PRESS CONFERENCES
Speech by Ardian Fullani, Governor of the Bank of Albania, at the Press Conference on the Decision of the Supervisory Council of the Bank of Albania to reduce the key interest rate by 50 basis points, 28 October 2009

In today’s meeting of 28 October 2009, the Supervisory Council of the Bank of Albania, after analyzing the latest economic and financial developments in the country, the macroeconomic projections and the balance of risks for the months to follow, decided to reduce the key interest rate by 50 basis points to 5.25 percent.

The Supervisory Council of the Bank of Albania concludes that the third quarter of 2009 witnessed positive signs in the Albanian economy and financial markets. It particularly marked a turning point in terms of restoring confidence in the Albanian banking system. The stable liquidity situation, the preservation of financial stability and the banking system’s capitalization parameters constitute a solid platform for restoring its intermediation and financial role in economy. In tandem with the latest positive tendencies of the global economy, which still remain frail in terms of their nature and permanence, these developments prompt us to consider the future Albanian economic activity under the optics of a prudent optimism.

Over the course of the year 2009, the Albanian economy has been affected by the global economic and financial crisis primarily through the decline of foreign demand and remittances, higher risk premiums and reduced and high-cost financial support. However, our economy continued to record positive economic growth rates during this period, while the domestic inflationary pressures remain contained. Economic activity at home has been sustained by the fiscal stimulus and the preservation of relatively high consumer demand rates. In the meantime, investments and export demand have recorded lower growth rates in the first nine-month period.

At a global level, the second quarter of 2009 and the following period witnessed stable economic activity. Although the world economy continued to contract in annual terms, the consumed stock cycle replacement set a floor on the downturn of Euro area and US economies. Moreover, this cycle served as a short-term catalyser for the reactivation of their industry and production sectors. In a longer-term perspective, the stable economic activity of the Asian countries -China in particular,- and the global trade growth will fuel the global economic growth. However, the world economy path to a sound and stable growth is a long one. The existing model of global economy has relied on the high consumption and the severe debt situation of the USA, against an Asian countries’ strategy that favours exports and savings. Coupled with below potential economic growth and downward inflationary pressures for a relatively long period of time, the addressing of these imbalances at a global level requires time.

The global financial system, the capital markets, the banking sector and other financial intermediaries seem to be recovering. The monetary and fiscal stimulus has provided its effect at a global level, helping first the recapitalization of the financial system and restoring the lending system. Despite the high risk perception and low risk readiness across the financial agents, the resumption of global financial flows will provide assistance to emerging countries through higher available funds.

Amidst the global development challenges, the Albanian economy recorded positive economic growth during the first half of 2009. According to preliminary data reported by the INSTAT, the GDP grew at an annual rate of 5.3 percent in the second quarter, maintaining similar growth rates as in the preceding quarter. Activity in services provided the main contribution to the GDP growth. The production sector provided additional contribution to the annual GDP growth, mainly owing to the performance of the construction sector. By contrast, industry deepened the downward growth rates that began in early 2009.

The economic growth tendency, albeit at lower magnitude, is also present in several indirect indicators of the economy, namely the higher budget revenues, higher lending to the economy and more stable labour market indicators. However, these indicators, particularly monetary and business and consumer confidence indicators, reflect slower economic growth rates relative to the previous year.

In a macroeconomic context, the slowdown is mostly a reflection of the fall in investment and foreign demand, while consumption and public expenditure have led to higher economic activity.

The economic performance of the first half of 2009, albeit positive, attests to a slowdown of about 1.4 percentage points compared with the same period in 2008. In addition to the general slackening of global inflationary pressures, this situation has been translated into the gradual reduction of inflationary pressures on the Albanian economy. Average inflation marked 2.0 percent in January to September 2009, fully reflecting the exclusion of the first round effects generated from the rise in raw material prices during 2007-2008 and the cessation of effects arising from the latest administrative rise in the energy price. The downward trend of core and non-traded goods’ and services’ inflation attest to the fact that the inflationary pressures generated from the domestic demand-side are subsiding. On the other hand, the relatively strong depreciating movements of the domestic currency, the ALL, during 2009 have pushed the traded goods’ inflation higher to about 3.1 percent in the third quarter. Developments in the labour market and wages do not signal higher future inflationary pressures on the supply-side. Unemployment rate was 12.7 percent in the first half of 2009, similar to the year-end 2008 level. For the same periods, the growth rates of average real wage in economy have been more contained.

The Bank of Albania forecasts and the anchoring of economic agents’ expectations for consumer prices support the preservation and firming up of consumer price stability in the medium run, expressed in low and stable inflation rates.

Current account deficit narrowed slightly by 1 percentage point y-o-y in the second quarter of 2009, reflecting slower imports and exports in the Albanian economy. In the meantime, workers’ remittances have reduced at relatively lower rates than in the preceding quarters. However, the current account deficit remains high, reflecting the high levels of consumption in the Albanian economy and the unfeasibility of the production capacities at home to meet it. Privatization receipts and the public sector’s foreign currency borrowing led to a positive balance of payments; however, its future stability should rely on longer-term factors.

The government ran an expansionary fiscal policy in the first eight months of 2009. In annual terms, budget expenditure increased by 23 percent, reflecting primarily the rapid increase of capital expenditure. Budget revenues maintained a slower rate than expenditure due to the slower economic growth rate during this period. Consequently, the additional budget expenditure was financed through the use of privatization receipts and the higher public borrowing. This policy has exerted pressure over the increase of Government debt securities’ interest rates of long maturity term.

The influence of fiscal policy on the domestic monetary markets was more moderate during this period since the public debt was to a large extent borrowed from the international capital markets. However, the future persistence of this policy will face less funding potentials of both the Albanian and the international market. This fact calls for the quick return to the consolidating trajectory that the fiscal policy pursued in the pre-crisis years.

The monetary indicators of the third quarter of 2009 attested to the slow money growth tendency. Money supply, M3, recorded an annual growth of 4.5 percent in August vis-à-vis the average growth rate of about 7 percent in the first half of 2009, owing mainly to the lower credit flows to the private sector. Deposits grew substantially in August – about ALL 25.4 billion in monthly terms – in line with their seasonal performance during this period of the year. As at end of period, about 70 percent of the total deposits’ stock growth was time deposits, hence signalling the higher confidence in the banking system.

Private sector credit maintained its slower growth rates in July and August 2009, reflecting both the tightening of credit supply and the contraction of credit demand. Coupled with the reduced use of capacities as reported by businesses in the Bank of Albania survey, this performance signals that the private sector’s investments in economy are downward. Banks continue to apply tight lending standards, while consumer demand and private sector investments have fallen.

In nominal terms, private sector credit grew by an annual average of 16 percent in June to August, markedly lower than the first five months’ average (29 percent). Despite the low growth rates, business credit provided the main contribution to the private sector credit growth, accounting for about 65 percent. The downward trend of credit attributes to the deceleration of foreign currency lending, whose growth rate was zero in August. In the meantime, ALL lending continued to maintain its average growth rate of 30 percent throughout the year 2009. As a result, the share of foreign currency credit in the private sector’s loan portfolio dropped to 67 percent. The understanding of the consequences of exchange rate movements and the greater tightening of lending for loans denominated in a currency other than that of the borrower’s income, caused the individuals to borrow less foreign currency credit than businesses.

The financial markets attested to an improved liquidity situation and the recovery of the agents’ confidence in these markets. The persistent Bank of Albania’s liquidity supply to the money market helped to calm the market participants down and to supply the market with funds, which served to the private sector’s domestic currency intermediation. The liquidity needs in the interbank market have been declining, hence exerting no pressure over the short-term interest rates. By contrast, the Government securities’ primary market experienced a reverse situation, with the T-bill yields of long-term maturity going up despite the ample liquidity. In September’s last auction, the 12-month yield was 9.40 percent, up by 0.64 percentage points from the year-end 2008.

The high risk premium on long maturity terms and the existence of a shallow financial market were the rationale behind the high Government securities’ long-term yields. On the other hand, the high yields attracted the individuals’ investment in this market, hence providing them with an alternative instrument to keep their savings and at the same time, increasing the share of budget deficit financing from this item. The individuals’ deposits held in the banking system have had a satisfactory return. Weighted average interest rate on ALL deposits marked 5.94 percent in August or up by 0.48 percentage points from the end of the second quarter. This increase led to lower intermediation cost for the ALL during the recent months. Interest rates on new ALL loans declined to an average of 12.86 percent in July and August, down by 0.79 percentage points from the average rate of the first half of 2009. The banking system’s inclination to relieve the cost of ALL loans is attested by the narrowing of its margin and the corresponding reference rate, the T-bills. The spread declined to an average of 3.6 percentage points in summer, from 4.8 percentage points in early 2009.

Going back to today’s decision of the Supervisory Council of the Bank of Albania, allow me to underline that the long-term development perspective of the Albanian economy is positive. Macroeconomic stability and the confidence in the Albanian financial system are the product of our responsible macroeconomic and financial policies undertaken continuously over the course of the recent years. Macro financial stability is a solid foundation for boosting the country’s development in the future.

This development will to a large extent depend on the capacity of the Albanian economy to attract funds, which will buttress its growth. The monetary conditions are relaxed in line with the dynamics of economic and financial developments in Albania, in our main trading partners and broader in the global economy. This decision represents a new incentive for the economic developments at home, aiming at reducing the financing cost of the economy further.

The performance of lending to economy will be of prime importance in the medium run. The Bank of Albania deems that the stabilization of the banking system’s liquidity and balance sheet indicators will pave the way for the lending process. In this context, the Bank of Albania has been engaged in an active role in terms of stimulating demand and supply with funds. The relaxation of monetary conditions will fuel the growth of business and consumer demand for funds, while the Bank of Albania’s injection of liquidity will assist the banking system in meeting the demand for funds in quantitative terms. The Albanian banking system should understand its role rightly and transmit the relaxation of monetary policy in economy completely and rapidly. On the other hand, a lower pressure of the fiscal sector over the domestic financial markets will in the future lower the risk premium in economy, will create more room for private sector lending and will facilitate the smoothing out of the interest rate curb in favour of lowering the cost of credit further. The efficiency of the monetary policy decision will depend on the market and its participants’ behaviour, wherein fiscal policy plays a key role.

In the long run, the attraction of foreign direct investments and other forms of stable capital inflows should be at the core of our development policies. These funds will not only improve the external position in terms of its stability, but also sustain the country’s long-term growth. Time is ripe for all the actors to carefully analyze the country’s economic growth model in the decade we are approaching. The future economic growth model should in particular consider the competitive advantages of the Albanian economy more, mitigating its reliance on short-term capital inflows and expanding the economic basis, which generates stable and long-term capital flows. In this context, the Bank of Albania remains committed to playing a key role in the periods to follow.

In compliance with our legal and institutional commitment, the Bank of Albania’s monetary policy will aim at creating the proper conditions for a balanced development, characterized by low consumer price inflation environment, moderate fluctuations of monetary indicators and sound macroeconomic agents’ balance sheets.