Public Information Notice No. 99/51

Public Information Notice: IMF Concludes Article IV Consultation with Albania

June 22, 1999

On June 14, 1999, the IMF Executive Board concluded the 1999 Article IV consultation¹ with Albania and approved the second annual arrangement under the Enhanced Structural Adjustment Facility, providing the equivalent of SDR 21.5 million (about US$30 million) to support the government's 1999/2000 program.

Background

Prior to the crisis in neighboring Kosovo, which erupted at end-March 1999, the Albanian economy was making a successful recovery from the impact of civil disturbances in 1997 brought about by the collapse of the pyramid schemes. Growth is estimated to have been 8 percent in 1998, reversing the 1997 decline in output, and inflation declined to 8.7 percent from 42 percent in 1997. Inflation fell further to 2 percent in March 1999. The return to growth and low inflation reflected the government's adherence to strong fiscal consolidation efforts: the domestically financed component of the deficit was reduced to 6.4 percent of GDP in 1998 from 10.8 percent of GDP in 1997. The external current account deficit also fell sharply from 12 percent of GDP in 1997 to 6 percent of GDP and foreign reserves climbed to 4.7 months of imports at end-1998.

Structural reforms were also progressing. Foreign administrators of the pyramid scheme companies completed their work and handed over to their local counterparts. In the banking sector, the authorities prepared the National Commercial Bank (NCB) for privatization and placed the Savings Bank under a foreign governance contract. In the enterprise sector, a further 450 small- and medium-sized enterprises were privatized and one of the four remaining enterprises formerly under the Enterprise Restructuring Agency (ERA) was leased to a foreign investor. In the agricultural sector, the process of land registration and consolidation of landholdings was progressing. In the public administration, overmanning was reduced through cuts in employment. In tax administration, a revised customs code was drawn up and a modern income and profits tax introduced. Last, but not least, the government began implementing an anti-corruption strategy.

The Kosovo crisis is a serious threat to macroeconomic stability and reform. Since the NATO bombing campaign began, over 460,000 refugees have flooded into Albania, augmenting the local population by some 14 percent. The large refugee population places a considerable strain on the social and political infrastructure, as well as on the budget, and stretches administrative capacity of the government with attendant risks of a breakdown in law and order. At the same time, humanitarian and military supplies are clogging Albania's ports, crowding out commercial imports.

Nevertheless, the authorities have shown continuing commitment to reform and stabilization. With the budget facing large, uncertain costs associated with the refugees, the authorities announced a freeze on public investment and a postponement of the 10 percent civil service pay rise planned for April 1. They only began to lift the spending restrictions when the international community began to make firm pledges of budgetary assistance. The exchange rate has remained broadly stable against the U.S. dollar. At the same time, some important structural measures have been implemented: Parliament passed the amended customs code, which is now being implemented; the government selected a foreign buyer for NCB; and the government has liquidated two more former-ERA enterprises.

With international donors and creditors making pledges at a meeting on May 26, 1999 to finance refugee-related expenditures on highly concessional terms, the crisis need not have an adverse impact on growth and inflation. Albania has negligible official trade with the Federal Republic of Yugoslavia, and supply side disruptions are likely to be offset by increased production elsewhere. The IMF staff projects that growth could continue at 8 percent in 1999, assuming that social stability can continue to be maintained and the capacity problem of the ports is solved quickly. A temporary increase in food prices is possible—although a decline in inflation to zero in the year to May 1999 suggests this has not happened so far—but would still be expected to leave inflation below the authorities' end-year target of 7 percent. Uncertainty in the outlook for growth and inflation has, however, increased substantially.

The Kosovo crisis apart, Albania still faces tremendous development problems. Despite rapid growth in the early years of transition, per capita GNP is only about US$800. Basic structural deficiencies in the economy run deep. The financial system is rudimentary; the tax base is inadequate; communications are hampered by a weak infrastructure; and waste and inefficiency are considerable in the public utilities. Corruption and organized crime are recognized problems and administrative capacity is weak. The internal and external security situation undermines investor confidence.

Executive Board Assessment

Directors commended the authorities for their success in restoring macroeconomic stability following the 1997 disturbances. Directors noted that output had rebounded from its earlier losses, inflation had declined significantly, and foreign reserves had risen to a reasonably comfortable level. The authorities' success stemmed from their firm implementation of prudent macroeconomic policies and progress in structural reforms, including in the key areas of privatization, the financial system, and the agricultural sector.

Directors praised the authorities' response to the formidable challenges posed by the Kosovo crisis. The flood of refugees into Albania since the crisis erupted in late March has placed tremendous strain on the social and economic infrastructure, as well as on the budget and balance of payments. Nevertheless, the authorities have persevered with their stabilization and reform efforts. Directors considered that, with sufficient external support, Albania should be able to meet its macroeconomic program objectives in 1999 and continue to address the still severe development problems facing the country. Noting that the transition process was far from complete, they underscored the importance of maintaining the momentum of structural reform and of efforts to improve governance as necessary conditions for sustained rapid growth. In this connection, Directors were encouraged by the recent actions and statements of the authorities.

Regarding fiscal policy, Directors noted that donor financing of Kosovo-related expenses should enable the government to keep within its domestic budget borrowing limits in 1999. At the same time, they considered that the government should intensify its efforts to raise tax collections, which were low in relation to GDP, in order to create room for increased government spending on infrastructure investment and for social purposes without compromising the process of fiscal consolidation. Directors considered that the achievement of the desired increase in tax revenues would require full implementation of the customs code and strengthened measures to combat fraud and smuggling, as well as a broadening of the tax base, especially in the agricultural sector. They also encouraged the authorities to continue their efforts to reduce expenditures where possible, notably through civil service reform. Directors stressed that it is critical for the authorities to observe the highest standards of transparency in accounting for expenditures and funding connected with the Kosovo crisis. In this regard, they welcomed the authorities' intention to place the financial assistance provided by the donor community in a separate account in the Savings Bank, and to make information on related transactions available to the public.

Directors observed that the Bank of Albania's pragmatic handling of monetary policy since the disturbances of 1997 had been rewarded with price stability. They agreed that, if inflation remained low and the exchange rate stable, there would be scope to cut interest rates further. There should also be room within the monetary program for an expansion of private credit, but such expansion would only be feasible and desirable if bank restructuring efforts were accelerated and bank supervision strengthened. Directors considered that better bank supervision would also be required before the Bank of Albania could begin to use indirect monetary instruments more fully. They agreed that the authorities should continue to maintain a market-determined exchange rate system.

Directors urged the authorities to maintain the momentum of structural reforms. Having brought the National Commercial Bank to the point of sale, they advised the authorities to finalize the sale quickly, and to accelerate plans for privatizing the Savings Bank. The commendable progress so far in agricultural land registration should be built upon and, if possible, accelerated in order to develop the land market and consolidate land holdings. Restructuring efforts in the telecommunications, petroleum, and mining sectors should be implemented vigorously, and the management and governance problems of the utilities, particularly in the electricity sector, should be urgently addressed.

Directors stressed the need for utmost vigilance to ensure that the strains created by the Kosovo crisis did not weaken governance. They urged the government to continue to implement its anti-corruption program and the necessary reforms in the customs administration, the judiciary, and public administration. Directors noted that the pyramid scheme episode was close to resolution, and urged that the remaining steps be completed quickly and transparently. They welcomed, as an indication of the authorities' commitment to transparency, their intention to publish the memorandum of economic and financial policies and their wish to participate in the pilot project for the release of staff reports for the Article IV consultation.

Directors encouraged the authorities to continue their efforts to create an open and liberal trade and exchange system, and welcomed the recent reduction of the maximum tariff rate and the authorities' plans to reduce tariffs further in the future.

Directors recognized that Albania's balance of payments position would likely worsen in 1999, reflecting the consequences of the Kosovo crisis, which had raised import demand, weakened export growth, and diminished the prospects for foreign direct investment. They indicated that, in view of the considerable economic and social strains on Albania resulting from the crisis, generous financial support on highly concessional terms from the international community would be required to enable the authorities to achieve the ambitious objectives of their economic program. Some Directors were of the view that the international financial institutions should stand ready to increase their support quickly in order to close any financing gap that might emerge on account of the Kosovo crisis.

Directors recommended that the authorities endeavor to improve the quality and coverage of economic statistics. They encouraged them to seek technical assistance from bilateral and multilateral sources to supplement their own technical resources.