…to create a resilient fiscal shield to adjust to shocks

Inflation can affect public finances through multiple channels. It tends to expand tax bases in nominal terms, increasing nominal tax revenues, but it can also increase the cost of government spending, more directly for budget items that are automatically indexed to inflation. Moreover, the accompanying increase in nominal GDP tends to reduce deficit and debt ratios. Over time, policies may also respond to inflation, including discretionary fiscal measures (eg, subsidies and tax cuts to ease the impacts of the cost of doing business and living), or tightening of monetary policy, raising costs. of government borrowing. Thus, inflation can affect taxpayers, civil servants, retirees, beneficiaries of government programs, government suppliers, and bondholders in several ways (Dynan, 2022, CBO, 2022a).

In fact, all the above is what has happened and is continuing with public finances in this period.

Deficit-to-GDP ratios fell while the nominal values ​​of the economy’s output and tax revenues increased, generating more revenue, while nominal budget expenditures did not follow the same trend.
In the absence of the still intact indexation of salary increases, real incomes have fallen for civil servants, just as they have also fallen for pensioners and beneficiaries of subsidy transfers from the budget.

The budget does not have much to give to the latter, as it is quite burdened even with what it has declared for the indexation of the salaries of the budget employees.

But what is really and directly visible to us voters in today’s format are the quality of public services and general productivity which are carrying the heavy burdens of hasty policies while also suffering the costs from these decisions. This suffering is quite simple since the nominal limits of expenditures, [1] face with the higher costs of goods and services.

However, last year’s period of rising inflation ate up some of the real value of government debt, both due to the initial improvement in fiscal balances and the nominal GDP denominator effect. The annual decline in the deficit relative to GDP may not last in the medium term. However, as inflation becomes a part of everyday life, spending in the following 2023 seems to move with the pace dictated by this factor. However, an old and new problem for Albanian finances will be the increasing cost of borrowing, as investors demand a premium from the inflationary risk, and this affects the central bank’s policy rates to push them towards growth.

Meanwhile, the overall impact on budget receipts from inflation was small, if we compare it to the expansion of the construction and energy sector (public and private sector), but without forgetting the financial services market. But inflation to a considerable extent prompted the fiscal policy to increase the non-taxable threshold and on the other hand also small tax benefits, since the bag of benefits has already been filled for years and years irresponsibly from the fiscal point of view.

However, the higher indexation of excise taxes, and the tax for free professions, as well as keeping other tax rates unchanged, as well as a higher bank interest rate towards business and citizens is a correctly calculated action in the interest of consolidating the budget, whose income increases from these combinations of fiscal and monetary rates.

But, if public and private expenditure continue to increase costs, this will undoubtedly significantly increase borrowing. All inflation, which is still not low, should be anticipated in the mid-year changes to the state budget as all benefits, tax credits and pensions and public service costs may increase by a larger amount than forecast.

So, the increased social pressure with an impact on the Albanian budget and the positioning of the budget between high inflation (if we also include that hidden by informality), the tightening of financing conditions and the ambiguity of the debt orientation, should promote as a priority the maintenance of the policy fiscal in line with central bank policies to promote prices and financial stability.

Tighter fiscal policy would influence the Bank of Albania’s decisions not to raise interest rates, which would help control borrowing costs for the government and keep financial vulnerabilities under control.

However, if the financial uncertainty of the markets abroad combined with the chaotic way of reaction of the Albanian economy as of today, then the fiscal policy may need to intervene quickly to facilitate the solution by not being fixated only on reducing the level of public debt, but mostly to better target the budget policy to protect the most vulnerable families, including addressing the insecurity of living (living minimum), restraining the general increase in spending, since if this is not addressed in this direction the government will face social pressures to offset past and current cost-of-living increases.

Despite the gradual fiscal tightening in 2023 and foreseen in the PBA 2023-2025, we analyze that the public debt will increase, driven by external and internal pressures, which suffer from the chaotic internal situation of the economy with low structure and the destabilized situation of markets abroad. In the end, concerns about the weaknesses of the debt, even though they are aimed at reducing it, if we look at the history of the budget policy in the last 15 years, we have never seen it for many periods below the level of 60% of GDP.

Medium-term fiscal plans should include credible policy commitment to achieve the sustainability of the reforms initiated by relying on the general mobilization of resources within and outside the public sector by reshaping specific expenditure and revenue measures or reforms to create a fiscal shield flexible to adapt to shocks.

[1] The nominal value is the current value, without considering inflation or other market factors. The real value is the nominal value after it has been adjusted to adjust for inflation.