To achieve a 50 percent debt level by 2016, real primary spending would have to be limited to 2 percent per year with unitary revenue elasticity, says the IMF in its latest report
TIRANA, Oct. 24 – The International Monetary Fund has warned Albania’s public debt, currently at the legal limit of 60 percent of the GDP, will rise to 64 percent by 2016 under current fiscal policies. In its new detailed country report, the IMF says that given the high public debt, the fiscal rule should be explicitly tied to debt reduction.
“Fiscal consolidation is the lynchpin for a sustainable medium-term outlook. This requires more realistic budgeting, and staff recommended an expenditure-based fiscal rule tied to public debt reduction to 50 percent of GDP over the medium term,” says the IMF report.
Albania’s public debt is approaching the 60 percent of GDP statutory limit, a relatively high level compared with emerging markets (average of 47 percent) and regional peers. With an average interest of some 6 percent, and notwithstanding a still large share of concessional external debt, debt servicing cost exceeds 3 percent of GDP or 15 percent of tax revenue, says the IMF.
Moreover, debt is set to increase further under the baseline and debt sustainability further put at risk by standard shocks. Including personnel expenditure and social insurance outlays, pre-committed spending amounts to three quarters of revenue, severely constraining budget flexibility.
One option is to adhere to a simple debt rule. A debt rule would comprise a target debt ratio and a convergence speed when debt is above the target. The current debt level can be sustained with primary deficits of about ޠpercent of GDP, says the Fund.
“An expenditure rule with a debt brake offers more advantages, allowing for greater play of automatic stabilizers and keeping the size of the public sector in check. The rule would put a ceiling on real public spending growth with the debt brake forcing a review of spending growth whenever debt is above the desired target. To achieve a 50 percent debt level by 2016, real primary spending would have to be limited to 2 percent per year with unitary revenue elasticity.”In its latest regional economic outlook, the IMF warned the high public debt level, its relatively high short-term share and the considerable amount denominated in foreign currency makes Albania one of the most endangered countries in emerging Europe.
In the 2008-2016 macroeconomic framework, the IMF expects the Albanian public debt to continue rising from 59.4 percent in 2011 to 63.6 percent in 2016. Meanwhile, GDP growth is projected to range from 2.5 percent in 2011 to 4 percent in 2016.
Under the review which was made soon after the budget cuts in mid-July, the Albanian government expects the country’s economy to grow between 5 to 5.2 percent from 2011 to 2014 down from 6.2 percent in the report approved earlier this year, twice more compared to IMF projections. However, what’s more concerning is that the public debt which had been forecast to be lowered to 54 percent by 2013 is now expected to lower to only 58 percent of the GDP by 2014 under the new 2012-2014 macroeconomic framework.
Eurozone risk
Uncertainty emanating from the euro-area periphery is the key near-term vulnerability, warns the IMF. Albania has large trade, labor-market, and banking-system links with Greece and Italy. Especially the latter two links could result in substantial spillovers with banking-system contagion potentially the most severe near-term risk, while sharply lower remittances could result in a significant GDP shock. Other risks are also mostly to the downside. Exports may slow down in a less buoyant global outlook and private domestic demand could falter. High public debt, rollover risks, and interest costs also leave the country exposed to a downturn in investors’ risk appetite, with knock-on effects on confidence in the financial system. On the upside, higher foreign demand and capital inflows could lead a stronger recovery of domestic demand and an improved political situation may boost confidence.
Data show Albania’s exports to the Euro area account for 72.3 percent of the total of which 8.4 percent in neighbouring Greece and 48.8 percent in Italy, which are in severe financial trouble. Albanian imports from the Euro area also constitute the majority 61.6 percent of which 33.4 percent from Italy and 13.6 percent from Greece. Bank assets from the Euro area also make up 73.3 percent with Greece possessing 20.4 percent and Italy 13.2 percent.
Need for pension reform
Demographic trends pose significant challenges to Albania’s pension system. The Albanian population is projected to age dramatically over the coming decades, with the median age exceeding the European and Southern European averages by mid century, says the IMF.Similarly, Albania’s old-age dependency ratio is projected to triple from around 18 percent now to just over 50 percent and thus close to the European average. On current policies the wedge between spending and contributions would continue to widen, requiring ever greater transfers from general taxation to fill the gap. This would prove to be unsustainable within a relatively short period of time.
Thus, pension reform is a priority, especially addressing the imbalances in the existing pay-as-you-go system. The 2006 and 2009 reductions in contribution rates should be revisited in order to strengthen the finances of the social security system, not least as these have not led to an increase in compliance. Second, the continued need for subsidizing rural contribution should be assessed. Third, pension spending increases could be kept at bay, by raising pensions by less than earnings. Looking beyond these immediate measures to bolster the social security finances, more fundamental changes should be contemplated; such as eliminating the distinction between urban and rural pensions (which would allow for better targeting) and making the link between contributions and pensions more apparent. The high degree of redistribution within the pension system (the maximum pension is only twice the minimum pension) has often been pointed out as a major reason why higher income earners are reluctant to participate in the scheme. After the state system has been made sustainable and coverage expanded-and the regulatory environment strengthened-a move towards a multi-pillar system could be considered. Such a move would preferably lead to additional pension savings rather than merely diverting existing contributions away from the social security scheme. International evidence shows that the diversion of contributions away from the first pillar into private pensions could create substantial and sustained transition costs with a negative effect on the public finances.
Sanctioning public debt ceiling on Constitution
The idea to sanction the limit of public debt at 60 percent of the GDP on the Albanian Constitution has found the consensus of some experts. The idea launched by opposition Socialist Party MP Ben Blushi is hailed by Adrian Civici, an economic expert and member of the Supervisory Council of the Bank of Albania, who says that this initiative would increase the economic stability at this difficult moment the Eurozone is facing.
However, Selami Xhepa, an economic expert and MP of the ruling Democratic Party says the best way would be the legal reduction of expenditure. According to him, public expenditures must be in line with economic growth rates.
Currently the 60 percent ceiling for the public debt is only foreseen in the budget law. The adoption of this rule in the Constitution means that under no circumstances the public debt can exceed 60 percent of the GDP.
Govt., opposition stance
The IMF’s warning about the high public debt levels and Eurozone spillover effects from Greece and Italy is not a worry for the ruling Democrats but remains a serious concern for the opposition Socialist Party which says the situation in Albania is not as it is portrayed by state institutions such as the Bank of Albania or INSTAT.
Asked by reporters on the possible impacts from the crisis in Greece and Italy, Finance Minister Ridvan Bode told reporters on Tuesday “we have taken all measures so that the Albanian economy is affected as little as possible or not at all by developments in the region. This means that there won’t be direct implications of developments in neighbouring economies to the Albanian economy.”
According to Bode, banks operating in Albania, which are overwhelmingly foreign are in good financial situation and well-capitalized, and under supervision by the Bank of Albania.However, the situation for opposition MP Mimi Kodheli, also the deputy chair of the parliamentary economy committee, appears quite different with the high public debt as the major threat.
“We hear government representatives saying that the debt is below the 60 percent threshold. A country like Albania must have its debt level at the 40 percent level. The average public debt level for developing countries is at 47 percent” said Kodheli.
