First Deputy Governor Gjoni: Interview for Monitor

Publication date: 21.05.2018

  1. What is the aim of the de-euroisation strategy and why was it introduced exactly now? Are there any other countries with a similar strategy?

Albania is a country with a high euroisation level.

This is empirically certified in various researches carried out by both national authors (including from the Bank of Albania) and international ones. These researches confirm the public’s preference to hold a considerable part of assets and liabilities in foreign currency. This is directly reflected in the assets and liabilities of the banking sector, where credit in foreign currency (public’s liabilities) and deposits in foreign currency (public’s assets) are relatively high. Also, studies evidence the presence of monetary and real euroisation. In other words, this means that the foreign currency serves as a means of payment for financial transactions, or prices on some products/goods (mainly durable and high values ones) and the wages in certain sectors or levels are paid in foreign currency (euro) or are indexed with its exchange rate.

The high euroisation in an economy drives to long-term negative consequences on the effectiveness of economic policies and exposure to risks.

In terms of macroeconomic policies, a high level of euroisation:

  • leads to the reduction of the monetary policy effectiveness,
  • limits the role that of the free exchange rate, as an automatic stabilizer in the case of macroeconomic shocks, given the high sensitivity of economic entities to large exchange rate volatility;
  • undermines the fiscal policy effectiveness through a possible increase in the cost of debt servicing and unwanted change of its structure;
  • usually comes with a cost for the central bank in the form of opportunity cost for maintaining a relatively high level of foreign exchange reserves and for the loss from seigniorage, which is associated with the replacement of the domestic currency by the foreign currency

In terms of financial stability, a high level of euroisation:

  • increases the exposure of the financial system and economic operators to unfavourable developments in the exchange rate;
  • increases the liquidity risk and affects the ability of the banking sector to carry out financial intermediation and support economic growth;
  • exposes the financial system to liquidity risk in foreign currency, when the central bank instruments for supporting liquidity in foreign currency are objectively more limited.

For these reasons, the de-euroisation process has been supported by the authorities of both the European Union and the European Central Bank. This is the case not only for Albania, but also for some regional countries.

In our assessment, this is the right time for this strategy.

The reasons are:

  • The presence of both economic and financial stability shows the public confidence in the national currency and helps to adopt more easily and strengthen the effectiveness of the measures. In case of shortfalls of these stable factors, then the lack of public confidence would make these measures ineffective.
  • The need to address some developments in the banking sector balance sheets, such as the fall in foreign currency lending or the high level of deposits in foreign currency. These tend to dynamically affect each other. Through these measures, we would like to control the performance of foreign currency deposits and to maintain lower levels of foreign currency lending, in particular lending to unhedged borrowers against the exchange rate risk.

This strategy takes on a long-term perspective and aims at strengthening the resilience of the whole economy.

The strategy for promoting the use of the national currency addresses a structural phenomenon of the economy and financial system in Albania. Our expectations, based also on the experience of other countries, show that the strategy effects will be gradually developed and become visible in the long term. The effects are expected to particularly appear in the banking sector. A better awareness of banks and their clients on the risks that accompany the unfounded activity in foreign currency, and the concrete regulatory measures, are expected to increase the preference for the domestic currency in both sides of the banking sector's balance sheet. Also, the purpose of the strategy is to increase the use of the national currency in establishing prices and in the trading of assets, and to promote the adoption of behaviours and use of instruments that mitigate this risk.

It should be highlighted that the effectiveness of the strategy will considerably depend on the adequate harmonisation of actions amongst public authorities. According to the Memorandum of Cooperation between the Bank of Albania, the Ministry of Finance and Economy and the Financial Supervision Authority, the parties are committed to undertaking concrete actions and monitor developments, in the respective areas of competence.

  1. In its framework, what are the concrete instruments that Bank of Albania will activate and for how long? What are the effects these measures are expected to bring about and what is the time span for their application?

On 7 February 2018, the Supervisory Council of the Bank of Albania approved the de-euroisation package in the framework of inter-institutional strategy “To strengthen the use of the national currency in the financial system and Albanian economy”. These measures were discussed in advance with the banking industry.

The approved package includes the policy document on increasing the use of the national currency in the activity of the banking sector and non-banking financial institutions that are supervised and regulated by the Bank of Albania, as well as the measures that will be undertaken this year in accordance with this policy.

In principle, this document defines the contribution of the Bank of Albania in the framework of this strategy and the manner the results of this contribution will be assessed.

The measures aim to render the use of foreign currencies less preferable, and also to raise the borrowers’ awareness regarding the risks associated with foreign currency borrowing. I would rather not enter into further details, but overall the measures consist in increasing the required reserve rate for foreign currency liabilities in the banking sector, and decreasing it for liabilities in lek; increasing the minimum regulatory requirement for liquid assets in foreign currency; providing in advance to the unhedged borrower an alternative loan in lek and to accompany the product with a concrete example on how the loan instalment changes in case of supposed exchange rate unfavourable volatilities. These are expected to enter into force after June 2018.

In the framework of the de-euroisation package and to assess the impact of the undertaken measures, the Bank of Albania will publish a half-yearly report, which monitors the performance of some financial indicators that reflect the levels of euroisation. The first report was published immediately after the approval of measures, while the second will be published in June 2018.

In addition to the close cooperation with the banking industry, the Bank of Albania used several channels of communication to make this strategy available to the public. Once approved, the strategy was published on our website. Also, we have informed the public about its objectives, the undertaken measures and the time horizon for the realisation of our expectations through press conferences. In compliance with the philosophy for dialogue, the Bank of Albania is always open to continuously discuss the above-stated issues.

  1. Recently, the euro has depreciated strongly and de-euriosation is thought as one of the reasons for this performance. How much of this is true?

To answer your question, we should distinguish the long-term trend of lek exchange rate, from its short-term fluctuations, and then focus on the de-euroisation effect on the short-term movement of the exchange rate.

In the long term, lek shows an appreciating trend, notably since 2015. We assess that lek exchange rate reflects stable economic developments related to:

  • Structural improvements in the Albanian economy, such as the expansion of exports base and improvements in tourism, which have driven to the narrowing of current account deficit, over time. Also, the way of financing this deficit, with stable flows mainly from Foreign Direct Investments, strengthens our assessment for these positive developments;
  • Decrease of preference of holding foreign currency assets, due to the rather low return rates for a long time. It is a fact, that almost for three years, investments in euro provide a negative return rate/ interest rate or (in the best case) close to zero, by considerably increasing the management costs of this portfolio from the economic entities, including banks. This seems to have affected the lowering of these’ entities’ preference to operate in foreign currency.

It is clear that the de-euroisation processes has not affected this long-term appreciating trend of lek, as the respective Strategy and the first concrete measures are approved in the period 2017-early 2018.

But, in the last months, an acceleration of lek appreciation against foreign currencies is noted. To understand the effect that the de-euroisation measures might have had on lek appreciation, the following should be considered:

 - the possible impact from the way how measures are perceived;

 - the possible impact from other factors, including the psychological ones.

a) In our assessment, the impact from the way how the de-euroisation measures are perceived, currently, are non-existent. The perception of these measures is such that no changes are expected in the short run in the foreign currency position and in the structure of banks’ balance sheet, due to them. If there are no changes in the bank balance sheets, then their presence in the market, in particular to accommodate the undertaken measures, is unnecessary.

To illustrate this point, let me give you an example. The increase of the minimum regulatory measure for liquid assets does not need to change the banks foreign currency position, but only to shift the investments in foreign currency, from other assets towards the liquid ones. This shift may be also needed only in a special bank, because at sector level, the current level of liquid assets is notably higher than the required level by the relevant measures.

The increase in the required reserve rate for foreign currency liabilities, for the period June 2018 - June 2019, will be maintained in lek (by employing the liquidity in lek that is released from the decrease in the rate of required reserve in lek), by not creating the need for transactions that would change the banks’ foreign currency positions (only due to this measure) for another year.

b) Possible psychological impacts are difficult to be measured and, as such, they are difficult to be excluded categorically. Nevertheless, the possible psychological impact, usually short term, should be accompanied by concrete actions of the public to shift their foreign currency savings/investments portfolio to lek. In fact, till 2018 Q1, these shifts have not appeared. Thus, according to banks’ reports, foreign currency deposits show a fall at the end of 2018 Q1, totally affected by the appreciation of lek exchange rate (the currency that they are reported). By original foreign currency (euro, US dollar, etc), deposits in foreign currency at the banking sector have grown compared with the end of 2017, and with the previous year (March 2017). Even if we compare the growth pace of deposits in original foreign currency in 2017 Q1 with 2018 Q1, the amount of deposits growth in euro and in US dollar, growth in 2018 Q1 was higher than growth in 2017 Q1. Hence, till the end of 2018 Q1, the analysis of aggregate figures does not show a shift of portfolios from foreign currency to lek. That means that there is no psychological impact from the introduction of measures.

I would like to repeat that de-euroisation is a structural phenomenon in the Albanian economy. As such, the impact on it will take a longer time to become visible. The conclusions is some media that the de-euroisation measures are affecting the exchange rate, that is they are providing the effect and the euroisation is being corrected in the short run, are premature and unreal. When the measures will be effective, they are expected to affect the increase the economic agents’ preference to hold and use the national currency. These measures are expected to provide the results in a 3-5 year period. Their application over an extended period of time excludes the potential impact on the exchange rate.

c) Allow me to add that Albania is not the only country that is facing the appreciation of the national currency. Many other countries, in the region and beyond, including those that have not taken concrete actions (or do not have problems) regarding de-euroisation, but face this development. In the IMF Spring Meetings 2018, these developments were addressed in dedicated sessions.

d) In our assessment, the reasons for the acceleration of lek appreciation in the short run may relate to other factors. Expectations for the tourism season are rather good. This means that expectations for income from this sector are higher, and potentially this may bring in advance certain operations with foreign currencies. This element, if proving as such from the balance of payments, is important. While it might drive to volatility in the short run, it may affect the mitigation of the previous seasonal behaviours and contribute to the stability of the exchange rate in the longer term. Also, the public was informed via media, on the decisions of some banks to convert part of their foreign currency capital into lek. Although a normal action, completely based on the regulatory framework, occurred even previously, the possibility that the news to have affected the economic agents’ expectations on the performance of the exchange rate is not excluded. I emphasise that the effect of these actions, which rarely occur, is totally temporary. Furthermore, banks are showing due attention that the action be extended maximally in time and be carried out at more adequate moments.

  1. Last, exporters seem worried about this appreciation; they have stated the damages it causes for them. Which is the impact of this appreciation on the economy?

The exchange rate plays an important role in small and open economies, such as Albania. It has a multi-dimensional impact: it affects the competitiveness of exports; the purchasing power of unhedged borrowers in foreign currency; it also affects inflation through the basket of imported goods, and, indirectly, economic growth. If the appreciation of the exchange rate derives from the economy improvement and perspective, it naturally accompanies the economy.

In any event, like for any other financial aggregate indicator, the exchange rate volatilities generate opposite results, which is potential financial profits or loss, in different segments of the economy. This reality cannot be avoided in an economy that operates in a free-floating exchange rate regime. For these reasons, we have continuously called the attention of economic and financial agents to be careful in their exposure to the exchange rate and to use hedging financial instruments. On the other hand, changes in the exchange rate, in real terms, imply the need for adjustments in different sectors of economy to explore alternatives for increasing productivity and becoming more efficient in the market.

Regarding its possible negative impact on either exports or competitiveness of our products in international markets, available data suggest that this appreciation should be more considered as a reflection of the increase in competitiveness and our exports, rather than an impediment to them.

  1. Is this trend considered to continue or is it considered as a short-term one?

The exchange rate, like other prices which are determined in the financial markets, is rather difficult to be predicted. Its behaviour is determined by a broad range of factors that vary from fundamentals to the way how the exchange rate is communicated.

As I mentioned earlier, the behaviour of the exchange rate is a product of demand and supply for foreign currency in the market, which is fuelled by the financial and trading transactions, assessed to be stable. The short-term volatility is normal in foreign exchange markets. It is acceptable and tolerable as long as it remains for a short period. It shows only the volatilities around the long -term trend and represents market attempts to discover the new equilibrium price.

Nevertheless, the Bank of Albania will continue to monitor the performance of the exchange rate, the determinants of this performance, and its impact on prices and on our capacity to converge with the inflation target.

  1. The Bank of Albania, in some statements, has put its emphasis on avoiding speculative behaviours, using protective instruments against the exchange rate risk, etc. Can we have a more detailed elaboration of them?

In a free-floating exchange rate regime, all real economy agents, who decide to engage in foreign currency transactions, are typically exposed to the exchange rate risk. Some of them, choose (intentionally, including speculative behaviour, or from the inadequate financial literacy) to maintain open positions in foreign currency, which may give rise to profits or losses, depending on the position they have in their balance sheet and the direction of exchange rate movement. Others choose to maintain closed positions in foreign currency.

A simple way to hedge against exchange rate risk is the “natural” defence, by matching the inflows and outflows in foreign currency, according to the business cycle. In practice, it is difficult to realise the natural defence, by considering the mismatch between the flows. In these and other cases, it is convenient for the entities “to buy” this protection through the use of certain financial instruments from banks or other non-bank financial institutions. Through these instruments, the entities avoid the uncertainties about the exchange rate level in the future and the effects of the exchange rate on the balance sheet, by better planning their business.

  1. What is role Bank of Albania expected to play? Is there any plane to intervene if lek will appreciate further? If yes, what instruments shall be used?

In compliance with its legal mandate, the Bank of Albania is exclusively focused on achieving and maintaining price stability, while the exchange rate regime is a free-floating one. It means that the Bank of Albania does not target a certain level of the exchange rate or of its volatility. It does not use the exchange rate as its instrument.

As a rule, the reaction of monetary policy against exchange rate volatilities considers a matrix of criteria, such as: the reason of volatilities, their expected duration; and the overall macro-economic situation. Hence, the Bank of Albania does not influence, or tries to affect the performance of the exchange rate when this movement is in compliance with the fundamentals. And, as I mentioned above, the short-term volatility is normal for foreign exchange markets, as long as it remains as such.

Nevertheless, the exchange rate is absolutely an important factor in determining the dynamics of both economic growth and inflation rates. The exchange rate appreciation affects directly the stability of prices, through the low import prices, and indirectly through the effect in both the aggregate demand and output gap. For these reasons, in formulating our monetary policy stance, we consider the expected impact of the exchange rate, to the extent and for as long as it affects the achievement of our inflation target. The decelerating inflationary pressures, originating also from lek appreciation, have strongly emphasised the need for an accommodative monetary policy stance in the short-term future. Our decision-making has been consistent with achieving the target, by maintaining the accommodative monetary policy stance for a longer period.

I would conclude my answer to this complex question, by citing a part from the last press release for the monetary policy decision: “Should the intensity and duration of decelerating factors for the return of inflation to target be stronger than our current estimations, the Bank of Albania stands ready to respond, through available instruments and in accordance with the monetary policy regime.”