Deuroization, finances and the case of Euro Credit transfer from EBRD to KESH sh.a.

The financial market in Albania, which is composed mostly by 16 banking institutions and 3 investment funds, is in fact dominated (80% of the market) by 5 large banks that have direct / indirect links with euro area banks, as the official currency. Interbank payments in the Albanian financial market comprise only 1/5 of the euro, with individuals making transfers in Euro as much as 39% of all bank transfers and businesses making transfers in Euro as much as 24% of all banking system transfers.

Although the euro / lek exchange rate in the first months of 2018 has been accompanied by fluctuations and negative exchange rates for Albanian exporters, the general public (households) continue to maintain their savings in euro.

The main reason is that the credibility / perception that savings in the euro are less likely to lose value in the medium run (when the euro is needed for spending) prevents the perception that an increase in the value of the Lek may have an impact on the appreciation of savings.

This is also the case because the public believes that deposits in the Euro maintain a safe value against the potential depreciation of the Lek, although it has not fallen sharply in recent years. Memories of past crises, when the US dollar and the euro were then overvalued against the Lek unjustified by the development of the Albanian market tend to influence the decisions of Albanian businesses and individuals to maintain euro deposits as more guaranteed for them.

One reason behind this psychology in the Albanian economy and households is mostly based on the fact that financial agents and analysts do not reassess the likelihood of unfavorable scenarios at the expense of the euro, but rather exaggerate the fact of an uncertain national currency based on perceptions and not by facts. Lek fluctuations in recent years have influenced the tendency of the Bank of Albania’s supervisory policy to increase the value of Lek deposit insurance, but without abusing this policy at the expense of foreign currency deposits.

The euroization of Albanian capital investments (tangible assets and bank deposits) as a consequence of the upward policy of maintaining the balances between the Euro and the Lek in the creation and movement of capital has also affected the banks’ lending portfolios, aiming that Euro to stay above the average of transactions for countries such as Albania, which have no objective, for the monetary policy to be oriented to the Euro.

To avoid monetary discrepancies between different currencies in their balance sheets, banks have had internal incentives from “parent” banks, where they report lending in foreign currency, mostly in Euro.

In small economies, and especially in economies where the use of foreign currency is high, such as Albania and other countries around it, the decisions to deposit savings, but also those for borrowing, are not only determined by the level of interest rates. promulgated by the Central Bank. To a significant extent, they have also been influenced by the interest rate differential between a country (e.g. Albania with the Lek) and the interest rate and expansionary policy of countries using these foreign currencies (e.g. Germany, France, Italy etc. with Euro).

The Bank of Albania’s role throughout 2018 (taking into account the first half of the year) continues to move towards a prudential approach, mainly to reduce the risks of financial stability due to euroization by raising awareness of exchange rate risks and by restricting euroization to areas of the economy that can better cope with exchange rate fluctuations.

On the occasion of the promulgation of this policy, it seems that the Albanian financial system and foreign exchange market has begun to reflect the uncertainty that such action carries in an informal economy.

In the face of the pro-Euroization policy implemented de facto year after year in the Albanian financial market, (but not in the markets of the countries around us) the anti-Euroization policy now stands.

However, pro-Euro policy has brought the euro into circulation over the years (in the form of capital investments and savings in bank deposits) and has hit the Albanian Lek by reducing its role in the economy due to the dependence of the economy and savings of individuals in Euro.

Already, as this high level of the euro has reduced the Lek’s circulation in the economy (which translates to a decrease in its effectiveness), it has made the Albanian foreign exchange market rigid, inelastic and not ready to respond to the risks the euro has to the American dollar, British Pound and other currencies (Japanese yen, Chinese renminbi).

Another significant impact applies to public finances from the effect of excessive euro turnover. A monetary overflow from the Euro bid affects the fiscal stability, which is calculated and based on the Lek.

In the event of a massive monetary circulation in the Euro, the reduction of the Lek turnover in transactions reduces its presence in the domestic market and at the same time affects the reduction of consumption rates by translating into fewer taxes to collect. In the situation when monetary policy is thinking about how to lower the Euro supply and increase the Lek supply, it has given the first impacts on Albanian products for export.

At the moment, when the euro is depreciated, there is a problem in the economy, which can be curbed by reducing productivity but also by impacting wages, consumption and taxes that cannot be paid by the economy to the extent planned by the budget.

This moment makes it necessary to combine monetary and fiscal policy, as all this policy must also take into account the effect of the informal economy, which seeks to formalize it through the policy of deuroisation and large civil and private infrastructure projects.

An informal economy overproduction brings an effect on the formal market (exporters), but without effect on the government budget, as the informal economy intends to remain outside taxation schemes in the future, even though they enter the market through various legal forms, but that fail to be monitored by Ministry of Finance and tax officials.

What to do when we are in a situation of Lek appreciation, and we also have monetary capital transfers in Euro, as a consequence of the further opening and expansion of the Albanian economy (taking into consideration the large infrastructure projects through private partnership and public)?

What, then, could be the risks of the financial market and the credit transfer policy in the Albanian financial system, unaccounted for with tens of millions of euros or other currency transfers?

The latest case for analysis and discussion on this topic is the transfer of EBRD loan money into the Albanian financial market for the state-owned energy company, KESH sh.a.

In order for KESH sh.a. to obtain the loan (first tranche) from the EBRD in the most efficient way and on the other hand to minimize the impact of this transfer on the foreign exchange rate in the domestic market, it was probably chosen to do what was best suited to Monetary Policy for 2018: Exchange from Euro to Lek by the Bank of Albania with a view to repaying overdrafts that had the highest financial cost for the company itself.

This prudent political and financial approach, which was most likely a positive result of the cooperation between the company, its governing bodies and the Bank of Albania executives, to the knowledge of the Ministry of Finance, managed to set a precedent for managing bank transfer risks for loans from a foreign bank in the Albanian financial market.

And if you look at the region for cases like this you might find little experience to consider. In this case, the Bank of Albania, after continuous signaling and cooperation with all the influential factors in this implementation of the EBRD financial loan transfer to KESH sh.a. appreciated this credit transfer, based on the risks, aiming to have minimal effects on the domestic monetary market, taking into account the depreciation of the euro exchange rate precisely in the period in which the transfer was to take place.

A correct implementation of a proactive monetary policy by both the conversion of the credit and the withdrawal (purchase) of the Euro, which was largely offered in the foreign exchange market, was evidence of a successful monetary operation done in June 2018. This loan transaction between EBRD and KESH sh.a. is a precedent for the future of transactions between resident Albanian companies and foreign creditors, which is the case for many Balkan countries.

The impact of monetary policy decisions on the real economy is of course transmitted in several stages. In the case of an expansionary monetary policy approach, as the declared deuroization policy itself is, the suggestion is that the economy should at the same time be offered more credit to be even more loose to spur growth of production in sectors that are already in the process of implementing approved projects.

But if the Bank of Albania’s decision-making authority fails to be transmitted to the economy by lending banks (for various reasons), they will in fact play the role of inhibitors of productive sector development projects, as they have been to date have affected the restraint of the financial market optimization of the credit market, which was strongly demanded by the Bank of Albania.

In this situation, the further euroization risk already declared by the Bank of Albania as a high level risk (with the deuroisation policy) needs to be shared with the Ministry of Finance by modifying and combining fiscal and monetary policy to influence through taxation mechanisms to increase the cost of euro deposits, and reduce the cost of the Lek.

On the other hand, both institutions conducting monetary and fiscal policies should aim for a medium-term balancing of the growth of capital investments in lek.

In this way, the risk of further euroization of the economy begins to be transferred step by step in favor of an increase of Lek’s presence in investments and sectors exporting “Made in Albania” products and services.

As long as the Lek is a currency that is not expected to be replaced by any other currency (in the case of Kosovo and Montenegro), a monetary and fiscal policy needs to be followed in a massive boost to its circulation in the economy.