Recent Economic Developments and Outlook
The economic recovery continues, supported by large energy-related
Foreign Direct Investment projects and rising consumer confidence.
GDP growth is projected to increase to 3.9 percent in 2017, driven by rapid
expansion of tourism and construction sectors, offsetting the negative
impact of drought on electricity production. Job recovery continues with
unemployment falling to 13.9 percent at 2017:Q2. Credit to households and
exports are rising. The current account deficit is expected to widen
slightly in 2017, reaching 8.0 percent of GDP, as energy investment and
drought-related electricity imports pick up. Pass-through of higher
external inflation and increasing domestic demand is expected to push
inflation to around 2 percent (yoy, average) in 2017.
Despite the strengthening recovery, fiscal consolidation is expected to
slow down in 2017
. Based on the revised budget, the mission projects the general government
primary balance to slightly deteriorate from a surplus of 0.2 percent of
GDP in 2016 to 0.1 percent of GDP in 2017, owing to large pending
value-added tax (VAT) refunds, electricity import guarantees, and local
government expenditures. However, overall general government deficit is
expected to decline modestly to 2.0 percent of GDP due to interest savings.
Public debt (including substantial local and central government arrears) is
also projected to decline from 73.3 percent of GDP at end-2016 to 71½
percent of GDP at end-2017.
The medium-term outlook appears favorable, provided the reform momentum
is sustained.
In 2018, growth is projected to ease to 3.7 percent as investments by the
large energy-related projects taper off. Growth is expected to subsequently
increase to 4 percent over the medium-term, catalyzed by reforms towards
European Union (EU) accession and recovery in the main EU trading partners.
Risks to the outlook are balanced. On the upside, improved confidence
following the resolution of political uncertainty and spillovers from the
large energy and infrastructure projects could lead to higher investment
and a stronger credit recovery. On the downside, continued drought
conditions could affect electricity generation and pose quasi-fiscal risks.
A slowdown in the reform momentum and fiscal slippages could dampen
confidence, increase risk premia and increase rollover risks. Banking
distress in Europe or rapid deleveraging by EU banks could lead to
financial sector stress.
In this context, the main policy priorities are to (i) maintain
macroeconomic stability and (ii) deepen structural reforms to improve
the investment climate and catch up to EU incomes levels.
Policies should seek to address challenges arising from high public debt,
low credit, and weak institutions that deter investment.
Fiscal Policy: Ensuring Fiscal Sustainability and Supporting
Growth-Friendly Spending
Fiscal consolidation should continue to ensure debt sustainability.
Albania’s public debt level and gross financing needs remain high. The
authorities are committed to reducing public debt below 60 percent of GDP
by 2021, in line with the long-term debt objective of 45 percent of GDP in
the Organic Budget Law. To achieve these objectives, the draft 2018 budget
and medium-term budgetary frameworks target a primary surplus of 0.6
percent of GDP, and a gradual consolidation to reach a primary surplus of
2.3 percent of GDP by 2021. The authorities’ fiscal strategy envisages a
large scale-up of public investment, while containing public wages (except
for health and education sectors) and reducing energy support, as well as
increased revenues from value-based property tax and compliance gains from
the anti-informality campaign.
To reach the debt objective, the mission recommends a more front-loaded
consolidation
. In the absence of tax policy measures, the mission projects public debt
to reach around 63.5 percent of GDP by 2021. This includes a buildup of a
prudent deposit buffer (1 percent of GDP) but excludes any debt or
contingent liability arising from Public-Private Partnerships-financed
investments (€1 billion, around 7 percent of GDP by 2021). The mission
estimates that additional permanent measures to the tune of 1¼ percent of
GDP over 2018-19 would be needed to achieve the debt target. Ensuring that
the 2017 revised budget stays within the original target by locking in
existing savings and avoiding inefficient year-end spending would also
help.
Additional measures are needed to mobilize revenues for increased
priority spending in health, education and infrastructure.
Tax efficiency is low compared to neighboring countries reflecting high tax
thresholds and weak compliance. Heavy reliance on specific taxes has also
led to low tax elasticity with respect to GDP. The mission welcomes the
planned introduction of a value-based property tax and strengthening of tax
compliance, and recommends additional measures such as indexation of
excises to inflation to preserve its real value, transfer duty on property
sales as a transition to the value-based property tax, environmental
excises, and broadening of the tax base. The authorities should refrain
from granting any new tax exemptions or preferential tax treatments, or
lowering tax rates. The design of VAT and CIT taxation on small businesses
should consider a simplified regime to minimize the burden on tax
administration.
Structural Fiscal Reform: Reducing Fiscal Risks and Improving
Efficiency
Strengthening fiscal institutions is crucial to mitigate fiscal risks
and enhance efficiency.
-
Tax administration
:
The tax administration has made good progress in implementing its
strategic plan. The mission supports its focus on improving debt
collection processes and compliance risk management. The announced
merger of the tax and customs administrations should be revisited,
given the high risks of undermining revenue collection and the ongoing
tax administration reforms. More generally, the reorganization of
central government administration should be implemented with due
consideration of its functional impact.
-
Public financial management:
With the planned scaling up of public investments, it has become
crucial to strengthen public investment management, in particular the
project appraisal and selection processes, in order to reduce waste and
abuse. Adhering to the medium term budgetary framework is important for
reducing the risks of unfunded commitments and arrears. Even under an
increased expenditure envelope in the 2018 budget, new planned projects
are crowding out existing commitments.
-
Public Private Partnerships (PPPs)
: The authorities’ ambitious agenda for public investment through PPPs
poses substantial fiscal risks. It is of paramount importance to
strengthen the implementation of the PPP framework and start making use
of the Ministry of Finance’s recently expanded legal powers to assess
and monitor PPP projects. Contrary to current practice, the impact of
PPPs on the fiscal accounts and public debt should be reflected
transparently and in line with international norms.
-
Debt management
: The Ministry of Finance should further lengthen the maturity of
public debt and diversify the investor base, while avoiding risks posed
by excessive reliance on foreign currency and non-concessional
borrowing.
-
Arrears clearance and prevention
:
As of end-June, central and local governments have accumulated arrears
of 1.1 percent of GDP. This includes 0.3 percent of GDP in arrears on
VAT refunds. To prevent arrears, the authorities should improve the tax
refund process, strengthen commitment controls, particularly at the
Ministry of Energy and Infrastructure, expand the Treasury’s IT system
to local governments, register all unbudgeted commitments, and record
unpaid bills.
Reforms in the state-owned electricity sector need to be reinvigorated.
After impressive early gains, the reform process has stalled. Continued
reforms are important for unlocking donor support, which will speed up
financial restructuring in the sector. The authorities should improve
operational efficiency, including through strengthened corporate governance
and better targeting of investment. In addition, institutional and market
design reforms should be accelerated, including establishing a power
exchange, unbundling the electricity distribution company, and moving
medium-voltage customers to the free market. The drought-induced fall in
hydropower generation so far this year underscores the importance of
diversifying Albania’s sources of electricity.
Monetary and Financial Policy: Strengthening Inflation Targeting
and Mitigating Risks
The Bank of Albania (BoA) accommodative monetary policy stance remains
appropriate,
in view of the still negative output gap and appreciating exchange rate . Any unwinding of monetary easing should await clear
evidence of a sustained rise in inflation. To strengthen inflation
targeting and reduce financial stability risks, the de-euroization strategy
should be implemented gradually, balancing the risks of financial
disintermediation. The central bank law needs to be amended to align it
with modern central banking legislation, strengthen BoA independence and
legal protection of employees , and improve its governance and operations.
The weak non-performing loans (NPLs) resolution framework continues to
hamper credit recovery, particularly for corporates.
The mission welcomes progress in restructuring the NPLs of large borrowers.
Together with mandatory write-offs, these actions have led to a sizable
decline in the NPL ratio. However, the recent regulation on private bailiff
fees is likely to hinder the collateral execution process and should be
reversed. The authorities should urgently adopt the bylaws to implement the
new Bankruptcy Law and facilitate out-of-court restructuring. Reviving the
NPL Working Group can help advance this agenda.
The mission welcomes the authorities’ continued efforts to strengthen
financial supervision.
The banking system remains stable, well-capitalized and liquid. The
authorities should continue to strengthen their microprudential focus on
the fastest-growing and systemically important segments of the banking
system to minimize build-up of credit risks. They should ensure healthy
capitalization levels by strictly enforcing limits on large exposures.
Recent structural changes in banking and non-banking sectors call for
enhanced supervisory vigilance
. The consolidation in the banking sector is welcome. To mitigate risks to
banking stability, BoA should ensure that new bank license candidates meet
appropriate fit and proper criteria, possess adequate banking experience,
and avoid conflicts of interest. Given the expansion of investment funds
and other non-bank financial institutions, the authorities should urgently
strengthen the regulator’s crisis preparedness and capacity. Close
cooperation between bank and non-bank supervisory authorities is needed as
financial interconnectedness increases. Developing capital market
institutions requires high transparency and governance standards. A liquid
secondary market for domestic government bonds will also be key for
financial deepening.
Structural Reforms: Deepen Reforms to Accelerate the Pace of
Convergence
Addressing structural impediments to competitiveness remains key to
achieving faster growth.
Despite recent improvements, Albania’s competitiveness indicators lag
behind regional peers. While Albania’s wages are competitive, its
investment climate suffers from low efficiency of the tax system, high
informality, skill mismatches, and regulatory unpredictability. Weak
property rights and a corrupt and inefficient judiciary also hinder
investment prospects. Albania’s infrastructure gap, the highest in the
region, remains a significant bottleneck to productivity.
Further structural reforms will be crucial to tackling these
bottlenecks
. The sweeping judicial reform adopted in mid-2016 should be pursued with
speed and determination. A new strategy on property rights is needed to
advance property registration and digitization and coordinate the
restitution and legalization processes. To address demographic pressures
arising from continued emigration, skills mismatches in Albania’s otherwise
flexible labor market, and the high youth unemployment rate, the
authorities should strengthen the capacity of public employment agencies
and invest further in higher education and vocational training. To reduce
informality, minimum wage policies for young, low-skilled, or part-time
workers should be revisited. In this context, the authorities’ goal of
reducing regulatory burden is also welcome.
***
The IMF team thanks the authorities and other interlocutors in the
public and private sectors for their cooperation, open and constructive
discussions, and warm hospitality.