PRESS RELEASE
Governor Sejko presents BoA’s opinion on 2018 draft budget to the Parliamentary Committee on Economy and Finance

Honourable Chairman,

Honourable Members of the Committee,

First, I would like to thank you for the invitation and opportunity to present to this Committee the opinion of the Bank of Albania on the 2018 draft budget.

The budget is the main instrument for the implementation of the fiscal policy. On the one hand, it programmes and realises the direct intervention of the state in economy. On the other hand, tax legislation that accompanies the budget determines the fiscal stimuli that affect the decisions of the private sector for consumption and investments. Both aspects affect domestic demand, the economic growth, the expansion of employment, and the improvement of welfare.

In this light, it is natural for this important project to be consulted with experts and groups of interest. The broad-based consultation should aim at producing a qualitative action plan, to determine the optimal use of limited financial resources, in view of the objectives for the long-term development of the country.

Let me now introduce the opinion of the Bank of Albania on this draft budget. Conform to the legal mandate; I will focus on those issues which are within the scope and activity of the Bank of Albania. In more concrete terms, my comments will be summarised in the following fields:

i Trend and impact of fiscal policy on the economy;

ii Long-term sustainability of public finances;

iii Public borrowing and its impact on the domestic financial markets; and;

iv Enhancing the effectiveness and sustainability of public finances.

First, I will summarise our vision on the development perspectives for Albania and the contribution that we, as policymakers, could provide in this regard.

1. Fiscal policy and 2018 draft budget

As we have emphasized in our public statements, the Bank of Albania finds that the Albanian economy is on a positive growth trend. Economic activity at home is growing, financial balance sheets of both private and public sectors are improving, domestic and external balances are becoming healthier, while private agents' confidence is being consolidated.

The improvement in the external environment favoured this performance, which in turn first reflects a proper domestic policy mix.

- The accommodative monetary policy has aimed and succeeded to ensure a liquid financial environment, with low interest rates and improved financial conditions.

- The fiscal consolidation has reduced risk premia in financial markets, has provided the pass through of our monetary policy into these markets, and has increased the space for credit to the private sector.

- The macro-prudential policy has safeguarded the financial stability, while the banking sector regulation and supervision have contributed to the normal functioning of this sector, as the main instrument for holding public savings and financing the economy.

Our analyses suggest that the outlook remains positive, but it should continue to be supported by prudent economic policies.

In this context, the Bank of Albania concludes that by targeting a positive primary balance and aiming the further reduction of public debt, the draft budget 2018 continues on the fiscal consolidation path. The Bank of Albania deems that this draft budget: maintains unchanged the economic policies mix that has sustained the development of Albania, which (i) helps to further strengthen the macroeconomic equilibriums; (ii) increases the investors' confidence in the Albanian economy, and; (iii) sends the appropriate signals to the financial markets and credit rating agencies.

In greater details:

- The primary balance of 2018 is projected to be positive, at 0.6% of GDP, and the public debt to GDP ratio is expected to reduce by 2.5 percentage points. The Bank of Albania deems that the 2018 draft budget strengthens the consolidating trend of the fiscal policy and ensures that the monetary stimulus will continue to be transmitted to the economy.

- Projections of fiscal income appear to be prudent, although the estimates appear slightly optimistic. These projections are based on an acceptable macroeconomic framework, while both public expenditure and tax policies appear to be consistent with the expected economic developments.

- Composition of public expenditure appears more supportive for the country's development. Capital expenditures are expected to grow faster than current expenditure over 2018, to 5.2% of GDP. Our research suggests that capital expenditures have relatively greater and more sustainable effect on economic growth, than current expenditures.

- The 2018 draft budget envisages the growth of tax revenues, mainly in line with the improvement of the economic activity, as well as, in part, from the increasing formalisation of the economy. The Bank of Albania welcomes the continuation of this initiative, deeming that the long-term benefits from the increase of competition and transparency in the economy, surpasses the short-term costs of the reform. With regard to this initiative, the Bank of Albania has already instructed the commercial banks, starting from year 2018, to base the borrowers' financial analyses on certified balance sheets, providing thus another incentive for the formalisation and increasing the costs of informal activity.

- Finally, the estimated fiscal effect from amendments to the tax and customs legislation appears to be low. Based on these assessments, the expected impact of fiscal measures on inflation is expected to be relatively low and transitional.

Following, I will focus on the issues regarding the long-term soundness of public finances.

2. Sustainability of public finances

The long-term sustainability of public finances is a pre-condition for the overall economic and economic stability of Albania.

The Bank of Albania finds that the 2018 draft budget meets the requirements stipulated in the Organic Budget Law. The continuous implementation of the criteria set out in this Law helps to discipline the compilation and implementation of fiscal policies, to increase their consistency in years and to strengthen private finances in the long term. Also, it reduces the risk premia and improves the investments' climate.

In the light of strengthening the public finances, the 2018 draft budget places a limit on the total value of the projects contracted under the Public-Private Partnership (PPP) programme, at 40.1% of GDP. The Bank of Albania judges the placement of this limit is a positive development, as it helps to prevent the unplanned expansion of public liabilities.

Now, I would like to share with you our assessment on the expected impact of the draft budget on financial markets.

3. Public borrowing and its impact on the domestic financial markets

The level of public debt and its financing structure have a direct and mutual connection to the development and soundness of the domestic financial system. We deem that maintaining financial markets' confidence should be one of the primary objectives of our fiscal policy, because - in the long term - it determines not only the public debt cost, but also the financing cost and the private sector's access to credit to the private sector.

The Bank of Albania considers that the budget deficit for 2018 is programmed to be financed entirely through domestic borrowing. Related to the relevant impact on the domestic financial markets, the Bank of Albania notes that:

- Our financial market is characterised by a good liquidity situation and by low interest rates. These trends are expected to continue during 2018, thus providing adequate conditions to accommodate the planned borrowing. In principle, due to the risk arising from the fluctuations in the exchange rate and in foreign investors' appetite against sovereign debt in emerging economies, the Bank of Albania suggests to continue addressing foreign commercial borrowing, as the last-resort alternative in the list of options for financing the budget deficit.

- Financial market remains sensitive to the fluctuations in the financing of budget deficit during the year. Therefore, the Bank of Albania suggests:

- Continuous monitoring of the financial market and enhancing the efforts to reduce liquidity fluctuations arising from public sector activity.

- Acceleration of efforts for the development of securities secondary market, which would reduce risks for the accommodation of the domestic borrowing. The well-functioning of this market will help expand the investors' base, grow liquidity of Government's debt instruments and reduce debt costs.

The draft budget includes - for the first time - the legal provisions for the transfer of funds created from foreign borrowing, from a fiscal year to next one. This novelty allows for a better allocation of the use of funds obtained from foreign borrowing, and enables the pre-financing of payments due for contractual obligations in the form of foreign debt. Overall, this provision helps to reduce fiscal vulnerabilities, when foreign borrowing and transfers are made in compliance with the repayment schedule of foreign debt. Also, it helps reduce refinancing risk, and potentially, lowering the cost of financing from foreign markets. However, the Bank of Albania suggests: (i) to consult it in advance on the foreign borrowing plans; and (ii) to show prudence and place quantitative limitation on this transfer's size, in years.

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Honourable Members of the Committee,

Allow me, in conclusion, to present some suggestions and recommendations of the Bank of Albania for enhancing the effectiveness and sustainability of public finances.

4. Some suggestions on enhancing the effectiveness and sustainability of public finances

On deficits in health and social insurance schemes

Deficits in pension and social insurance schemes remain a heavy burden to the budget. The deficit of these schemes is around 2.5 times higher than the total value of budget deficit. This phenomenon should be continuously monitored. Its medium and long-term implications should be assessed seriously - and if necessary - corrective measures should be taken. In particular, the Bank of Albania thinks that the establishment of private pension schemes should be promoted more strongly; they facilitate the burden on public finances and provide further breath to the development of financial markets.

On Public-Private Partnerships

The 2018 draft budget considers the risks arising from the expansion of public-private partnership (PPP) projects, by establishing a limit on the total value of these projects and detailing in advance the list of new PPPs over the year. Nevertheless, the Bank of Albania suggests considering the possibility to include an overall upper limit on the PPPs total value in the Organic Budget Law. This option would discipline, in long term, the total contracted volume of these projects and will be in line with the provisions of this Law on the maximum limit that the servicing of these schemes shares in the budget expenditure of the year.

Also, the other concern about these projects relates to the potential liabilities that they may the budget may incur. In this aspect, we emphasise the need for: (i) the continuous improvement of professional capacities of units that manage the assessment, the contracting and monitoring of these projects, in particular regarding their financial and legal aspects; and (ii) the implementation of best standards in accounting their impact on budget indicators.

On the financing structure of the budget

The concentration of public debt in the domestic market and the focus on local currency was a strong element in the financing structure of the Albanian public debt. This element has maintained the refinancing risk relatively low and has reduced the fluctuations in the size and cost of debt servicing, arising from exchange rate volatility. The Bank of Albania deems that this element of the structure should be maintained in the future.

Lastly, I would like to mention two long-standing concerns of the Bank of Albania.

On compliance with the projected level of the budget deficit over 2018

While the macro framework and fiscal projections of the 2018 draft budget, overall, appears to be prudential, the Bank of Albania draws the attention to the fact that maintaining the budget deficit should be set out as a non-negotiable objective. In terms of fiscal prudence, it means that the budget should include, either implicitly or explicitly, contingency plans to cope with possible situations, when the deficit risks go above the limit.

On the effectiveness of public finances

It would be appropriate at this point to reiterate the appeal for a uniform allocation of budget expenses throughout the year, which would reduce unnecessary fluctuations in financial markets and increase the effectiveness of the fiscal policy.

Thank you for your attention!