvement. Non-oil exports, which are concentrated in low value-added products, have yet to achieve significant gains in market share. The exchange rate is estimated to be moderately overvalued, with the external position moderately weaker than implied by fundamentals, which poses challenges for external competitiveness. Several cross-country indicators of competitiveness highlight, as key structural weaknesses in Albania, infrastructure gaps that constrain trade, high informality that leads to low productivity, weak institutions and corruption that hamper the rule of law and business environment, and complex tax procedures that increase the burden on businesses.

12. Further structural reforms to improve the business environment would be critical for strengthening Albania’s competitiveness. Flexible labor markets have helped maintain low unit labor costs. However, faster growth in labor productivity would require additional improvements in the business climate to foster investment as well as further reforms in both higher education and vocational training. Further improvement in the country’s infrastructure could ease the cost of doing business. In particular, electricity sector reforms focusing on further deregulation and improved corporate governance would improve energy supply and lower the cost of doing business. In order to improve its competitiveness, Albania also needs to sustain the fight against informality, simplify tax collection procedures, and improve governance. To strengthen property rights, efforts to establish the legal cadastre for property registration should be expedited. Progress in judicial reform is a prerequisite for opening EU accession negotiations, and should be guided by the recommendations of the Venice Commission.

Program Performance

13. The IMF team and the authorities have reached staff-level agreement on the completion of the seventh review. The program remains broadly on-track with all performance criteria met, although two indicative targets were missed by small margins and implementation of three structural benchmarks on public financial management and tax administration reforms has been delayed. The authorities have committed to accelerate the implementation of these reforms as well as safeguard the fiscal targets from the negative impact of the decline in commodity prices through strict budgetary discipline and strengthening of the revenue base and tax compliance.

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The IMF team thanks the authorities and other interlocutors in the public and private sector for their cooperation, open and constructive discussions, and warm hospitality.