Interest rates and inflation require the expansion of the financial market

Today’s economy looks vastly different compared to last year and worries about inflation, exchange rate fluctuations, rising bank interest rates and the cost of personal and business loans and even a recession are weighing on in the minds of each of us.

One of the topics that finds optimism for the passing of the transitional period of price increases is the mechanism of the Bank of Albania’s policy about how the increase in interest rates can help reduce inflation. But since this effect directly creates secondary effects, a topic open to debate is also the fact that such an action could result in the impact for a recession.

While not all goods and services have been affected equally by inflation, categories such as food and transportation experienced the largest increases.

The increase in prices in all these months is caused by many varied factors, starting with the influences from foreign markets. These impacts are summarized from the supply-demand disturbances that came from the pandemic situation in the markets from which Albania imports, from indirect impacts from the war in Ukraine that led to a rapid increase in energy prices, as well as supply chain shortages of supply. They had a domino effect on the prices of other consumer goods, including services related to them. In other words, the main influence from abroad came because the unaffordable prices of goods and services could not cope with the demand from many countries at the same time. This effect has already started to decrease, but not at the levels of the beginning of 2022.

Meanwhile, the increase in prices is also caused by internal factors, such as the continuation of abuse of prices in the absence of a formal economy and the dysfunction in accordance with the duties of the institutions responsible for responding to abuse situations with the market and the regulatory framework. The intervention in the market with decisions of the Government Boards to freeze the freedoms to operate retail fuel businesses, as well as for some of the basic goods for living have affected the maintenance of a uniform price regime outside the reality of the free market based on demand – supply. Although this control mechanism is declared to help consumers, in daily practice it has influenced the avoidance of bankruptcy of some of the largest commercial businesses in the country, but with a secondary impact on limiting commercial freedom for all others. This mechanism keeps inflation at a prominent level. Meanwhile, throughout this year evasion has not decreased, even many cases mentioned by economic crime confirm the weak reaction of the institutions to perform their duties and an obvious favoritism for the state budget as a policy that benefits from taxes on consumption to strengthen tax revenues and fiscal consolidation.

Immediately after the fiscal policy is the Bank of Albania, which in implementation of its main function to maintain a low inflation rate with an impact, among other things, on the unemployment level, has reacted in 2022 by controlling the interest rate with their increase up to 2.75%. By increasing the interest rate, lending has become more expensive for banks, and as a result, credit for consumers and businesses has become more expensive. So, borrowing from commercial banks today is a risky decision due to the increase in costs. So, for one year, the loan installment has become more expensive by several thousand-hundred thousand lek more or up to 40%.

For consumers, higher interest rates mean that it has become more expensive to buy houses, cars, furniture, and large appliances, as well as spending on health, education, entertainment services, etc.

The same logic of increased costs is also for businesses, which are already restrained even more by loans due to increased costs of borrowing by trying alternative sources of credit.

Here it is worth mentioning again that if there was a formal market and with much less informal money than at present, that is, if we had an administration similar to other countries with which Albania is compared, then lending from informal sources ( usury, informal money from crime and corruption, etc.) then the financial market itself would be at a more optimal level to offer loans with lower interest rates than it offers at any moment when the cost of money increases from monetary policy.

If the paths to borrow money from the informal monetary market would be minimal and the premise for the exchange would have been created, then even the financial market itself for a small country like Albania would not feel the external pressures the same way it does.

On the other hand, if there was a visionary policy regarding salaries in Albania, even their higher level than it is currently could be a mechanism that would be valid for minimizing damages, where the money that could have been excessive from consumption in the best of times and would be part of the deposits, would apply to consumption in these times of money appreciation.

However, with the devaluation of the euro in the market, this will create uncertainty to increase deposits for those individuals or businesses that have the opportunity.

In the meantime, there needs to encourage new policies of diversification and expansion of the financial market, and one of the most effective that applies to the inflationary period that the country has entered are the various funds, the most valuable of which is the pension fund.

In the various countries that have already developed the financial market, the increase in interest rates is stimulating the pension plans of businesses and individuals, while also offering fiscal policy an option to lighten the balance sheets of their companies and transfer liabilities to insurers.

In the conditions, when inflation is present and will not go away over time, then even the savings of citizens according to pension plans can be adapted from these funds. The moment they become effective in the Albanian market for individuals, it will be guaranteed to have a fully funded pension plan by them for the future (near or far) to transfer it entirely to themselves or to a third party.

On the other hand, as good news for the economy, it turns out that pension funds have a significant impact and serve as a financial guarantee in the development of a country. The main and most visible impact is on the open opportunities for financing with an additional formal source in the development of the credit needs of the country’s economy. This approach of pension funds increases the supply of capital in the market, but without directly competing with the banks, since the market itself is more complete in the case of a more diverse supply opportunity than until today, where even though there is no competition, there is still no that expected development.

This whole policy of saving money, which is already in a discussion phase even by the government, requires a different orientation of the perception of personal funds in the interest of the personal future.