On the meeting of the Supervisory Council of the Bank of Albania on 26 November 2008

Publication date: 26.11.2008


The Supervisory Council of the Bank of Albania, in its meeting on 26 November 2008, reviewed and approved the "Monetary Policy Report for the third quarter of 2008". After analyzing the economic and financial situation, the Supervisory Council of the Bank of Albania decided to keep the key interest rate unchanged at 6.25 percent.

Please find below the speech of the Governor of the Bank of Albania, Mr. Ardian Fullani.


Economic activity during the third quarter the present year has been carried out amidst strained settings in the developed countries' financial markets and economies. The turmoil the financial markets went through is being translated into the deceleration of consumption and investments, which in turn generate the slowdown in economic growth and the upsurge in unemployment in many developed countries. Despite the financial markets' strains and the first signs of global economic slowdown, the Albanian economy has been relatively resilient during the third quarter. According to the available data, economic growth at home has progressed in line with the projections, inflation remains at contained rates and within the Bank of Albania target. In addition, the Albanian banking system is presented sound and stable and adequately capable of carrying out its financial intermediation function. Taking note of the increasing public interest in the stability of the Albanian financial system, the Bank of Albania remarks that the economic agents' confidence in our financial institutions and their products has been intact.

Under these global circumstances, the economic developments in the past months have been characterized by a vague situation in the monetary and financial markets and institutions. Global economy has been swept by an upward uncertainty during this period while the financial crisis has been extending further being reflected - through the contraction of lending and the reduction of consumption and investments - in the real economy as well. The end of the third quarter and the first months of the last quarter found the economies of developed countries - USA, Euro area, England and Japan - in a deep economic crisis, which is anticipated to extend its effects to the following year as well. While the supervisory, monetary and fiscal authorities of affected countries have at a national or international level launched co-ordinated or one-sided emergency measure to cope with its immediate effects, the professional consensus converges to characterizing this crisis as one of the most severe of post-war period.

Sub-standard mortgage loans-related troubles during the past 12 months manifested their real extent during the third quarter. The collapse of one of the largest investment banks, Lehman Brothers, served as a signal for a chain reaction in the financial markets. The following events proved that many innovative financial products were invented and launched into the market skipping all the testing mechanisms and without being entirely acknowledged by the market agents. They were market priced based on a wrong perception of the risk, in particular of the counterparty risk. The awareness for the nature of this type of risk increased the uncertainty in the financial markets, yielding large disruptions and the virtual cessation of the lending system, which is the backbone of a functional and free market economy. The resetting into operation of the lending system required massive fiscal interventions, high liquidity injections from the central banks, the partial nationalization of some financial institutions and the state guaranteeing of financial institutions' obligations. Although reactive and often uncoordinated, these measures proved successful in revitalizing the financial sector and re-establishing the public trust.

The challenge of coping with the economic growth contraction remains open. Euro area countries have now confirmed the economic growth slowdown and have revised downward the economic growth forecast for the last quarter and the year 2009. GDP continued to drop by 0.2 percent in the third quarter compared with the previous one, as a result of the fall in domestic demand, exports and investments. A similar setting, characterized by an economic decline and increase in unemployment during the quarter, was also noted in the economies of the US and England. On the other side, the marked decline in food and raw materials' prices has helped to ease the inflationary pressures on these economies. In October, Euro area inflation marked 3.2 percent from 3.6 percent the previous month. The fall in consumer prices is expected to persist in the following months as well, causing the monetary policy to shift its focus to preventing deflationary situations and boosting economic growth. In their efforts to ease the pressures on the markets and better fine-tune the monetary conditions with the moderated inflationary pressures, the main central banks, including the Federal Reserve, the ECB and the Bank of England, lowered the key interest rate on 8 October 2008. Following that, these banks lowered again their interest rates, the Federal Reserve and the ECB by 50 basis points, while the Bank of England was more aggressive lowering it by 150 basis points.

While developed countries were experiencing hard times, emerging countries have by and large shown resilience to this crisis' consequences. Their immunity attributes to their incomplete financial integration with the developed countries, and to the fact that their economic growth is ever-increasingly being supported by domestic factors. The same setting is also confirmed for neighbouring countries which have not been affected by the first wave of global financial crisis, while their domestic demand remains high.

The performance of the Albanian economy for this quarter has been characterized by features comparable with those of the emerging countries. Albania has shown resilience to the financial markets' turmoil and the pessimism that has accompanied the large economies, some of which Albania's trading partners. The available data show that economic activity for the first nine months of 2008 has been in line with the projections, macroeconomic balances remain stable and the banking system maintains its soundness. Economic activity at home maintained an upward trend during the second quarter of 2008, being evidenced in the high annual increase of turnover indicator. The positive indicators of credit and sentiment indices show that the same performance was also maintained in the third quarter. Services and the trade sector in particular continued to provide the main contribution to the annual increase of turnover indicator. In addition, the high contribution of construction sector continues to dominate the expansion of production activity at home.

Following the increase in the first half of 2008 beyond the threshold of 4 percent, the annual consumer price increased by 3.0 per cent in the third quarter, which is fully in line with the Bank of Albania's price stability objective. CPI inflation dropped in October to 2.7 percent. The inflation rate drop for this period was fuelled by the moderated aggregate supply-side shocks, in the form of high food, oil and raw materials' prices in the international market. On the other side, more specific indicators of inflationary trends - core inflation for instance - show that macroeconomic balances at home and the monetary conditions have been adequate to warrant an inflation rate close to the Bank of Albania target. The inflationary expectations of economic agents, which have been anchored to around 3 percent, have also provided their positive contribution. These developments attest to the fact that the monetary policy tightening and the strengthening of supervisory measures by the Bank of Albania have been efficient steps in containing inflationary pressures. The assurance of a more contained credit growth rate, the generation of a more proportionate ratio of consumption and savings incentives and the support to demand for ALL-denominated financial assets have proved to be fundamental contributions of the Bank of Albania monetary policy to the country's economic development.

The positive performance of economic sectors and the economy in general has been propelled by the positive rates of domestic demand at home, while the latter has been favoured by the macroeconomic and financial stability of the Albanian economy. The low inflation rates and the anchored inflation expectations have expanded the decision-making horizon of economic agents and have generated a more efficient allocation of financial resources. On the other side, the expansion of the banking system network, the decline in the intermediation costs and the wider range of banking services have provided better support to the economy with credit. Outstanding loans grew by 29 billion leks in the third quarter of 2008, hence maintaining the high annual growth rates of 43 percent. As a share of GDP and the system's assets, loans have recorded further growth to 36 percent and 41 percent, respectively. Foreign currency-denominated loans continue to provide the main contribution to the growth of loans being pushed by the positive interest rate spread of ALL loans to foreign currency loans. Businesses were the main banking loans' users, accounting for 66 percent of loan portfolio growth. The distribution of lending by sectors of economy attests to the fact that the loan portfolio is dominated by lending to the sectors of trade (24.8 percent), construction (14.7 percent) and industry (15.5 percent). The growth rate of households' loan portfolio has reduced to 41.0 percent from 67.7 percent for 2007, owing to the contained annual growth rates of consumer loans. Households' portfolio has shifted to housing loans which accounted for 66 per cent of this portfolio in the third quarter.

Fiscal policy has provided a more uniform contribution during 2008 to buttressing domestic demand. Fiscal balance ended in a deficit during the first months of the present year, mainly as a result of the higher pace in capital expenditures, which is different from the previous two years' performance. Budget expenditures and revenues were met by 98 percent and 94 percent, respectively, of the first nine-month plan, recording high increasing rates. The fiscal policy pursued during the entire year 2008 has observed the targets set in the Medium-term Budget Programme for 2008-2010; consequently, it has not yielded any repressions in economy and performance of prices.

Foreign demand, materialized in the balance of goods and services trade exchanges with abroad, remains at negative levels. Trade deficit accounted for 22.7 percent of the GDP in the third quarter, increasing slightly compared to 21.6 per cent the previous year. Imports grew by 17.2 percent, while exports grew by 21.9 percent. The deepening of trade deficit owes to a large extent to temporary factors and to the deterioration of trading terms as a result of the risen price of energy and food products in the global markets. The import of minerals, fuels and energy', including fuels, accounted for 20.6 percent of total imports. Excluding the imports of this item, the annual growth of the import of goods would have recorded 13.1 percent, while trade deficit as a share of GDP would have been 18.7 percent. However, the deep trade deficit remains an issue which requires special attention in the context of the stable economic development in the long run. While the trade and current account deficit is a normal phenomenon in emerging economies, the generation of stable foreign currency resources in the form of exports and foreign direct investment needs to be a priority of economic development policies. In addition, the structure of exports by trading partners attests to a high concentration of exports with EU countries (76.33 percent); hence, exposing our economy to oscillations of demand in these countries.

Demand for money in economy has maintained average rates in the third quarter - around 14 percent - being mainly pushed by private sector lending. The growth of M3 aggregate mainly attributes to foreign currency-denominated deposits which recorded an annual growth of 26 percent in September. Narrower money aggregates, M2 and money base, recorded in September an annual increase of 9.6 percent and 4.8 percent, respectively.

The financial markets have not been affected by the turmoil in global or European financial markets. This performance does not only attribute to the low integration level with the European markets and to the orientation of the Albanian banking system to financing the internal activity, but also to the prudent Bank of Albania supervision. Being the monetary and supervisory authority of the banking system, the Bank of Albania has been particularly prudent in terms of meeting the system's liquidity needs and constantly monitoring the performance of banks' financial indicators. To this purpose, it has conducted open market operations and injected liquidity for longer periods and beyond the banks' anticipated needs.

The interest rates in the interbank market increased in September and October, a period during which the change in the required reserve was met. On the other side, the interest rate fluctuations in the interbank market also relate to the features characterizing this market, such as the asymmetric market distribution and the hesitation to trade in maturities of longer than one week. Interbank market fluctuations have not been transmitted to other markets, which in contrast have been characterized by decrease in interest rates. T-bills' and bonds' yields in the primary market have confirmed their downward trend which commenced in the second half of the present year. The spread between maturities has narrowed, reflecting the improved market agents' expectations of inflation, the enhanced confidence in these debt instruments and the monetary policy efficiency. Following the considerable increase of deposits' interest rates in summer as a result of banks' aggressive market strategies, they dropped in September once the offers terminated. Interest rates of ALL loans have shown a downward tendency in 2008. Combined with the increase of ALL deposits' interest rates, this performance attests to the improvement of the intermediation rate. The spread between ALL and EUR interest rates has shown a narrowing trend since the latter have increased in line with the performance of foreign currencies' interest rates in the international markets. Despite the historical developments in foreign currency loans, lending in currencies other than in lek has been contained in the last two months as a result of the strengthening of supervisory measures.

Concluding, I would like to underline that the period to follow will present major challenges to the Albanian economy and the decision-makers.

Economic crisis recovery at a global level requires time. Revitalization of domestic demand, the increase in employment and the development of the economy at the level of its production capacities remain constant challenges to the political authorities. Its solution will materialize through the resetting of a number of internal and external economic balances, the re-arrangement of many supervisory institutions and the re-design of the regulatory framework on many financial market segments and on their managers' incentives systems.

The Albanian economy has not been affected by the financial turmoil or recession that has gripped the developed countries. The Albanian banking system has not invested in any toxic securities of developed markets, while its internal activity remains sound. The ongoing supervision conducted by the central Bank of Albania is an additional safety element that this system will continue to operate within normal parameters. Safeguarding financial stability is a permanent objective of the Bank of Albania, which carries out its mission through its traditional role as the lender of last resort and through the constant improvement of legal and institutional infrastructure of the interbank market functioning. The fiscal authorities' commitment to facing any plausible events in this context completes the safety network package.

In an economic context, Albania may be faced with more difficult conditions in terms of financing the economic activity. The fall in foreign demand, remittances and foreign direct investments may yield a lower growth rate during 2009; however, their levels will remain at acceptable figures. In addition to the not too high integration levels with the global markets, the resilience shown by the Albanian economy to foreign shocks attributes to the economic stability at home and to the anchored expectations of economic agents. Therefore, the Bank of Albania believes that the decision-makers' attention will focus on maintaining macroeconomic balances. Fiscal policy should be anchored to a fiscal rule, which will orient fiscal performance and set clear quantitative criteria for coping with the various shocks. The Bank of Albania will continue to have as its key priority the preservation of price stability in economy, close to our 3 percent target of annual consumer price increase. We believe this is the best contribution monetary policy could provide in terms of economic growth and wellbeing in the medium and long run.