With double-dip recession hitting the eurozone, leaders across Europe are rightly turning attention to restarting the growth engines of their economies. The continued eurozone turmoil has translated into a marked slowdown of growth in all Western Balkan countries, including Albania where World Bank’s latest growth projection for 2012 has been revised down to about 1.5 percent. In 2009, when the first wave of the global crisis hit, its impact on Albania was partially cushioned by significantly increased public spending that year, largely for infrastructure projects. It may be tempting to apply that recipe again, especially given that the sharp slowdown in growth coincides with the beginning of the 2013 election pressures. Yet, with the exhausted fiscal space and greater external risks in 2012, this recipe is no longer applicable and will make Albania’s economic growth prospects worse.
One of the lessons from the sovereign debt crisis in the eurozone periphery is that once macro-economic stability is shattered, it punishes many citizens more than the gains they have made during relaxed macro-economic management. Another striking lesson is that markets may lose faith in the country’s ability to manage its finances earlier than the governments or analysts assume they would. Thus, while macro-economic stability has always been considered the foundation for sustained growth, it is now ever more important. And it is now being assessed by investors and banks using a stricter standard than ever before.
The key risk to Albania’s macro-economic stability is its high stock of public debt, estimated at over 800 billion Lek currently, or almost 60 percent of Albania’s gross domestic product (GDP). After it jumped from 55 to over 59 percent in 2009, the government has shown efforts to stabilize public debt as a percent of GDP, but attempts to reduce it further and rebuild the much needed fiscal space has been futile. In addition, reliance on consequent mid-term budget adjustments to contain the deficit has resulted in unpaid bills to private contractors for undertaking publicly financed works, which I observe first-hand from some World Bank-financed projects.
Why is it in the best interest of Albania’s economy and citizens to start gradually reducing this elevated level of public debt, even at the time of economic downturn? First, staying too close to 60 percent carries a significant risk of crossing it over if a major shock to the budget occurs, as for example, nearly happened during the last winter due to unforeseen electricity imports. Crossing the 60 percent mark, in turn, carries a high risk that markets will take it as a sign of macro-economic instability and react badly, making furthermore difficult to support both growth and fiscal policy objectives. Montenegro, Albania’s neighbor, whose debt level has approached 60 percent too, is taking drastic measures to reverse the trend by adopting a conservative indexation for wages; rationalizing subsidies, social aid and transfers; and postponing nonessential capital expenditure.
Second, the need to roll over a sizable portion of debt each year presents an increasing risk, especially in the current environment. Nearly 60 percent of the public debt is in short-term, high-interest loans by domestic investors, mainly banks. If some of these banks get into liquidity troubles because they cannot collect their credits or if their parent banks decide to change their portfolio structure and move away from government securities to loans to the private sector, Albania will find itself in a difficult position to secure funds to pay for ongoing expenditures and to continue to roll over its domestic debt. Furthermore, a high level of government borrowing from the domestic market reduces availability of credit to private companies at the time when the private sector already feels liquidity squeeze - with an adverse implication for growth.
Third, the current level and composition of public debt result in the high interest cost, chiefly due to domestic debt cost at about 8 percent on average. The 2012 budget sets aside 50 billion lek for interest payments. This is over 3 percent of Albania’s GDP, and puts Albania as the third highest, after Hungary and Turkey, among all emerging European countries in terms of interest payments. The amount that Albania spends on interest payments this year is approximately equal to the amount of tax revenue it collects from profit and personal income taxes. That is money that could have gone to build roads or schools or pay for teacher salaries. If Albania’s annual interest expenditures were to be halved from the current level, the resources would be enough to raise above the poverty line the income of 12 percent of the population who are, based on 2008 data, below the poverty line.
What can the country do to protect its hard-won achievements of macro-economic stability and one of fastest average growth rates in 21th century Europe? An essential first step would be for the government to begin, without a delay, a program of gradually reducing its public debt and budget deficit over time and limit its domestic borrowing needs while taking steps to retire the most expensive of existing debts. Let’s be clear: no one is suggesting strict austerity at the time of weak national growth and European recession. But a moderate program of fiscal consolidation - of reducing the level of debt by about 5 percent of GDP over 5 years - is both absolutely essential and pro-growth. Other countries such as Poland are adopting this approach.
This means limiting government spending, while enhancing public revenue through both administrative and policy measures. This means effecting, once again, budget revision to bring the 2012 deficit credibly down to 3 percent, and targeting lower deficit levels under the medium term macro-fiscal framework. At the same time, it is critical to ensure that delays in the payment for work completed work by private companies are quickly addressed. It also means giving priority to measures with, as economists call it, “multiplier effects” for growth when deciding on immediate spending cuts (e.g. by protecting essential operations and maintenance and capital expenditure) and focusing on structural reforms that bring efficiency gains and positive fiscal impacts in the medium term (e.g. pensions and energy sector reforms). As with other countries in the region, the World Bank is committed to support Albania in undertaking this program through both technical advice and financial assistance.
At the time of the highest economic stress in over a decade, it is the duty of all ministries, agencies and local governments to support the consolidation effort, maximize their own performance, and make internal adjustments in full and in time that would not leave private companies unpaid for months for the work done on schedule and per contract conditions. It is the duty of all parliamentary groups to put the politics and electoral pressures aside, support the necessary fiscal tightening, and communicate to their constituencies of why this is needed for the country’s sake - and for the soonest restart of faster growth. It is the imperative of the time to support growth while proactively rebuilding fiscal buffers and putting public debt on a sustainable path. Doing less would be gambling with Albania’s future.