DOCUMENT OF THE EUROPEAN BANK FOR RECONSTRUCTION AND DEVELOPMENT STRATEGY FOR ALBANIA As approved by the Board of Directors at its meeting on 11 December 2012 . TABLE OF CONTENTS EXECUTIVE SUMMARY ......................................................................................... 1  1.  THE BANK'S PORTFOLIO ............................................................................. 4  1.1. Overview over Bank activities to date ........................................................... 4  1.2. Implementation of the previous country strategy .......................................... 5  1.3. Transition impact of the Bank's portfolio ...................................................... 8  2.  OPERATIONAL ENVIRONMENT ................................................................. 9  2.1  Political Context............................................................................................. 9  2.2  Macroeconomic context ............................................................................... 10  2.3  Structural reform context ............................................................................. 11  2.4  Business environment .................................................................................. 12  2.5  Social context ............................................................................................... 12  2.6  Legal context ................................................................................................ 13  2.7  Energy efficiency and climate change context ............................................ 14  3.  STRATEGIC ORIENTATIONS ..................................................................... 15  3.1  Transition challenges ................................................................................... 15  3.2  Bank priorities for the strategy period ......................................................... 15  3.3  Sectoral challenges and the Bank’s operational response ............................ 16  3.4  Environmental and Social Implications of Bank Proposed Activities ......... 23  4.  ACCESS TO CAPITAL: PRIVATE AND PUBLIC SOURCES OF FINANCE .......................................................................................................... 24  4.1  Private sources of capital ............................................................................. 24  4.2  MDB finance and collaboration with other IFIs and multilateral donors .... 24  Annex 1 – Political Assessment ................................................................................. 27  Annex 2 – Assessment of Transition Challenges ..................................................... 34  Annex 3 – Legal Transition ....................................................................................... 42  Annex 4 – Small Business Support ........................................................................... 46  Annex 5 – Technical Cooperation ............................................................................ 49  Annex 6 – Selected Economic Indicators ................................................................. 50  Annex 7 – Gender Equality ....................................................................................... 51  i EXECUTIVE SUMMARY Albania is committed to and applying the principles of multiparty democracy, pluralism and market economics in accordance with the conditions specified in Article 1 of the Agreement establishing the Bank. In the period since the adoption of the previous Strategy in 2009 progress in further democratic transition has been uneven. The main opposition political party did not recognise the outcome of the 2009 general elections. There has been considerable improvement in the political dialogue following the November 2011 political agreement between the government and the opposition. Albania applied for membership in the European Union in 2009, and the EU approximation process remains an important anchor for democratic reforms. Albania was the only country in the south-eastern European region that avoided a recession in recent years. However, while GDP growth is still above the regional average, a slowdown is increasingly apparent, and growth in 2011 of around 3 per cent was lower than in previous years. The deceleration in economic activity in the past year is largely due to weakening performance in some key EU markets. Exports have continued to grow, but at a slower pace, and growth in imports has slowed down as well. Remittances from Albanians working abroad have also been hit by the crisis. Inflation has been low for many years but total public debt is high by regional standards at just below 60 per cent of GDP. The scope to take on extra public debt is therefore limited. In the banking sector, credit growth remains positive but well below pre-crisis levels. The level of non-performing loans is high and it has been increasing over the past year, reaching nearly 19 per cent by the end of 2011. The short-term outlook for the Albanian economy is highly uncertain. GDP growth is currently forecast by the Bank to fall to about 1.2 per cent in 2012, with a modest increase to 1.8 per cent in 2013. Under the Bank’s baseline scenario, growth is expected to be around 3-4 per cent in 2014/2015. Significant short-term vulnerabilities remain due to Albania’s close trade, investment and remittance linkages to Greece and Italy. The lack of fiscal space is an additional source of vulnerability, highlighting the need for further efforts to broaden the tax base, improve the efficiency of public spending and intensify efforts to improve the business environment and attract greater inflows of investment. Albania has made steady progress with structural reform over the past two decades, despite having to overcome serious institutional weaknesses and one of the most difficult starting points for transition. However, the country faces significant challenges across the board. Key transition challenges that can be addressed with the support of EBRD financing and assistance include:  Moving towards a more balanced energy sector. Albania has the potential to become a regional player in the renewable energy market, but achieving this goal will require improved efficiency and viability of distribution and generation, a substantial increase in private sector participation in power generation, and an improved regulatory framework. 1  Upgrading infrastructure including through increased participation of the private sector. The implementation of PPP projects and other concession financing will be critical for addressing this transition challenge. The development of railways and port infrastructure will also be a key factor in advancing Albania’s regional integration and sustainable transport.  Developing a more vibrant corporate and agribusiness sector. In a difficult international economic environment the Albanian private sector will need financial and technical support to promote greater vertical integration, innovation, competitiveness and improved corporate governance. Further challenges include the reduction of the administrative burden facing businesses, the completion of privatisation and greater enforcement of the rule of law.  Deepening financial intermediation. Financial intermediation is still low by regional standards and its development was slowed down by the negative impact of the crisis. Challenges ahead include enhancing the flow of credit to the real economy in the face of more stringent capital requirements and boosting the development of non-bank financial services. Strategic directions The Bank’s priorities for the next three years will focus on sustainable development of the private sector, building on the strong entrepreneurial spirit in the economy. The Bank will also invest in high-priority public sector projects in infrastructure where such investments can address important transition gaps. In light of the transition challenges identified above, the Bank’s activities in Albania will focus on the following areas:  Promoting Sustainable Energy Policies and Environmentally Sound Investments. The Bank will work closely with the Albanian authorities and the independent regulators to enhance the regulatory and administrative framework for private sector investments, particularly in the renewable energy sector. The Bank, through its dedicated facilities, will finance energy efficiency and renewable energy projects and, in cooperation with other IFIs and commercial banks, will support the upgrading and financial viability of energy generation and distribution. Interconnection lines and gas pipeline will also be of key importance to improve competitiveness and regional integration.  Enhancing commercialisation, competition and private sector involvement in infrastructure, alongside targeted public projects. The Bank will assist the Albanian authorities, both at the national and local level, to increase private sector involvement in transport and municipal services, including in road maintenance. Financial assistance will be complemented by technical advice, capitalizing on the Bank’s experience to successfully structure and implement PPP and concession financing. The Bank will also work closely with the Government on advancing transition in the seaport and railways sectors.  Supporting the development of a more competitive private sector. The Bank will continue to be a strong partner for foreign investors and for local corporates, both directly and through the Local Enterprise Facility (LEF). The Bank will pursue an active investment policy in sectors such as agribusiness, manufacturing and services, ITC and tourism, all of which have the potential to modernise and increase value creation in the Albanian economy, which is still too reliant on imports and labour-intensive textile subcontracting. 2  Strengthening the financial sector and deepening intermediation. The Bank will support the banking system in a difficult market environment with credit lines and other facilities such as the Medium Size Co-Financing Facility (MCFF). The Bank, through a close consultation with the Bank of Albania, will respond in a timely way to emerging needs of the local financial sector. The Bank will cooperate closely with the European Union and with other IFIs in all of its operations as well as through policy dialogue, in order to achieve maximum transition impact and to enable Albania to integrate further into EU and global structures. 3 1. THE BANK'S PORTFOLIO 1.1. Overview over Bank activities to date As of end-2011, the Bank had signed a total of 56 projects in Albania with a cumulative EBRD investment value of €667 million since the start of its operations in 1992. On average, every 1 euro of EBRD investment has attracted 2.5 euros of investment by other partners, implying a total project value of €2.33 billion (see Table 1). The current portfolio stock is allocated 37 per cent to infrastructure, 33 per cent to energy, 22 per cent to industry, commerce and agribusiness and 7 per cent to financial institutions. This distribution broadly represents the investment needs and opportunities in the Albanian economy over the past two decades. During 2009-2011, the Bank increased its financing activities in Albania, in part responding to a decrease in alternative sources of funding amidst the European sovereign debt crisis and its impact on neighbouring countries such as Greece and Italy. During 2011 the Bank achieved new records with an annual business volume of €96 million and gross disbursements of €93 million. The private sector share of the EBRD portfolio in Albania has gradually increased during the course of the previous country strategy period, from 47 per cent in 2008 to 56 in 2011. Another positive trend in recent years is the decrease in the percentage of undrawn amounts: from 44 per cent in 2008 to 30 per cent in 2011 (see Table 2). Table 1: Portfolio Overview in Albania as of 31 December 2011 NET CUMULATIVE BUSINESS SECTOR CURRENT PORTFOLIO STOCK VOLUME Number Total % of of EBRD Project EBRD % % of Operating Operating Amount in EUR million projects Signed Cost of Total Portfolio Portfolio Assets Assets Energy 12 211 805 26% 150.3 33% 93.3 29% Natural Resources 2 39 110 35% 36.8 8% 33.8 11% Power and Energy 10 172 695 25% 113.5 25% 59.5 19% Financial Insitutions 16 75 128 59% 31.4 7% 29.9 9% Bank Equity 4 38 45 84% 3.6 1% 3.6 1% Bank Lending 5 23 43 53% 20 4% 20 6% Small Business Finance 5 8 30 27% 4.3 1% 4.3 1% Services 2 6 10 60% 3.5 1% 2 1% ICA 20 188 767 25% 101.7 22% 98.1 31% Agribusiness 4 14 32 44% 0.8 0% 0.8 0% Equity Funds 5 8 17 47% 5.5 1% 2.4 1% Manufacturing & Services 5 64 350 18% 53.1 12% 53.1 17% Property & Tourism 3 39 82 48% 17.5 4% 17 5% Information & 3 63 286 22% 24.8 5% 24.8 8% Infrastructure 8 193 629 31% 169.7 37% 95.9 30% MEI 1 15 15 100% 11.5 3% 9.3 3% Transport 7 178 614 29% 158.2 35% 86.6 27% TOTAL 56 667 2329 29% 453.1 100% 317.2 100% 4 Table 2: Portfolio Development in Albania, 2008 – 2011 Development over 2007-10 Amount in EUR million 2008 2009 2010 2011 (3 years since last Strategy) (end 2008 vs end 2011) Net Cumulative Business Volume 475 518 575 667 192 Current Portfolio Stock 339 370 393 453 114 Number of Operations 41 46 52 56 15 Operating Assets 189 226 253 317 128 % Undrawn 44% 39% 36% 30% - 14 p.p. Annual Business Volume 88 59 75 96 8 Number of Operations 9 7 9 9 0 Gross Disbursements 82 61 57 93 11 Annual Cancellations 9 5 0 9 0 Active Pipeline Stock 180 273 286 243 63 Private Sector Share (% Portfolio) 47% 54% 54% 56% - 9 p.p. Non Sovereign (% Portfolio) 53% 62% 62% 62% + 9 p.p. 1.2. Implementation of the previous country strategy The previous Strategy for Albania was approved on 17 November 2009 and outlined the following main priorities:  In the Energy sector: Support much-needed priority safety investments in dams with other IFIs and donors. Consider working with private investors to develop new hydro power plant concessions through the Western Balkans Sustainable Energy Direct Financing Facility (WeBSEDFF), and in the natural resources sector. Support appropriate regulatory and institutional reforms through policy dialogue.  In the Transport sector: Continue to support the upgrading of networks in Albania with emphasis on regional linkages and local roads network. Support sector reforms also through technical assistance and promote private sector involvement in the development of transport infrastructure through PPPs or other forms of concession financing. Seek to widen dialogue and explore opportunities to develop economically viable projects in the railway sector  In the Municipal and Environmental Infrastructure sector: Consider investments in municipal services, such as water and public transport, combined with regulatory improvements to allow for bankable structures on a sub- sovereign basis. Explore opportunities to work with larger municipalities for priority projects with particular attention to waste and water systems.  In the Enterprise sector: Promote the private sector through financing existing companies, greenfield developments and/or or acquisition projects. Reach SMEs either directly, through LEF and WeBSEDFF or with local banks through products such as the MCFF and Western Balkans Sustainable Financing Facility (WeBSEFF). Expand activities in agribusiness (including processing, logistics and retail distribution), textiles/processing, property and construction materials. Design new products to provide financing of energy efficiency/sustainable energy and also to support companies which are developing in the IT sector.  In the Financial sector: offer MCFF facilities and other risk-sharing products aimed to ensure continued lending to the real economy and strengthen the 5 banks’ risk profile and their lending policies and procedures. Support the banking system in case of need with equity and quasi-equity instruments and to maintain the level of lending and ease the impact of the crisis seek to design adequate lending products mobilising donor funds to support SME and MSME development. Work with the Bank of Albania to provide policy advice on deposit insurance and financial sector supervision.  Policy dialogue: Seek to further strengthen Albanian institutions and to enhance the environment for the private sector to flourish. Focus on (i) identifying the existing impediments to private sector and gain direct feedback on Government policy and actions; (ii) ensuring environmental and energy efficiency reforms are adopted at the Government and company levels; (iii) ensuring requirements for transparency and accountability are included in projects; (iv) expanding the use of private concessions in infrastructure; and (v) examining the scope for further specific assistance for the telecoms authorities. Since the Strategy was approved, the Bank has committed €230 million for 25 new projects. Although market conditions have been difficult, the Bank has continued to play an important role in Albania and has expanded operations across a number of areas, working closely with other IFIs as needed. Overall, the Bank successfully addressed most of its objectives during the past strategy period. Business volume increased, project implementation and disbursement were improved, and the Bank engaged in an enhanced policy dialogue and coordination with other IFIs and donors. There was strong collaboration with the IFC in the private sector and the EIB in the public sector. The cooperation with the EU, through the WBIF framework and the availability of IPA funds, has increased the affordability of public investments, helping the Government to overcome some of the constraints imposed by the limited fiscal space. Further technical cooperation programmes were developed in areas such as transport, energy, municipal infrastructure and legal and regulatory improvements to support sector reforms and private sector development. The Bank responded to the key transition challenges by implementing the following activities in the priority areas: In the Energy sector, the Bank worked with the IFC to support the turnaround of the distribution company (OSSH), following its privatisation, by co-financing the investment programme of CEZ Shperndarje. In the hydropower sector the EBRD was the first IFI to finance the construction of small HPPs through the WeBSEDFF and has set new standards for local commercial banks. The Bank has also worked to improve the regulatory framework by providing TC to the Ministry of Economy, Trade and Energy to develop a proper feed-in tariff methodology for renewable energy projects. In the Transport sector, the Bank has assisted the Government in rebuilding and upgrading the underdeveloped Albanian infrastructure. The Bank contributed to the reconstruction of the transport network by financing the rehabilitation of the Local and Regional Roads Project and the construction of Fier and Vlore Bypasses. These projects are examples of successful donor coordination among the Bank, EC and EIB through the Western Balkans Investment Framework (WBIF). The Bank is implementing a major TC project to assist the development of the railway sector by upgrading the railways link between the capital Tirana and the city of Durres. At the 6 same time the Bank has been implementing the Levan-Vlore and Levan-Tepelene road projects and the construction of a passenger terminal at the Port of Durres. These projects are also linked to sector reforms and institutional strengthening, such as the preparation of a Tolling Strategy for the Albanian Roads and the preparation of a Sustainable Transport Plan. In the Municipal sector, the Bank has been working very closely with the administration of the City of Tirana, supporting investment initiatives such as the new multi-modal transport terminal, which is expected to be the first large PPP project ever implemented at the municipal level. In the same period the last component of a Municipal Road Project has been completed as well as preparatory work for an integrated transport control system in Tirana. Activities elsewhere in this sector have been hampered by lack of capacity at the local level and an incomplete decentralization process. In the Enterprise sector, the Bank supported a local company, Balfin Group, for the construction of the largest shopping mall in the country, facilitating the entry of prominent international players such as the French retailer Carrefour. In the strategy period important foreign investments were completed with a significant impact on job creation, export promotion and business innovation, such as a new modern hospital, Hygeia Hospital, offering unique medical services in the region, and a new cement factory, Antea Cement. The Canadian company, Bankers Petroleum has constantly increased production and exports also thanks to a new financing package provided by the Bank in early 2012. The Bank has also been successful in reaching out to local corporates with its dedicated facilities, the LEF and the WeBSEDFF. The WeBSEDFF has made the Bank a strategic player in the hydropower sector which is considered a key driver of Albanian future economic growth. LEF and WeBSEDFF clients are implementing good business standards in their respective sectors in Albania, thus setting examples for other investors to follow. In addition, the Bank has been cooperating with other local banks, inviting them to participate in co-financing private sector projects. In the Financial sector the Bank has continued to be a reliable partner for local banks and financial institutions. The banking system has maintained adequate capitalisation and liquidity levels thanks to an increasing deposit base and new regulations introduced by the Bank of Albania; hence, the need for external funding has been limited. The Bank has, however, increased its role in the sector through a credit line to Tirana Bank, a subsidiary of the Greek Piraeus Bank and through the MCFF signed with Societe Generale Albania. The Bank has also supported the credit flow to local SMEs through a credit line with a local micro-finance institution, Fondi Besa, and the first operation with a local leasing company, Landeslease. An Advisory Support project to the Albanian Financial Supervisory Authority has been successfully completed, with new regulations implemented and legislation passed by the Parliament. 7 1.3. Transition impact of the Bank's portfolio Since 2009, when the previous strategy was adopted, eight transition-rated operations were signed by the Bank in Albania.1 All eight projects in Albania were ex ante rated as having “Good” or “Excellent” transition impact potential, therefore exceeding the institution-wide target of 80 per cent of projects to be assessed “Good” or better. One project that involves the development and environmental remediation of an oil field in Albania was rated with Excellent transition potential. The operation targets increased private sector participation in a sector that has been dominated by the state-owned player, as well as a significant upgrade in environmental standards and skills and technology transfer. The transition objectives of projects signed during the strategy period reflect the diversified nature of the Bank’s activities in Albania in 2009-2012. Apart from the above described project in the country’s oil and gas sector, the Bank extended two SME credit lines to Albanian financial institutions, signed two road rehabilitation projects, invested in two corporate projects and participated in the electricity distribution efficiency improvement programme. As a result, key transition objectives for the new projects varied across different dimensions, with a special focus on setting higher standards for corporate governance and business conduct, demonstration effects related to successful restructuring, as well as market expansion (see Figure 1). Figure 1. Targeted transition objectives in Albania (share of projects), 2009-2012 The projects in the country’s portfolio are performing well in terms of achieving their envisaged transition impact. Out of 22 operations projects in the Bank’s active portfolio all but one are, as of end-May 2012, on track to achieving their transition potential.2 Out of these 21 projects, five active operations have a rank3 in the range 1 There were 3 additional operations (under LEF and WeBSEDFF frameworks) which were not individually assessed for their transition; these are assessed and monitored at facility level. 2 All active operations more than 6 months since signing and are monitored for their transition impact at least once. 3 Rank is a combination of the relevant rating for transition impact potential and risks to transition impact. Expected transition of operations is usually monitored once a year and is ranked numerically 8