TIRANA, Feb. 5 – Recession in Italy during the second half of 2018 and growth prospects for the next couple of years having received a severe blow for the Eurozone’s third largest economy and Albania’s main trading partner, signal trouble also for the small Albanian economy which has strong trade, investment and remittance ties with the neighboring country across the Adriatic.
The Italian recession is a new external threat to the Albanian economy, which is already facing a series of problems at home, mainly related to Europe’s single currency having lost around 7 percent against the Albanian lek, credit struggling with moderate growth rates over a declining but still high level of non-performing loans, two large-scale energy-related investment nearing completion, public debt reduction agenda at risk over a hike in controversial public private partnership contracts, as well as new unpaid government bills of around €200 million, equal to 1.5 percent of the country’s GDP, putting liquidity pressure on the private sector.
In addition, a prolonged drought hitting the country’s hydro-dependent electricity generation, has forced authorities to switch to costly imports to meet domestic demand in quite a different picture compared to 2018 when a favorable hydro-situation made the country a net exporter of electricity and the state-run electricity sector was one of the key drivers of growth in the first half of last year.
The Italian economy contracted for two consecutive quarters in the second half of 2018, technically putting the euro area’s third largest economy into recession though average growth for the whole of 2018 was positive at 1 percent, down from 1.6 percent in 2017.
Italy’s recession is mainly a result of declining manufacturing activity and investor confidence dropping over soaring debt amid lower than expected growth after Italy’s populist government struggled to reach a late 2018 deal with EU leaders over higher spending plans running against the EU’s fiscal rules.
Last month, Italy’s central bank slashed growth forecasts for 2019-20 to 0.6 percent and 0.9 percent respectively amid fears of a new recession that recently proved real as Italy slipped into its third recession over the past decade when it has been one of the hardest-hit Eurozone economies.
Possible implications for Albania
Due to the sizeable trade, investment and remittance ties, a slowdown in Italy, the destination of half of Albania’s exports and the host of half a million Albanians, means more trouble for the Albanian economy and growth outlook could be revised downward, with a negative effect on the country’s fiscal consolidation and debt reduction agenda.
International financial institutions such as the World Bank and the IMF forecast the Albanian economy will slow down to 3.5 to 3.7 percent this year, after an expected decade high of 4.2 percent in 2018.
However, the newly confirmed Italian recession and grim prospects ahead for the Eurozone’s third largest economy and Albania’s main trading partner, could lead to a new downward revision even by the Albanian government which expects growth to pick up to 4.3 percent this year.
“It has been proved that the stronger the trade partnership between two countries, the higher the positive or negative effect coming from the trading partner,” economist Arben Malaj has told a local TV.
A former finance minister and current member of the Bank of Albania’s Supervisory Council, the highest decision-making body at the central bank, Malaj says the tough economic situation in Italy could be long-term and the Albanian government should be well-prepared to handle negative effects on thousands of Albanian resident households relying on migrant remittances from Italy and create opportunities for potential migrants considering coming home in case of massive loss of jobs.
Experts have warned that due to stronger trade, investment and human ties with Italy, a possible slowdown in Italy’s GDP growth, could affect the Albanian economy more than the Turkey and global trade dispute spillover effects.
Over 90 percent of Albania’s garment and footwear products, an industry relying on cheap labor costs but employing dozens of thousands of people and producing the country’s top exports, go to Italy, which is often not the final destination of those products.
Relying on raw material coming from Italy and cheap labor costs at home, garment and footwear producers in Albania, among whom even Italian investors, have been facing a sharp cut in profits over Europe’s single currency losing a sharp 7 percent against the Albanian lek last year and continuing trading at a 10-year low of 124.5 lek. Exporters also complain over delays in value added tax refunds putting them in financial straits.
The call center industry employing thousands of young men and women also relies on marketing and customer service campaigns targeting Italians.
Unlike the severe recession in Greece, the recession in Italy did not have any significant effect on trade and investment ties that have followed an upward trend, although the flow of migrant remittances suffered a major blow.
Trade exchanges between Albania and Italy slightly dropped to 324.4 billion lek (Euro 2.6 billion) in 2018 on higher Albanian exports, but lower imports narrowing Albania’s trade gap with Italy.
The stock of Italian FDI to Albania also rose to €650 million in Sept. 2018, up 30 percent compared to early 2014, according to Albania’s central bank.
Meanwhile, the 500,000 Albanian migrants living and working in Italy are estimated to bring home around €120 million annually in remittances, in inflows that have been constantly declining over the past decade due to recession and economic slowdown in Italy, family reunions and a new generation of Italy-born migrants with weaker links to Albania.
Meanwhile, growth prospects in Greece, Albania’s traditional second largest trading partner, have slightly improved over the next couple of years, with growth expected above 2 percent.
The host of some 500,000 Albanian migrants, Greece faced an 8-year recession ending in 2016 that saw its economy shrink by about a quarter, with a series of spillover effects also in Albania, mainly hitting exports and thousands of migrants.
Albania’s current trade links with Greece are at around 7 percent of total, half of what the country traded with Greece just before the onset of the global financial crisis
Prolonged recession in Greece, the country’s traditional top foreign investor, has also led to a number of Greek-owned banks and businesses leaving the country in the past few years.
Facing spillover effects from main trading partners, the Albanian economy has been growing by an average of 2.7 percent annually in the past decade, less than half of a pre-crisis decade of 6 percent annually that is estimated to bring tangible welfare to Albanian households and bridge huge development and income gaps to EU member countries.
Investment, human capital effect
Economy expert Besart Kadia says lower private investment in the past five years and the loss of human capital due to a new migration wave hint Albania’s economic growth will be lower in the upcoming years.
“Albania’s economic growth will be at low rates in the coming years due to the fact that private investment has been declining since 2014 and that human capital is also contracting and scarce. The sluggish growth rates will translate into lower income for state budget which means that public debt and the social security system will put further pressure on our economy and require tax hikes and as a result further lower private investment,” Kadia says in an op-ed published with a local business portal.
“In case high taxes are compensated with reforms and institutional modernization, then the challenge is not that big. But implementing economic reforms under tough economic circumstances is difficult. That’s why economists recommend ‘repairing the roof in sunny weather’,” says Kadia.
High taxes compared to regional competitors, a long-standing issue of unclear property titles and an inefficient judiciary that is undergoing reform are the main concerns for current and potential foreign investors to the country, mainly focused on low value-added sectors such as oil, mining, hydropower in the past decade.
