TRANSITION REPORT 2014 Innovation in Transition

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Highlights

  • Albania has become a European Union (EU) candidate. This decision, endorsed by the European Council in June 2014, reflects the country’s progress in recent years in political and economic reform. No date has been set for the opening of accession negotiations.
  • A new International Monetary Fund (IMF) programme has been agreed. The programme will help strengthen public finance sustainability and should lead to a much-needed improvement in fiscal discipline, as well as the gradual clearing of public sector arrears.
  • Efforts are under way to improve the investment climate. The government has put business environment reforms at the heart of its economic programme and has established a National Economic Council to advise on the most urgent reforms. However, the central bank changed its top management in September 2014, and the manner in which this was conducted has brought the independence of the institution into question.

Key priorities for 2015

  • Further visible achievements with regard to the business environment are needed. Although efforts to improve the business environment are noteworthy, the authorities must continue with reforms in areas where Albania scores poorly on international comparisons, such as getting electricity, dealing with permits and paying taxes. 
  • Energy sector problems should be tackled vigorously. Following the resolution of a dispute with a major foreign investor in this sector, there is a great need for fresh investment, combined with commercially oriented reforms to reduce budget-funded losses.
  • Further efforts are needed to reduce non-performing loans (NPLs). Despite legislative improvements, the level of NPLs remains among the highest in the region. A comprehensive and coordinated approach by the government, the central bank and local banks is needed to help alleviate the problem.

ALBANIA HAS BECOME A EUROPEAN UNION CANDIDATE

A NEW IMF PROGRAMME HAS BEEN AGREED

EFFORTS ARE UNDER WAY TO IMPROVE THE INVESTMENT CLIMATE

2014 sector transition indicators
Corporate Energy Infrastructure FI

Source: EBRD.
Note: FI – Financial institution; ICT – Information and communication technology; Water – Water and wastewater; IAOFS – Insurance and other financial services; PE – Private equity.


Main macroeconomic indicators %

  2010 2011 2012 2013 2014
          proj.
GDP growth 3.5 2.3 1.1 0.4 1.7
Inflation (average) 3.5 3.4 2.0 1.9 2.0
Government balance/GDP -4.3 -3.6 -3.5 -5.2 -6.7
Current account balance/GDP -11.2 -13.3 -10.0 -10.4 -11.0
Net FDI/GDP 8.7 6.4 6.7 9.0 9.4
External debt/GDP 33.9 33.9 36.5 36.3 n.a.
Gross reserves/GDP 21.6 21.0 20.9 21.0 n.a.
Credit to private sector/GDP 38.2 40.1 39.6 38.2 n.a.

Macroeconomic performance

Economic performance remains feeble. Growth in the past two years has slowed significantly, reflecting domestic problems as well as falling remittances and difficulties in EU periphery countries that have strong trade links with Albania. Growth in the first quarter of 2014 was similarly slow at 1.6 per cent year-on-year. The unemployment rate has risen to 17.7 per cent in the second quarter of 2014, up four percentage points from two years ago. Weak aggregate demand, low imported inflation and restrained inflation trends have kept inflation below the central bank’s tolerance range of 2-4 per cent for over a year. In line with the declining inflation rate, the central bank implemented an expansionary monetary policy and began a series of cuts in the base interest rate, with the latest – in May 2014 – bringing the interest rate down to an historic low of 2.5 per cent.

The fiscal situation deteriorated in 2013. The 2013 budget deficit stood at more than 5 per cent of GDP, in comparison to 3.5 per cent, which was envisioned by the 2013 budget law. Failure to achieve the target was mainly due to problems with revenue collection as well as uncontrolled pre-election spending. These problems occurred because of a weaker-than-expected economy and a reduction of administrative discipline in tax collection owing to the significant gap between elections and the formation of the new government in 2013. The deficit should narrow over time as tax collection resumes – with an increase in the corporate income tax rate from 10 to 15 per cent and the introduction of progressive personal income tax rates – and the government implements restrictions on public sector pay and headcount. Public debt reached approximately 70 per cent of GDP at the end of 2013, which is worryingly high by regional standards.

In February 2014 the IMF approved a three-year €331 million Extended Fund Facility arrangement. The IMF arrangement is complemented by two development policy loans from the World Bank, totalling US$ 220 million, which aim to strengthen public financial management and maintain stability in the financial sector. The government has started using these funds to clear public arrears to companies, which had reached an estimated €500 million or 5.4 per cent of GDP.

The short-term outlook remains uncertain. Growth is likely to pick up modestly in 2014, with the clearing of a large sum of government arrears, but the downside risks are high as macroeconomic imbalances persist. In addition, the financial sector continues to be exposed to both domestic and external risks, while other macroeconomic policy buffers have been exhausted. As for 2015 some positive externalities are expected to be derived from Albania’s EU candidate status and the construction of the Trans Adriatic Pipeline. Over the medium term, Albania could benefit considerably from a global recovery if it is able to make further progress on structural reforms. At the same time, the regulatory independence of the central bank needs to be preserved.


Major structural reform developments

EU grants Albania candidate status. At its meeting in June 2014, the European Council endorsed the European Commission’s recommendation that Albania be granted official EU candidate status. In its 2014 Progress Report, published in October 2014, the European Commission stressed the need for sustained reform efforts in key priority areas, such as public administration and judiciary, the fight against corruption and organised crime, and protection of fundamental rights, so that the country can move towards the opening of accession negotiations.

Little progress has occurred in strategic privatisation over the past year. Although privatisation is largely complete in Albania, there are still a number of companies where significant state shares remain, some of them in strategic sectors such as energy, natural resources and telecommunications. The government has announced plans to sell stakes in at least 21 enterprises by the end of 2014, including 10 companies where the government has a majority stake. The most valuable minority stake is likely to be the 16.8 per cent state share in Albtelecom. Plans for the sale of the oil company Albpetrol remain unclear after a failed privatisation in February 2013.

Albania has settled a major dispute with CEZ, the state-owned Czech power company. In June 2014 the government signed a €95 million settlement agreement with CEZ over a long-running dispute, which began after CEZ was stripped of its licence to operate Albania’s sole power distribution company. The dispute had been damaging to investor confidence in the country, so its resolution could unlock further investment in critical energy infrastructure. The energy sector is a major drain on the government’s finances and the authorities are preparing a recovery plan for the sector, with support from the World Bank.

The government is pushing business environment reforms. The government has established a National Economic Council, chaired by the Prime Minister, to provide overall advice on strategies to promote investment and growth. Albania has also signed a Memorandum of Understanding with the EBRD to improve the investment climate in the country. The memorandum provides a framework for cooperation between the EBRD and the government of Albania in support of the country’s National Economic Council. As a first step, the EBRD will help to establish an independent investment council – a platform for bringing together businesses and policy-makers – to provide advice to the National Economic Council. Other efforts are under way to implement a new customs code (approved by parliament) and to cut red tape for businesses. The overall positive direction of business environment reforms is highlighted by Albania’s significant jump in the World Bank Doing Business 2015 report. The country climbed 40 positions, ranking 68th out of 189 countries for ease of doing business.

Plans have advanced for the creation of a functioning gas market in the next decade. To date there has been no gas market in Albania given the absence of a distribution network and lack of interconnections with neighbouring countries. A trilateral intergovernmental agreement with Greece and Italy was signed in 2013 for the development of the Trans Adriatic Pipeline. The project, which is designed to transport natural gas from Azerbaijan via Greece and Albania, and across the Adriatic Sea to Italy, progressed further this year. The new pipeline is expected to start operating in 2018. In addition, the construction of the proposed Ionian Adriatic Pipeline from Albania, through Montenegro and Bosnia and Herzegovina, to Croatia could enable Albania to become a regional gas hub.

The level of non-performing loans remains high, but efforts are under way to address the problem. As of mid-2014, the level of NPLs stood at 24.1 per cent of total loans. Some measures have been taken to help alleviate the problem. The gradual clearance of public sector arrears, with assistance from international financial institutions, should make it easier for private companies to repay some of their outstanding loans. In addition, the authorities have made changes to the civil code to ease collateral execution, and to the tax law to make it easier for banks to write off loans. Despite the high level of NPLs, the banking sector has a relatively high capital adequacy ratio of 17.9 per cent.

A comprehensive pension reform is being prepared. In April 2014 the government prepared a draft strategy, with the assistance of the World Bank, designed to strengthen the link between contributions and benefits and thus move towards a sustainable pension system. The new pension law was approved by parliament in June 2014. Under the new strategy, the retirement age, which is currently 65 for men and 60 for women, would be raised gradually to 67 for both sexes by 2056. The strategy also proposes a number of other reforms to the system, which aim to significantly reduce the pension deficit.