2 Macroeconomic conditions
Economic developments during 2004 have followed a similar pattern to 2003 and have consolidated the progress made since 1998, with the following key features:
- Relatively high economic growth (at about 6% in real terms);
- Low annual inflation (at 2.9%);
- Decreasing deficit of the government budget (down to 4.6% of GDP);
- Improvements in the balance of payments, with an increase in reserves;
- Strong exchange rate.
If the current progress in Albania can be maintained over the next decade, the incidence of relative poverty should be halved, absolute poverty will be eliminated, average incomes will be nearly double their current levels and the gap between Albania and neighbouring countries will be substantially reduced. The main macroeconomic indicators for 1998-2004 are given in the table below:
|Exchange rate||Lek / $US||150.6||137.7||143.7||143.5||140.2||121.9||102.8|
|Lek / Euro||147.0||132.6||128.5||132.4||137.5||127.7|
|Gross Domestic||Lek billion||412.3||474.3||530.9||588.7||630.0||695.1||780.1|
|Gross Domestic||$ billion||2.7||3.4||3.7||4.1||4.5||5.7||7.6|
|Real GDP growth||%||12.7||10.1||7.3||7.2||3.4||6.0||6.0|
|GDP per capita||Lek thousand||122.9||140.6||164.3||191.4||203.4||223.9||249.9|
|GDP per capita||$||816||1021||1143||1334||1450||1837||2431|
|Total revenue||Lek billion||102.5||123.2||130.6||145.6||154.6||167.2||184.4|
|Total expenditure||Lek billion||141.6||165.7||170.6||186.1||192.5||201.2||222.4|
|Overall deficit||Lek billion||-39.1||-42.5||-40.0||-40.4||-37.9||-33.9||-38.1|
|Total revenue||% GDP||24.9||26.0||24.6||24.7||24.5||22.4||23.6|
|Total expenditure||% GDP||34.3||34.9||32.1||31.6||30.6||27.0||28.5|
|Overall deficit||% GDP||-9.5||-9.0||-7.5||-6.9||-6.0||-4.6||-4.9|
|Internal debt||% GDP||36.2||37.4||42.6||39.6||38.8||38.0||37.8|
|External debt||% GDP||36.9||32.3||31.6||28.2||24.4||23.3||18.3|
|Balance of payments|
|Trade balance||$ million||-604||-663||-821||-1027||-1155||-1336||-1579|
|Reserves - Import||Months||3.7||3.8||4.2||4.3||4.3||4.7||5.2|
|Trade balance||% GDP||-22.1||-19.2||-22.2||-25.0||-25.7||-21.9||-20.8|
|Export growth rate||%||31.1||32.3||-7.2||19.3||8.4||35.4||35.0|
|Import growth rate||%||17.0||15.5||14.8||23.7||11.6||20.1||22.4|
2.1 ECONOMIC GROWTH
Economic growth is the main factor in reducing poverty and stabilising Albania’s macroeconomy. Figure 2.1 below presents real growth over the past 7 years, showing that Albania has consistently managed to achieve high economic growth since 1998. During 2004 real GDP growth was estimated to be 6%.
Figure 2.1Economic growth in Albania and selected countries, 1998-2004
Source: IMF Country reports; the figures for 2004 are projections
The combination of high growth and a decline in the resident population of Albania (by about 3.4% since the year 2000), has led to a doubling of per capita incomes, in Lek, over the last 7 years. Nevertheless, GDP per capita still remains very low compared with other countries and its increase constitutes one of the strongest challenges for the future. Real increase in the GDP for the period 1998-2004 in Albania and neighbouring countries is given in Table 2.2.
|Structure of GDP (%)||Real growth rate (%)|
The sectoral composition of growth in 2004 has followed a similar pattern to the previous year, as shown in Table 2.2. Construction and transport have continued to grow strongly, while industry and agriculture are growing at a lower rate than the national average.
Agriculture continues to be one the most important sectors of our economy, contributing 24% of GDP and 58% of employment in 2004. Real growth in agriculture is estimated to be 3%, as a result of adequate climate conditions, investment in new production and technologies, especially in agro-industry, and improved power supplies. Good levels of production have led to low prices. Despite the strong Lek, there has been an increase in agricultural exports and domestic agricultural products have competed successfully against imports.
However, agricultural growth is below the national average growth rate, and is constrained by a number of issues, including emigration from rural areas and the legal framework on property. Agricultural growth is of particular importance to Albania, in view of the very low productivity of the agricultural and agro-industrial system inherited from the past. Further measures are needed to promote the commercialisation of agriculture, both for exports and domestic markets, and to encourage new technologies.
Growth in industry is also about 3% and has been dominated by the energy sector, which grew by around 48.9 %, because of investment, reform and favourable weather conditions. Growth of the energy sector remains one of the key elements of national strategy, both for economic and social development. In contrast, the metallurgical industry declined by 68.3 % in total, despite an increase in steel production. The manufacture of leather-shoes and chemicals grew by 25.3 % and 19.2 % respectively, while wood processing declined by about 4.3 %. The petroleum subsector grew at 7.6 %, despite a decline in volumes. The textile and confectionary industry both grew at about 3.4 %.
Transport grew by 10.1 % in 2004 and this has been dominated by road transport. Port activity has grown by 5.9%. Railway traffic has declined by 24.2% in volume, with a 15% decline in the value of passenger traffic and a 19.3% decline in goods traffic. The government is committed to improving the situation of the railway system and carrying out an efficient privatisation.
Construction is one of the most dynamic sectors of the Albanian economy, with a real growth of 10.6% in 2004. Construction activity is concentrated in the major urban centres. Private sector construction is mainly focused on flats and buildings for families, which comprise about 81.6% of the total financing of private construction. State participation in the construction sector is mainly focused on infrastructure and engineering constructions. State financing for engineering constructions constitute 84.8 % of total state financed construction, but is 69 % above the level achieved in 2003.
An analysis of future prospects for construction, based on construction permits issued during 2004, does not look optimistic. Problems appear to be associated with the limited number of construction permits issued, along with constraints on state investment, rather than with private investment capacity and demand.
Services contribute 46.3% of GDP and grew at a rate of 6.4% in 2004, slightly above the national average. Post and telecommunications have increased rapidly, as a result of improvements in service quality, although reforms and price changes in the telecommunications market have led to some major changes. Reforms and restructuring at Albtelekom remain a priority, in preparation for privatisation. Tourism is a major part of the service sector: during 2004 it is estimated to have generated $673m in revenues, marking an increase of over 29% compared to 2003, with increases in visitor numbers and expenditure per person.
Public debate on economic growth and poverty
The NSSED Department organised a public debate in March 2005 to discuss the sources of economic growth in Albania and the impact of growth on poverty. The debate was attended by bout 50 people, from a variety of public, private and voluntary organisations. It was launched by a statement from the Minister of Finance, which stressed the need for growth to incorporate social dimensions, as well as economic dimensions, in order to be sustainable. This will involve increased emphasis on human development, civil society and government transparency.
Discussion was stimulated by presentations covering: regional experience with economic growth; the national macroeconomic situation; the sources of economic growth; and the linkages between growth and poverty.
Participants were invited to fill in a questionnaire indicating the importance of different sectors and constraints for economic growth and for poverty alleviation. They were also divided into groups, and asked to define the key actions which would: a) promote economic growth; and b) promote poverty alleviation.
There was broad agreement about the actions required to promote economic growth, as already defined in the NSSED. However, there are a wide variety of views about the relative importance of these different actions. Infrastructure and private investment were widely stated as high priorities, but there were differences on the following issues:
- One group argued that the financial sector should have a high priority, whilst others argued that this would have little impact until financial institutions started offering services to a variety of activities.
- It was argued by 2 groups that modernising and commercialising the agricultural sector should be given the highest priority, in view of current employment patterns and the potential for reducing poverty in rural areas. However, the view was also expressed that economic growth in recent years had come largely by shifting from agriculture to more productive sectors and that this should continue.
- Contrast views were also expressed on the relative importance of barriers to investment, including the definition and enforcement of administrative, regulatory and legislative controls. One group placed this as the top priority, whilst another argued that growth had already been occurring without strong enforcement, and could continue to do so.
- One group placed free trade and exports as a high priority, whilst the others did not. There was some discussion about the complex nature of free trade impact on the economy.
- Property status and its use for collateral was considered as important by a number of individuals, but did not emerge as a key priority during group discussions.
- A number of people mentioned the importance of tourism, as a key source of economic growth and there was a debate about the importance of supporting a type of tourism which would have the widest possible benefits for the local economy. Environmental issues were not raised in the debate, except as a constraint for tourism development.
The discussion on poverty reduction supported the assertion that economic growth was the main priority and would lead to poverty reduction. One group argued that education needed particular attention, whilst another group reminded the debate that there were disagreements on what type of skills and attitudes were required for poverty reduction.
2.2 BALANCE OF PAYMENTS AND EXCHANGE RATE
The overall balance of payments in 2004 has seen some marked improvements, with a strong surplus of $288 million, compared with $100 million in the same period in the previous year. Key trends in the current account in 2004 have followed a similar pattern to last year.
- Exports were $603 million, increasing by 35%, despite the strong Lek. The fastest growing exports were in minerals, fuel and electrical power and in construction materials and metals. Textiles and shoes dominate exports and grew modestly. The least successful sector was wooden and paper products.
- Imports totalled $2182 million during 2004, increasing by 22%. The highest increases were in machinery, equipment and spare parts and in chemical and plastic products. There was a decline in imports of minerals, fuel and energy, as a result of the recovery of domestic electricity production.
- The trade deficit worsened to $1579 million in 2004, 21% higher than the previous year. However, this picture is exaggerated by the weak dollar. The prospects for continued improvements in trade are good, as opportunities arising from free trade agreements are taken up, especially if the current strength of the Lek is moderated.
- The service balance during the period had a deficit of about $24 million, compared with a deficit of $83 million for the same period in 2003. This improvement is largely explained by the rapid increase in tourism receipts, as a result of improvements in infrastructure and service quality.
- Net factor income was almost unchanged since 2003, with a positive balance of $168 million.
- Net private transfers increased by 25% during 2004, to $978 million. These are dominated by remittances.
The capital account has improved during 2004. Capital transfers had a surplus of $132 million in 2004, down 16% on 2003, whilst the financial account had a surplus of $399 million, up 97.5%. Currency reserves increased by $348 million during 2004 to $1374 million and were sufficient to cover 5.2 months imports of goods and services.
The strong balance of payments performance, has led to a continued appreciation of exchange rates (see Figure 2.2). During 2004, the average annual exchange rate reached 102.76 Lek/$ and 127.66 Lek/Euro, reflecting the weakness of the dollar on international markets. In addition to the balance of payments situation, the strengthening of the local currency in recent years has been caused by greater public trust in the financial system, high real interest rates and lower demand for government financing.
Figure 2.2Lek exchange rate with the Euro and the dollar
The strengthening of Lek has advantages and disadvantages. On the negative side, trade competitiveness is reduced. There are lower export earnings, lower earnings from foreign exchange savings and remittances, and lower customs revenue. On the positive side, there is lower inflation due to cheaper imports, greater trust and investment in economy, cheaper debt service and incentives to sell locally, rather than export.
Export activity increasingly concentrates in 5 sectors although there have been changes in recent years. Textile exports peaked in 2000 but their relative share has been declining since. Mineral (petroleum) and metal (chromium and locks) exports were declining throughout the 1990s but have returned to positive growth.
The share of footwear exports, the single biggest exported item, has remained constant since 2000. All exports from this sector during 2004 were directed to Italy from where they are often re-exported. The potential for increasing footwear exports to European markets is substantial as a result of geographic advantages and cheap labour.
European Union countries continue to absorb 90% of Albania’s exports and are the source of 2/3 of its imports. Regional markets offer new opportunities after the free trade agreements signed between 2002 and 2004. Exports to these countries increased substantially between 2003 and 004, notably to Kosovo and Macedonia, which has helped to reduce the overall trade deficit of Albania with South-East Europe.
There have been notable changes in the composition of agricultural and agro-industrial exports in the last couple of years. There were no exports from the prepared meat sector in 2002 but they made up a third of the total in 2004. Similarly, the share of beverage exports (especially bottled water and juices) increased almost fivefold in the same period. Attention now needs to turn to gaining access to foreign markets and developing business practices.
2.3 PUBLIC FINANCE
Budget revenues in 2004 were equivalent to 23.6% of GDP, which is 10.2% higher than 2003, in nominal terms. As a proportion of GDP, 2004 saw a small decline in public revenues, from 24.1% in 2003. Total revenue was 93.1% of budget, with tax revenues at 97.3%. These figures have been achieved despite a reduction in customs revenue associated with the weak dollar. Improvements have been made across all sources of revenue, and in particular for tax revenues, which account for 90% of revenue. Nevertheless, revenues are still low in comparison to other countries in the region. This is due partly to weak revenue collection and partly to the large size of the informal sector, and, in particular, agriculture. Key features of revenue in 2004 are as follows:
- Revenue from foreign grants was about the same in 2004 as in 2003 in dollar terms, but fell from 0.38% to 0.31% of GDP.
- Tax revenues account for 90% of total revenues and increased from 20.9% to 21.3% of GDP. Actual tax revenues were 97.3% of budget.
- VAT has increased by 15% in Lek terms and is about 1.8% above budget, reflecting improvements in VAT administration, resulting in better registration and collection rates.
- Excise collection has increased by 29% in Lek terms but was still only 97.3% of budget. This is partly caused by exceptional events on fuel excises and unfulfilled potential for increasing excise collection on alcoholic drinks.
- Profit taxes also increased strongly, by 24% in Lek, and were 7.3% above budget. This resulted from improvements in analysis, inspection and collection of arrears.
- Small business taxes were 38% higher than in 2003, and were roughly in line with budget. There were considerable advances in administration, although there is still scope for further improvements.
- Personal income tax increased by only 6.8% in nominal terms, and was only 84% of budget. Part of this may be explained by reductions in tax on savings income, as a results of declining interest rates However, the relatively poor performance on the various elements of personal income tax is a major challenge in the next few years.
- National tax revenues were 3% lower than in 2003, and were 85.6% of budget. Road circulation tax was roughly in line with budget, but problems have been experienced in collecting taxes on radio-television usage and a number of other taxes, such as carbon taxes, foreign vehicles and plastic packaging.
- Revenue collected by the customs administration is 10.5% higher than last year, and about 97.8% of budget. Customs duties account for most of the shortfall, with excise and VAT on trade both showing a strong increase, in line with the budget. If exchange rates had been maintained at the levels expected in the budget, revenue from customs administration would have been about 8% higher, and would therefore have been well above budget. This would have resulted in total public revenue being at 24.3% of GDP, showing an improvement on 2003.
- Non-tax revenues are 76.8% of budget. The majority of the budget shortfall was caused by low profits from the Bank of Albania. However, all other items were also below budget, including the revenues of budget institutions and revenues from dividends, fines and sequestrations.
- Revenues from local government during 2004 were 15.3% lower than budget, although they were 21.3% higher than last year. There were shortfalls in property tax (640 million), agricultural land tax (206 million), vehicle registration tax (239 million) and local taxes (662 million). Only revenues from small business taxes were higher than budget by Lek 16 million. They increased to 1.2% as proportion of GDP, compared to 1.1% in the previous year.
Constraints to raising taxes: an institutional perspective
Tax collection is lagging in Albania compared to its neighbouring countries. In addition, it should not be forgotten that revenue from the informal sector is not recovered either. The latest estimate1 using alternative methods inferred that the size of the Albanian informal economy is at least 30% of the GDP.
It is vital to broaden and secure the revenue base. The government has a well-developed plan to modernise tax administration and receives advice and technical assistance to strengthen collection efforts. A report by the IMF has suggested changes in the value-added tax and the coverage of profit tax, simplification of personal income tax rates, and increases in excise taxes on vehicles, alcohol, tobacco, and petroleum products.
However, a recent study2 points out that in the long term an increase in government revenue cannot simply be met with administrative measures. Norms of behaviour and perceptions are critical to achieve tax compliance. The analysis was based on a household survey in the area of Tirana that obtained evidence on the incidence of tax evasion and assessed its relation to individual attitudes. The results showed that people with pessimistic attitudes about formal institutions, such as the tax and audit authorities, were more likely to evade small business income tax. A strategy to raise government revenues will not be effective unless it is built around attempts to establish confidence in public institutions.Sources:1 M Muço et al. (2004) Private sector and labour market developments in Albania: Formal versus informal, Vienna Institute for International Economic Studies;2 K Gërxhani (2004) Tax evasion in transition: outcome of an institutional clash? European Economic Review, Volume 48, pp.729-745.
Public expenditure has grown steadily during the last 7 years, although it has declined as a proportion of GDP. Current expenditures for 2004 were about 8.5% higher that the previous year or 99.2 % of budget. As a proportion of GDP, current expenditures declined from 24.4% in 2003 to 23.6 % in 2004. Salaries were below budget (at 97.5% of budget), whilst other expenditures were over budget, including operational expenses (107.6%), social and health insurance (101.5%) and other expenses (114.7%). Subsidies were also above budget (at 122.8%) largely because of the use of contingency funds for to clear old obligations for KESH, without which subsidies would have been 6% below budget. Local government expenditure was about 90.3% of budget because of the delays in approving local council budgets.
Capital expenditures were 70% of budget in 2004, but were still 21.6% higher than 2003, in nominal terms. This level of capital expenditure was strongly influenced by foreign financing which was 46% below budget and 19% lower than in 2003. Problems with foreign financing of projects affect many government ministries. Domestically financed investment was 51% higher than last year, although it was still only 89% of budget. Problems with slow domestically financed investment were found mainly in the Ministries of Foreign Affairs, Justice and Public Order.
The public deficit, as a proportion of GDP, has declined from nearly 10% in 1998 to 4.9% in 2004. Besides, there has been an increase in revenue from privatisation compared to the previous year. As a consequence the internal financing of the budget deficit has been reduced considerably. There has been some rationalisation of existing domestic debt and soft credits to state owned companies have been reduced, further reducing the crowding out effect on private credit. The domestic debt of government has declined from 42.6% of GDP in 2000, to 37.8% at the end of 2004 and the terms of this debt have improved.
With regards to effects on the interest cost, calculations to the end of 2004 show savings up to Lek 1.9 billion for internal debt and Lek 720 million for external debt. The main factor is continuous reduction of all sorts of short-term and mid-term instruments.
2.4 MONETARY POLICY AND INFLATION
The annual growth rate of money supply at the end of 2004 was 13.1%, which was higher than in 2003. However, the main monetary ratios (such as M2 to foreign currency and M3 to money outside banks) have remained stable and the banking sector remains sound.
The base interest rate has seen a gradual decline during 2004. This has decreased the cost of borrowing and increased the level of credit in the economy, which has expanded by 30% in 2004, reaching Lek 70 billion. The structure continues to be oriented towards mid-term and long-term credits, thus responding to the country’s needs for increased investment in production capacities. Trade, construction and real estate continue to dominate borrowing, but there was some increase in supply of credit to agriculture and agro-processing and some decline in credit for trade. At the same time, there has been an increase in the proportion of credit in Lek, although 82% of credit is still in foreign currency.
The stable monetary situation has led to continued stable prices and Albanian inflation has remained below the levels of neighbouring countries. Annual inflation was 2.9% in 2004, compared with 2.4% in 2003. Low inflation has been the result of lower seasonal prices of agricultural products, control over the increase in budget expenditures and appreciation of the local currency, which has offset the risk of imported inflation from increased prices of oil and other imported products. The low inflation has been achieved despite some increases in administered prices, partly in preparation for privatisation. There have also been some increases in market-based prices, particularly during vacations when consumer spending is boosted by returning Albanians.
2.5 LABOUR MARKET
Economic growth has had an impact on employment indicators, although this impact is difficult to quantify due to the informality of the labour market and the economy in general. The unemployment level was estimated at 14.4% in 2004, showing a slight improvement from 15.0% in 2003 and a major improvement from 18.4% in 1999. This rate compares favourably with the official unemployment rate in other countries in Eastern Europe, although the comparison is difficult to make, given the different treatment of the informal sector. Improvements in employment have been mainly due to employment in the private non-agricultural sector, which accounts for 22% of the total.
In recent years, the government has implemented a policy to increase average salaries in the public sector by an annual average of 5-10%. Priority has been given to the sectors of education, health and defence, which have the largest number of employees. At the same time, pensions have been increased in both rural and urban areas. In 2004, the average salary in the public sector reached Lek 24957, which is 14% higher than in 2003 and double the average salary in 1998.
Despite continuous improvements from year to year, a problem still remains with the payment of social insurance contributions by employees and employers. These indicators remain at low levels especially in the private sector.
2.6 MACROECONOMIC PROJECTIONS
The government’s macroeconomic projections are defined in the Medium Term Budget Programme (MTBP) for the period 2005-2007. These are based on continued stability:
- Sustaining economic growth at a level of 6 %,
- Maintaining an annual inflation rate at the interval 2-4%,
- Preserving foreign currency reserves at the level 4 to 4.5 months import cover, and
- Reducing the deficit of the balance of payments current account, with exports growing faster than imports.
Economic growth in 2005 is expected to be based first on the growth of the services and construction sectors, accompanied by an increase in transport, agriculture and industry.
Some of the main macroeconomic indicators for 2005 are given in Table 2.3:
|GDP at current prices||Lek million||780100||857300||9.9|
|Real GDP growth rate||%||6.0||6.0|
|GDP per capita||$||2431||2575||5.9|
|Trade balance||$ million||-1579||-1981||25.5|
Reforms in the tax and customs administration, combined with efforts to reduce the informal economy, will increase the total budget revenues from 23.6% to 24.1% of GDP. This is equivalent to an 11.9% increase in revenue in nominal terms. All forms of revenue will increase, with tax revenues (notably personal income tax) and social contributions increasing slightly faster than the rest. Expenditure will remain constant as a proportion of GDP, allowing for a 6% real increase in public spending.
The main objective of monetary policy during 2005 will continue to be the preservation of the annual inflation rate at 2-4 %. This objective will be achieved by maintaining the increase in money supply at a level in line with the increase of nominal GDP, and assuming some progress in the rate of money circulation. Macroeconomic stability will lead to a continued decline in interest rates and expansion of credit in the economy.
Methodology of macroeconomic projections
The macroeconomic projections are generated by a model which uses independent projections of underlying (or final) demand in the economy and then calculates the level of domestic economic activity needed to meet this demand, using input-output analysis. The final demand of the economy is defined as: government spending (current and capital); exports (of goods and services, including tourism); and private spending (both on investment and consumption). A part of private income is also projected independently (spending of government transfers and income from abroad), whilst spending of income earned domestically is calculated from the input-output analysis. Projections are made as follows:
- Government spending is projected by the Budget Department at the Ministry of Finance, based on the Medium-Term Budget Programme process.
- Exports of goods are projected by the Ministry of Finance in discussion with IMF.
- Exports of services (mainly tourism) are projected by the Macroeconomic Department at the Ministry of Finance to grow at 10% per year.
- Government transfers to households are projected from budget and Medium-Term Budget Programme data.
- Private income from overseas (mainly remittances) is projected from Ministry of Finance and IMF figures.
- Independent projections are made of private investment and food consumption, leaving a residual of private income for other consumption goods.
The sectoral composition of each element of final demand is assumed to be constant. The model then uses input-output analysis to calculate the level of output which is necessary to produce the demand from these underlying forces. The input-output analysis also produces estimates of private income from domestic activity and of imports of goods and services, both to economic ctivities and for household consumption. The model then calculates government revenue, based on the tax incidence on economic activities. This provides a projected government deficit. Expenditure can then be re-specified and the model is run again, to achieve the desired deficit.
The government is currently working on medium term projections to 2008 and extending to some additional years. This work has initially been done using the Ministry of Finance macroeconomic model described above. However, extending the macro model to include a fuller picture of the macroeconomy has raised a number of issues, which are being debated within government bodies. In particular, the Ministry of Finance aims to compare the conclusions from the macroeconomic model with the conclusions from more typical macroeconomic consistency frameworks, such as those used by the IMF and the World Bank.
The government is also working on the definition of a number of scenarios, which will help to illustrate the range of possible macroeconomic outcomes. This will help in setting revenue projections within a range, so that government expenditure can be planned to take place at different rates of progress.