Mission Concluding Statement 

Albania: Staff Concluding Statement of the 2023 Article IV Mission

October 27, 2023

Washington, DC:

The Albanian economy has emerged as one of the stronger performers in the region. Thanks to a strong rebound in tourism, growth last year beat expectations at close to 5 percent, while the external position saw a notable improvement. A combination of fiscal consolidation, higher income, and lek appreciation brought the public debt ratio back to pre-pandemic levels. Monetary policy is rightly focused on reducing inflation, which has been gradually declining after peaking at a lower rate than in regional peers.

Albania’s economic prospects are expected to remain robust. Real GDP is projected to expand by 3.6 percent in 2023 and 3.3 percent in 2024, led by resilient private consumption, with notable strength in tourism and construction activity. Inflation hovers around 4 percent amid tight labor markets and is expected to revert only gradually to the Bank of Albania’s target of 3 percent by early 2025. Heightened geopolitical tensions represent a major potential headwind, even as the economy remains vulnerable to the risks of weather-related energy sector shocks, a sudden exchange rate reversal, and more persistent inflation.

The current favorable conjuncture creates an opportunity to advance on a broad set of reforms to secure sustainable and inclusive growth. An ambitious revenue-based consolidation would build fiscal space for countercyclical policy in the future and support monetary policy. Revenue reforms are also needed to generate resources for human capital development, infrastructure, and climate adaptation. Further progress on de-euroization is critical to strengthen the effectiveness of monetary policy and reduce financial sector vulnerability. Structural reforms in the fiscal and financial sectors, on governance, and the labor market, will amplify the gains from sound and prudent policies.

Safeguarding fiscal sustainability

The authorities have undertaken considerable fiscal consolidation in the post-pandemic years, with notable improvements in value-added tax collection . With a zero primary balance-to-GDP ratio expected in 2023, the fiscal rule requiring a non-negative primary balance will be met one year ahead of the deadline. Under the baseline, the mission projects limited additional fiscal consolidation in the medium term with the 2024 budget aiming for a small primary surplus. Public debt is expected at around 60 percent at the end of 2023 and is projected to be sustainable over the medium-term.

A stronger fiscal effort than currently projected starting in 2024 remains critical as Albania continues to grapple with high gross financing needs . Additional frontloaded net fiscal measures of around 1½ percent of GDP over the next five years would bring public debt on a clear downward path towards the fiscal rule target of 45 percent, and lower gross financing needs decisively. The bulk of the adjustment should be through revenue mobilization and complemented by spending efficiency gains. Stronger public investment management will also enable more resource allocation towards productive investment, including on education and climate adaptation. These measures should go hand-in-hand with the implementation of the debt management strategy to lengthen maturities and reduce floating rate debt.

A sound medium-term revenue strategy is necessary for credible fiscal consolidation. The authorities have legislated several of the tax policy reforms in line with past IMF technical assistance. Timely adoption of measures still in the pipeline—including property and gambling tax reforms—is critical. Frontloading measures slated for later introduction, such as removing further VAT exemptions and the zero tax rate for small businesses, could also be considered. Work to fulfill the prerequisites for a timely introduction of property tax reforms, including fully operationalizing a centralized fiscal cadaster, needs to be completed. Raising further revenues will hinge on strengthening revenue administration, including on tax compliance of high net-worth individuals and an action plan for the General Directorate of Taxation. Progress in these areas would also support broader efforts to reduce informality and expand the tax base.

Medium- and long-term spending pressures call for efficiency improvements. The recent increases in public wages and indexation to inflation will lead to a higher wage bill for the government.Absent further reforms, the pension system will impose a growing burden on public resources. Higher public wages should be accompanied by a broader review of public sector functions and linked to efficiency increases, including by leveraging information technology and on-the-job training. The forthcoming public expenditure review is an opportunity to set in train reforms that reduce long-term spending pressures, including from pension obligations.

Continued progress in fiscal structural reforms will help strengthen public financial management. Operationalizing the 2022 public investment management guidelines will enhance project classification, management, and monitoring. Integrating public-private partnerships (PPPs) into the regular public investment framework and budgetary process is urgently needed and will require legal changes. The planned publication of a standalone fiscal risk statement in 2024 is an important step towards forward-looking monitoring of fiscal risks, including those arising from PPPs, contingent implicit and legal liabilities, and state-owned enterprises (SOEs). The fiscal risk statement should also clearly identify risk mitigation measures, including enhancing SOE oversight and governance.

Albania'sclimate vulnerability calls for timely actions. Given the outsized role of hydroelectricity and the dependence of energy SOEs on public support, gradual tariff adjustments to cost recovery levels are needed with complementary measures to support the vulnerable. It is also critical to enhance the electricity sector’s transparency and SOEs’ corporate governance. In this context, efforts to develop renewable sources of energy are a step in the right direction. The implementation and integration of the National Climate Change Strategy 2030 into the budgetary process and medium-term planning will help direct resources to green priorities.

Reducing inflation while reaping the benefits of the floating exchange rate

Returning inflation to target will likely require some further increases in the policy rate. Following a rise of 250 basis points to 3 percent,the Bank of Albania (BoA) appropriately paused its rate increases in March, amid declining inflation and strong lek appreciation. With domestic inflation pressures rising amid tight labor markets and real rates still negative, there is scope to hike further. A gradual increase of the policy rate to a broadly neutral stance—estimated at around 4½ percent—should help allow inflation return to target by early 2025. There is, however, uncertainty around the inflation path and a flexible meeting-by-meeting approach to rate-setting is appropriate. The BoA has a strong statutory equity position, and its recognition of recent unrealized revaluation losses should not detract from its focus on reaching the inflation target.

A flexible exchange rate should remain the main shock absorber, with FX interventions limited to respond to disorderly market conditions. While the lek has been on a gradual appreciation trend since 2015 in line with improved fundamentals, the steep appreciation since 2022 calls for vigilance given the risk of a sudden reversal. Further de-euroization of the economy would maximize the benefits from the flexible exchange rate and inflation targeting regime. In addition to measures taken by the BoA, effective de-euroization should be supported by government action to promote the use of local currency for the pricing and payment of non-tradable goods.

Preserving financial stability

The financial sector remains broadly resilient, but pockets of vulnerability persist . The banking system’s overall capital adequacy is well above required levels, and profitability and asset quality have improved. However, there is scope for further strengthening the capital positions of some banks, and the sector continues to face lingering risks from the outsized role of domestic government securities in banks’ portfolios and exposures to the real estate sector, amid still significant unhedged foreign currency lending. While there have been strains in 2022 in some non-bank financial institutions, the sector is unlikely to pose systemic risks, given its small size.

Continued nimble supervision and enhanced prudential tools will help tide through current financial and economic uncertainties . Bank heterogeneity calls for continued prudent provisioning on a case-by-case basis as well as focused and timely asset quality reviews. The BoA should continue efforts to strengthen bank capital buffers, including by requiring temporary suspension of dividends for banks with shortfalls. The recently adopted legislation that collects data on loan-to-value and debt-to-income ratios is key to the introduction of borrower-based tools. Differential requirements on such tools by FX and domestic currency would help mitigate risks from FX lending. Over the medium-term, a positive neutral countercyclical capital buffer rate could be considered to further support financial stability.

Steady progress with financial structural reforms would help solidify past achievements. Key areas include: (i) aligning supervisory and regulatory frameworks with EU standards, including related to cyber and climate risks, (ii) continuing to strengthen the private debt resolution regime, including implementing out-of-court settlements, (iii) continuing to promote sound corporate governance in the financial sector, and (iv) gradually deepening capital markets including increasing liquidity in government securities’ secondary markets.

Bolstering inclusive growth

Albania has struggled with closing the income gap with EU countries. Informality, shortcomings in governance and the rule of law, weaknesses in the labor market, infrastructure gaps and demographic pressures have hindered efficient allocation of resources and held back productivity.

Cognizant of these challenges, the authorities have made important strides in key areas. Thanks to substantial progress in addressing AML/CFT shortcomings, the Financial Action Task Force (FATF) recently announced that Albania would exit its list of jurisdictions under increased monitoring. A comprehensive judicial reform program has progressed steadily. The National Employment and Skills Strategy also rightly seeks to strengthen vocational training, upskilling, and inclusion.

Further improvements to governance and the rule of law would enhance the business environment. Judicial reforms should be completed by the December 2024 constitutional deadline and supported by measures to improve the efficiency of the courts and addressing case backlog. The Structure Against Corruption and Organized Crimes (SPAK) should have sufficient resources to fulfill its mandate. Work should resume to formulate the Intersectoral Strategy Against Corruption 2023‒30 and implement recommendations by the Council of Europe’s Group of States against Corruption (GRECO), including those related to police reforms and post-employment restrictions for members of the Council of Ministers and political advisors.

Decisive implementation of policies to develop and retain human capital would boost potential growth and raise living standards. Key areasinclude (i) modernizing the education curriculum, (ii) improving the labor market relevance and quality of vocational education and training, (iii) investing in digital skills, and (iv) fostering the R&D environment, thereby nurturing innovation. Measures to encourage female labor force participation, including by expanding access to childcare, will help reduce the gender gap, which is more prevalent for women without tertiary education. Adequate budget resources and monitoring mechanisms need to be put in place to ensure that the authorities’ efforts in these areas translate into better outcomes.

The mission would like to thank the Albanian authorities and other counterparts for their hospitality, engaging discussions, and productive collaboration.