Mission Concluding Statement 

Albania: 2021 Article IV Consultation Concluding Statement

October 12, 2021

Washington, DC: Albania’s economy has shown considerable resilience in the face of the 2019 earthquake and the pandemic. After a terrible 2020, activity is rebounding strongly. Policies have played a critical role in preserving lives and livelihoods and thereby paving the way for the recovery. The key challenges now are twofold: first, investing efficiently in people and the economy to support the continued development of the country; and second, rebuilding room for fiscal policy maneuver by lowering the very high fiscal deficit and public debt ratios. The way to bridge these challenges is an ambitious strategy to raise tax revenues and to improve the transparency and quality of public spending. With a renewed mandate, the government is well positioned to address these challenges and enlist the support of all stakeholders in society to that effect. Concretely:

• Now is the time to adopt a credible medium-term fiscal adjustment plan, underpinned by a sound Medium-Term Revenue Strategy. Making this strategy a success will require, first and foremost, strong political leadership. At the same time, the quality and transparency of public spending should be increased and overly ambitious domestically financed (non-earthquake) public investment pared back. Fiscal support should better target those most in need. The credibility of the budget and fiscal framework needs to be bolstered and rising fiscal risks need to be better monitored and managed.

• As fiscal policy support is pared back, monetary policy should remain accommodative. Monetary tightening is only warranted if there are clear indications of inflationary pressures broadening and becoming persistent. In the meantime, the Bank of Albania will also need to continue to watch financial stability developments carefully, as the impact of the shocks continues to work its way through the banking system.

• Importantly, Albania needs to step up efforts to strengthen the rule of law, reduce vulnerabilities to corruption, and boost competitiveness, to support the realization of its long-term development goals and aspirations.

The Albanian economy has been resilient in the face of two major shocks

Following a contraction of 4 percent in 2020, the economy is rebounding strongly by a projected 7.8 percent in 2021, spurred by continued monetary and fiscal policy support, reconstruction, reduction in movement restrictions, strong electricity production due to favorable weather conditions so far, and a relatively good tourism season. We project economic growth to normalize to 3.8 percent in 2022, reflecting less policy support and the maturing of the recovery cycle. Headline inflation has risen on account of higher food and energy prices but core inflation has thus far remained stable and inflationary pressures are subdued. The emergence of vaccine-resistant variants at the global level or localized outbreaks in Albania as well as potentially tighter global financial conditions and elevated global energy prices represent major downside risks to the economic outlook. A faster normalization from the pandemic presents an upside risk.

With the recovery firming up, fiscal policy should pivot towards rebuilding the firepower to withstand future shocks and reduce debt while meeting Albania’s development needs—all these will hinge on raising tax revenue

While the sizable increase in the 2020 deficit was necessary to cushion the impact of the shocks, fiscal policy in 2021 is more expansionary than warranted. Despite a strong rebound in tax revenue, the primary deficit would remain at 4.6 percent of GDP, similar to that in 2020. General government debt is projected to rise to almost 80 percent of GDP at end-2021, among the highest in the region. It is expected to decline gradually as support measures and reconstruction wind down and the fiscal rule of a zero primary balance is adhered to starting 2024 as per the requirement of the Organic Budget Law (OBL). Without further adjustment efforts we project debt will still hover above 70 percent of GDP in the medium term. The government’s gross financing needs remain high at about 20 percent of GDP annually.

The authorities’ track record of keeping the fiscal deficit under control and reducing debt prior to the shocks has earned them some policy credibility and space, allowing them to respond swiftly and cushion Albania from the worst effects of the shocks. Now it is crucial to make use of the recovery to rebuild policy buffers. A credible medium-term adjustment plan—best formulated now and implemented from 2022—should articulate measures to reduce the primary deficit to about 2 percent of GDP in 2022 and steadfastly reach a primary surplus of about 1.5 percent of GDP in 2024.

The lynchpin of such a credible fiscal adjustment must be a sound Medium-Term Revenue Strategy (MTRS) to broaden the tax base and remove loopholes. Accordingly, we welcome the government’s plan to finalize and adopt the MTRS following public consultation and begin implementation in early 2022. Strong political leadership and broad stakeholder support are crucial to making this a success. We continue to advise against tax amnesty and ad hoc tax cuts, exemptions, and incentives, which go against the government’s longer-term revenue-enhancing strategy. We see the need to create a dedicated tax policy unit with adequate resourcing and staffing in the Ministry of Finance and Economy (MOFE).

At the same time, it is important to pare back overly ambitious domestically financed (non-earthquake) public investment given weak capacity and low efficiency. The fiscal room created in this way should be partly used for the provision of health care—notably vaccination rollout, as a larger share of population needs to be vaccinated—and targeted support to the most vulnerable, particularly given rising food and energy prices. Looking further ahead, after the governance and efficiency of public spending have been strengthened and fiscal risks contained, tax revenue reform gains can be used to address Albania’s development needs. We believe that with such a strategy, government debt could be brought back close to 65 percent of GDP by 2026, which would mean that there is again good policy space to address new shocks that may hit the country. Windfall revenues should be saved for faster deficit and debt reduction. If the recovery suffers setbacks, higher targeted support can be deployed.

Bolstering the credibility of fiscal frameworks, increasing the quality and transparency of public spending, and improving the monitoring and management of rising fiscal risks are also crucial for achieving sound public finances.

Strengthening the credibility of the budget and fiscal framework will help maintain market confidence and keep borrowing costs down. Changes related to the design and application of the OBL should only occur through normal parliamentary procedures, and the use of normative acts to amend the budget in-year, except for emergency circumstances, should be discontinued. A robust debt management strategy is also warranted to guide the government’s decisions on external commercial borrowing, which is subject to rollover and exchange rate risks. The MOFE should continue to enhance its cash management toolbox.

The rapidly rising stock of public-private partnerships (PPPs)—expected to reach 50 percent of GDP in 2021, up from 33 percent in 2018—requires redoubling efforts to strengthen public investment management (PIM). Domestically financed (non-earthquake) public investment has also grown markedly since 2020. Key challenges include the lack of transparency on cost and schedule overruns and noncompliance with established selection and approval processes, including when PPPs are used to circumvent medium-term budgetary ceilings. It is important to strengthen the capacity of the MOFE to pro-actively act as gatekeeper in project selection and to engage actively in evaluation and monitoring. The processes for PPPs and budget-funded projects need to be aligned.

Albania will benefit immensely from concerted efforts to better monitor and manage rising fiscal risks. The lack of clear data on the government’s true exposure to PPPs is a key challenge. The government guarantee schemes to the private sector currently under discussion and the reliance of state-owned enterprises, especially in the utility sector, on sovereign guarantees (which are rising) and intermittent budget support also add to the fiscal risks. In this context, it is important to reinvigorate electricity and related water sector reforms that have been delayed in recent years.

Steadfast commitment to transparency and accountability, underpinned by robust Public Financial Management (PFM) systems, is a priority. Transparency and accountability measures for spending carried out under the emergency procedures should be implemented as soon as possible and the use of earthquake reconstruction funds be subject to adequate PFM controls. We welcome the ongoing progress to implement a public registry of beneficial owners and look forward to the imminent completion and publication of the Supreme Audit Institution’s audit of earthquake and pandemic-related spending in 2020.

Monetary accommodation remains appropriate as long as inflationary pressures are contained

The Bank of Albania’s (BoA) accommodative monetary policy continues to be appropriate, as inflation has remained below the target and expectations are well anchored. We expect the recent rise in headline inflation—driven by international food and energy prices—to be transitory. A shift towards monetary policy tightening should be data-driven, based on clear indications of broadening and persistent inflationary pressures. Exchange rate flexibility has served Albania well and should continue its role as a shock absorber.

The banking system has remained stable and liquid, and continued vigilance will be required to safeguard financial stability

As the full impact of the shocks on banks’ balance sheets may only become visible after some time, close monitoring of loan portfolio quality and timely identification and management of problem assets are warranted, as well as subjecting more vulnerable banks to enhanced on-site and off-site supervision. A focused Asset Quality Review (AQR) by the BoA could be considered to accurately assess the pandemic’s impact on banks’ asset quality and capital position. In the same vein, banks’ capital buffers need to be preserved until the pandemic’s full impact on asset quality is known.

The risk of an increase in NPLs underlines the importance of strengthening resolution frameworks. The regulatory framework for dealing with large borrowers with NPLs with more than one bank (i.e., Tirana approach) should be more broadly implemented. Beyond the BoA’s remit, the insolvency and resolution frameworks already in force should be swiftly implemented, including out-of-court loan restructuring. The long-standing impasse in bailiff reform should also be resolved.

The changing landscape of the banking system warrants enhanced vigilance in regulation and supervision. The presence of more banks with significant shareholding by individuals and non-financial groups raises the risk of capital shortfalls, related-party transactions, and a growing share of large exposures. We recommend continuing to strengthen and implement the licensing and supervisory framework, including the fit-and-proper status of significant shareholders and controllers, beneficial owners, and senior managers. We also stress the need for enhanced surveillance of the potential impact on financial stability from the fast-growing real estate market. The BoA’s ongoing efforts to align its bank regulatory and supervisory framework with international standards should continue.

Improving governance and institutions would underpin Albania’s long-term prosperity and aspirations

The implementation of the comprehensive judicial reform launched in 2016 with EU support is progressing. Notably, the authorities indicated that the asset declaration platform was in the final stages for operationalization and information will be publicly available. The vetting of judges has progressed further but there is a need for more trained judges and prosecutors. Remaining reforms should be expeditiously implemented, as corruption remains a key impediment to equitable growth.

Albania has made progress in improving its AML/CFT framework and should continue its efforts. In February 2021, the FATF put Albania under increased monitoring (“grey list”) owing to concerns about the AML/CFT framework and its effectiveness, and an action plan was agreed. The country is making good progress on its action plan and should continue efforts to exit the grey list promptly.

Albania’s structural competitiveness gaps vis-à-vis regional peers persist. Strengthening the institutional framework, reducing vulnerabilities to corruption, and addressing shortages of skilled labor and infrastructure gaps will improve the business environment and productivity. Any further increase in the minimum wage needs to be accompanied by measures to reduce informality and increase productivity.

We would like to thank the Albanian authorities and all our other counterparts for the close collaboration and fruitful exchange of views.