The meeting of the Supervisory Council of the Bank of Albania on 29 September 2008

Publication date: 29.09.2008


The Supervisory Council of the Bank of Albania, in its meeting on 29 September 2008, reviewed and approved the "Monetary Policy Statement for the first half 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%.

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

Governor's Speech

The recent developments attest to further deepening of the U.S. financial crisis, peaking in the last weeks with the collapse of one of the largest investment banks Lehman Brothers. Prior to this startling failure, the two U.S. mortgage giants, Freddie Mac and Fannie Mae, were subject to an unprecedented and costly rescue plan designed by the U.S. Treasury Department. In fact, this has only been one of the U.S. authorities' interventions, followed by a number of other actions, involving the AIG insurance company, Merryl Lynch and in particular the plan announced on 21 September 2008 for the creation of a 700 billion dollars fund for the purchase of mortgage-related assets.

This crisis which is characterizing the global economy for more than a year has caused many reputable international financial institutions to experience large financial losses. The situation remains unclear and the spreading process of its undesired effects may also be present in the months to follow.

U.S. crisis and its combination with a number of other global developments have caused the economic situation in developed countries to be characterized by numerous uncertainties. Inflation has now turned into a concern for most international economies, mainly reflecting the surge in prices of raw materials, oil and food. Economic growth in developed economies has shown distinct signs of slowdown. Economic growth for the Euro area shrank by 0.2% in the second quarter of 2008 relative to the first quarter of the same year. Meantime, the U.S. economy is expected to continue to grow at slow rates during the second half of the year.

Under these circumstances, there has been high tension in the markets being mainly reflected in the dropping value of financial assets, changes in the prices of raw material and commodities, contracted house prices and the increase in the interest rates spread. In response to this situation, the largest global central banks have taken co-ordinated measures to relieve the markets by mainly injecting large amounts of liquidity. However, in their last meetings, both the Federal Reserve and the ECB kept the key interest rate unchanged at 2% and 4.25%, respectively.

With respect to internal developments, year-on-year inflation dropped to 2.5% in August 2008, being in line with the previous projections of the Bank of Albania. The eighth-month period of January - August 2008 was characterized by considerable fluctuations of the year-on-year inflation rate which marked an average of 3.8%. Since August 2007 to June 2008 there have been negative developments in this respect, causing the inflation rate to remain above the upper tolerance band of 4%. The price rise of food and oil in the global market, the performance of agricultural production in 2007 and the price rise of energy in March 2008 represent some of the main causes to explain the inflation increase during this period.

Headline inflation and other measures of core inflation have shown a downward tendency in the last two months. Supply-side factors which pushed the increase of inflation in the previous period reduced their effect in July and August. Weather conditions during the present year have been encouraging, causing the domestic supply of agricultural production to grow. Seasonal effect generated by the entry of domestic agricultural production was more considerable relative to the previous year. Oil and grain prices in the global market have been falling in the last two months. The projections of the Bank of Albania staff indicate that the inflation rate will remain in the following 12 months at around 3%, which is also our quantitative objective.

Despite this, worth to note is that the risks for its upward deviation are still present and they mostly relate to the international developments. However, plausible risks are present in the internal developments and they will be constantly subject to analyses of the Supervisory Council of the Bank of Albania. Any unwelcome developments in the energy situation in the months to follow, the rapid growth of credit to economy and other possible fiscal implications in the future represent the main risks in this context.

Statistical monitoring of the Albanian economic activity continues to reflect difficulties. According to the data made available for the first quarter of 2008 and some other indirect indicators covering the 6 and 9-month period (growth of exports, growth of budget revenues, hydro energy situation and some other consumer indicators) it may be concluded that gross domestic product will grow in line with the previous projections by 6%. However, more statistical information is required to make a more detailed and comprehensive sectoral analysis.

In contrast to the previous two years, budget revenues followed a different trend in the first half of 2008, being mainly manifested in a more rhythmical spending. Unlike the last two years, budget balance ended negative, 2.3 billion leks, which is far behind the projected level of 18 billion leks. Budget revenues continued the previous months' trend, exceeding the planned target by about 3% in the first half of 2008. Expenditures accelerated their meeting rates, in particular in the end of the six-month period, and met 92% of planned target. Domestic borrowing represents the main instrument of budget deficit financing, sharing 90% of total borrowing.

The first half of 2008 recorded a 60% growth of current deficit in annual terms, which amounted to 591 million euros. Consequently, it accounts for about 13% of the GDP. The high trade deficit, which has provided the main contribution to current deficit deepening during this period, was also followed by the deficit on trade in services and the narrowing of net current transfers' surplus. The Bank of Albania is monitoring prudently the developments in the external sector of the economy, which for the moment remain a concern in terms of long-term developments in economy. The main implications relate among others with the financial stability in the country, while their source relates with the imposed correction of long-term ratios within a short period of time.

Demand for money in economy has grown at a stable rate by an average of 12% in annual terms during 2008. Credit to the private sector dominates the money growth in economy, while credit to the public sector still remains at modest levels, accounting for only about 2.5 percentage points of M3 annual growth. In terms of constituent components of money supply, its most liquid part, currency outside banks, continues to grow at slow rates, while deposits show high growth rates. Being mainly pushed by the marketing strategies of the banking system applied during summer 2008, annual growth of lek and foreign currency-denominated deposits was 11.2% and 30%, respectively. During the last two months, their time structure has shifted to time deposits, being mainly reflected in the growth of households' time deposits.

During the seven-month period of 2008, credit to economy continued to grow at an average annual rate of 45.5%, accounting for 34% of the GDP and 45.3% of (M3) broad money. Credit growth rates have generally followed the downward trend of the last two years, except for June and July which recorded higher growth rates relative to the previous months.

Composition by currency continues to maintain the same structure, with foreign currency-denominated credit sharing the main weight. In average terms, during the first seven months of 2008, credit denominated in foreign currency accounted for about 72% of credit portfolio or about 2 percentage points more than the 2007 average.

Credit to the private sector recorded an average annual growth by 41% in the first seven months. Business loans provided the main contribution, out of which the sectors of trade, construction and industry shared 77% of loans extended to businesses. In annual terms, household loans grew by an average of 51% during January - July 2008. Despite this figure, the two-month period, June - July, showed a slowdown for this type of loan. On the other side, real estates loans, which account for about 66% of household loans, maintained the high growth rates providing the main contribution to the growth of this portfolio.

During 2008, the interest rates in the money market increased in line with the monetary policy orientation. In average terms, overnight interest rate in the interbank market increased by 80 basis points relative to the previous year, to 5.6%.

The oscillations of interest rates in the interbank market related to the change of liquidity conditions in the market and to its asymmetrical distribution. The beginning of the third quarter was followed by the relief of the liquidity situation and a more balanced distribution being reflected in the downward performance of overnight interest rates to 5.6% at the end of August.

The primary market showed low oscillations of the yields during 2008. They have gradually transmitted the tightening of monetary conditions signalled in the second half of 2007 while the spread between the maturities has narrowed.

Long-term yields in the bonds' market show a narrowing trend of spreads between maturity terms in the last two years. 2-year bonds which have a higher (monthly) frequency in average terms have increased slightly during 2008 relative to the previous year, while the yields for other maturity terms have been decreasing. As of end August, 2-year bonds' yield stood at 8.3% or 0.06 percentage points higher than last year's average, while 5-year bonds' yield dropped by 0.76 percentage points to 9.06%.

The interest rates for credit denominated in foreign currency have been in line with the developments in the global markets and in proportion to the changes in LIBOR and EURIBOR. The interest rate of euro-denominated credit was 8.15% in July, dropping by 0.35 percentage points relative to June 2008.

Intermediation rate in the banking system has dropped in average terms. With respect to lek, it is shown that the spread between the weighted-average interest rate of lek-denominated deposits and lek-denominated credit has dropped to 7.56% in the first seven months from 9% the same period the previous year. In addition, average intermediation rate for the euro has dropped by 0.82 percentage points to 4.44% relative to the first half of 2007.

The appreciating tendency of the lek against the main foreign currencies shown in the first two quarters of 2008 continued in the third quarter although at more moderate rates. In nominal effective annual terms, the lek has appreciated against the euro and the U.S. dollar by an average of 2.63 percentage points. In annual terms, nominal exchange rate of the lek against the euro and the dollar has appreciated by an average of 0.75% and 9%.

Monetary developments should not be analyzed separately from the factors establishing the financial system's stability. With regard to the latter, I would like to underline that the financial system in Albania has developed at stable rates in the first half of 2008. Capitalization indicators of business, liquidity and profitability are at satisfactory levels. Given the increased importance of these indicators and in light of the recent developments in the international financial markets, the Bank of Albania has expanded the information sources in terms of deepening the analysis of the stability of the financial system and in particular of the banking sector, endeavouring to identify in advance the possible risks and propose measures to prevent them.

In general, the abovementioned situation contains, in addition to positive developments, some old and new risk factors which affect both the monetary developments and the financial stability. In case of materialization, they may compromise the achievement of the Bank of Albania objective mandated by law. This setting imposes the need for greater prudence in assessing and analyzing these factors and in the decision-making process.

In conclusion, I would like to highlight that the Bank of Albania has preceded the latest developments in the Albanian banking system by taking a number of structural reforms which aim at ensuring its smooth functioning and maintaining the financial balances. During the last year, the Bank of Albania has focused on improving the technical and legal infrastructure of the banking system. The establishment and functioning of Credit Registry, the review of credit regulations in view of enforcing the prudence norms for foreign currency-denominated loans and the review of regulations on interbank loans in view of itemizing the ownership titles, are important reforms which sustain the stable development of the financial system.

On the other side, the establishment of specialized structures, namely the Committee for the Implementation of Monetary Policy and the decisions made by the Supervisory Council of the Bank of Albania, have provided a direct contribution to maintaining macroeconomic balances and the financial system's stability. The effects of the increase in the cost of money have driven more contained credit growth rates and more appropriate proportions of its foreign currency structure. Lately, the Bank of Albania has established a fruitful co-operational relationship with the supervisory authorities of the international financial system and other central banks, in terms of exchanging information and analyses on the latest developments in the global financial system and on their implications.

Even though the maintenance of macro-financial balances is ever-increasingly becoming challenging, on behalf of the Supervisory Council of the Bank of Albania I would like to clarify to the public at large that the maintenance of price stability and the strengthening of financial stability remain the Bank of Albania's priority objectives and that we will be fully committed and willing to achieve them.