Interview with Gent Sejko, Governor of the Bank of Albania

1. ​​​How would you assess the flexibility of the Albanian economy in its ability to respond to consecutive national and global crises, such as the earthquake, the pandemic, and the crises following the war in Ukraine?

The Albanian economy has been resilient toward the several crises striking over the past years, one after the other. Particularly, in regards to the earthquake in 2019, the Covid-19 pandemic in 2020-2021, and the economic impact following the war in Ukraine, which hit at the beginning of 2022 and is still present, its response has been satisfactory.

 

In a general view, the Albanian economy has succeeded to maintain the positive economic growth trend and the overall economic and financial stability.

If we scrutinize the situation a little deeper, the positive performance of the Albanian economy is evident in several dimensions:

• first, the persistent positive economic growth trend. The Albanian economy went into a recession in 2020, due to the social distancing measures undertaken during the pandemic, which were not related to the domestic economic trends. Nonetheless, it recovered quickly, fully, and comprehensively over 2021, and continued to grow with a relatively high pace over 2022, despite the external supply-side shocks and the tightening of the financial conditions. This performance testifies the breadth and strength of the growth sources, the effective response of the monetary, macro-prudential and fiscal policies, as well as the flexibility of our private sector;
• second, the positive growth trend of employment, unemployment and wages. The rising demand for goods and services after 2020, was accompanied by a fast rebound in employment, a fall of the unemployment rate to historical minimal levels, and a dynamic growth of wages in the private sector. This performance suggests that economic growth is bearing its fruits, from which a broader range of the Albanian society is benefiting, making this an encouraging development for the future;
• third, the lower fiscal weaknesses and those of the foreign sector. Public debt has been declining, the current deficit has reduced, foreign currency reserves have grown, and international agencies have not changed their credit risk assessment for Albania;
• fourth, the preservation of the monetary and financial stability. The banking sector enjoys good financial soundness indicators, and it continues to fund the economy. This sector managed a part of the financial cost caused by the shocks, and it continued to fund the Albanian enterprises and households. The financial environment is stable, with contained risk premia and interest rates which reflect an adequate price for the movement of funds in the economy. In particular, the exchange rate stability, despite the weight of global uncertainties, has partly cushioned external pressures and has supported financial sustainability. On the other hand, the rise of inflation has pushed the cost of life up, and became the main threat.

This performance was driven by several main factors such as: the right and coordinated choices of economic policies; the solid balance sheets and operational flexibility of private sector; coupled with the implementation of structural reforms in a timely manner; which enhanced the resilience of the banking sector against the shocks, and improved the monetary policy transmission mechanism.

These positive premises are expected to continue support economic growth in the future as well.

However, we are aware that 2023 will be a challenging year. Inflation and uncertainties are high, and the tightening of financing conditions are expected to decelerate the economic growth pace. However, as inflation simmers down and uncertainties peter out, we expect the economy to continue grow at a stable manner in the medium-term horizon. On the other hand, the resilience of our economy is enables the continuation of structural reforms, which will enhance the potentials and competitiveness of our economy. This will further strengthen the economy’s resilience against potential future shocks.

 

2. The banking system, on the other hand, how did they deal with these crises?

The banking sector has been quite good in facing these situations that the economy has experienced over the last years.  As previously emphasized, this sector managed a considerable part of financial costs caused by the shocks, yet it was able to guarantee the savings of enterprises and households, and it will continue to finance the expansion of consumption and investments.

As a result, I think that the banking sector has fully exercised its function as a shock absorber, and this provides another guarantee to our future economic resilience.

In more details, the banking sector appears liquid, well-capitalised, and profitable. In particular, the liquidity and capitalisation indicators of the banking sector (where the capital adequacy ratio recorded 18.1% at the end of 2022) are significantly above our regulatory requirements, illustrating the stability of their business model and a high degree of resilience against shocks. This performance shows both the effective exposure management by banks, and the timely creation of the necessary financial reserves that cushion their effects. 

I am confident that this prudential approach adopted by banks will continue to be present in the future.  The banking sector will continue to assess its resilience against adverse scenarios, and strengthen risk management systems. This process should aim to prevent significant exposures on both sides of the balance sheet, on one hand, and protect or strengthen the level of capital, on the other.

 

3. What role has the Bank of Albania played in facing these crises and what kind of weight is it holding? According to you, how effective is the intervention of the central monetary institution?

The objective of the Bank of Albania is the same: guaranteeing monetary stability and promoting financial stability. Fulfilling this objective during the past two crises, the pandemic and the war in Ukraine, has meant taking different paths to reach the same destination: the monetary and financial stability of Albania.

During the pandemic, we increased the monetary stimulus and launched a package of macroprudential, supervisory, and operational measures, which aimed at persevering financial markets’ liquidity, reducing the costs of borrowing, and maintaining a uninterrupted flow of crediting and financial services. Our response allowed for:  (i) the reduction of borrowing cost and the continuous support to households and enterprises with bank loans; (ii) the banking system to be liquid, well-capitalised, and equipped with robust risk management practices; and (iii) the reduction of uncertainty and the increase of trust in the future. Let me recall that the stable monetary and financial environment was one of the main factors that, first, contained the impact of the pandemic on the economy, and second, supported the economic recovery in 2021.

Upon the start of the war in Ukraine and the intensification of the overall inflationary pressures, we started the normalisation process of the monetary policy stance in order to prevent inflation from becoming persistent and damaging households’ savings, restraining the investment of enterprises, and threatening domestic stability. This normalisation is being realised through raising the policy rate and continuously communicating to the markets our firm willingness willpower to guarantee price stability. Our transparent communication has served to clarify the public on monetary policy forward guidance and has helped control the inflationary expectations. As a result of these measures, inflation has declined and is expected to return to objective in the next year.

Overall, I am confident that the actions undertaken by the Bank of Albania, besides being in compliance with its legal mandate, have had a positive contribution to the performance of the Albanian economy in facing these shocks.

 

4. What costs did these interventions and market developments incur on the central bank’ balance sheet?

The normalisation of the monetary policy stance at a global level, which was driven by the need to curb the fast rising inflation after the Russian military aggression on Ukraine, has had a negative impact on the balance sheets of all central banks, including the Bank of Albania. However, these financial consequences are inconsiderable when compared to the advantages of the normalisation of the monetary policy stance to the Albanian economy. In quantitative terms, they are marginal and transitory and absolutely unable to hinder central bank’s ability to fulfil its mandate. Overall, these consequences should be treated as a necessary cost that central banks bear for the general interest of the society.

In more concrete terms, the fast normalisation of the monetary policy stance over 2022, yielded negative financial results for the balance sheets of many central banks, such as the European Central Bank, the Central Bank of Germany, Bank of England, Bank of Netherlands, Bank of Belgium, Bank of Sweden, Czech National Bank, and regional central banks, including the Bank of Albania. These results originated from the faster decline in the value of assets compared to the value of liabilities of the central bank.

In practice this phenomenon happens in:

• periods when there is a fast rise of the policy rate, due to the fall in the price of securities that central banks hold in their balance sheet for implementing the monetary policy, and/or
• periods when the exchange rate appreciates, due to the depreciation of the national currency of the foreign exchange reserves that banks hold in their balance sheets for supporting the monetary policy and financial stability.

In the case of Albania, it seems that both these factors have contributed to a negative financial result in 2022, due to a deepening of the negative surpluses in the Revaluation Reserve of Foreign Currencies and Securities. More concretely, the rising interest rates in international markets has devalued the assets of the Bank of Albania, part of the Foreign Currency Reserve for the end of 2022, whereas the appreciation of the exchange rate has reduced the counter-value in lek of our foreign exchange reserves.

 

5. Is this a normal phenomenon for central banks’ balance sheets and could it have been avoided?

Central banks are institutions mandated by the law to formulate and implement monetary, supervisory, and regulatory policies, for safeguarding both price stability and financial stability of Albania. Also, the best world practices reckon that central banks have a high degree of financial and operational independence.

This institutional configuration has a twofold motivation. On the one hand, it creates the necessary preconditions for central banks so that their decision-making process is focused on the objective of achieving monetary and financial stability, instead of incurring financial costs on their balance sheets. On the other hand, it considers the fact that the necessary measures for achieving monetary and financial stability usually have a negative impact on central banks’ balance sheets, in the short term. Periods of monetary policy stance normalisation or rising policy rates, are typical examples of this contradiction. This normalisation is a necessary measure to control inflation and to preserve the value of savings of Albanians, although it always has a negative financial cost on central banks.

Concerning both these factors, it is important to keep in mind that:

• first, raising the policy rate was a measure necessary for the Bank of Albania to control increasing inflation and to support the overall economic and financial stability, in Albania.  Our assessments show that the level of prices at the end of 2024 will be around 13.5% lower, while rising interest rates are present rather than absent. Thus, the purchasing power of the savings of Albanian households at the end of 2024 will be around ALL 190 billion higher, which provides an important benefit to the society compared to the costs incurred to the Bank of Albania. Also, high inflation would have damaged the financial stability of Albania, threatening the soundness of banks’ financial balances sheets and social cohesion;
• second, the appreciation of the exchange rate has been overall positive to the soundness of public balance sheet and has supported the monetary and financial stability. Our assessments show that the appreciation of lek during 2022 has reduced the public debt by around ALL 37 billion over 2022. By also accounting the negative impact on the BoA's balance sheet, the appreciation of lek against foreign currencies has improved the public sector’s balance sheets by around ALL 23 billion. At the same time, a stronger exchange rate for the national currency has helped in containing inflation (which signifies the need for a slower rise of policy rate) and has strengthened financial stability (through easing credit costs for borrowers in foreign currency, who receive their income in lek).

Against this backdrop, I would like to convey some important messages to the public:

• The policies implemented by the Bank of Albania are always drafted in accordance with our legal mandate and bring benefits to the Albanian society and economy;
• The impact of these policies on the BoA's balance sheet will continue to generate temporary negative costs, as well, but insignificant nonetheless in relation to the benefits;
• The negative financial costs are transitory, because they represent costs that stem from accounting principles, rather than final asset losses. These costs recover gradually with the passage of time and by re-investing assets at higher interest rates;
• Despite the temporary capital volatility, the Bank of Albania is - in any case - financially and operationally able to fulfil its mission.

 

6. Inflation, though slowing down, continues to remain high. How do you foresee its performance, regarding imported inflation and price increases caused by domestic factors?

Inflation has been positive during the last months. This indicator has started a declining trajectory since the end of last year, down to 7.1% during the first months of 2023.

The fall in inflation was dictated, mostly, by the drop in the prices of oil and commodities in the global markets. This trend is expected to continue in the future, reflecting the reduced bottlenecks in production and international trade chains, as well as the synchronized tightening of global monetary policies. In addition to these factors, the stability of the exchange rate is expected to help decrease imported inflation.

On the other hand, pressures from the domestic economy remain high, fuelled by an economic environment characterized by a steady increase in consumer demand, employment, wages and economic agents’ expectations for inflation above the target in the future. In this regard, the normalization of the monetary policy stance is expected to help in better balancing demand and supply in the economy and in reducing the pressures from the domestic economy.

Based on available information and in the absence of new shocks, we expect inflation to fall in 2023 and return to our 3% target in 2024.

 

7. The European Central Bank and the Federal Reserve have declared that they will continue the cycle of increasing interest rates, as long as inflation remains high. What is the BoA’s forecast on the intensity of interventions and in which direction?

Communicating the monetary policy is one of the most necessary, but also the most difficult, tasks of central banks. On the one hand, they want to guide the market on the future trajectory of monetary policy, in order to anchor public expectations and avoid unexpected events in financial markets. On the other hand, central banks want to avoid unnecessary commitment to a monetary policy trajectory, as it becomes more problematic and potentially more harmful in situations where uncertainty regarding future developments is high.

For this reason, the communication of our monetary policy has highlighted three main situations. First, the fact that inflation is high and that it is being supported from domestic factors, mostly related to the relatively stable aggregate demand and the increasing shortages that are being found in the labour market. Second, the fact that these high pressures dictate a more cautious approach of the monetary policy, which means that the normalization of its stance seems a necessary move to guarantee the return of inflation to the target and to support a stable and long-term growth of the country. Third, and no less important, the fact that future monetary policy stances will depend on new information, which will enable us to read in real time the balance of inflationary pressures and our decision-making.

In simple words, our monetary policy is not on autopilot. We have been and remain attentive to internal and international developments, which will dictate our reaction.

To be more specific, some of the main issues, which are and will remain in our focus, are:

• the strength and stability of the demand for goods and services and the stress it creates on the country's productive capacities. The higher these indicators are, the more necessary the further normalization of the stance of monetary policy becomes;
• inflation performance in our trading partners, and mainly in the euro area and regional countries. At the moment, external inflationary pressures seem to have peaked, but the risks have been and continue to be high;
• Size of reaction of the financial market and the Albanian economy in regard to the developments of the monetary policy so far. The higher their reaction to the normalization of the monetary policy undertaken so far, the less the need to intervene in the future;
• last, the coordination of our monetary policy with the fiscal policy in Albania and the monetary policy in the euro area and in the whole world. In principle, the higher the speed of fiscal consolidation in the country, the less need there will be for monetary policy intervention. In the same line, a strong divergence between the monetary policy in the euro area and that in Albania is not desirable, in the context of the stability of our domestic financial markets.

The Bank of Albania will continue to monitor all these indicators and will take care to formulate a monetary policy, which will enable inflation to return to the target, with the least possible cost on the long-term growth of the economy.

 

8. The euro currency reached its lowest level against the national currency in December 2022 and continues to be exchanged close to the historical low levels, although the current account balance has not seen any significant improvements over the past few years. In your opinion, which are the factors that influenced this strong depreciation of the euro currency?

The appreciating trend of the exchange rate of our domestic currency, lek, against the main currencies has a real basis. This trend is fuelled by both, the continuous improvements in the balance of trade and financial exchanges with abroad, as well as the strengthening of domestic financial stability and the reduction of risk premiums. The first factor follows an upward trend of foreign exchange inflows into the country, while the second factors helps increase the interest for preserving savings in our national currency.

In concrete terms, the current account deficit in Albania, reduced from 10.8% of GDP in 2014, to 5.9% of GDP in 2022. This significant improvement is dictated to a large extent by the growth of Albanian exports and, in particular, of income from tourism. The latter increased from EUR 1.3 billion in 2014 to EUR 2.8 billion in 2022. In parallel, foreign direct investments generated high and stable foreign exchange inflows. These investments fluctuated around 8% of GDP during the last few years, covering more and more the current account deficit. During 2022, foreign exchange inflows generated by the foreign direct investments, recorded an annual growth of 33%, reaching at EUR 1.4 billion, around 10% higher than the current account deficit.

As a result of these trends, the country's overall balance of payments has resulted in a surplus, which has been reflected in the increase in the supply of foreign currency in the domestic market and in the increase of the foreign exchange reserves of the Bank of Albania. At the same time, the growing of the confidence that the Albanian public has in its national currency has brought an increasing interest for savings in lek.

That being said, I think that the exchange rate performance is an indicator of the structural improvements that have taken place in the recent years, and also an important anchor of the country’ s monetary and financial stability.

 

9. In January, for the first time after many months, non-performing loans trended upward, while the increase in interest rates is containing lending. What way is the banking system expected to be affected by the high-interest rates?

The decline in the NPLs ratio has been happening for years. This trend continued even after the pandemic, when the measures taken within the framework of the inter-institutional plan, as well as the careful management and supervision of the Bank of Albania, managed to mitigate the immediate and expected second - round effects of shocks. Achieving the level of 5% at the end of 2022 was as a result of several years of interaction of banks operating in Albania, where the incentives given were effectively used by the banks, while the impact of other actors – such as the companies that buy non-performing loans, which have come to the aid of this process in other countries - was not very present in the case of Albania.

The increase in interest rates naturally contracts the demand for loans and affects the financial flows of existing borrowers. The Bank of Albania is aware that banks may face an increase of non-performing loans, due to the increase in loans instalments and the insolvency of borrowers to meet their liabilities.

For this reason, in September 2022, through a proactive approach, a process of communication with the banks began to ask them to carry out internal analysis on the possible impact that this situation could have on their financial statements. Likewise, banks were also asked to draw up internal plans to manage the insolvency of customers, as well as to build internal financial capacities to preserve the soundness of economic indicators.

The stress tests suggests that the overall rise in interest rates may be reflected in a slight increase of the NPLs ratio. However, this increase will neither affect the stability of the banks nor their ability for financial intermediation. The progress so far, despite the increase of non-performing loans in the first two months of the year, is below our expectations. However, the Bank of Albania will carefully monitor and take timely appropriate measures to guarantee the soundness of the banking sector.

 

10. The International Monetary Fund (IMF) in its latest statement warned us on the risks that the financial system may be faced with, as a result of the crisis that the real estate market is experiencing. Given the high pace of construction, do you think there is a risk of a real estate bubble? If so, is the financial system prepared and cushioned to face it?

Prices of the real estate market increased rapidly, mainly for residential housing, during the last 4-5 years. This performance has been driven to a large extent by the increase in demand for it, but it has also reflected the increase of construction costs. This phenomenon has been present in the Albanian and in the global market as well.

From the perspective of the BoA as a supervisor and regulator, the banks’ exposure to the construction sectors is controlled. This exposure takes the form of financing the purchase of or developing real estates, as well as accepting them as collateral. In the first case, the direct or indirect exposure of the bank loan to the price performance in the real residential construction accounts for a relatively small part, although not negligible, in the total loan portfolio. In the second case, we find that the collateral coverage ratio of the loan offers high flexibility margins for the sector.

For these reasons, we estimate that the banking sector's exposure to real estate prices is contained. The relatively limited size of bank loans for real estate and the strong standards that banks are applying in lending practices, significantly mitigate the risk that the banking industry may face from potential changes in the current trends observed in this market.

However, the Bank of Albania is continuously analysing developments in the real estate market, as well as carefully monitoring the exposure of the banking sector to this market. Improving the monitoring and risk management framework in this regard is the focus of our work. At the same time, we are also working on developing the necessary instruments to address any possible contingencies.

 

11. What role are central banks expected to have in the future and what is their level of adaptation in an environment that continues to appear challenging?

The primary task of central banks has been and will continue to guarantee monetary and financial stability, as an indisputable prerequisite for a sustainable economic growth and for the increase of the overall well-being of the society.

In nowadays situation, characterised by unprecedented negative supply shocks for consecutive decades, this role become quite challenging. The central banks’ monetary policy should work on, on the one hand, creating the necessary monetary premises for reducing inflation and returning in to the target, and, on the other hand, avoiding or minimizing the impact of these measures on the economic activity. Speaking long-term, these two objectives do not conflict each other. In the short and medium term, they definitely relate indirectly. So far, I think that the normalization of monetary policy, both in Albania and abroad, has been the right action, at the right time and with the right energy. Central banks however, must continue to be cautious and carefully monitor the economic dynamics, in order to timely adjust the monetary policy to a constantly evolving reality. This process requires strengthening of the monitoring, analysing and forecasting capacities of these institutions. It also requires cautious and transparent communication with financial markets and the general public.

In parallel, central banks should increase their attention to the overall financial stability and soundness of the banking sector’ balance sheet. It is no secret that the fast upward trend of interest rates in the world is an unprecedented development for more than a decade. Our duty is to comprehend the consequences they have on markets and financial indicators and take the necessary corrective measures in a timely manner.

However, I am convinced that the Bank of Albania will know how to rise to the height of these challenges. The continuous investment we have made in building institutional capacities, illustrated by the results of our work so far, is a solid guarantee for the fulfilment of our objectives.

 

12. Recently, global financial systems are under pressure, as a result of bankruptcies and issues with some banks. Is it possible for this risk to be present in Albania, and is the domestic financial system safeguarded anyhow?

First, let me emphasize the fact that the Albanian banking sector has had a negligible exposure to banks that have had problems recently (in particular, Silicon Valley Bank and Credit Suisse).

Second, in a more general plan, the Bank of Albania regularly carries out stress test exercises, to monitor the resilience of the banking sector against possible shocks. Our analysis shows that the banking sector can withstand the inherent potential decline in the value of the foreign securities portfolio and still remain well-capitalized. This consistency is high at the system level and more than sufficient at the level of individual banks.

In general, we estimate that despite all the stress that the international financial markets are currently experiencing, the reforms undertaken to strengthen the capital and liquidity of financial institutions (banks and non-banks) after the Global Financial Crisis of 2007-2008, as well as the flexible mechanisms available to the supervisory authorities and central banks for addressing eventual shocks, provide security for coping with the situation created in global markets. These improvements have been replicated in our country, where we highlight the strengthening of capital and liquidity requirements for banks, as well as the completion of the legal and regulatory framework for liquidity support actions or for supervision and the creation of a special fund. These developments have enabled the banking sector and the financial system as a whole, to cope with some stress situations, such as the Greek crisis; non-performing loans and the impact of the pandemic, without significant issues or obstacles.

In the framework of capacities strengthening, the Bank of Albania remains willing to cooperate with international financial institutions, and here I would like to mention our constructive and sustainable cooperation with the International Monetary Fund and the European Central Bank.