Press Release No. 02/30

Press Release: IMF Approves In Principle 3-year, US$36 Million PRGF Loan to Albania

June 19, 2002

The Executive Board of the International Monetary Fund (IMF) today approved in principle a three-year arrangement under the Poverty Reduction and Growth Facility for SDR 28 million (about US$36 million) for Albania. The IMF Board's decision will become effective after the World Bank Executive Board's endorsement of Albania's Growth and Poverty Reduction Strategy (GPRS) on June 20. Upon effectiveness of the IMF's Board decision, Albania will be able to draw SDR 4 million (about US$5 million) under the PRGF.

Following the Executive Board discussion, Anne Krueger, First Deputy Managing Director and Acting Chair, said:

"On the basis of the fiscal and monetary policies the Albanian authorities have followed, as well as the ongoing structural reforms, the Albanian economy is on a path of high GDP growth and moderate inflation. External reserves are also at a comfortable level.

"The new PRGF-supported program aims to build on the progress made under the previous arrangement and, consistent with the authorities' Growth and Poverty Reduction Strategy, strengthen the poverty-reduction focus of policies. The GPRS provides a comprehensive basis for the arrangement, with the expectation that it will be updated regularly, in particular to strengthen its links to the budget process.

"Policies in the first year of the program will address in particular the problems in the energy sector and recent problems in tax collection. The recent—albeit apparently temporary—rise in inflation, and the large-scale withdrawal of deposits from the two largest banks caused by unfounded rumors of their insolvency, underscore the importance of continued cautious monetary policy and strengthening of bank supervision.

"Achieving medium-term fiscal sustainability while raising priority spending hinges crucially on ambitious planned improvements in tax collection. Recent revenue slippages point to the need for continued resolve in improving the efficiency of tax administration and monitoring its performance closely, as well as identifying contingency measures on a timely basis.

"Sustaining high growth and ensuring a sustainable external position over the medium term will require a wide range of reforms to improve the business climate and establish a fully functioning market economy. Reforming the electricity sector, reconciling inter-enterprise arrears within the public sector, strengthening governance and the rule of law, and completing the privatization process will be crucial in this regard," Ms. Krueger said.

ANNEX

Recent Developments

Sound financial policies and structural reform under the previous PRGF-supported program, which expired in July 2001, helped stabilize the economy and restore high growth, but poverty remains widespread. Despite rising average incomes and ongoing reforms, Albania remains one of the poorest countries in Europe. Poverty is most prevalent in rural areas and has led to large-scale emigration.

Real GDP growth in 2001, while still high at an estimated 6.5 percent, was adversely affected by unfavorable weather conditions and other supply shocks. Despite reform efforts, electricity supply has been severely constrained by low rainfall, and power outages have been extensive. As a result of supply shocks, headline inflation rose from 3.5 percent year-on-year in December 2001 to over 6 percent in the first four months of 2002. However, core inflation has remained at around 3 percent. Interest rates have been raised to help prevent the spread of inflation, in the context of a rise in domestic currency in circulation. Although recent monetary and electricity developments have influenced the current account, the exchange rate has remained fairly stable. The fiscal deficit has remained well within the budgetary target at 8.5 percent of GDP at end-2001, despite end-year revenue shortfalls.

Program Summary

Within the umbrella of the GPRS, the proposed three-year PRGF arrangement focuses on ensuring a sound macroeconomic environment as a pre-condition for sustainable growth. In particular, it aims to mobilize resources for priority expenditures, while ensuring fiscal and external sustainability. To this end, it includes measures to improve tax administration and limit unproductive spending, including budgetary subsidies to public enterprises. Moreover, the program includes actions to promote private sector activity through privatization, financial sector development, and sustainable provision of electricity.

Prospects for price stability and growth remain relatively favorable in the context of a sustainable strategy. Assuming essential structural reforms continue, growth is expected to decelerate marginally to 6 percent in 2002, mainly on account of the electricity situation, but return to about 7 percent in subsequent years. Private investment should serve as the engine for growth, with ample scope for acceleration of mining and other industrial activities, and expansion of tourism, and further productivity gains in agriculture. Inflation is expected to return to the upper end of the 2-4 percent target range by end-2002, as supply constraints ease and higher interest rates start having an impact.

Fiscal policy under the program aims to reconcile financial sustainability with the provision of adequate resources for priority spending. The fiscal deficit is projected to moderate to 5.5 percent of GDP by 2005 from 8 percent in 2002.Consolidation will be somewhat lower in 2002 than in later years, reflecting the need for higher electricity subsidies. Albania's public debt ratio—which is already lower than in the majority of other PRGF countries—would drop further by about 6 percent of GDP in 2002, owing largely to debt forgiveness, and continue to decline, albeit more gradually in the medium term. The current account deficit is projected to narrow over the medium term, in part reflecting the programmed fiscal consolidation.

Over the medium term, the government's strategy aims to stabilize primary expenditure at 28.5 percent of GDP. The authorities intend to boost spending on primary education and health care, in particular for rural areas, and to implement in stages their fiscal decentralization program, in conjunction with improved tracking of local expenditures. Revenues are projected to rise from 23 percent of GDP in 2001 to 26.5 percent by 2005 through further improvements in tax and customs administration and an expanded tax base.

The monetary framework—including the use of indirect instruments to keep inflation within the 2-4 percent range, with flexible exchange rates—has served Albania well and will be continued. Restoring financial sector and price stability is the immediate priority of the monetary authorities. Given the high rate of inflation in recent months, and the risks of further inflationary and depreciation pressures stemming from the enlarged stock of domestic currency in circulation, the Bank of Albania intends to continue exercising vigilance in setting policy interest rates.

Maintaining high growth will require ongoing improvements in financial services, the provision of utilities, the business environment, and governance. The privatization process should continue expeditiously. A speedy sale of the Savings Bank would be key to creating a more dynamic financial sector, but the limited interest expressed in the sale could jeopardize the process. Priority will be given to implementing a bold strategy for limiting harmful electricity shortages, while phasing out subsidies over the program period. The authorities will seek to reduce excessive demand, especially for space heating, by gradually raising average electricity prices, improving bill collection, and reducing losses.

Structural conditionality under the PRGF-supported program focuses on four categories: fiscal management and control, and payments discipline; budgetary implications of electricity sector reform; financial sector reform; and privatization. Improvements in each of these is critical to the macroeconomic success of the program.

Albania joined the IMF on October 15, 1991. Its quota¹ is SDR 48.7 million (about US$63 million), and its outstanding use of IMF resources is SDR 60.9 million (about US$79 million).