European union – albania stabilisation and association committee 11 March 2015 table of contents political criteria 3

Economic outlook in Albania

The Albanian economy has shown signs of improvement during the first nine months of 2014. Value added in the economy recorded an annual increase by 1.3% during first nine months of 2014. The slight contraction which took place in Q2 was temporary, mostly linked to supply side shocks in specific sectors of the economy like construction, industry and transport contributing negatively to growth. With the exception of transport which suffered a decline of 24.1%, economic growth in the third quarter was supported by an expansionary activity of all the economic sectors. The largest contribution came from the service sector, with 1.9 percentage points. The positive performance of services was led by activities in other services and trade branches.

The manufacturing sector contributed with 1.4 percentage points to the total value added growth. The activities of this sector - construction, industry, and agriculture – contributed to the value added growth respectively by 0.8, 0.4 and 0.2 percentage points. In the third quarter of 2014, the branches with positive growth were: "Trade, Hotels and Restaurants with 10.4%, "Construction" with 7.5%, "Post and communications" with 5.4 %, "Other Services" with 3.8%, "Industry" with 2.5%, and “Agriculture" with 1.2%.
From an aggregate demand standpoint, the growth during 2014 was mostly generated by domestic demand, while foreign demand is assessed to have had a negative contribution. On the other hand, private sector demand remained on a positive trajectory. Improved confidence and favourable financial conditions have supported the growth of private consumption and investment during the first half of the year. Private investment was positively affected by improved business confidence, increased utilization rate, the growth of new orders and the easing of credit conditions. The recovery of the investment will depend on the sustainable growth of the consumer demand and the continued improvement of financial conditions. For 2014, growth is projected to be slightly higher than the previous year standing at 2.1%. This growth is expected to rely mainly on domestic demand. The easing of monetary conditions, the correction of the public and private sector balances, and the improving of the economic agents' confidence is expected to fuel domestic demand. For the medium term ahead growth is expected to accelerate at 3% for 2015, and around 4%-4.5% for 2016-2018.
Available data according to the Labor Force Survey show an increase in employment in 2014 and also a slight decrease in the unemployment rate in the second and third quarter. However, the unemployment rate in Q3-2014 still remains 0.2 percentage points higher compared to Q3-2013. In the third quarter of 2014 the number of employed persons of working age (15-64 years) was 1,043,057. Compared to the same quarter of 2013, it increased by 78.844 persons or 8.2%. The number of unemployed persons of working age was 219.585. Compared to the same quarter of 2013, it increased by 19,728 people. The unemployment rate in the third quarter of 2014 was 17.4% compared to 17.2% registered in the same period of 2013.

The Albanian economy continues to operate below potential, which in turn is reflected in inflation ​​below the target of the Bank of Albania. During January-September 2014, the annual inflation averaged 1.6%, slightly lower than in the same period of 2013.

Until November 2014, deposits increased by 0.9 percent and the credit to the economy grew by 3.8 percent compared to November 2013. Banks, businesses and households remain risk averse. Credit growth is segmented in terms of both banks activity in lending and also of sectors of the economy that are being financed. Credit growth has been driven by expansion of credit to private non-financial corporations. On the other hand, credit to households has been sluggish, registering near zero growth for the last 12 months. In 2014, credit growth continues to be supported by credit in domestic currency, while foreign currency credit continues to shrink. The level of nonperforming loans (NPL) made up 24.88% of total loans until the third quarter of 2014, increasing slightly by 0.54 percentage points compared to the third quarter of 2013. The majority of NPLs continues to be well provisioned and banks remain well capitalized above the regulatory minimum. In overall, banking system soundness parameters remain sound. The capital adequacy ratio, liquidity as well as profitability indicators stayed positive in 2014, and improving slightly compared to the previous year.
For the first nine months of 2014 the current account registered a deficit of €901 million, increasing by 29% as compared to the same period of the previous year. The expansion of the trade deficit by 13.7% was the main factor behind the higher current account deficit. Here, a general pickup in imports, the overturned net balance of the energy sector from net exporter last year to net importer this year and volatile oil prices in the international market were primary facets of trade developments. Net primary income registered a higher deficit linked to larger direct investment income outflows. Services performed better this year compared to the same period last year. After the 19.8% annual drop last year, secondary income inflows have increased only slightly this year. Remittances have stabilized at almost the same level of last year. Net flows to the capital and financial accounts including net errors and omissions resulted in about EUR 1038 million during the first nine months of 2014, compared to EUR 796 million in 9M-2013. As a result the overall balance of payment was positive at EUR 136 million for nine months of 2014, higher than 97 million for the same period of 2013.

Bank of Albania has estimated an economic growth of 1.8% during 2014. Improved lending conditions and balance sheets of economic agents, as well as increased confidence are the main drivers behind economic growth. These factors have positively affected the growth in private spending, while fiscal policies have remained consolidated and foreign demand at low levels. Our medium term projections suggest improvement of economic growth during 2015.

The deteriorating weather conditions at the end of 2014, and particularly the first two months of 2015 caused several floods and lots of damage to the agricultural produce and farming stock in southern Albania. The impact on the value added of the Albanian economy has affected the downward revision of economic growth in 2015. Nonetheless, supply shocks are expected to be temporary and to have no effect on the economic growth trend in the medium term. Our medium term projections suggest an economic growth of 3-3.5% during 2015.

Inflation pressures from the demand side are expected to grow, affecting the gradual growth of inflation. The average annual inflation rate is forecasted at 2.3% in 2015. The balance of risks remains on the downside. Inflation will be affected by the recovery pace of economic growth, foreign price developments in the world markets, potential supply shocks, mainly from developments of the agricultural produce, but also by the materialization of second round effects of oil price reductions and increase of several administered prices.

In January 2015, the Supervisory Council of Bank of Albania reduced the repo rate by another 0.25 percentage points, to a new low of 2.0%. The stimulating monetary policy stance has been motivated by weak pressures on the demand side, slowing trend of inflation expectations as well as the risk of materialization of second round effects due to oil price reduction. Along with these measures, Bank of Albania in its public communications has been clear about its forward guidance orientation.
The accommodating monetary policy has been reflected in the reduction of the financing costs in the economy, while also stimulating credit growth in lek. Despite the transmission of base rate reductions in the credit market, demand for credit continues to remain weak. The reaction of the economy to the stimulating monetary policy is affected by the lowered risk appetite of both businesses and the financial institutions. These circumstances are expected to affect developments in 2015 as well and our forecasts suggest a gradual recovery of credit activity. Credit growth in annual terms is expected to fluctuate around 4%-6%. The revival of demand for credit is expected follow economic activity growth with a lag. Meanwhile, the policies imposed by the parent banks have affected the tightening of credit supply. At the same time, credit growth in 2015 will be negatively affected by the consolidation of banks’ balance sheets, in line with supervisory regulatory requirements. In general, monetary expansion and deposits are expected to improve during 2015, backed up both by the growth in demand for money and financial intermediation. However, this growth will remain modest compared to historical average, suggesting low inflationary pressures from the monetary sector during the year.
As economic activity recovers and the output gap expands positively, inflationary pressures are expected to grow during 2016-2017. Core inflation is estimated to increase gradually, reaching its historical average at the end of 2017. Non-core inflation is also expanded to follow a growing pattern; however it will remain below its historical average, delaying its return to the BoA target. We judge that the current stance and the magnitude of the monetary policy remain appropriate given these circumstances.