Macroeconomic indicators of Albania a year before and after 2021, according to the Monetary Fund

According to the latest publication for Albania, the IMF mission this December 2021 states that:

The recovery is broad-based with all sectors but agriculture registering positive growth in 2021H1. Electricity production doubled in 2021Q1 compared to 2020Q1 due to favorable weather conditions. January‒September 2021 tourist arrivals reached 89 percent ofthe2019 level, although the sources of tourist flows have shifted to more regional and emerging market countries. Labor market indicators have improved in the first half of 2021, but labor force participation and employment rates remained one percentage point below the pre-pandemic levels while unemployment was 0.7 percentage point higher. Headline inflation has risen on account of higher food and energy prices, but core inflation has increased only modestly, and broader inflationary pressures are contained. Average wages have grown by more than inflation in 2021Q2, following a year of muted increase, partly due to an increase in the minimum wage in January 2021.

Budget support during the main year of the pandemic (2020) reached 3.4% of GDP in Albania. If we look at this support at the regional level, we notice that Kosovo is in first place with a support of 12.7% of GDP. Serbia achieved support of up to 5.6% of GDP, while Northern Macedonia sustained the economy and individuals at the level of 3.8% of GDP. Bosnia-Herzegovina and Montenegro were presented at the lowest levels with a level of support of 2.5% of GDP.

The difficult year 2020 corresponds to an increased level of public debt by 10.8 percentage points in Western Balkans. Montenegro holds the largest increase in public debt with 28.4 percentage points. In second place is Northern Macedonia with 106 percentage points. In third place is Albania with 9.9 percentage points. Kosovo, Serbia and Bosnia and Herzegovina have increased public debt close to 6% of GDP.

Public debt level in the Western Balkans, 2019-2020                                               % of GDP

Source: MoFE, IMF

The table above shows that during 2021 the funds for reconstruction have exceeded those against Covid-19 (funds for business support and health) and this has affected the optimization of consumption to a higher level than the fact that occurred during 2021.

Despite weak public investment management, the government has ramped up domestically financed (non-earthquake) public investment since 2020, more than the COVID-19 targeted support.

Gov. support to Covid-19 and the aftermath of the 2019 earthquake                                      % of PBB

Source: MoFE, IMF

The fourth budget revision in July increased the 2021 deficit by 0.7 percent of GDP to accommodate higher (non-earthquake) capital expenditure.

Revenue collections so far have rebounded to above pre-crisis levels. Execution of spending accelerated in the lead-up to the parliamentary elections in 25 April 2021. It has slowed down since but is expected to pick up toward the end of the year. Accordingly, despite a strong rebound in revenue, the primary deficit is projected at 4½percent of GDP in 2021, similar to that in 2020.General government debt is projected to rise to slightly above 80percent of GDP at end-2021, among the highest in the region. Eurobond issuance of 650 million euros in November 2021 is already effective to help meet the needs for budget financing in 2021 and 2022.

Considerable uncertainty over the future trajectory of the pandemic presents a major downside risk, either through the emergence of vaccine-resistant variants or localized outbreaks in Albania due to slower-than-expected vaccination. Higher global energy prices present another downside risk to the recovery. Tighter global financial conditions stemming from a potential de-anchoring of inflationary expectations in major advanced economies could also make financing more challenging for Albania, a scenario that could be further exacerbated by any significant deterioration in the country’s fiscal position.

The 2022 budget approved by Parliament indicates that increased spending pressures will continue, backed by overly optimistic revenue forecasts. Government spending plans include: locally funded infrastructure and reconstruction projects; support for the state-owned public utilities sector to keep electricity tariffs unchanged for households and most businesses despite rising energy prices; new subsidies for farmers; further salary increases for health and education workers and the adjustment of year-end bonuses for retirees, and higher health care costs, including vaccination. Using realistic revenue forecasts and assuming some underpayments based on past experience, the basic staffing level predicts a primary deficit of about 3.2 percent of GDP in 2022, higher than 2.7 percent of GDP. provided in the budget.

Moreover, without additional adjustment efforts, public debt will continue to stand above 70 percent of GDP in the medium term, significantly higher than the pre-pandemic level. The government’s gross financing needs will also remain significant at around 21 percent of GDP per year.

As the recovery strengthens, fiscal policy needs to make a greater effort, based on revenue, to build room for policy maneuver, which is essential to withstand future shocks. The government’s experience in controlling the fiscal deficit and reducing debt before shocks gave them credibility and policy space, enabling a rapid response to protect Albania from the worst effects of shocks. IMF staff recommends medium-term income-based adjustment, to achieve a primary deficit of about 2.4 percent of GDP in 2022 and to achieve a primary surplus of 1½ percent of GDP in 2024. This means a Total structural adjustment of about 3.8 percent of GDP over the three years with significant consolidations starting in 2022 (about 1 percent of GDP) to help strengthen the reliability of the adjustment. The proposed additional adjustment in 2022 (regarding the budget of the authorities) should be based on measures to eliminate tax gaps and exemptions and reduce non-priority, low-efficiency expenditures, as well as non-targeted support, which should be have a limited growing impact. With such a strategy, government debt could return below pre-pandemic levels by 2026, assuming the economy will not face any new shocks.

Budget-funded public investment has increased significantly since 2020, but shortcomings remain unaddressed and some key recommendations from the 2016 Public Investment Management Assessment (PIMA) remain unresolved. Key challenges include a lack of transparency about cost and timeframes and non-compliance with established selection and approval processes, including the use of PPPs to circumvent medium-term budget ceilings. Before increasing public investment, it is important to address PIMA’s exceptional recommendations and strengthen the MoFE’s capacity to act proactively as a watchdog in project selection and to engage actively in evaluation and monitoring. Processes for PPPs and budget-funded projects need to be harmonized.

Fiscal risks have increased and the lack of clear data on government exposure makes it difficult to assess and manage them effectively. Limited information on government actual exposure to PPPs is a major challenge. Government guarantee schemes for the private sector currently under discussion, and the growing reliance of state-owned enterprises — particularly in the service sector — by sovereign guarantees and intermittent budget support also add to fiscal risks.

In this context, it is important to reinstate electricity and water sector-related reforms that have been delayed in recent years to help reduce fiscal risks and climate-related vulnerabilities.

Furthermore, court decisions can have high fiscal costs and need to be properly identified and monitored as contingent liabilities.

The government reacts to this fact by noting that the pace of consolidation will have to start slow, given the increased spending pressures in 2022 stemming from the government’s economic program and the need to address the challenges of presented by rising energy prices. The government reiterates its strong commitment to comply with fiscal rules from 2022 and to achieve a primary balance of at least zero from 2024 onwards. The government will ban the use of normative acts for budget reviews within the year from 2022 and will ensure that any changes in the design and application of the LOB will be subject to normal parliamentary approval.

The government highlighted the role of revenue reforms as the main pillar of fiscal consolidation and envisioned the timely implementation of a Medium-Term Sound Revenue Strategy, aiming to increase additional revenues by 2.3-3 percent of GDP over four years. The government also agreed on the need to reduce overly ambitious budget-funded capital expenditures, but signaled plans to continue pursuing infrastructure projects already under development. The government further committed to strengthening public investment management (including PPPs) and to more closely monitor and manage growing fiscal risks. In this context, they noted that an annual PPP monitoring report has been published since 2019 and MoFE also periodically reports on budget payments for PPPs and whether overall support in the medium term is below the legal limit. of 5 percent of tax revenue. KLSH has signaled its intention to continue the work of auditing crisis-related expenditures in 2021.

Poverty rate in Albania is one of the highest in the Western Balkans, while its coverage with social protection is among the lowest. The level of poverty in the country is estimated to have increased by 0.8 percentage points as a result of the earthquake and pandemic, partially reversing a downward trend started in 2014. Thanks to the strong economic recovery in 2021 and government support measures, the World Bank estimates a decline in the poverty rate below pre-pandemic levels in 2021. Given the high level of informality, relatively low employment rates and limited government resources, social protection coverage is among the lowest in the region.

Western Balkans Poverty Levels[1], 2019-2021                                        % of population

Source: WB

In response to the pandemic, the government rapidly and temporarily expanded existing social protection programs by about 1 percent of GDP in 2020-2021, among the lowest in the Western Balkans. High informality and low social protection coverage mean weak automatic stabilizers, strengthening the case for discretionary support for the affected population.

The government introduced temporarily higher social assistance benefits, extended unemployment insurance, and provided wage subsidies to formal employees, unpaid family business members, and workers in the informal sector if they were formalized.

Increasing the coverage of social protection programs will require raising tax revenues and increasing social insurance contributions by raising labor force participation and reducing informality. Furthermore, it will be important to enhance the design of the social protection system, including better targeted and higher coverage of social protection to help those most in need, and reducing exclusion errors and beneficiary information inaccuracies.

Despite progress in recent years, corruption remains a major obstacle to economic growth. Implementation of the government’s anti-corruption strategy has continued, but slowly. Completing the wider justice reform will be key to maintaining the momentum of past efforts. A mid-term review of the national anti-corruption and cross-sectoral strategy has been completed under the auspices of the Ministry of Justice and work is under way to draft an updated strategy and action plan. Enforcement capacity has been strengthened with the verification, appointment and training of new prosecutors and investigators. Authorities need to continue to work closely with development partners to increase transparency and accountability of public spending as part of the broader anti-corruption agenda.

The structural shortcomings of Albania’s competition against its regional counterparts continue. The business and investment environment suffer from a weak institutional framework, weaknesses in corruption, lack of skilled labor and infrastructure gaps. The resulting productivity gap is reflected, inter alia, in the remaining levels of GDP per capita and relatively low wages. A further increase in the minimum wage should be accompanied by measures to reduce informality and increase productivity. Despite above-average levels of public investment, persistent deficiencies in the quality of infrastructure vis-. -Vis regional countries also weigh on efforts to foster a favorable business environment, which further underscores the urgency of strengthening the efficiency and quality of public investment.

Setting the level of minimum wage should balance the need to alleviate in-work poverty and reduce income inequality and economic factors. The appropriate level of minimum wage should provide a “decent wage floor” without adversely affecting firm productivity, competitiveness, and employment.

– Productivity. The increase in the minimum wage should be in line with the evolution of productivity to compensate workers in accordance with their contribution to production while avoiding economic distortion. Productivity in Albania is low compared to the EU and neighboring countries and has declined in recent years.

– Competitiveness. By increasing costs for firms, an increase in the minimum wage could reduce export competition and the formal sector. In a survey of business owners in the Western Balkans, less than 0.1 percent of managers consider regulating work as one of the biggest obstacles for business in Albania. Unfair competition from the informal sector emerges as a serious obstacle for businesses in the region. – Monopoly power. Market concentration reduces the bargaining power of workers’ wages and can contribute to increasing poverty and inequality across the workforce. There may be a role for the minimum wage to address market failures and promote economic efficiency. In Albania, large firms (50+ employees) represent only 1.4 percent of the total number of firms, but employ 41.4 percent of formal workers and contribute more to net employment growth, which suggests the existence of monopoly power in some sectors.

High levels of informality, the impact of the minimum wage increase on most vulnerable workers, and past minimum wage increases have coincided with an increase in informality. About 110,000 individuals benefited from the recent increase in the minimum wage, which corresponds to 4.6 percent of the population over the age of 15. At the same time, informal workers represent 30.3 percent of the workforce, the highest in Europe, and will only benefit to a small extent from the increase in the minimum wage even though their employment is more fragile and higher paid than workers formal. Moreover, previous minimum wage increases have coincided with an increase in informality, which may put further pressure on the most vulnerable workers.

The minimum wage increase must be complemented by effective measures to reduce informality and improve productivity. Albania’s minimum wage is low and a further increase to ALL 40,000 is likely to have little effect on competition. But a further increase in the minimum wage must be accompanied by crucial measures to reduce informality, as high informality limits the benefits of the minimum wage to the most vulnerable workers. It is also essential that raising the minimum wage be commensurate with productivity growth to avoid economic distortions.

[1] Poverty is defined as living on less than $5.5/day per person in revised 2011 PPPs