Mission Concluding Statement 

Albania: Staff Concluding Statement of the 2018 Article IV Mission

November 20, 2018

An International Monetary Fund (IMF) mission, led by Mr. Jan Kees Martijn, visited Tirana during November 6–20, 2018 for the annual Article IV consultation discussions. At the end of the visit, the mission issued the following statement:

Albania’s economic growth has trended upward in recent years, as the country has benefitted from the implementation of reforms and from the economic expansion of its European trade partners. At the same time, much remains to be done to make this growth more sustainable and inclusive, and to reduce the appeal of emigration. It is also important to build stronger buffers, especially now that risks to Europe’s economic outlook have increased. Key reforms include strengthening the rule of law and economic institutions, removing obstacles to higher private savings and investment, and reducing public debt at a faster pace by enhancing the management of public investments and broadening the revenue base. In addition, safeguarding financial stability within the changing architecture of the banking sector increases the complexity of financial supervision. Progress on these fronts should also help Albania in its pursuit of further integration with the European Union.

A mostly positive outlook

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, we project growth to stay close to 4 percent, supported by buoyant exports, including tourism, and investments in infrastructure. The exchange rate has appreciated sharply since March, putting downward pressure on inflation, which 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 are tapering off, we foresee the current account deficit narrowing to around 6 percent of GDP over the medium term. Although the banking system is well-capitalized and liquid, the provision of credit to support business investments remains weak. Non-performing loans (NPLs) have declined by more than 10 percentage points since 2014, but they remain high in some banks.

However, risks are tilted towards the downside. Albania is strongly exposed to the increasing risks to growth in Europe, including in its main trading partners. A downturn in these countries could spill over through lower exports, remittances, and Foreign Direct Investment (FDI). Moreover, the expected tightening in global financial conditions would raise Albania’s cost of financing. In addition, there are also important domestic risks. Looking forward, structural reforms —including in public finance management, the energy sector, and judicial system—if insufficient, could soften confidence and delay convergence with regional peers. Adverse weather conditions could affect electricity generation, creating risks to the budget.

C ontaining fiscal risks and improving the quality of public goods

Fiscal consolidation should be accelerated. Fiscal deficit reduction is needed to create fiscal buffers; if adverse risks to growth were to materialize in the near term, there would be very limited space for fiscal stimulus. We project that, in the absence of additional measures, the government deficit will remain close to 2 percent of GDP in 2018 and beyond, resulting in continued declining path of public debt, although with slower reduction than we would recommend —to 62.3 percent of GDP by 2021 (including projected general government arrears of 0.6 percent of GDP). This 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 the confidence of financial markets. For 2019, we would advise an additional reduction in the deficit by more than 0.5 percent of GDP, which can be achieved through a mix of excise-rate indexation, environmental taxation, and further broadening of the tax base. decrease

Strengthening the fiscal rule would support consolidation and the credibility of the fiscal framework over the longer run. We recommend setting 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.

Given the absence of fiscal space, we strongly urge the authorities to refrain from introducing ad-hoc tax cuts, exemptions, or preferential treatments and consider rolling back those already implemented. These make the tax system more complicated and less predictable, thereby undermining both the investment climate and tax collection. At the same time, actions to strengthen the quality of the revenue administration are progressing, including through a new system for data integration that is being established in GDT . In addition, we welcome the progress in property tax reform and the expected launch of the fiscal cadaster in January 2019. Further strengthening of the database and of valuation methodologies will be important to enhance transparency and to support the implementation of this system by the local tax authorities.

On the expenditure side, efforts to strengthen efficiency should not erode the level of spending in priority areas. The need for upgrading education, health care, and infrastructure towards European standards requires raising both the quality and the level of spending. In particular, spending on education remain low while skills shortages are a serious constraint to productivity and growth.

The rapid increase in Public-Private Partnerships (PPPs) has raised fiscal risks, calling for additional improvements in the public investment framework. It is essential to strengthen investment planning and execution at all levels of government, including local and central governments and state-owned enterprises, and to redouble efforts towards obtaining value-for-money. Within public investment, the stock of PPPs is expanding. The documents accompanying the budget for 2019 foresee, in addition to the existing stock of PPPs of 31 percent of GDP (of which concessions in energy of more than 23 percent), a pipeline of potential new PPPs capped at 15 percentage points. We welcome current efforts to bolster the role of the Ministry of Finance and Economy as a gatekeeper in containing the potential fiscal cost of PPPs. We also advise promoting a competitive bidding process by halting the acceptance of unsolicited PPP proposals. While the projected PPP-related spending remains below the legal limit of 5 percent of tax revenues, this leaves little room for any additional government-funded PPP projects.

The increase in budgetary arrears during 2017 should be addressed without delay. Arrears are estimated at 1.5 percent of GDP as of end-September 2108 (including local governments). Their prevention and control require strengthening revenue forecasting and cash management, and further improving commitment controls, in particular by the Road Authority. Paying value-added tax (VAT) refunds promptly is important for creating trust in the tax administration and the functioning of the VAT system.

The inclusion of a fiscal risk assessment in recent budgets is welcome, but the depth and coverage of the published document needs to be enhanced. This should involve extending the analysis to a wider range of risks to the public-sector balance sheet including, but not limited to, a more granular analysis of large contingent liabilities, including those embedded in PPP contracts. The assessment should also present mitigation measures, to enhance the credibility of budget estimates.

Planned reforms to make the electricity sector financially sustainable should be implemented in a steadfast manner. The reforms, guided by the five-year financial recovery plan prepared with World Bank support, foresee the clearance of arrears, a further reduction of distribution losses, and better targeting of investments. Completing the reform process also requires timely decisions on the governance structure of the public energy sector companies, pricing (throughout the production chain) that ensures cost recovery, and contingencies to deal with droughts.

Making monetary policy more effective

The current accommodative monetary policy stance remains appropriate until inflation approaches the target, but structural bottlenecks mute policy effectiveness. Although the lowering of the policy interest rate to a historical minimum has been transmitted to financial markets, the upward effect on headline inflation remains to be seen. Monetary transmission is constrained by the extensive use of euros and cash (rather than lek deposits) and structural weaknesses in the provision of credit, including continued high NPLs, weaknesses in the property rights and insolvency regimes, high informality, banks’ deleveraging and risk aversion. Addressing these bottlenecks would support credit growth and money creation and enhance the transmission of monetary policy.

Within Albania’s flexible exchange rate regime, the authorities have intervened to dampen the recent strong appreciation pressures. Since June-2018, the Bank of Albania (BOA) has conducted unscheduled interventions in the foreign exchange market in response to the sharp appreciation of the domestic currency. These purchases have been focused on preventing disorderly market conditions and on dampening the downward pass-through effects on inflation, within the BOA’s mandate of inflation targeting. Looking ahead, we encourage the authorities to phase out these operations as disinflation risks recede; exchange rate flexibility has served Albania well, by mitigating the impact of shocks on the economy.

A stronger financial system

Albania’s financial landscape is changing: the decline in NPLs should set the scene for increased lending, while non-EU banks are playing an increasing role. The BOA continues to improve its supervisory and regulatory framework, but pockets of vulnerability remain.

• Reducing NPLs. The authorities’ approach has been effective in reducing the NPL ratio, especially through write-offs. A 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 the deadlock around more efficient operations of private bailiffs and (iv) rules to accelerate loan write-offs further.
• Supporting the quality of the banking system. Subsidiaries of EU banks have played an important role in setting the standard for banking in Albania. As bank ownership is shifting to domestic and non-EU conglomerates, bank supervision has a critical role in containing risks stemming from related-party lending, cross-border lending, and large exposures. To face these challenges, as well as new Basel standards, it is crucial that the supervision department of the Bank of Albania is adequately staffed to conduct more frequent on-site inspections of banks that pose elevated risks.
• Developing financial markets. A well-functioning sovereign debt market provides the foundation for developing other financial instruments. The authorities are strongly encouraged to commit to the predictable issuance of short-term T-bills and to balance the reduction of debt-service costs with a focus on developing domestic capital markets. In addition, developing second- and third-pillar private pension plans would enhance the social safety net through new savings vehicles. As the market evolves, financial literacy should be enhanced to mitigate risks and stimulate financial inclusion.
• De-euroization strategy. The introduction in July of differentiated reserve requirements for foreign currency deposits was a useful step, in line with the de-euroization plan. As a next phase, it would be helpful for the authorities to 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 the integrity of Albania’s financial system.

Enhancing the Business Climate and the rule of law

Determined efforts are needed to improve the business climate to promote faster and more inclusive growth, stronger regional integration, and to blunt the appeal of emigration. In this context, priorities include (i) vigorous implementation of judicial sector reform, enforcement of the rule of law, and the anti-corruption strategy; (ii) strengthening the framework for property and contractual rights to foster private sector credit growth and facilitate FDI; (iii) improving the quality of health care and education, which is critical for curtailing the deepening shortage of skilled labor; (iv) closing infrastructure gaps with regional peers; and (v) aligning rules and standards with the EU to foster participation in global value chains.

The IMF team would like to thank the authorities and other interlocutors for the fruitful collaboration and kind hospitality.