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S&P affirms Albania at B+, outlook stable

S&P affirms Albania at B+, outlook stable gary yim/Shutterstock.com

TIRANA (Albania), February 6 (SeeNews) - Standard & Poor's said it has raised its long- and short-term foreign and local currency sovereign credit ratings on Albania at B+ with a stable outlook.

"We expect Albania's economic growth to remain solid during 2017-2020, supporting the government's budgetary consolidation, despite the risk of budgetary slippage, for example, due to the upcoming 2017 general elections," Standard & Poor's said in a statement late on Friday.

The rating agency also noted the gradual progress of Albania toward strengthening its institutional framework, underlining the role of the IMF Extended Fund Facility and the preparatory efforts in the EU accession process.

"The stable outlook reflects our expectation that continued fiscal consolidation and a declining government debt-to-GDP ratio will balance vulnerabilities stemming from Albania's still-high risks for external financial positioning over the next 12 months" S7P added.

Standard & Poor's also said:

"The affirmation of the 'B+' rating reflects the sovereign's progress in recent years with regards to fiscal consolidation, economic development, and institutional effectiveness. We believe that the policy anchor provided by the International Monetary Fund's Extended Fund Facility arrangement (IMF EFF) that concludes in February 2017 contributed significantly toward improvements in Albania's fiscal framework, including the formalized deficit brake, the "organic budget" law, and generally strengthened institutional oversight, preventing the accumulation of arrears. Although we consider that there is a risk of fiscal slippages ahead of the upcoming general elections in June 2017, in our view, this risk is lower than in the previous general election year of 2013, when financing pressures had emerged. Overall, we note that Albania outperforms its peers in the same rating category on the fiscal performance side. The current exchange rate regime is more stable than peers' and Albania has made improvements in its institutional set-up.

This progress on the fiscal side coincides with increased and improving economic growth, as well as enhancements to the nation's institutional set-up. Aided by the country's cooperation with international organizations--such as the International Bank for Reconstruction and Development (IBRD); the EU, in the context of preparatory measures in the EU accession process; and the IMF EFF--the government of the Republic of Albania has implemented several institutional reforms over the past years. These aim to strengthen the rule of law and fight the informal sector. Although there is further progress to be achieved, successful implementation of these reforms would, in our view, improve the economy's business environment, attracting foreign direct investment and increasing the country's economic growth outlook.

The current IMF program for Albania will run out at the end of February 2017, and we do not expect negotiation of another arrangement to start ahead of the general election in June 2017.

Last year's judicial reform represents a particularly noteworthy piece of legislation regarding Albania's institutional framework. If this reform is fully implemented, creating a more independent judiciary, it would improve the country's business environment. For example, it would increase the effectiveness of enforcement of property rights and offer a more-effective bankruptcy resolution process. Further institutional reforms are being debated, such as the electoral reform. However, this is unlikely to be enacted ahead of the upcoming elections, given the tight schedule.

On the fiscal side, we estimate that the government outperformed its own 2016 budgetary plan, posting a general government deficit of around 1.7% of GDP. This is much lower than the deficit of 5.2% only two years earlier in 2014, which was also adversely affected by the clearance of arrears that were mainly accumulated ahead of the general elections in 2013. We attribute the favorable 2016 estimate mainly to lower-than-budgeted government spending, which more than offset lower-than-budgeted revenues. The grey economy weighed on revenues, despite significant reform efforts with respect to tax compliance. As a result of the strengthened fiscal framework, we consider the possibility of fiscal slippages ahead of the general election in 2017 to be far lower than in the last election year, 2013.

During 2017-2020, we project a slightly delayed path of fiscal consolidation compared with the government's plan and expect the deficit to be at 1% of GDP by 2020 (versus 0.6% of GDP, as planned by the government). Deficit-reducing measures will likely include higher tax revenues due to increased tax compliance and the introduction of new taxes. As a result, we expect the general government debt burden to decline to about 60% of GDP in 2020 from 71% at the end of 2016. Although the average maturity of government debt has lengthened considerably over the past three years, for the domestic portion of debt, average maturity remains relatively short, at 763 days as of the third quarter of 2016. Domestic debt currently accounts for around 53% of the total public-sector debt stock and around 40% of total government debt is denominated in foreign currency. Albania's banking system still holds the largest share of domestic debt, and about 25% of the banking system's assets are government securities.

We expect Albania's fiscal performance will be supported by solid economic growth of about 3.8% per year on average in real terms during 2017-2020. We expect the growth to be primarily based on strong domestic demand, with rising consumption and private investment. We expect the negative impact of net exports on economic growth in recent years, due to a terms-of-trade shock in the extracting industry, will recede. In 2016, we noted particularly strong growth in tourism, where capacity has been increasing.

At the same time, Albania's external vulnerabilities remain high. We estimate Albania's gross external financing needs, at around 118% of current account receipts and usable reserves in 2017, are significant. Its external indebtedness is relatively low as financing for the current account deficit has historically been more in the form of net foreign investment, particularly in the energy sector, than in debt-creating inflows. Narrow net external debt, by our measures, will amount to 20.7% of current account receipts in 2017. We expect this share will stay roughly constant over our forecast horizon.

Progress on the Trans-Adriatic Pipeline (TAP) project, which will connect Albania with Italy and the Caspian Sea, appears on track. The project is to be executed by 2018 and will cost an estimated €1.5 billion. Given that the largest share of the TAP will be executed in 2017, we estimate the foreign direct investment (FDI) inflow at above 11% of GDP in 2017. Further FDI inflows are related to Albania's energy sector, particularly projects in the hydropower sector. However, we see a risk that Albania's large projected FDI flows could fall in the coming years, especially as Albania's net external liability position is much weaker than its narrow net external debt position, surpassing it by over 120% of current account receipts in 2017. The improvement of the institutional environment could therefore help by attracting a broader base of FDI inflows in the coming years.

We expect that the current account deficit, estimated at 12.5% of GDP on average over the coming four years, will continue to be financed mainly by foreign direct investment. We further estimate a relatively steady transfer balance of around 7% of GDP over our forecast horizon (compared with an average 13% of GDP over 2004-2008). In this respect, Albania has been hit by the economic developments in Greece, where a significant Albanian diaspora lives, but migration of Albanians to other countries will help by further diversifying remittance sources.
Improvements in the legal system could also play an important role in reducing the share of nonperforming loans (NPLs) in Albania's financial sector. NPLs in Albania have consistently remained high at around the 20% mark. This hampers lending and constrains economic recovery. We project that the deposit-funded financial sector will remain in a net external creditor position over the next few years. Capital buffers and liquidity in the banking system remain well above minimum capital requirements. The continuous increase of the financial sector's net foreign assets--partly reflecting high liquidity--mirrors the country's weak growth performance and limited lending opportunities for banks in recent years. We estimate growth of bank credit to the entire domestic sector to have slightly picked up to about 2.6% in 2016. Subsidiaries of Greek banks maintain a sizable presence in Albania and the authorities have taken measures to limit exposure to their parents and prevent contagion risks to the rest of the sector.

Since the second quarter of 2016, the central bank has maintained a rather accommodative policy to try and meet its 3% target inflation rate. Nevertheless, it missed the target again in 2016. The central bank has set and kept the policy rate at a historically low level of 1.25%. The high share of foreign currency loans and foreign currency deposits, both currently estimated at around 53%, hinders the effectiveness of Albania's monetary policy, as it does in several economies across the region. We project that the target inflation rate will not be reached before 2019.
Albania's central bank has intervened only marginally in the foreign exchange market in the past years, mainly relating to increasing its foreign currency reserves in line with its targets. Otherwise, it maintains a free-floating exchange rate regime. The only significant open market operations of the Bank of Albania included three-month liquidity injections regarding enforcing its policy rate.

OUTLOOK

The stable outlook reflects our view of the balanced risks to the ratings on Albania from continued fiscal consolidation and a declining government debt-to-GDP ratio. These factors are set against vulnerabilities stemming from Albania's external financial position.

We could raise the ratings if structural reforms established a track record of more robust institutions and strengthened economic growth prospects. Faster-than-forecast government debt reduction to below 60% of GDP, combined with a reduction in interest payments as a share of government revenues, would also be positive for the ratings.

We could lower the ratings if we observed deterioration in government finances, for example, due to a significant deviation from our current forecast, along with pressures on borrowing conditions. We could also lower the ratings if we saw significant deterioration in Albania's external position and ability to fund its high current account deficit".

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