December 12 (SeeNews) - S&P Global Ratings said it has affirmed its 'B+/B' long- and short-term foreign and local currency sovereign credit ratings on Albania, with a stable outlook.
Albania's real gross domestic product (GDP) growth is expected to slow to 2.2% in 2023 from an estimated 3.3% in 2022, before rebounding to 3.4% in 2024-2025, proving resilient to global headwinds and weaker demand from Europe, the global ratings agency said in a statement on Friday.
The country's fiscal deficit is projected to narrow to 3.7% of GDP in 2022, before it improves further to 2.9% by end-2025, in line with the government's pledge to balance public finances, the ratings agency added.
S&P also said in the statement:
"The stable outlook reflects our view that Albania can continue to manage risks from the Russia-Ukraine conflict thanks to its strong external buffers, despite the economic slowdown in Europe--Albania's largest trading partner. Additionally, the country's modest growth prospects and the government's fiscal consolidation efforts should facilitate a reduction in debt over our 2022-2025 forecast horizon.
Downside scenario
We could lower the ratings over the next year if the public debt stock increases significantly beyond our expectations due to high fiscal deficits or the materialization of contingent liabilities from public-private partnerships (PPPs).
Upside scenario
We could consider raising the ratings over the next year if external funding risks decrease materially or if a pronounced reduction in fiscal deficits yields a fall in public debts levels. We could also raise the ratings if the institutional framework is strengthened, possibly through structural reforms implemented as a part of the country's EU accession objective.
Rationale
Our ratings on Albania are limited by a moderately weak institutional framework that, in our opinion, hampers long-term policymaking. The ratings are also limited by high public debt and large external financing needs. Over 50% of government debt is denominated in foreign currency or has a short but lengthening duration that requires continuous refinancing. Furthermore, the economy's extensive euroization, high informality, and shallow capital markets impair the Bank of Albania's (BoA's) monetary policy transmission channel.
The ratings are supported by Albania's moderate growth prospects and monetary flexibility through its free-floating currency and relatively high reserves. These, in particular, continue to serve as important buffers against potential external shocks. Furthermore, we believe authorities will revert to a fiscally conservative position, thereby lowering public debt over 2022-2025, despite the external shocks Albania has faces in recent years.
Institutional and economic profile: Albania's robust GDP growth will slow in 2023 before picking up again in 2024
Lower external demand from Europe and tightening monetary policy will likely slow Albania's economic growth to about 2.2% in 2023 from an estimated 3.3% in 2022.
Albania has negligible direct trade with and financial links to Russia and Ukraine.
EU accession talks are underway, but Albania's path to full membership will be protracted.
Albania's real GDP growth has proven resilient in the first half of 2022. During that time, the economy expanded by 4.1% compared to the same period last year, notably thanks to strong activity in the services (mainly tourism related) and real estate sectors. We expect real GDP growth to stand at 3.3% at end-2022. The pace will slow in 2023 to roughly 2.2% due to tightening monetary policy; a slowdown in the euro area, Albania's largest trading partner; and a reduction in fiscal stimulus. Thereafter, economic growth should bounce back to an average of 3.4% in 2024-2025.
Albania's negligible direct trade links with Russia and Ukraine have limited the economic fallout of the conflict. Before the start of the war, Albania imported approximately 4% of its refined fuel from Russia. What's more, Albania sources almost all domestic electricity production from hydropower. That said, in recent years, costly drought-triggered electricity imports from international spot markets have prompted Albanian authorities to diversify away from hydropower.
Structural issues continue to burden Albania's economy. Pain points include infrastructure gaps, a weak legal environment, corruption, and labor market shortages. Nevertheless, Albania's EU membership bid has anchored efforts to address some of these issues. For example, the Trans-Adriatic Pipeline will gradually reduce Albania's reliance on hydropower, and judiciary vetting, with assistance from the EU, will improve the legal framework. In our view, successful reforms will improve the business environment, help stem emigration, and attract new foreign investment inflows to Albania, potentially allowing the country's economy to catch up more quickly with that of stronger peers.
The Socialist Party of Albania (SPA) has continued to govern since winning the general election in April 2021, when it secured a majority in parliament. Policymaking decisions have remained stable since then, with a focus on fostering economic development considering the aim to join the EU. Earlier in the year, citizens across Albania protested against the rapid increases in energy and food prices due to the Russia-Ukraine conflict. The government responded with two separate packages of social security measures and price freezes to ease the cost of living. We see this as positive for political stability. Local elections are due to be held in May 2023.
EU accession has remained a key policy priority for successive government administrations since Albania became a candidate in June 2014. The EU had previously grouped Albania's accession bid with neighboring North Macedonia. However, bilateral disputes between North Macedonia and Bulgaria froze negotiations for numerous years until a recent breakthrough resulted in the EU and Albania holding their first inter-governmental conference in July 2022. Albania's screening process is now underway. However, given the experience of regional peers in the EU, we believe Albania's EU accession will be protracted.
Flexibility and performance profile: External pressure will likely remain elevated this year but start declining thereafter
We project Albania's fiscal deficit will narrow to 3.7% of GDP at end-2022, then improve further to 2.9% by end-2025.
However, the current account deficit will widen to 8.3% of GDP in 2022, from 7.6% in 2021, before easing over 2023-2025, financed by net foreign direct investments (FDI).
High euroization and the possibility of a sharp reversal in real estate prices are potential risks to the banking sector.
Contrary to our previous estimates, we now expect the fiscal deficit will narrow to 3.7% of GDP in 2022. Inflation has boosted tax receipts, leading to strong revenue year on year, while expenditures have remained flat. The windfall in revenue has enabled the government to offset additional spending to help certain parts of the population deal with the economic fallout of the Russia-Ukraine conflict. For instance, two social resilience packages included public wage increases and the indexation of social assistance and pension payments, among other fiscal measures.
Our estimate budget deficit is higher than the Albanian parliament's target. In the recently passed 2023 budget, authorities signaled a budget deficit target of 2.6% of GDP, while we estimate 3.2% due to our lower growth assumptions and higher energy import bill (household electricity prices are subsidized by the government). The government has indicated that the budget deficit will be financed by a mixture of domestic and external borrowing. Multilateral support will be forthcoming; the World Bank, French Development Agency, and European Commission plan to provide a total of €320 million of budget support. Moreover, if market conditions are ideal, the Albanian government intends to issue €500 million of Eurobonds and designate €250 million of the funds raised to buy back a part of the Eurobonds due in 2025.
Because of the multitude of external shocks Albania has faced in recent years, we expect fiscal consolidation will be slightly protracted, converging toward a deficit of roughly 3% of GDP by 2025. Importantly, this means that the authorities will comply with their own fiscal rules as stipulated by the Organic Budget Law (OBL) and its debt brake rule. These require the government to achieve a primary balance from 2024 and a continuously declining debt-to-GDP ratio if it is above 45%. Notably, the authorities target a positive primary balance in 2023, one year ahead of schedule. Nevertheless, we believe fiscal consolidation will hinge on sustained robust economic growth and additional reforms to public finances. The government expects to implement a medium-term strategy to boost revenue collection. At about 27%, Albania's fiscal revenue-to-GDP ratio is the lowest in the Western Balkans. We attribute this to Albania's large informal economy as well as tax loopholes and exemptions.
We project Albania's net general government debt will narrow to approximately 65% of GDP by end-2025, alongside a decrease in general government debt to roughly 69% of GDP. Albania's debt stock is somewhat higher than regional peers' and subject to refinancing and foreign currency risks. Average debt maturity has increased but remains relatively short. Moreover, about 53% of central government debt is denominated in foreign currency and unhedged, exposing it to exchange-rate volatility. The domestically issued debt is short term, with maturity dates approximately over two years from issuance. Additionally, and despite a pick-up in bank lending to the private sector in recent years, Albania's banking sector still holds the largest share of domestic government debt, which constitutes about 26.2% of the sector's total assets.
Although the authorities continue to reduce contingent fiscal risks, off-balance-sheet PPPs are still a vulnerability. Currently, Albania has over 200 PPPs covering road infrastructure, power generation, and health care. Furthermore, under the OBL, payouts to PPPs are limited to 5% of tax revenue in the previous year. Despite efforts to address Albania's infrastructure gap, the risk framework governing these projects has yet to sufficiently develop, particularly with cost transparency. Consequently, potential fiscal risks from PPPs remain hard to predict and quantify.
Inflation in Albania is at its highest level since 1999, reaching 8.3% in October 2022 from 3.7% in December 2021. This remains lower than for regional peers, however, due to the subsidization of electricity prices in Albania. The acceleration in inflation is mainly attributable to an increase in food and energy prices. The BoA has responded by raising the policy rate by a cumulative 225 basis points this year. We expect inflation will remain elevated, averaging 6.4% in 2022, before falling gradually toward the BOA's target of 3% by 2024, on the back of monetary policy tightening and weaker external prices pressures.
The BOA's monetary policy transmission mechanism remains impaired by shallow capital markets and extensive euroization in the economy (similar to regional peers). Roughly 57% of deposits are denominated in foreign currencies; euros continued to be widely accepted in transactions, even in the formal economy including the real estate sector. Nevertheless, the BoA has enacted measures to de-euroize the economy.
Despite tightening global financial conditions, the Russia-Ukraine conflict, and a slowdown in global economic activity, the Albanian lek (a free-floating currency) has appreciated against the euro. The lek's stability has lessened pressure on public finances and the domestic banking system.
Strong financial account inflows and the absence of foreign exchange interventions have strengthened the foreign currency reserves. We also note positively the BoA's efforts to accumulate reserves. We expect usable reserves (that is, gross reserves net of required reserves on commercial banks' foreign currency liabilities) will cover roughly six months of current account payments over the next few years.
We expect the current account deficit to widen to 8.3% of GDP in 2022, from 7.6% in 2021 primarily due to higher energy and raw material imports. Still, these imports will be somewhat offset by a pickup in remittances and services exports, in particular tourism receipts. Twelve-month rolling foreign tourist arrivals reached a record high of 7.2 million in September, surpassing the 6.4 million peak registered in 2019. Over the next few years, the current account deficit will continue to narrow as commodity prices decrease, tourism revenues recover, and post-earthquake reconstruction activities wind down. Net FDI inflows and external borrowing will likely continue to finance the external deficit until 2025.
Albania's banking sector is liquid, well-capitalized, and profitable. The regulatory tier 1 capital as a percentage of risk-weighted assets reached 18.0% in September, up from 16.9% in December 2021. Nonperforming loans reached 5.1% of gross loans in September, compared with a peak of almost 25.0% in 2014. Nonetheless, house prices increased by 39.2% over the 12 months ended in September 2022, suggesting that a sharp reversal in house prices could jeopardize financial stability. In addition, the banking sector remains highly euroized. That said, we continue to see the overall risk of contingent liabilities as moderately low."