IMF Country Report No. 17/373 ALBANIA 2017 ARTICLE IV CONSULTATION—PRESS RELEASE; December 2017 STAFF REPORT; AND STATEMENT BY THE EXECUTIVE DIRECTOR FOR ALBANIA Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. In the context of the 2017 Article IV consultation with Albania, the following documents have been released and are included in this package: • A Press Release summarizing the views of the Executive Board as expressed during its December 4, 2017 consideration of the staff report that concluded the Article IV consultation with Albania. • The Staff Report prepared by a staff team of the IMF for the Executive Board’s consideration on December 4, 2017, following discussions that ended on October 3, 2017, with the officials of Albania on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on November 14, 2017. • An Informational Annex prepared by the IMF staff. • A Staff Supplement updating information on recent developments. • A Statement by the Executive Director for Albania. The documents listed below have been or will be separately released. Selected Issues The IMF’s transparency policy allows for the deletion of market-sensitive information and premature disclosure of the authorities’ policy intentions in published staff reports and other documents. Copies of this report are available to the public from International Monetary Fund • Publication Services PO Box 92780 • Washington, D.C. 20090 Telephone: (202) 623-7430 • Fax: (202) 623-7201 E-mail: [email protected] Web: http://www.imf.org Price: $18.00 per printed copy International Monetary Fund Washington, D.C. © 2017 International Monetary Fund Press Release No. 17/491 International Monetary Fund FOR IMMEDIATE RELEASE 700 19th Street, NW December 14, 2017 Washington, D.C. 20431 USA Was IMF Executive Board Concludes 2017 Article IV Co nsultation with Albania Washington, D.C. 20431 USA On December 4th, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the 2017 Article IV Consultation with Albania.1 Albania’s economy grew by 3.4 percent in 2016 and continues to strengthen, benefitting from rising domestic demand, large energy-related foreign direct investment (FDI), and a recovery in key EU trading partners. The declining output gap and pass-through of higher external inflation have pushed up inflation to just under 2 percent. Overall credit growth remains stagnant as banks continue to clean up their balance sheets. Short-term external vulnerabilities are limited, as the current account deficit is predominantly funded by concessional borrowing and large FDI inflows, while official foreign reserves are ample. Fiscal and financial vulnerabilities have been lowered over the past four years. However, challenges remain from the high level of public debt and financing needs, non-performing loans, and pervasive institutional weaknesses that hinder investment. The new government’s clear mandate following election victory in June, the favorable economic outlook, and the prospects for opening EU accession negotiations provide a window of opportunity to resume implementing the reform agenda. The main policy objectives at the current juncture are to maintain macroeconomic and financial stability, and to deepen structural and institutional reforms to accelerate the pace of convergence. The medium-term outlook remains favorable. GDP growth is projected to accelerate to around 4 percent, driven by continued strong domestic demand, reforms that improve the business climate, and a strengthening EU recovery. Inflation is expected to edge up toward the 3 percent target as the output gap closes. The current account deficit is expected to narrow, as import-intensive energy projects wind down, the Euro Area continues to recover, and higher non-energy FDI propels export diversification. Risks to the outlook are balanced. On the upside, accelerated 1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. donor support as part of the EU accession process could lead to higher investment and a stronger credit recovery. On the downside, volatile domestic politics or shocks to global growth could pose risks to reform implementation and fiscal consolidation. Executive Board Assessment2 The Executive Directors emphasized that the growing economy and the new government’s clear electoral mandate provide a good opportunity to continue reform efforts to increase Albania’s growth potential, enhance the resilience and competitiveness of the economy, and strengthen the financial system while maintaining fiscal discipline. Directors supported the need to reduce public debt to build fiscal space and ensure debt sustainability. They recommended that the authorities consider a more ambitious and front-loaded consolidation path. They also emphasized that strengthening fiscal institutions remains key for mitigating fiscal risks and enhancing efficiency. They noted that public debt management should focus on lengthening the maturity of public debt and diversifying the investor base. Directors underscored the need for higher revenues while refraining from lowering tax rates or granting any new exemptions or preferential tax policies. They supported the tax administration’s efforts to improve compliance and welcomed the plan to introduce a value-based property tax. Directors agreed that it is critical to strengthen public investment management, given the planned scaling-up of investment spending. They urged the authorities to ensure proper implementation of the framework for public-private partnerships in line with international best practices. They also emphasized the need to minimize the recurrence of arrears, including by improving the VAT refund process. Directors noted that after impressive early gains, reforms in the state-owned electricity sector have been delayed and need to resume. They recommended improving operational efficiency, speeding up financial restructuring, and advancing institutional and market design reforms in the sector. Directors agreed that the Bank of Albania’s accommodative monetary policy stance remains appropriate, and any unwinding of monetary easing should await evidence of a sustained rise in inflation. Directors supported the authorities’ de-euroization strategy and stressed the importance of aligning the central bank law with modern central banking legislation. 2 At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm. Directors supported the authorities’ continued efforts to strengthen financial supervision with a focus on the fastest-growing and systemically important banks. They highlighted the need for continued vigilance and improved crisis preparedness, particularly in light of the increased interconnectedness in the sector. To mitigate risks to banking stability, candidates for new banking licenses should possess adequate banking experience and avoid conflicts of interest. They commended the progress in restructuring the NPLs of large borrowers, including by revising bailiff regulation, implementing the new Bankruptcy Law, and facilitating out-of-court debt restructuring. Directors agreed that addressing structural impediments to competitiveness remains key for achieving faster growth. They welcomed the progress achieved in structural reform implementation, and stressed the need to further advance institutional reforms in areas such as the judiciary, property rights, and anti-corruption. Directors recommended investing further in vocational training to encourage labor participation, especially among women and youth. Albania: Basic Indicators and Macroeconomic Framework, 2013–17 2013 2014 2015 2016 2017 (est.) Real sector (Growth rate in percent) Real GDP 1.0 1.8 2.2 3.4 3.9 Consumer Price Index (avg.) 1.9 1.6 1.9 1.3 2.1 Consumer Price Index (eop) 1.8 0.7 1.9 2.2 2.3 GDP deflator 0.3 1.5 0.1 -0.2 2.1 Saving-investment balance (Percent of GDP) Foreign savings 9.3 10.8 8.6 7.6 8.0 National savings 17.9 15.9 16.3 15.9 16.2 Public -0.8 0.6 0.7 1.2 1.2 Private 18.7 15.4 15.6 14.7 15.0 Investment 27.2 26.7 25.0 23.5 24.2 Public 5.1 5.0 4.7 4.6 4.6 Private 22.1 21.7 20.2 18.9 19.6 Fiscal sector (Percent of GDP) Revenues and grants 24.0 26.3 26.4 27.4 28.2 Tax revenue 22.0 24.1 23.9 24.9 25.9 Expenditures 29.2 32.2 31.0 29.6 30.2 Primary 26.0 29.3 28.3 27.2 28.1 Interest 3.2 2.9 2.7 2.5 2.1 Overall balance (excluding arrears payment) -5.2 -5.9 -4.6 -2.3 -2.0 Primary balance (excluding arrears payment) -2.0 -3.0 -1.9 0.2 0.1 Net domestic financing 4.4 3.4 -1.3 0.9 -1.7 of which: Privatization receipts 1.2 0.0 0.1 0.2 0.0 Foreign financing 0.8 2.5 5.0 1.3 3.7 Public Debt 70.4 72.0 74.1 73.3 71.5 Domestic 43.4 42.4 39.7 39.0 35.3 of which: Unpaid bills and arrears 4.8 1.9 1.0 0.9 … External (including publicly guaranteed) 27.0 29.6 34.4 34.3 36.2 Monetary Indicators (Growth rate in percent) Broad money growth 2.3 4.0 1.8 3.9 4.3 Private credit growth -1.4 2.0 -2.8 0.4 0.9 Velocity 1.2 1.2 1.2 1.2 1.2 Interest rate (3-mth T-bills, end-period) 3.4 3.1 1.5 1.2 … BoA repo rate (in percent) 3.0 2.3 1.8 1.3 … External sector (Percent of GDP, unless otherwise indicated) Trade balance (goods and services) -18.0 -19.0 -17.3 -16.9 -16.5 Current account balance -9.3 -10.8 -8.6 -7.6 -8.0 Gross international reserves (in billions of Euros) 2.0 2.2 2.9 2.9 2.9 (In months of imports of goods and services) 5.4 5.6 7.6 7.2 6.4 (Relative to external debt service) 4.9 2.9 2.6 3.6 3.1 (In percent of broad money) 24.6 25.7 32.5 31.5 29.5 Change in real exchange rate (eop, in percent) 1.0 2.3 1.5 3.9 … Memorandum items Nominal GDP (in billions of lek) 1350 1395 1428 1473 1562 Output gap (percent, - = gap) -0.7 -1.2 -1.6 -1.2 -0.6 Sources: Albanian authorities; and IMF staff estimates and projections. ALBANIA STAFF REPORT FOR THE 2017 ARTICLE IV CONSULTATION November 14, 2017 KEY ISSUES Albania’s economy continues to strengthen, benefitting from rising domestic demand, large energy-related FDI, and a recovery in key EU trading partners. Fiscal and financial vulnerabilities have been lowered; however, challenges remain from the high level of public debt and financing needs, non-performing loans (NPLs), and institutional weaknesses that hinder investment. The clear government mandate following election victory in June, the favorable economic outlook, and the prospects for opening negotiation for EU accession provide a window of opportunity to resume implementing the reform agenda. Albania remains under Post-Program Monitoring. The main policy objectives at the current juncture are to: (i) maintain macroeconomic and financial stability; and (ii) deepen structural reforms to accelerate the pace of convergence. Specifically, the key priorities are to: • Fiscal policy: Maintain fiscal discipline and continue revenue-based fiscal adjustment to rebuild room for policy maneuver and reduce public debt levels to below 60 percent of GDP by 2021. Further fiscal structural reforms, namely improved tax administration, public investment and debt management, are crucial to control arrears, reduce fiscal risks, enhance efficiency, and improve the investment climate. • Monetary policy: Maintain the current accommodative monetary policy stance given still weak inflationary pressures and implement the de-euroization strategy. Amend the Central Bank Law to strengthen its independence. • Financial sector policy: Implement the NPL strategy, maintain enhanced supervision of systemic and rapidly expanding banks, and cooperate with EU parent banks and their regulators to minimize risks from a sudden exit. Strengthening crisis management preparedness in the non-banking financial sector is also a key priority. • Structural reforms: Implement institutional reforms to improve the business climate, reduce informality, and deepen financial markets, in order to encourage higher investment in more diversified, higher value-added activity. In the face of rising demographic pressures, policies are needed to raise youth and female labor participation and improve human capital. ALBANIA Approved By Discussions took place in Tirana during September 20–October 3, 2017. The staff team comprised Ms. Tuladhar (head), Messrs. Jörg Decressin (EUR) Cabezon and Slavov (EUR), Mr. End (FAD), and Mr. Weller (SPR). and Mr. Reinke (Resident Representative) and Ms. Spahia (local Zeine Zeidane (SPR) economist) assisted the missions. Mr. Di Lorenzo (OED) attended some meetings. Mr. Song, Ms. Akil, and Mr. Stewart (all EUR) assisted in the preparation of the staff report. The staff team met with Prime Minister Rama, Minister of Finance and Economy Ahmetaj, Minister of Energy and Infrastructure Gjiknuri, Minister of Justice Gjoni, Bank of Albania Governor Sejko, Parliamentarians, other senior officials, donors and representatives from banks and the private sector. Albania is an Article VIII country (Informational Annex: Fund Relations). Data provision is adequate for surveillance (Informational Annex: Statistical Issues). CONTENTS CONTEXT_________________________________________________________________________________________ 4 RECENT DEVELOPMENTS _______________________________________________________________________ 4 OUTLOOK AND RISKS ___________________________________________________________________________ 5 POLICY DISCUSSIONS ___________________________________________________________________________ 7 A. Fiscal Policy: Ensuring Fiscal Sustainability and Growth-Friendly Consolidation ________________ 8 B. Strengthening Fiscal Institutions: Reducing Fiscal Risks and Improving Efficiency _____________ 12 C. Monetary Policy: Strengthening Inflation Targeting and Mitigating Risks _____________________ 14 D. Financial Sector: Ensuring Financial Stability __________________________________________________ 16 E. Structural Reform: Improving the Investment Climate and Boosting Labor Force Participation _____________________________________________________________________________________ 19 STAFF APPRAISAL _____________________________________________________________________________ 21 BOX 1. NPL Resolution in Albania _____________________________________________________________________ 17 FIGURES 1. Real GDP Growth and Inflation ________________________________________________________________ 34 2. Monetary Sector Developments _______________________________________________________________ 35 3. External Sector Developments _________________________________________________________________ 36 2 INTERNATIONAL MONETARY FUND ALBANIA 4.Fiscal Sector Developments ___________________________________________________________________ 37 5.Social Spending Indicators ____________________________________________________________________ 38 6.Banking Sector Indicators _____________________________________________________________________ 39 7.Structural Indicators ___________________________________________________________________________ 41 8.Labor Market and Demographic Developments _______________________________________________ 42 9.Inclusiveness Indicators _______________________________________________________________________ 43 TABLES 1.Basic Indicators and Macroeconomic Framework, 2013–22 ___________________________________ 24 2a. General Government Operations, 2013–22 (Percent of GDP) _________________________________ 25 2b. General Government Operations, 2013–22 (Billion Lek) ______________________________________ 26 3a. Balance of Payments, 2013–22 (Percent of GDP) _____________________________________________ 27 3b. Balance of Payments, 2013–22 (Million Euros) _______________________________________________ 28 4.External Financing Requirements and Sources, 2014–22 ______________________________________ 29 5.Indicators of Capacity to Repay to the Fund, 2013–22 _________________________________________ 30 6.Monetary Survey, 2013–22 ____________________________________________________________________ 31 7.Summary Accounts of the Central Bank, 2013–22 _____________________________________________ 32 8.IMF Core Indicators of Financial Soundness, 2007–17 _________________________________________ 33 ANNEXES I.External Sector Assessment ____________________________________________________________________ 44 II.Risk Assessment Matrix ________________________________________________________________________ 46 III.Implementation of the Recommendations from the 2016 Article IV Consultation ____________ 47 IV.Debt Sustainability Analysis (DSA) ____________________________________________________________ 49 V.Medium-term Growth in Albania ______________________________________________________________ 60 VI.Fiscal Anchor for Albania _____________________________________________________________________ 61 VII.Revenue Mobilization in Albania _____________________________________________________________ 62 VIII.Judicial Reform and Anti-Corruption Efforts in Albania ______________________________________ 64 IX.Financial Deepening __________________________________________________________________________ 65 INTERNATIONAL MONETARY FUND 3 ALBANIA CONTEXT 1. Albania is making good progress in raising living standards. The economy successfully weathered the global financial crisis with one of the highest growth rates in the region. However, economic growth slowed down significantly in the wake of the Euro Area crisis and policy slippages ahead of elections, leading to a large buildup of macroeconomic vulnerabilities in the fiscal and financial sectors. Albania has since been gradually recovering and is implementing several key reforms that have reduced its macroeconomic imbalances and are laying the foundation for a more rapid economic growth as it pursues the opening of EU accession negotiations. 2. The ruling Socialist Party has emerged from the latest Parliamentary elections with a strong mandate for continued reforms. After winning a clear majority, the new government has reiterated its intention to focus the economic agenda on improving the business climate, property rights, and the public administration, while continuing fiscal consolidation efforts to reduce macroeconomic vulnerabilities. Albania is currently under Fund Post-Program monitoring. RECENT DEVELOPMENTS 3. Albania’s economic recovery continues. Real GDP growth reached 3.4 percent in 2016, accelerating to 4 percent (yoy) in 2017:Q2 (Figure 1). Investment gained momentum due to large energy-related FDI projects and a revival of construction and tourism services. A recovery in the labor market and household credit, supported by an accommodative monetary policy, boosted private consumption. The declining slack and pass-through of higher external inflation pushed inflation to around 1¾ percent (yoy) in 2017:Q3. However, core inflation remains low at ½ percent amidst a negative output gap. 4. Overall credit growth remains stagnant as banks continue to clean up their balance sheets. Credit to the private sector declined, largely due to writeoffs of NPLs (Figure 2). Adjusted for these write-offs, credit grew by around 3 percent (yoy) in 2017:Q2, led by lek credit to households. Despite the monetary policy easing and excess liquidity—especially in euros—banks remain reluctant to lend to corporates and are increasing foreign placements. 5. The current account deficit narrowed to 7.6 percent of GDP in 2016, supported by strong services exports (Figure 3). Remittances also rose, reflecting a recovery in Italy and Greece, the two largest sources of inward remittances. 4 INTERNATIONAL MONETARY FUND ALBANIA 6. Short-term external vulnerabilities are limited, as the deficit is predominantly funded by concessional borrowing and large FDI inflows. The euro-lek exchange rate appreciated by 3½ percent in nominal terms and 4 percent in REER terms (yoy), while reserve accumulation reached six months of imports coverage at end-September 2017. 7. Despite these recent improvements, Albania’s external competitiveness is lagging regional peers (External Sector Assessment, Annex I). The results from the EBA-Lite model indicate an external position that is moderately weaker than implied by fundamentals and desirable policy settings, reflecting mainly the structural impediments to improved export competitiveness. While its ranking in the World Bank’s Doing Business indicators has improved, Albania continues to trail regional peers (¶40). External Sector Assessment Summary Table External Sector Assessment Summary Table (Percent of GDP) (Percent of GDP) Current account Adjusted actual Current account REER gap norm current account gap EBA-Lite (Current account approach) -4.9 -6.0 -1.0 6.1 External sustainability approach -4.4 -6.4 -2.0 9.5 REER approach n.a. n.a. n.a. -1.0 REER elasticity -0.17 Source: IMF staff calculations. 8. Fiscal performance is weaker than expected. Revenues were bolstered by economic and commodity price recovery, although some one-off revenues have not materialized.1 Primary balance at end-September stood at 1.1 percent of GDP. Based on the revised 2017 budget, staff projects the general government primary surplus of 0.1 percent of GDP in 2017 (compared to initial budget of 0.7 percent of GDP), reflecting large pending VAT refunds, drought-related emergency support to the electricity sector and larger-than-anticipated local governments spending. Net new arrears of around 0.3 percent of GDP have accumulated in 2017:H1 (¶24). However, the overall general government deficit is expected to narrow, from 2.3 percent of GDP in 2016 to 2.0 percent in 2017, due to large interest savings. Public debt, including arrears, is also projected to decline moderately to 71.5 percent of GDP at end-2017 compared to 73.3 percent of GDP at end-2016. OUTLOOK AND RISKS 9. Economic growth is expected to strengthen further in 2017–18. GDP growth is projected to reach 3.9 percent in 2017, supported by rising domestic demand and FDI in large energy projects. Despite the slowdown of these FDI projects in 2018, GDP is expected to grow 3.7 percent due to a recovery in private credit, an expansion in public investment, and a boost in 1 Bankers Petroleum Ltd. has appealed the tax dispute regarding diluent excise and the tax amnesty has not yet recorded any principal payments on tax liabilities. However, the tax rebate on self-declared real-estate capital gains has yielded slightly more than expected. INTERNATIONAL MONETARY FUND 5