MONETARY POLICY REPORT€¦ · Monetary Policy Report, 2019/IV 9 Bank of Albania of monetary...

MONETARY POLICY REPORT

2019/IV

Bank of Albania

Monetary Policy Report, 2019/IV

2Bank of Albania

Data from this publication may be used, provided the source is acknowledged.Published by: Bank of AlbaniaSheshi “Skënderbej”, Nr.1, Tirana, AlbaniaTel.: + 355 4 2419301/2/3; + 355 4 2419401/2/3Fax: + 355 4 2419408E-mail: [email protected]

Printed in: 220 copiesPrinted by: Adel Co sh.p.k.

www.bankofalbania.org


3 Bank of Albania

C O N T E N T S

INTRODUCTION 7

FOREWORD BY THE GOVERNOR 8

1. PRICE STABILITY AND BANK OF ALBANIA’S MONETARY POLICY 11

2. EXTERNAL ECONOMIC ENVIRONMENT 152.1 Global Economy 152.2 Commodity prices in global markets 192.3 Financial markets 20

3. FINANCIAL MARKETS AND MONETARY DEVELOPMENTS 223.1 Financial markets 223.2 Deposit and credit interest rates and financing conditions 273.3 Credit to the private sector 293.4 Money and deposits in the economy 31

4. INFLATION AND ECONOMIC GROWTH 334.1 Inflation 334.2 Gross Domestic Product and aggregate demand 354.3 Cyclical position of the economy and inflationary pressures 48


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B O X E S

T A B L E S

2. External economic environmentTabelë 1 Economic indicators for countries in the region 19

4. Inflation and economic growthTable 2 Contribution of key items to annual inflation (p.p.) 35Table 3 Balance of payments indicators (data in million euro) 48

Box 1 Balance of Payments in 2019 Q2 47Box 2 Labour market developments and wage dynamics in the economy 53


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C H A R T S

1. Price Stability and Bank of Albania’s Monetary PolicyChart 1 Cyclical position of the economy and core inflation 13Chart 2 Policy rate (left) and daily EUR/ALL exchange rate (right) 13

2. External economic environmentChart 3 Composite Leading Indicator of GDP (left) and inflation (right) in major countries 16Chart 4 Selected macroeconomic indicators 16Chart 5 Euro area, composite output index (PMI) and quarterly GDP (left), confidence survey indicators (middle) and the economic sentiment indicator (ESI) and annual GDP (right) 17Chart 6 Commodity prices in global markets 19Chart 7 Policy rates of major central banks 20Chart 8 Selected global financial indicators 20

3. Financial markets and monetary developmentsChart 9 Bank of Albania open market operations and interbank rates 23Chart 10 The exchange rate trend in the domestic foreign exchange market 24Chart 11 The exchange rate trend in the domestic foreign exchange market 24Chart 12 Yields in the primary market 25Chart 13 Deficit, instruments for financing it (left) financing instruments in the domestic market (right) 26Chart 14 Interest rate on new loans (left) and deposits (right) in lek 27Chart 16 Determinant non-price terms and conditions for loans to enterprises and households 28Chart 17 Lending to the private sector 29Chart 18 Credit to the private sector and annual contributions by currency and economic agent 30Chart 19 Monetary Indicators 31Chart 20 Deposits in the banking system 32

4. Inflation and economic growthChart 21 Headline inflation, target (left) Inflation in regional and EU countries (right) 34Chart 22 Contributions by food and non-food categories to headline annual inflation 34Chart 23 Gross Domestic Product by sector and confidence indicators 36Chart 24 Contribution of branches to value added in “Industry, energy and water”, and the capacity utilisation rate in industry 37Chart 25 Valued added and capacity utilisation rate in construction 38Chart 26 Contribution of branches and capacity utilization rates in the services sector 39Chart 27 Economic sentiment indicator and structure of domestic demand 40Chart 28 Private consumption and consumer confidence 41Chart 29 Quantitative (left) and qualitative (right) indirect indicators from surveys on private consumption 42Chart 30 Gross fixed capital formation, annual change 42Chart 31 Short-term quantitative and qualitative indicators from investment surveys 43


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Chart 32 Orientation of fiscal 43Chart 33 Budget expenditures 44Chart 34 Performance of revenues 45Chart 35 Contribution of net exports to aggregate demand (in p.p.) 45Chart 36 Import and export by category (in ALL million) 46Chart 37 Annual Dated Brent oil prices, domestic oil export (left), metal prices index and domestic metal export (right) 46Chart 38 Indicators of the cyclical situation of the economy 49Chart 39 Participation in labour force, employment level and unemployment level in economy 50Chart 40 Average wage indicators (left) and annual flattened average changes of labour cost and their breakdown (right) 50Chart 41 Long-term inflation expectations (left) and short-term expectations (right) 51Chart 42 IIPI and contributions of its components (left). Contributions of imported inflation and domestic inflation to annual headline inflation (right) 52Chart 43 Labour market indicators and their dynamics over time 53Chart 44 Indicators of average wage in the economy 54Chart 45 One-year-ahead inflation expectations, businesses and consumers (left) and financial agents, according to three horizons (right), annual change in % 56


7 Bank of Albania

The primary objective of monetary policy in Albania is to achieve and maintain price stability. In quantitative terms, it is defined as maintaining inflation close to the 3% target.

In achieving this objective, the monetary policy sustains the stable and long-term growth of the Albanian economy, promotes financial stability and supports improvement in the overall welfare of society.

In accordance with the principles set out in the Monetary Policy Document, the Bank of Albania implements a forward-looking, consistent, balanced, prudent, and transparent monetary policy.

This Report refers to the Supervisory Council’s Decision No. 64, dated 6.11.2019. The economic and monetary analysis in this report is based on the statistical and qualitative data available as at 27 October 2019.

INTRODUCTION


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The new information analysed in this Report has resulted overall in line with our expectations. Economic growth continued to slow down in the second quarter, in line with the performance observed in the previous quarter, while inflation remained low, undershooting the target in the third quarter.

This performance was dictated mainly by temporary supply-side shocks. As such, it does not change significantly our expectations on economic developments in the medium term.

In our baseline scenario we forecast that the economic growth pace will be improving in the next two years, enabling inflation to converge to target within this time horizon. Against this backdrop, the current monetary policy stance is assessed as adequate.

In the third quarter, inflation averaged 1.4%, close to the values recorded in the previous quarter. The downward contribution of both non-food consumer goods and housing services on inflation was offset by the higher inflation of items in the category of services and durable consumer goods.

From the macroeconomic perspective, inflation has reflected the build-up of domestic inflationary pressures, and the fall of inflation rates in trading partner countries. Looking ahead, the Bank of Albania deems that the increase in wages and production costs, coupled with the stabilisation of the exchange rate, will create premises for inflation to gradually converge to target.

According to INSTAT data, the Albanian economy grew by 2.3% in the second quarter of 2019. Growth was driven by the expansion of public and private consumption, while net exports and investments were down.

Similar to the first quarter, the slowdown in the growth pace reflects the reduction in production and exports of electrical energy, the transitional effects of the gambling shutdown and the entry into the final stage of works in a large energy project. These effects will continue to be present in the second half of the year. Thus, the economic growth pace in this period is expected to be comparable with that of the first half of year, but to accelerate in the next two years.

The economic activity expanded in the second quarter, reflecting the low cost for financing consumption and investment, the improved balance sheets of economic agents, and the increased revenues from tourism. The combination

FOREWORD BY THE GOVERNOR


9 Bank of Albania

of monetary stimulus with fiscal consolidation and the strengthening of banking sector’s soundness have provided a favourable environment for growth.

In particular, the domestic financial environment appears stimulating, in response to the monetary policy stance implemented by the Bank of Albania. The exchange rate appears relatively stabilised: the ALL/EUR exchange rate is closer to the equilibrium, while its fluctuations are dictated by seasonal factors. Risk premia in financial markets are low, and liquidity conditions appropriate. Interest rates on loans, deposits and government’s securities are close to minimum levels, thus bolstering credit growth and stimulating higher consumption and investments.

Credit to private sector grew 7.5% on average in the third quarter. The acceleration of growth is attributable to both the expansion of demand and the improvement of bank credit supply. The latter reflects the on-going improvement of credit environment and the balance sheet of the banking sector, as shown by the drop of the non-performing loans ratio to 10.6%, as well as the increase of competition in the system, following the finalisation of consolidation in the banking sector. Regarding its composition, credit growth picked up on the back of a broad base, in terms of: currency structure; beneficiaries; and its destination. This is another encouraging signal suggesting an expansion of credit in the future.

The fiscal policy continues to maintain a consolidatory trend, but its intensity has been lower. This development reflects a faster increase of public expenditures vis-a-vis revenues, although budget deficit remains at low levels. The Bank of Albania continues to highlight the importance of strengthening public finances’ soundness, through maintaining the focus on budget deficit control and furthering reforms to improve public finance management.The further expansion of aggregate demand has enabled a continuous increase of employment and decrease of the unemployment rate. The unemployment rate stood at 11.5% in the second quarter, recording a historical minimum level of this indicator. The increase of labour demand has created the premises for the rise of wages and production costs. According to INSTAT data, the average wage in the economy was up by 4.5% in the second quarter, continuing the positive trend started since 2017.

The Bank of Albania deems that economic growth will remain in positive territory in the medium term ensuring an increasingly fuller utilisation of production capacities. Projections in our baseline scenario suggest that the Albanian economy will return to equilibrium in the next year, creating premises for faster increase in wages and domestic production costs. Coupled with the expected stabilisation of the nominal exchange rate, they will help inflation converge to target in the second half of 2021.

Our baseline macroeconomic forecast scenario confirms the adequacy of the current monetary policy stance. This scenario predicts that the expansionary


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monetary policy trand will be kept in the medium term. The intensity of the monetary stimulus is expected to be reduced in accordance to and conditional with the forecasts of a steady inflation increase towards its target. The normalization of the monetary policy will be gradual and –in any case – it is not expected to start before the second quarter of 2020.

In parallel with the developments expected in the baseline scenario, the Bank of Albania notes that downward risks to the forecasts remain present. These risks arise from both the external environment, with the Euroarea economy showing slowdown constantly, and the domestic environment, with the political tension continuing to induce uncertainties and potential shocks to the exchange rate may shift it farther away from the equilibrium. The materialization of these shocks would hinder and/or slow down the inflations return to target, creating the premises for an increase of the monetary stimulus.


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The new information analysed in this Report has resulted close to our expectations. Economic growth continued to slow its pace in the second quarter, while inflation continued to record low rates in the third quarter as well. Domestic inflationary pressures are assessed as upward, while the negative impact of the exchange rate on inflation has been fading. On the other hand, inflationary pressures from external environment decreased further. Financial markets appear liquid, amid low interest rates and low risk premiums. In parallel, the improvement of both bank credit supply and demand accelerated lending.

The analysis of available information confirms our previous assessments that the slowdown of economic growth reflects mostly sector-specific developments. Their effect is expected to cause lower growth rates in 2019, but to not affect the economic growth trend in the medium-term.

The medium-term perspective of the economy remains positive. The expansion of aggregate demand is expected to be underpinned by favourable financing conditions, the improved balance sheets of private agents and improvement in the labour market. The higher utilisation of production capacities is expected to be accompanied by a faster increase in wages, domestic production costs and inflationary pressures from the domestic economy. In parallel, stabilisation of the exchange rate is expected to ease the transmission of foreign inflationary pressures. Inflation is expected to converge to target within 2021. In accordance with these projections, the current stance of the monetary policy is assessed as adequate. The monetary policy is expected to remain on the accommodative side for the medium-term horizon.

Nevertheless, the new available information confirms the persistence of downside risks. The materialisation of these risks may require a response on the accommodative side of the monetary policy stance.

The external economic environment is characterised by a slowdown of the growth pace and low inflation rates. The new information about the European economy shows a decrease of economic activity, persistence of downside risks and low current and expected levels of inflation. Forecasts about global and European economy suggest a slow growth pace in the medium-term horizon as well. Some central banks have increased their monetary stimulus, which is expected to sustain economic activity and build-up inflationary pressures.

1. PRICE STABILITY AND BANK OF ALBANIA’S MONETARY POLICY


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The new information about the Albanian economy shows a slowdown of its growth pace in the second quarter and a slow increase of inflation in the third quarter.

Annual inflation averaged 1.4% in the third quarter, hovering close to the level recorded in the previous quarter. The increase in services and processed food prices was almost offset by the slower increase of non-processed food prices. Prices of other items in the consumer basket contributed, overall, to a lower but positiveinflation for this period.

From the macro-economic perspective, low inflation reflects the still insufficient increase of inflationary pressures from the domestic economy and the weak imported inflationary pressures. The latter are affected by the downtrend of consumer prices and commodity prices in global markets. By contrast, the negative impact of exchange rate appreciation on inflation has slowed, reflecting its relative stabilisation over 2019. The domestic inflationary pressures are deemed to have builded up, as shown by the slight increasing trend of core inflation. Nevertheless, its low values account for the still low and below historical average increase of wages and other production costs.

Economic activity expanded at a slow pace in 2019 Q2 as well. According to INSTAT data, the Gross Domestic Product grew by 2.3% in the 2019 Q2, from 2.4% in the first quarter. From the sectoral perspective, the slowdown of economic activity in 2019 H1 mostly reflected the negative performance of electrical energy production, affected by the unfavourable climatic conditions and the reduction of construction activity. Growth in other sectors was positive. From the perspective of aggregate demand, economic growth reflected the expansion of both public and private consumption, which accelerated their growth pace in the second quarter. On the other hand, investments and foreign trade performed negatively, affected respectively by slow construction activity and the unfavourable conjuncture of prices and foreign demand.

The new information analysed in this Report was close to our expectations. Its analysis suggests that growth slowdown was mostly affected by supply-side factors. As such, their effect is expected to be limited in time and economic growth is expected to accelerate in the forthcoming years.

Our assessments on the cyclical position of the economy have not changed. Albanian economy is assessed to be still operating under potential, but spare capacities in economy have been reducing during the last four years. Aggregate demand expanded, triggering increase of employment, fall of unemployment to 11.5%, and growth of firms’ capacity utilisation rate. Nevertheless, the current level of aggregate demand is still insufficient to ensure the return of economy to its potential.


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Chart 1 Cyclical position of the economy and core in�ation

Source INSTAT, Bank of Albania.

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Unemplyment rate gapOutput gap assessment

The accommodative monetary policy implemented by the Bank of Albania sustains the continuous economic growth through lowering financing costs and increasing credit. The monetary stimulus has been transmitted through the low policy rate, the forward guidance instrument, and the continuous injection of liquidity into the interbank market. The interest rates on deposits and loans in the Albanian currency remain near historic lows, whereas fluctuations in government security yields have not been transmitted to other segments of the financial market. On the other hand, the performance of exchange rate has been broadly in line with its seasonal behaviour. Its annual appreciation trended downward compared to the high levels recorded in the previous year, thus reducing the tightening effect on monetary conditions.

Chart 2 Policy rate (left) and daily EUR/ALL exchange rate (right)

Source INSTAT, Bank of Albania.

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Lending has been improving sustained by low interest rates and a better combination of the increased demand for financing with the banking system’s supply. This improvement is noted in the 7.5% acceleration of growth


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of credit to private sector, in 2019 Q3 - adjusted for foreign exchange rate and written off loans - also in the expansion of its base.

The further increase of credit demand, the improvement of banking sector’s supply and the further reduction of credit risk establish the premises for a faster growth of lending and for the transmission of monetary stimulus at a broader base into economy.

Our forecasts show an improvement of economic growth in the medium-term horizon Supply-side shocks are expected to drive to a temporary slowdown of economic growth pace in 2019. In addition, the favourable financing conditions, the improvement of economic agents’ balance sheets and the improvement in the labour market are expected to drive to a faster increase of aggregate demand and fuller utilisation of production capacities. The convergence of economy to equilibrium is expected to be accompanied by higher rise in wages and production costs. In parallel, stabilisation of the exchange rate is expected to ease the transmission of foreign inflationary pressures. Inflation is projected to average around 1.5% in 2019 and return to target in the second half of 2021.

The materialisation of forecasts in the baseline scenario would require maintaining the accommodative stance of the monetary policy in the medium term. Monetary stimulus is necessary to support the growth of aggregate demand and build up domestic inflationary pressures. This scenario forecasts a gradual normalisation of monetary policy, which is expected to start not earlier than 2020 Q2. In any case, the normalisation of the monetary policy will be prudential and in line with the new information on macro-economic forecasts.

Downside risks continue to dominate the forecasting horizon. They mostly relate to uncertainties surrounding future developments in the external environment. Also, uncertainties originate from the domestic environment, related with the possibility of supply-side shocks extension or their transmission into related sectors of economy. The materialisation of these risks may require a response on the accommodative side of the monetary policy stance. In this perspective, it is important to continuously and scrupulously continue with the implementation of structural reforms, which strengthen the resilience of the Albanian economy against shocks.


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The global economy is set on a synchronized slowdown trend, recording weakest economic growth levels since the global financial crisis1. The slowdown is notable both in advanced and emerging economies. The performance of global economy has felt the uncertainties originating from the increase of trade barriers, Brexit process and the structural problems in the manufacturing sector in some countries.

Inflation rates continue to be low affected by the fall in energy and food prices. Inflationary pressures continue to be weak, while in some countries the unemployment rates record the lowest historical values.

Major central banks have moved on the accommodative side of their monetary policy trying to boost inflationary pressures and expectations. Financial markets remained overall stable, with yields on a downward trajectory.

2.1 GLOBAL ECONOMY

The global economy’s pace of growth continues to slow down in the second half of the year. The contraction of international trade indicators and the decrease of economic growth pace has reflected the risks related to trade tensions, the Chinese growth downgrade, and Brexit-related uncertainties regarding the time and manner. In 2019 Q2, GDP slowed down in USA, China, euro area and in many advanced economies. OECD confidence indicators and leading indicators on economic growth suggest slowdown trend will continue in both third and fourth quarters.

Financing conditions continue to be favourable, while major central banks have increased monetary policy easing. Uncertainties surrounding economic outlook and the communication on monetary policy easing are translated into a fall of long-term yields. Inflation continues to hover at low levels and inflationary pressures appear on the downside.

1 World Economic Outlook, October 2019, IMF.

2. EXTERNAL ECONOMIC ENVIRONMENT


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Chart 3 Composite Leading Indicator of GDP (left) and in�ation (right) in major countries

Source OECD (Organisation for Economic Co-operation and Development).

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US ECONOMY

The US economy grew at positive terms in 2019 Q2, but at a decelerated pace. Economic growth was supported by consumer spending and central and local government spending. Investments and net exports provided an opposite impact. The previous monetary stimulus, loose lending terms and conditions and improved employment fuelled the growth of available incomes. Foreign trade suffered the consequences from the increased fiscal barriers between USA and China and the European Union. The possible developments in these relationships have heightened the uncertainty about the future, by somewhat decelerating investments. In the next period, the economy is expected to grow at a slower pace, driven by the decrease of stimulating fiscal policy and the difficulties in the manufacturing sector.

Chart 4 Selected macroeconomic indicators

Source Eurostat, BEA, BLS.

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Unemployment fell again in September, reaching at 3.5%, amongst the lowest historical values. Nevertheless, inflationary pressures remain contained. Annual inflation continued to undershoot the target of Federal Reserve. The latter re-started the easing monetary policy in 2019 Q3 and is expected to pursue a similar trajectory.

EURO AREA ECONOMY

The pace of economic growth in the euro area weakened both in the second and third quarters. Compared to a year earlier, economic growth in 2019 Q2 was slower, 1.2% from 1.3% in the first quarter.

The economic growth slowdown mainly reflected the negative contribution of foreign demand, while consumer spending and investments continue to have a positive contribution. Preliminary indicators of economic developments (PMI2) continue to show the contraction in the activity of manufacturing sector and weak expansion on service sector. Their analysis and the analysis of confidence indicators for the last months suggest economic growth will continue at the same pace also in the next quarter. Implications of trade tensions on foreign demand is one of the factors that contributes to such slowdown, notably the manufacturing sector in Germany. In the summer months, inflation decreased mainly driven by the fall in electricity prices (in September, inflation was 0.8%). Also, core inflation remains at low levels (1.1% in 2019 Q3) continuing to reflect, in particular, the weak dynamic of industrial output prices. The updated forecast of ECB experts assess that inflation will slightly increase in the next two years.

Chart 5 Euro area, composite output index (PMI) and quarterly GDP (left), con�dence survey indicators (middle) and the economic sentiment indicator

(ESI) and annual GDP (right)

Source: Markit, Eurostat, EC.

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2 PMI is the composite output index, constructed from the information available from survey and serves as preliminary indicator on economic growth. This index is published by Markit on a monthly basis.


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The economies of Albania’s two main trading partners, Italy and Greece, performed at an uneven pace in 2019 Q2. In Italy, economic activity contracted annually -0.1%, for the second consecutive quarter. Economic activity in Italy was fuelled by the slight improvement in both consumer and government spending and in investments. This contribution was offset by the growth of imports and the change on inventories, which have shifted the economic growth into negative territory. Economy is expected to perform weakly in the next quarters. Economic growth in Greece accelerated in 2019 Q2, underpinned by government spending, investments and net exports.

Annual inflation, in both countries recorded the low value 0.2% in September. This phenomenon was present throughout 2019 Q3. Also, core inflation hovers at low rates showing the persistence of weak inflationary pressures.

REGIONAL ECONOMIES3

Regional economies, excluding Turkey, showed positive growth in 2019 Q2. They benefited from higher consumer spending and investments. Net exports, overall, slowed down, reflecting the weak activity in the euro area, the trading partner of the regional countries. Unemployment rates are trending downward, albeit continuing to record high values. High frequency preliminary data suggest regional economic activity improved in 2019 Q3.

Economy in Turkey shrank also in 2019 Q2, but at a more moderate pace. Economic activity was underpinned by government spending and net exports, which reflect the strong contraction of imports. Consumption and investments continued to shrink rapidly, hence taking economic growth into a negative territory. The economy of Kosovo grew rapidly in 2019 Q2. The positive growth was supported by the strong increase of both investments and exports. Consumer spending increased at more moderate terms, while government spending provided a negative contribution. Economic activity in Serbia continued to show positive growth, supported by consumer spending, government spending and investments. Net exports provided a decelerating effect in 2019 Q2, due to the growth of imports. Growth slowed down in North Macedonia in 2019 Q2, but it remains at good rates. The high domestic demand and investments acceleration fuelled economic growth, while exports provided a decelerating contribution.

Annual inflation was down across the region in September. In all countries, the main contribution came from the performance of food and alcoholic beverages. Also, inflation in Turkey was down, recording one-digit rate in September.

3 The main trading partners outside the European Union (Kosovo, North Macedonia, Serbia, Turkey).


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Table 1. Economic indicators for countries in the region

Countries Annual change of GDP Annual inflation Unemployment rateQ2-2019 September 2019 2019 Q2

Italy -0.1 0.2 9.5*Greece 1.9 0.2 16.9**North Macedonia 3.1 0.3 17.5Serbia 2.9 1.1 10.3Turkey -1.5 9.3 13.9**Kosovo 4.1 2.4 25.3Albania 2.3 1.3 11.5

Source: Respective statistical institutes. * August 2019; ** July 2019.

2.2 COMMODITY PRICES IN GLOBAL MARKETS

Main commodity prices in global markets continued the downward trend in 2019 Q3. Their performance reflected the uncertainty of investors related to trade barriers, the lower demand driven by economic growth slowdown, and the revision on the negative side of expectations for the outlook.

Chart 6 Commodity prices in global markets

Source WB indices; INSTAT, staff’s calculations.

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In September, Brent oil price averaged 64$/barrel, down 20% annually. Notwithstanding the restrictions in production by OPEC countries, the slowdown of economic activity and trade exchanges in large economies exercise weak pressures on oil price increase in the future.

The escalation of trade tariffs between the USA and China lowered metal prices considerably in August. The prices of this group recovered slightly in September, following the positive signal on a solution of the situation between these two countries. However, the slowdown of the Chinese economy higher than forecasts and the low demand from emerging economies are expected to keep metal prices low. Food Price Index also recorded negative growth in 2019 Q3, although more diminished compared with the previous quarter. Within this index, prices of cereals recorded a strong decline.


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2.3 FINANCIAL MARKETS

Some major central banks eased the monetary policy stance in 2019 Q3. Hence, Fed cut twice the federal funds target range, by 25 basis points, down to 1.75%-2.0%. The ECB, in September, maintained the interest rate on the main refinancing operations unchanged, but lowered the interest rate on the deposit facility by 10 basis points to -0.50%. Also, the ECB has restarted the quantitative easing program. The policy rate of the Bank of England stands at 0.75%, while that of the Bank of Japan stands at -0.1%.

The yields on government securities in advanced economies showed a downward trend in these months. The low levels of long-term yields rose mainly as an effect of expectations and continuation of eased policies by the majority of central banks (Fed, ECB,

etc.). The last decisions by Fed and ECB drove to a materialisation of this effect from market agents, thus maintaining the downward trend of yields. The trade tensions among major economies present during this year were other factors driving to an increased uncertainty on global economic growth. The spread between securities of countries that need fiscal consolidation against German Bonds reduced during this period. Yields on corporate bonds in the euro area markets also edged slightly down in these months affected by the expectations on the expansion of the ECB’s asset purchase programme of private sector securities. In the euro area money market, interest rates on short-term instruments remain at negative levels.

Chart 8 Selected global �nancial indicators

Source Bloomberg, Reuters and Eurostat.

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Chart 7 Policy rates of major central banks

Source Central banks (ECB, FED, BoJ and BoE).

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21 Bank of Albania

The euro continued to depreciate against the US dollar in 2019 Q3. This trend reflected, mainly, divergences in the monetary policies implemented by these two economies. In September, the euro was traded for 1.10 US dollars, or 2.0% lower than in July. In average quarterly terms, the euro depreciated 1.0% from the previous quarter, and 4.4% from a year earlier.


22Bank of Albania

Financial markets were calm and showed low risk premiums in the third quarter. Low financing costs and the increase of competition among banks established the premises for a further decrease of interest rates on loans to enterprises and households. Yields on government securities remain subject to short-term volatility of both demand and supply for securities in the market. Nevertheless this volatility is not transmitted into the other markets. In the foreign exchange market, the Albanian lek continued to appreciate in this quarter, in line with its seasonal behaviour. Credit to the private sector improved the growth pace in this quarter, reflecting the expansion of credit demand from both enterprises and households. This dynamic reflected the boost of demand and the reactivation of supply from banks that changed ownership. Overall, monetary expansion in economy remains moderate.

3.1 FINANCIAL MARKETS

INTERBANK MARKET

The interbank rates hovered near the policy rate, in line with the operational objective of monetary policy, while baking system liquidity was within the optimum levels. In details, interests applied on one-week maturities resulted slightly downward, while overnight transactions have not changed. The spread of money market interest rates with the policy rate remained at its minimum. Their volatility was also low, close to values noted in the previous quarters of the year4. Trading volume was slightly down compared with the first half of the year, mainly due to their reduction in one-week transactions. Overnight and one-week maturities remain the most employed ones; in addition, the 2-, 3-days transactions have been also used.

4 The standard deviation of the overnight interbank rates was 0.05 in 2019 Q3, from 0.06 and 0.05 in the two previous quarters.

3. FINANCIAL MARKETS AND MONETARY DEVELOPMENTS


23 Bank of Albania

Chart 9 Bank of Albania open market operations and interbank rates

Source Bank of Albania.

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The Bank of Albania continued to supply liquidity through its main instrument, the one-week repo, and through the one-, two- and three-month maturity injections. The injected amount was higher than in 2019 Q2, mainly in injections with higher maturity. In particular, the amount injected in July and August was considerably higher, while interest rates in auctions stood always close to the policy rate. At the end of August, as a result of the entry into force of changes in the required reserve the system needed less financing from Bank of Albania. In September, injections returned at average levels close to those noted in 2019 Q2.

DOMESTIC FOREIGN EXCHANGE MARKET

The domestic currency (lek) continued to appreciate against the euro in 2019 Q3. The average exchange rate was 121.6 lek/euro, with a quarterly appreciation of lek of 1.2%, as in 2019 Q2. Also, the annual appreciation of lek in this period, averagely 3.5%, was close to the value recorded in 2019 Q2 (3.4%). Compared with the previous year, lek appreciation during 2019, slowed down considerably, given that current deficit, particularly trade deficit, have expanded.

This performance of exchange rate is estimated to be in line with its seasonal behaviour and coincides with a better tourist season, as shown by the indirect data from tourism5. In addition, in the last years this season has been longer as reflected by the earlier start of lek seasonal appreciation and its partial prolongation till September. The fading out of the seasonal effect, typical in September, started only at the end of this month and seems to be reflected

5 In 2019 Q3, the number of foreigners entering into Albania was 5.8% higher than in the previous year. While the net indicator calculated as the difference between the entrance of foreigners and exit of Albanian citizens was 3.3% higher (INSTAT, October 2019).


24Bank of Albania

mostly in October. In the first three weeks of October, one euro is traded on average for ALL 123.0, with a monthly lek depreciation of 1.2% and a slowdown of its annual appreciation at 1.7%. Overall, the trading of euro in the foreign exchange market has been calm and stress indicators in it have ranged at optimum levels6.

Chart 10 The exchange rate trend in the domestic foreign exchange market


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Performance of the US dollar reflected its appreciation in the international exchange market, at a diminishing degree, due to the appreciation of lek against euro. The USD/ALL exchange rate averaged 109.4 lek per one US dollar in 2019 Q3, with a lek depreciating 0.9% compared to the previous year. Lek continued to depreciate against the US dollar in the first three weeks of October as well, mainly reflecting the depreciation of the domestic currency against euro7.

Chart 11 The exchange rate trend in the domestic foreign exchange market


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6 Bid-ask spreads and volatility indicators have been low; meanwhile, in the market, no slanted expectations have been noted on either the appreciation or the depreciation of the exchange rate.

7 The EUR/USD rate was relatively stable in average terms, in September and October.


25 Bank of Albania

In nominal effective terms8, lek appreciated by 1.1% in 2019 Q3. The annual effective appreciation of lek continued to narrow, standing at 2.2% in September, from 5.8% and 10.2% in June 2019 and at the end of previous year, respectively. The appreciation of lek against euro mainly drove to the effective appreciation of lek. Meanwhile, the reduction of this appreciation was dictated by its performance against Turkish lira. The real exchange rate showed a similar trajectory with the nominal one: the real appreciation of lek in annual terms dropped at 1.9% at the end of 2019 Q3, from 4.5% at the end of 2019 Q2.

PRIMARY MARKET

T-Bills and bond yields trended upward throughout most of 2019 Q3. However, since the end of September and October, they have registered consecutive declines. The change in their performance has mainly reflected the rising interest of the banking system to invest in government securities during this period, although government securities’ issue has also increased. Banks’ demand continues to be high, particularly for long-term segments9. In October, yields stood near the average levels of July, and below the ones registered before the latest change of the policy rate. However, the yields curve has been flattening, as the decline has been stronger in higher maturities, the most preferred by banks.

Chart 12 Yields in the primary market*

*The chart includes auctions conducted as at 24 October 2019.

Source: Bank of Albania.

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Change Oct.19 - May18*Change Oct. 19 - Jul 19Oct.2019Jul. 2019May 2018**

**before the latest change of the key rate.

The yield of 12-month T-Bills averaged 2.1% in October from 1.8% in end-July yet downwards from 2.3% in September. Similarly, bond yields increased in

8 The nominal effective exchange rate (NEER) is calculated against the currencies of Albania’s five major trading partners (Italy, Greece, Germany, Turkey and China), using the relevant market weights. For the purpose of calculating lira/lek and renminbi/lek rates, the official reference rates remain those of the Turkish lira and the Chinese renminbi against the US dollar. The real effective exchange rate (REER) is calculated similarly to the nominal, but it considers the domestic inflation and those in the trading partners, as well.

9 The bid/cover ratio for T-Bill auctions in July-September resulted near 1. This ratio for bond auctions resulted 1.4 for this period.


26Bank of Albania

July and August only to decrease later in the latest auctions. For 2-, 3-, 7- and 10-year bonds, yields in the latest auctions resulted at 2.4%, 2.6%, 4.2% and 5.20%, respectively, decreasing 0.1 p.p. to 0.3 p.p. from the auctions conducted in July and August.

FINANCING TO PUBLIC SECTOR

The budget balance of 2019 Q3 was positive at around ALL 1.2 billion, bringing the narrowing of the nine-month cumulative deficit at ALL 2.3 billion. Borrowing structure during this quarter was similar to that of the previous quarter. The increase of funding with domestic debt instruments was offset somewhat by the lower use of foreign debt instruments in total funding in this period. Thus, net foreign borrowing during this quarter decreased by ALL 4.4 billion due to the lower amount of foreign loan obtained compared with repayments of foreign debt coinciding with this period.

Borrowing in the primary securities’ market in 2019 Q3 increased by around ALL 5 billion. The borrowing profile in terms of maturity continued to improve in this quarter, supported mainly by long-term instruments, which formed around 70% of the increase of domestic borrowing in 2019 Q3. In this quarter there was also a specific development related with the domestic debt profile in terms of denomination. More concretely, in August the last 2-year bond denominated in euro matured10, amounting to around ALL 4.8 billion, which was entirely offset by the increase of borrowing in bonds of the same maturity, but in Albanian lek. Unlike the previous quarter, in this quarter, the government also increased the level of liquidity that it holds in the accounts at the Bank of Albania.

Chart 13 Budget de�cit �nancing*

*Values above the horizontal axis in the chart imply a scal decit, below zero they indicate scal surplus.Source: Ministry of Finance and Economy, Bank of Albania.

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10.020.030.040.050.0

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T-Bills BondsPrivatizations Use of liquidityForeign �n. Budget de�cit

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10 First issue of bonds in the domestic securities’ market dates December 2013. Since then, although not frequently used, this instrument has been part of the government’s primary securities market. As of August 2019, the government has completely settled the liabilities related with this debt instrument.


27 Bank of Albania

The borrowing structure in the primary securities’ market in 2019 Q3 was similar to that of the previous quarter, where commercial banks continued to play the primary role in buying government securities. On the other hand, households continued to decrease their securities’ portfolio. Such behaviour has been observed for five quarters consecutively. Besides the structure shaping in the primary market11, the lower participation of households in the government securities’ market is also attributed to lower yields from these types of instruments.

3.2 DEPOSIT AND CREDIT INTEREST RATES AND FINANCING CONDITIONS

Average interest rate on new loans in lek to the private sector was 6.3% in 2019 Q3, slightly lower than in 2019 Q2 (6.4%). During this year, interest rates on loans have generally been downwards. Interest rates fell also compared with the same period of the previous year. Their downward trend these months was driven by the interest rates of loans to enterprises, whereas interest rates of loans to households hovered at similar levels. Interest rates of loans to enterprises in 2019 Q3 reflected mainly the decrease in loans for liquidity, whereas for investments they showed more volatility. Interests for households decreased slightly for mortgage loans whereas for consumption they were volatile showing even a slight upward trend during these months.

Chart 14 Interest on new loans and deposits in lek


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Average interest rate for new loans in euro to the private sector resulted at 4.0% for 2019 Q3, slightly lower than in 2019 Q2 (4.1%). From a broader time horizon, interest rates in euro have been around this level in the last two years. By purpose of use, interest rates in this quarter declined for loans to households,

11 Since the beginning of the issue of the benchmark bonds, in July 2018, government borrowing increased mostly due to this type of instruments. For 2018, they were 5-year bonds, whereas in 2019 3-year bonds were also added.


28Bank of Albania

both for consumption and mortgage loans12. Meanwhile, interest rates for loans to enterprises have not changed much from the previous quarter.

Chart 15 Interest on new loans and deposits in euro


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Average interest rate on new time deposits in lek continued to decrease even in this quarter, although at marginal values. It resulted at 0.74% in this quarter, from 0.76% and 0.92%, respectively in the previous two quarters. The decrease was formed for both up to one-year and above one-year maturities. Average interest rate on new time deposits in euro registered a marginal growth this quarter, reaching 0.15% from 0.12% in the previous quarter. This increase was mainly due to developments in the 1- to 12-month interval, which also constitutes the main share of new deposits in this currency.

Chart 16 De�ning non-price terms and conditions of loans*

*: “Loan covenant terms and conditions” is a shorter series, since this factor is included in the review of bank lending survey of July 2018**. Non-price terms and conditions is the average of net balances for each indicator. Positive/negative

balance of non-price terms and conditions implies easing/tightening of terms and conditions. Source: Bank Lending Survey, Bank of Albania.

**Bank of Albania - Bank Lending Survey. Non-price terms and conditions are generated as the arithmetic average of: commissions, loan size, maturity, collateral demanded for the loan received, and terms of the loan covenant.

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According to the bank lending survey for 2019 Q2, non-price terms and conditions of loans to enterprises remained on average unchanged. This 12 The share of households in new loans in euro is small and for this reason their rates’ fluctuation

finds little reflection in aggregate interest.


29 Bank of Albania

result expressed, on the one hand, the easing of the size standards of loans to enterprises and, on the other the tightening of terms and conditions on loan agreements during this quarter. Meanwhile, other non-price terms and conditions, like collateral requirements, loan maturity and commissions, remained unchanged. However, the performance of this indicator during the last year confirms a somewhat favourable approach of banks to enterprises.

According to banks, in 2019 Q3, non-price terms and conditions for households were slightly tightened, reflecting the increase of collateral requirements. This result was affected by only one bank of the system, whereas the other banks reported it as unchanged. Other non-price terms and conditions remained unchanged. From a longer point of view, non-price elements for households remain overall easing.

3.3 CREDIT TO THE PRIVATE SECTOR13

Credit to the private sector continued to improve in 2019 Q3, registering 7.5%14 annual growth. GDP expansion was even more significant at 36.4%, or 1.1 percentage points higher than at the end of 2018. This improvement reflected a higher demand for funding by the private sector, in response to a positive performance of the labour market, enterprises’ confidence and the economic activity overall. Also, the changes of ownership of the banking sector have led to a more positive approach of banks to accommodate the increased demand for funding by the private sector15. Meanwhile, the ratio of non-performing loans to total loans has been trending continuously downwards, confirming more favourable conditions for expansion of lending supply by banks.

Chart 17 Lending to the private sector


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13 Credit data are based on monetary statistics and are adjusted for the effect of written-off loans and exchange rate movements.

14 In the previous two quarters, the annual growth of credit to the private sector averaged 6.7% and 5.9%, respectively.

15 As confirmed by the decline of loan rejections by banks.


30Bank of Albania

Lending by currency confirmed the recovery of funding in the domestic currency, which, in 2019 Q3, registered 9.1% average annual growth. During this period, loans in lek expanded by ALL 9.4 billion, or around twice the average growth during the first two quarters. The portfolio of loans in foreign currency also registered an improvement, and increased on average by 6.4% year on year, or 1 percentage point more than the average of the first six months of the year. Loans in lek in 2019 Q3 found wider support from enterprises’ demand for funding in lek, compared with the stable pace of loans to households. These developments supported a more balanced structure by currency of credit to the private sector. The ratio of loans in lek to total loans increased at 47.8% in September, or 0.6 percentage point higher than December 2018.

Chart 18 Credit to the private sector and annual contributions by currency and economic agent


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Improvements in the growth rates of credit to the private sector reflected a better performance of loans to enterprises, which increased by 7.8% in 2019 Q3. Positive developments in the segment of loans to enterprises were supported by higher growth rates of lending for liquidity, on average 11.2%, while that for investments registered a slight slowdown, at 5.5%. In particular, during the two months of summer a high use of loans for liquidity was observed, reflecting both the increased tourist activity and the demand from the energy sector. In addition to these two factors, the comparative basis was also affected by the previous year, when loans for liquidity declined sharply. Loans to enterprises for investments appear fluctuating, affected by the lack of stable demand in time for this purpose.

The outstanding loans to households registered 6.9% annual growth on average in 2019 Q3, or 0.7 percentage point higher than in the previous quarter. For the year 2019, the portfolio of loans to households registered a stable increase, driven by the continuous demand for funding by this segment as well as by the eased lending standards by banks. The expansion of lending in 2019 was affected by the improvement of growth of consumer loans, whereas loans for house purchase registered a stable growth throughout the year.


31 Bank of Albania

3.4 MONEY AND DEPOSITS IN THE ECONOMY

Monetary supply in 2019 Q3 continued to register a stable growth, but with a moderate pace. The broad money indicator, the M3 aggregate, registered 3.5% annual growth on average in 2019 Q3, similar to the previous quarter. The expansion of money supply, on the assets side, is supported mainly by the increasing contribution of lending to the economy, followed by the increase of net foreign assets of the banking system. The aggregate in lek, M2, maintained the growth rates of the previous quarter, at around 2.7%. The expansion of the aggregate in lek was supported by the funding of the private sector with loans in lek, as well as the shift of internal government borrowing toward instruments in the domestic currency16. On the liabilities side of the banking sector, the time structure of money aggregates registered a further shift toward the liquid component. The ratio of currency outside banks to M2 aggregate registered high values this quarter, reflecting also the seasonal increase of this indicator in 2019 Q3, typically in August (27.9%)17. However, in the longer run, the increase of this ratio, as well as the partial shift of deposits towards the extremities of the liquidity spectrum is below the expected effect of the accommodative monetary policy that has been implemented for several years.

Chart 19 Monetary Indicators


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Deposit developments show an increase of the stock in 2019 Q3 by around 4.6% on average in annual terms. The ratio of deposits to GDP is assessed at around 69.8% at the end of September. The deposit expansion was mainly in the form of foreign currency deposits, which contributed by around 2.9 percentage points in the annual growth of total stock. In absolute terms, deposits

16 The government matured the entire euro-denominated bond portfolio in August, replacing this portion of foreign currency funding with additional funding in lek.

17 In the ratio of currency outside banks to M2, the denominator is adjusted for all instruments in the domestic currency. Thus, to the M2 aggregate, are also added other lek instruments, which are not included in calculation of M2, such as deposits whose maturity is longer than two years, and investments by households and other financial (non-bank) institutions in Government securities in lek.


32Bank of Albania

in the banking system increased by around ALL 29 billion in 2019 Q3. This increase was concentrated mainly in August, with deposits in foreign currency expanding during this month by ALL 18.4 billion. The high foreign currency flows during this period were driven by the increased activity of tourism sector, remittances, as well as the maturation of the euro-denominated government bond. Deposits in lek maintained similar annual growth rates with the previous quarter, contributing by around 1.8 percentage points on average to the annual rate. The slight expansion of deposits in lek is in line with high liquidity holdings (cash), as well as with the increase of public sector liquidity maintained at the Bank of Albania.

Chart 20 Deposits* in the banking system

*Total deposits, which include deposits under two years and over two years.Source: Bank of Albania.

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The time structure of deposits reflects the further shift toward the liquid component, demand deposits. At the same time, deposits with long-term maturity (above two years), which offer relatively favourable interest rates, continue to increase. Demand deposits and deposits with maturity above two year accounted for around 46% and 13%, respectively, of the total deposit stock at the end of September.


33 Bank of Albania

Annual inflation averaged 1.4% in 2019 Q3, unchanged from the previous quarter and in line with our forecasts. The food group, which generally triggers the strongest fluctuations in inflation, maintained a stable behaviour in this quarter, registering almost the same contribution of the previous quarter (70%) in the formation of headline inflation.

In longer terms, the undershooting of inflation reflects the still weak pressures from the presence of the negative output gap and the slow increase of costs in the economy. Also, pressures from imported inflation remain weak, driven by the moderate increase of foreign prices as well as by the slowing down effect of the exchange rate appreciation.

Economic activity increased 2.3% in 2019 Q2, comparable with the previous quarter and close to our expectations. This development continued to reflect the contraction of electricity output, in turn reflected in the expansion of the net exports deficit. The main contributor to growth was final consumption, affected by the increase of employment and the positive performance of services.

The stabilisation of economic growth towards potential is expected to boost the absorbing capacity of the economy and contribute to the return of inflation to target in the medium-term horizon.

4.1 INFLATION

Inflation averaged 1.4% in 2019 Q3, unchanged from the previous quarter. The performance of inflation in this quarter reflected the low pressures from food, oil and house prices. The slight fluctuations of inflation during this quarter were driven by temporary supply-side factors. Inflationary pressures from the demand side are assessed as contained, mainly due to the presence of the negative output gap. Imported inflationary pressures remain low and diminishing. This development is determined by the impact of the exchange rate appreciation, coupled with the downtrend of commodity prices in foreign markets as well as inflation in EU and regional countries.

4. INFLATION AND ECONOMIC GROWTH


34Bank of Albania

Chart 21 Headline in�ation, target (left) In�ation in regional and EU countries (right)

Source: INSTAT, Trading Economics database and calculations of the Bank of Albania.

0.0%

0.5%

1.0%

1.5%

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Average headline in�ationtarget

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AlbaniaRegional countries

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Food prices remain the main contributor to the formation of inflation, forming around 70% of headline inflation in 2019 Q3. Unprocessed food contributed by around 50% to the formation of headline inflation. In August and September, the annual contribution of this category declined at 0.6 against 0.9 percentage point in July. This development caused a decline of the contribution of this category by 0.1 percentage point compared with the previous quarter18.

Processed food increased the contribution to the formation of inflation in this quarter (0.3 percentage point from 0.2 percentage point). This increase was driven mainly by the sub-groups “Bread and cereals” and “Milk, cheese and eggs”. As a result of these movements, these two food categories offset each other, maintaining a stable contribution of food to annual inflation in 2019 Q3.

The “Non-food consumer goods” contributed by 0.1 percentage point to the inflation of this quarter, lower compared with the previous quarter. This performance has reflected the lower annual inflation of fuel due to: the downwards trend of oil prices in foreign markets; the appreciation of the domestic currency; and the impact of the high comparative base of the previous year.

18 In 2019 Q3, the contribution resulted at 0.7 percentage point against 0.8 percentage point in the previous quarter. This development was driven by the slowdown of inflation in the sub-group “Vegetables”.

Chart 22 Contributions by food and non-food categories to headline annual ination

Source: INSTAT and Bank of Albania calculations.

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Contribution of food inationContribution of non-food inationTotal


35 Bank of Albania

Tabelë 2. Contribution of key items to annual inflation (p.p.)*Q1‘17 Q2‘17 Q3‘17 Q4‘17 Q1‘18 Q2‘18 Q3‘18 Q4‘18 Q1‘19 Q2‘19 Q3‘19

Processed food 0.6 0.5 0.2 0.0 0.1 0.2 0.2 0.1 0.1 0.2 0.3 Bread and cereals 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 -0.1 0.0 0.1 Alcohol and tobacco 0.1 0.0 0.0 0.0 0.1 0.1 0.1 0.1 0.1 0.1 0.1Unprocessed foods 1.3 1.1 1.2 1.3 0.9 1.1 1.0 0.9 1.3 0.8 0.7 Fruits 0.3 0.3 0.5 0.6 0.6 0.1 0.0 -0.1 -0.3 0.0 0.0 Vegetables 0.9 0.7 0.7 0.6 0.2 0.9 0.9 0.9 1.5 0.8 0.7Services 0.2 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.0 0.0 0.1Goods at regulated prices 0.0 0.0 0.0 0.0 0.2 0.2 0.2 0.2 0.0 0.0 0.0 Water supply 0.0 0.0 0.0 0.0 0.2 0.2 0.2 0.2 0.0 0.0 0.0Housing Rent 0.0 0.1 0.1 0.2 0.3 0.4 0.4 0.3 0.1 0.2 0.1Non-food consumer goods 0.3 0.2 0.2 0.2 0.3 0.3 0.3 0.2 0.1 0.2 0.1 Fuel 0.0 0.0 0.0 0.0 0.1 0.1 0.2 0.2 0.1 0.1 0.0Durable consumer goods 0.0 -0.1 -0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1Consumer Price Index (annual change, %) 2.4 2.0 1.7 1.8 1.9 2.2 2.2 1.8 1.6 1.4 1.4

Source: INSTAT. *The table shows some of the main groups of items.

The prices of other more stable components of inflation, which includes mainly the prices of housing, services, durable consumer goods and goods at regulated prices, had a higher contribution to inflation (0.3 percentage point) compared with the previous quarter. This development reflected the contribution of “services” and “durable consumer goods” which increased by 0.1 percentage point each. The additional contribution of services was driven mainly by the higher prices of air transport services during August. Meanwhile, the contribution of “Durable consumer goods” increased due to higher prices in group “Furnishings, household equipment and house maintenance”. The category “Housing-Rent” registered a stronger base impact compared with the previous quarter, decreasing its contribution by 0.1 percentage point. Meanwhile, the contribution of “Regulated prices” remained negligible, reflecting the diminishing impact from the increase of water prices in the previous year (-0.2 percentage point).

4.2 GROSS DOMESTIC PRODUCT AND AGGREGATE DEMAND

In 2019 Q2, economic growth resulted at 2.3%, close to that recorded in the previous quarter (2.4%). The services sector continued to generate the largest economic growth. Meanwhile, economic activity was affected downwards by the lower electricity output and the performance of construction.

In terms of aggregate demand, domestic demand continues to be the main driver of growth, whereas net exports deepened their negative impact. The growth of domestic demand was driven mainly by the expansion of private consumption and, to a lesser extent, by the increase of public consumption. Meanwhile, investments resulted lower than in the previous year, reflecting the end of investments in a strategic project.


36Bank of Albania

Information obtained by indirect, quantitative and qualitative, indicators suggests that the moderate performance of economic growth is expected to continue in 2019 Q3 as well.

4.2.1 GROSS DOMESTIC PRODUCT BY SECTOR19

The slowdown of economic growth in 2019 H1 is attributed to the performance of the production sector. Activity in this sector reflected, to a large extent, the contraction in the electricity branch. This branch is assessed to have affected negatively economic growth by 0.9 percentage point (from -1.7 percentage points in the previous quarter).20 In the same quarter, the contraction of construction decreased the annual growth of GDP by 0.2 percentage point. This development reflected mainly the contraction of construction activities related with the Trans Adriatic Pipeline (TAP) project, which have entered the completion phase. Meanwhile, industry and agriculture, forestry and fishing supported economic growth by 0.6 and 0.4 percentage point, respectively. The services sector, notwithstanding the slight slowdown of growth rates, continued to drive the economic performance in 2019 Q2. This sector formed around 77% of the economic growth, contributing by 1.8 percentage points from 2.0 percentage points in the previous quarter. The component of net taxes continued to support economic growth by 0.5 percentage point for the fourth consecutive quarter.

Chart 23 Gross Domestic Product by sector and condence indicators

Source: INSTAT and Bank of Albania. *Semi-nal data. ** A preliminary estimate.

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-3

-1

1

3

5

7

Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2Q4Q1Q2

2011 2012 2013 2014 2015 2016 2017*2018**

2019**

Contributions of economic activities in yoy real GDP

Agriculture, forestry, shing

Industry, energy and water

Construction

Services

Taxes minus subsidies on products

-30

-15

0

15

30

Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2Q4 Q2 Q4 Q2 Q4 Q2Q4 Q1 Q3

2011 2012 2013 2014 2015 2016 2017 2018 2019

Diference from long term average

Industry condence indicatorConstruction condence indicatorServices condence indicatorTrade condence indicator

19 Gross Domestic Product and Gross Value Added by sector are treated in terms of real annual changes. The analysis relies on the latest GDP data by output method for 2019 Q2, published by INSTAT on 30 September 2019. The differences between the sectors’ growth rates of this publication and those analysed in the Monetary Policy Report 2019/III are the result of the revision of the series.

20 Bank of Albania calculations. The contraction of value added in energy continued to be affected largely by the higher comparative base with the previous year when the net domestic output of electricity expanded by around 89%. The impact of electricity output in economy is treated more extensively in the Box “Electricity related shocks and monetary policy decision-making”, published in the Monetary Policy Report 2019/III.


37 Bank of Albania

The Industry, energy and water sector moderated the downwards dynamics in 2019 Q2. The value added of the sector resulted around 1.9% lower than the same period in the previous year, after contracting 6.3% in the previous quarter. In 2019 Q2, the downwards dynamic of the sector is attributed mainly to the lower annual level of electricity21 output, and, to a lesser extent, the decrease of value added of output of the metal products manufacturing industry. The moderation of the decline of valued added of these activities was reflected in the decrease of the negative impact on the performance of the sector compared with the previous quarter, from 12.9 to 7.5 percentage points by “Energy” and from 0.6 to 0.4 percentage point by “Metal products manufacturing industry”.

With the exception of the activity of metal products manufacturing industry, the other composing sub-branches of the manufacturing industry contributed positively to its performance. The value added of the manufacturing industry accelerated its annual growth rate at 5.3%. As a result, its contribution in the performance of the sector resulted higher, reaching 2.5 percentage points. In addition to the manufacturing industry, mining and quarrying registered a positive dynamic in 2019 Q2.

Chart 24 Contribution of branches to value added in “Industry, energy and water”, and the capacity utilisation rate in industry

Source: INSTAT and Bank of Albania. *Semi-�nal data. ** A preliminary estimate.

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2013 2014 2015 2016 2017* 2018**

2019**

Annual changes (%) and contributions (percentage points)

Mining and quarring, eletricity, water supply and seweragemanufacturing industryIndustry, energy and water supplyElectricity production (net domestic, annual changes in %, rhs.)

60

64

68

72

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2011 2012 2013 2014 2015 2016 2017 20182019

%

Capacity utilisation rate

The performance of the industry sector is expected to continue to be affected by the negative pace of energy output and water in 2019 Q3 as well, but with a lower impact. At the same time, the strong, improvement of confidence

21 The negative developments of the branch “Electricity, steam and air conditioning” is also confirmed by the annual decrease of the index of output and net sales volume by 30.9% and 12.6%, respectively. This dynamic continues to bear the impact of a higher comparative basis with the previous year, where for the first three quarters the output volume of the branch registered and average annual increase by 51.4% and in the first two quarters net sales volume expanded on average by 43.7% in annual terms. Data from INSTAT - from the electricity balance - evidence that the domestic net output of electricity resulted around 52.7% lower than in the same period the previous year, mitigating the contraction by 60.1% of the previous quarter.


38Bank of Albania

in industry signals further reduction of the contraction trend of the sector during 2019 Q3.

Chart 25 Valued added and capacity utilisation rate in construction

Source: INSTAT and Bank of Albania.

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Value added in construction (annual changes in %, in real terms)Capacity utilisation rate (rhs.., in%)

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2008

2009 2010 2011 2012 2013 2014 20152016 2017 2018 2019

Issued building permits(moving sum, 4 terms, index 2008=100)Order books(balance from the business survey, moving average with 4 terms, rhs)

The construction sector registered a decline in 2019 Q2. This performance is attributed to the Trans Adriatic Pipeline (TAP) project entering its final stage. More concretely, the value added in construction decreased by 1.7% in annual terms, after the increase of 6.1% in the previous quarter.22 Despite the increase in the category of reconstruction, the annual decline of construction output is assessed to have reflected mainly the lower volume of new constructions, and, to a lesser extent, engineering. The increase in foreign direct investments inflows and the support by the public component seem to have resulted insufficient to reverse the performance of the construction sector upward in the quarter under review.

The dynamic of the construction sector is assessed to have reversed slightly in 2019 Q3. On one hand, the upwards trend of the number of construction permits granted supports the positive performance of the sector. On the other, the decline of the confidence indicator and the capacity utilisation rate in construction, the continuation of the decelerating impact from the TAP project on construction, as well as the high comparative base of the previous year are factors providing a slowdown impact on the growth of the sector. 23

22 The output volume index and the volume of net sales also showed the same dynamics, which fell by 0.7% and 1.8%, respectively, in annual terms, after the increases of 3.0% and 4.4%, respectively, registered in the previous quarter.

23 The number of construction permits granted in total for new buildings in 2019 Q2 was 310, from 270 permits granted in the same period the previous year. The annual growth of this indicator, which still remains under the historical average, reflected mainly the granting of a high number of construction permits for other buildings (like hotels, office buildings, commercial buildings, industrial and others). The number of construction permits granted for housing purposes increased as well. From our assessments, the component of nominal public investments continued its annual increase in 2019 Q3 as well.


39 Bank of Albania

The services sector slowed down slightly its growth in 2019 Q2, at 4.1%, from 4.3% in the previous quarter. This performance was caused by the slower activity in “Professional activities and administrative services”24 and “Real estate”. These branches decreased their annual contribution to the annual performance of the sector by 0.5 and 0.3 percentage point, respectively, compared with the previous quarter. The main services’ activities continued to support upwards the dynamic of the sector, with the exception of “Art, entertainment, recreation and other services activities”. The contraction of this branch, mainly driven by the closure of the gambling activity, contributed negatively for the second quarter by 1.1 percentage points to the value added of services.

Meanwhile, among services, “Trade, transport, accommodation and food services” continued to largely support the dynamic of the sector. Its contribution was unchanged from the previous quarter (1.6 percentage points). Despite the key impact of the trade activity on it, the continuation of the growth of the volume of net sales for “Hotels” and “Bar-restaurants” shows a positive impact for these activities.25 The “Information and communication” branch contributed also to annual growth at the same extent as in the previous quarter, with 0.6 percentage point. Services related with “Public administration, education and healthcare” and “Financial and insurance activities” increased slightly their contribution to the performance of the sector: by 1.0 and 0.7 percentage point, respectively.

Chart 26 Contribution of branches and capacity utilization rates in the services sector

Source: INSTAT and Bank of Albania. *Semi-�nal data. ** A preliminary estimate.

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9


2011 2012 2013 2014 2015 2016 2017* 2018**2019**

Annual change (%) and contribution (p.p.)

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%, Capacity utilisation rate

Trade Services excluding tradeArts, entertainment and recreation servicesPublic administration, education and healthProfessional and administrative servicesReal estate activityFinancial and insurance servicesInformation and communicationTrade, transport, accomodation and food servicesServices value added

24 By volume of net sales, the slowdown of the increase of value added of this branch reflects to an extent the accelerated annual decline of the volume of net sales for the sub-branch “Architecture and engineering activities”.

25 In line with these developments are also the signals received foreign citizens’ entry data. Their number registered an annual increase of 16.0% in 2019 Q2 after the increase of 2.7% in the previous quarter. The main impact by purpose of travel came from the increase of the number of individuals travelling for personal purposes in the category “Vacation, visit to relatives, etc.”.


40Bank of Albania

The growth of the services sector in 2019 Q3 is assessed to be similar to 2019 Q2. The improved level of confidence and the capacity utilisation rate above the level registered in the previous year and above its historic average are in line with the expectations for positive developments in this sector.

4.2.2 AGGREGATE DEMAND

Domestic demand continued to determine economic growth in 2019 Q2. The main contributors to the increase were “private consumption” and “public consumption”. On the other hand, “investments” resulted in a negative contribution. Net exports also had stronger negative impact, due to the growing deficit in 2019 Q2 compared with Q1. Data from indirect indicators signal that economic growth for 2019 Q3 is expected to record similar values to the previous quarter. Private consumption is assessed to remain the main contributor to growth, whereas the positive impact of public consumption is expected to continue. At the same time, a slight positive contribution from net exports it is expected. The performance of investments remains weak.

Domestic demand expanded 2.2% in 2019 Q2, a slightly slower rate than in the previous quarter. The annual dynamic was defined by population consumption, with positive contributions from public consumption as well. On the other hand, investments decreased compared with the previous year.

Leading and indirect indicators suggest domestic demand will continue to grow in 2019 Q3. Private consumption is expected to have the main impact, followed by investments and public consumption.

Chart 27 Economic sentiment indicator and structure of domestic demand


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Economic sentiment indicator (lhs)Domestic demand, yoy (rhs)

- t average= 100 in%


41 Bank of Albania

PRIVATE CONSUMPTION

The upward trend of private consumption continued in 2019 Q2, constituting the main contributor to the expansion of aggregate demand in Albania. Its annual growth was 2.9% in 2019 Q2, higher than that of 2019 Q1. Private consumption increased driven by the increase of income from employment, the stability of confidence indicators and the financial environment with low interest rates, which boost consumption and consumer credit.

The increase of private consumption during 2019 Q2 materialised mainly in the increase of expenditures for consumer goods. Expenditures for durable goods were lower this quarter, judging by both disaggregated data of the retail trade index, as well as qualitative data from the consumer confidence survey26. On the other hand, expenditures in the category of services show a higher stability during the last quarters, increasing comparably with those of the first quarter27.

Chart 28 Private consumption and consumer con�dence


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Deviation form long- term average

The information filtered by indirect indicators suggest a continuation of the upwards rates of consumer spending during 2019 Q3, supported by the increase of income, low inflation and eased financing conditions. Short-term quantitative indicators give more optimistic signals compared with the qualitative indicators from the consumer and business confidence surveys.

26 The index “Household equipment, furnishings, etc.” slowed down from 11.1% in 2019 Q1 to 3.9% in Q2. Also, the balance of the question on major purchases in the consumer confidence survey registered a slight decrease in Q2.

27 Based on data from the Gross Domestic Product by output, the increase in value added in the services excluding trade was 3.8% in 2019 Q2, comparable with the 4% increase in Q1.


42Bank of Albania

Chart 29 Quantitative (left) and qualitative (right) indirect indicators from surveys on private consumption


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Consumer creditIImport of food, beverages and tobacco

annual changes, in %

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diff.from l- t average

INVESTMENTS

Total investments continued their downward trend started in 2018 Q3, and contracted by 0.9% in 2019 Q. Indirect estimates show that the public investment component contributed positively, even though it failed to offset the negative contribution from the private investments. The contraction of private investments was driven by both the decline of construction investments, mainly related to developments in the TAP project, as well as to investments on machinery and equipment28.

Consumer demand, spare capacities of firms, Foreign Direct Investments; and loan for investment purposes were factors that had a positive impact on the business investment climate in 2019 Q2.

The indirect indicators that proxy the performance of investments suggest that in 2019 Q3, investment will perform similarly to 2019 Q2. In a longer-term perspective, increase of consumer demand, increase of capacity utilization rate as well as eased financial conditions remain supportive for the increase of private investments of businesses in the economy. In parallel, it is estimated that effect from the TAP project will remain present on the investment dynamics during the remainder of the current year. The magnitude of this effect will be determined by the ability of businesses to redistribute capacities in other investment projects within a short-term horizon.

28 Assessment from foreign trade data. INSTAT does not publish quarterly data on Investments in economy, by type and sector. The import of capital goods fell by 5.4% y-o-y during Q2.

Chart 30 Gross �xed capital formation, annual change

Source INSTAT.

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Investments 4Q MA

annual changes, in %


43 Bank of Albania

Chart 31 Short-term quantitative and qualitative indicators from investment surveys

Source INSTAT and Bank of Albania.

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Businesse �nancinal situation, BCS, diff. from average

Credit for investments, yoy, in %

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Import of capital goods, in % (lhs)Public investments, in % (ra)

PUBLIC SECTOR DEMAND AND FISCAL POLICY29

Fiscal policy continues to follow a consolidating cycle during this budget year. However, the intensity of fiscal consolidations weakened compared to the previous year, thus generating a higher positive impact of the fiscal policy on aggregate demand growth. Fiscal impulse, which proxies the impact of fiscal policy for a full fiscal year on aggregate demand growth, was estimated at about 0.2 percentage points of GDP. Although at a small magnitude, at the end of the quarter, this indicator crossed the negative threshold that had been present since 2018 Q2.

The budget deficit was ALL 2.3 billion at the end of the year, at around 0.2% of GDP. It is lower compared to the end of the first six-months, when this deficit was about ALL 3.5 billion.

Chart 32 Orientation of �scal policy*

*The orientation of �scal policy is proxied by changes in the ratio of primary cumulative de�cit for a 12-month period to the GDP, compared to a year earlier. Negative changes, i.e. the values of these indicator below zero, show that the �scal

position has improved, which indirectly indicates negative values of �scal impulse in the economy. Source: Ministry of Finance and Economy, INSTAT, and Bank of Albania staff calculations.

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Orientation of �scal policy

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Budget de�cit/ GDP, in %

29 The fiscal data published by MoFE are preliminary and subject for future review.


44Bank of Albania

Budged expenditures in Q3 increased by 5.1% in annual terms, at a slower pace compared to the first half of the year. Growth slowed down due to the contraction by about 14.4% of capital expenditures in 2019 Q3. On the other hand, current expenditures maintained similar growth rates to the first half of the year, at 7.9%. The profile of current expenditures increase was similar to that of the first half of the year, where about 77% of their annual expansion was driven by increased spending on staff, special funds, local government, and interest payments on the public debt.

Performance of budget expenditure suggests that the fiscal sector will continue to support aggregate demand growth in 2019 Q3, mainly in the form of an additional impulse from public consumption.

Chart 33 Budget expenditures

Source: Ministry of Finance and Economy.

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For the first nine months of the year, budget expenditures amounted to about ALL 345.8 billion, or 6.1% higher than the same period a year earlier. Their growth was entirely driven by current expenditures, whereas capital expenditures contributed negatively to growth by 0.9 percentage point. Capital expenditures for the nine-month period recorded about 6.9% annual contraction.

Revenues in 2019 Q3 increased by about 4.6% y-o-y, slightly at a better pace than the average recorded in the first half of the year. This improvement was dictated by the increase of tax revenues on personal income30; in terms of other components, the income growth profile was almost similar to the first half of the year. The only exception is the VAT revenue item, whose dynamics deteriorated further during 2019 Q3, giving a negative contribution of 2.3 percentage points to total revenues, compared to -1 percentage point on average during the first half of the year. However, if we consider the shortfall of revenues from this item as a result of refunds, the performance of VAT in 2019 Q3 is more positive, with revenues provided by it almost at the same levels as in the previous year31.

30 In addition to earnings / wages and salaries, this item also includes income from the acquisition of a partner or shareholder in the company, rental income, etc.

31 Based on MoFE’s publication on gross and net VAT revenues, VAT revenues, excluding VAT refunds for 2019 Q3, would be about 0.3% higher in annual terms, compared to - 6.8% referring to the VAT data in net terms (VAT after refunds).


45 Bank of Albania

Chart 34 Performance of revenues

Source: Ministry of Finance and Economy.

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Until the end of the first nine months, budget revenues amounted to around ALL 343.5 billion, or 4.2% higher than in the previous year. This increase was mainly supported by the tax revenues on personal income, which accounted for about 67% of the growth of total revenues.

Performance of revenues closely related to the economic indicators suggest consumption will continue to grow, improving the indicators of labour market and economic activity in 2019 Q3.

EXTERNAL DEMAND AND FOREIGN TRADE

The trade deficit in goods and services expanded by 12.6% in real annual terms in 2019 Q2. The deficit deepened at a higher pace than in the previous two quarters. This performance was determined mainly by the rapid growth of imports of goods by 3.5%, and services (10.4%). For the same-stated quarter, exports expanded by 3.2%, driven mainly by the annual increase in exports of services (9.2%). Meanwhile, the export of goods was characterized by a significant annual decline (-12.9%). This performance coincides with the considerable reduction of electricity exports. In parallel, energy imports have been increasing, also contributing to the deepening of trade deficit.

Data on exports and imports of goods for 2019 Q3 show trade deficit deepened at a lesser extent

Chart 35 Contribution of net exports to aggregate demand (in p.p.)


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46Bank of Albania

compared to the 2019 Q2 (8.2% compared to 12.1%). The deficit dynamics is determined by the performance of imports.

Chart 36 Import and export by category (in ALL million)

Source: INSTAT.

0

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Food, beverages,and tobacco Minerals,

oil andelectrical energy,

Chemical andplastic products

Leather andrelated

products

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and metals

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and metals

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Others

Imports

2017M1-M92018M1-M92019M1-M9

The exports of goods in value declined by about 1.1% y-o-y during 2019 Q3, slower compared to the previous quarter (4.2%). The performance of “Minerals, fuels, electricity” category, continued to produce negative contributions albeit at a lesser extent compared to the first half of the year. The main determinants of the annual decline in exports were the categories “Textiles and footwear” and “Construction materials and metals”. These two categories have suffered from both unfavourable conditions from foreign demand and prices reduction (most notably in the case of building materials). It should be emphasized once again that the appreciation of the exchange rate is also an important factor as statistics are expressed in domestic currency.

Gra�k 37 Annual Dated Brent oil prices, domestic oil export (left), metal prices index and domestic metal export (right)

Source: INSTAT, IMF, EIA, London Metal Exchange, Marketindex, Cameco.

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Metals export (value)IMetal price index


47 Bank of Albania

Imports expanded by about 3.8% y-o-y during Q3, remaining the same as in the previous quarter. The main source relates to the category “Minerals, Fuels, Electricity”, “Chemicals and Plastic Products” and “Food, beverages, tobacco”.

By geography, the countries of the European Union, and particularly Italy, remain our main trading partners for both exports and imports. A decrease in the relative shares of Kosovo and Italy was observed during 2019 Q3. This is related to the poor performance of the categories “Minerals, fuels, electricity” and “Textiles and footwear”.

BOX 1 BALANCE OF PAYMENTS IN 2019 Q2

Net current account position recorded a deficit of EUR 273.3 million in 2019 Q2, expanding by about 62.1% y-o-y. It stood at 7.6% of nominal GDP, about 2.6 percentage points higher than the same quarter a year earlier. A key driver in this dynamic was the rapid expansion of the trade deficit in goods. This performance was determined by the rapid growth of imports, mostly driven by electricity imports. In the case of exports of goods, a significant decline in annual terms (by about 12.8%) was mainly affected by the rapid decline in electricity exports, as well as in other categories. Regarding services, the positive balance expanded in annual terms mainly due to the increase in exports (by about 2.1%). The categories that have affected this are “input processing services” and “other services”. In the case of travel services, despite the rather high export growth (about 11.6% y-o-y), the positive surplus decreased by 2.5%. The increase in the import of travel services (about 14.7%) contributed in this regard.

The “primary income” account was characterized by a negative surplus, while a year ago, the surplus was positive. This was due to the increase in income outflows related to “direct investment”. Regarding the secondary income, a positive surplus of 4.1% was recorded in annual terms. In this regard, net remittances grew annually by 1.9%. The main impact on the overall surplus of “secondary income” relates to the increase in other private transfers.

The financial account was characterized by an annual expansion of net liabilities by 77.1%. Direct investments net flows expanded by about 3.5%, while only the liabilities of direct investments expanded by 19.2% in annual terms. The balance of payments was characterized by a decrease in reserve assets by about EUR 43.6 million in 2019 Q2. The reserve is sufficient to cover 6.5 months of imports of goods and services or 150% of short-term external debt. The balance of payments reports an outflow of “errors and omissions” at EUR 89.8 million.


48Bank of Albania

Table 3 Balance of payments indicators (data in million euro) 2017 Q4 2018 Q1 2018 Q2 2018 Q3 2018 Q4 2019 Q1 2019 Q2Current account (in EUR million) -309.9 -178.4 -168.6 -144.0 -370.3 -243.9 -273.3

Y-o-y (%) 74.5 13.3 -34.1 0.9 19.5 36.7 62.1/GDP (%) -10.2 -6.3 -5.0 -4.5 -11.0 -7.9 -7.6Goods and services -570.2 -358.3 -427.2 -359.7 -614.8 -403.8 -518.9Y-o-y (%) 30.5 14.9 -12.2 -3.8 7.8 12.7 21.5Exports, f.o.b. 875.6 841.8 1024.0 1240.4 952.8 885.2 1058.3Y-o-y (%) 2.2 8.8 14.5 11.7 8.8 5.2 3.4Imports, f.o.b. 1445.8 1200.1 1451.2 1600.1 1567.6 1289.0 1577.2Y-o-y (%) 11.7 10.6 5.1 7.8 8.4 7.4 8.7Net Travel 109.6 77.6 83.5 197.1 72.1 75.9 81.5Primary income 7.1 -22.8 19.8 -17.1 6.3 -31.4 -2.9Credit 98.4 70.3 123.6 94.0 105.0 78.8 132.5Debit 91.2 93.1 103.8 111.0 98.7 110.2 135.4Net income from Direct Investments -46.4 -69.4 -81.2 -83.9 -48.1 -73.4 -104.1

Secondary income 253.1 202.8 238.9 232.8 238.3 191.3 248.6Credit 284.7 224.4 260.5 253.9 264.1 220.1 274.2Debit 31.6 21.6 21.6 21.2 25.8 28.8 25.6Net Remittances 172.1 148.6 181.7 170.0 169.2 150.2 185.2Y-o-y (%) 4.1 10.0 11.7 2.6 -1.7 1.0 1.9Capital account 42.9 18.3 21.2 22.9 41.6 17.9 12.3Net borrowing/net lending -267.1 -160.1 -147.3 -121.1 -328.8 -226.0 -261.0

Financial account -205.4 -285.2 -198.0 -16.9 -271.0 -369.8 -350.7Y-o-y (%) 72.0 -3.6 -4.1 -92.4 32.0 29.7 77.1/GDP (%) -6.8 -10.1 -5.9 -0.5 -8.0 -12.0 -9.7Direct investments -221.3 -290.3 -218.2 -268.7 -244.9 -286.1 -225.9Y-o-y (%) -13.8 40.6 -3.4 -21.0 10.7 -1.5 3.5Portfolio investments 27.9 5.5 108.3 13.1 -203.0 -0.2 -82.4Financial derivatives 0.0 0.0 0.0 0.0 0.0 0.0 0.0Other investments -227.3 142.0 -173.3 83.9 -96.9 -12.9 1.2Reserve assets 215.4 -142.4 85.1 154.8 273.9 -70.7 -43.6Errors and omissions 61.7 -125.1 -50.7 104.1 57.8 -143.8 -89.8

Source: Bank of Albania, INSTAT and staff’s estimates.

4.3 CYCLICAL POSITION OF THE ECONOMY AND INFLATIONARY PRESSURES

The main trends in the labour and capital markets, as well as the increase in employment, wages and capacity utilisation rate contributed to the stability of domestic inflationary pressures.

The generation of upward pressures from costs on inflation remains slow, as the convergence of the economy towards the potential is still incomplete. Exchange rate remains appreciated, slowing down the return of inflation to target.

In the medium-term horizon, costs are expected to respond faster to the improvement of the cyclical situation of the economy, building up inflationary pressures and improving the anchoring of inflation expectations toward inflation.


49 Bank of Albania

The update of the macroeconomic situation with the latest information and our estimates on the cyclical position of the economy suggest the negative output gap will close at a more moderate speed in the short-term period. On the other hand, other alternative indicators on the cyclical position of the economy, such as the gap of the unemployment rate, and the capacity utilisation rate, signal a more intensive utilization of production factors. However, the positioning of the economy below its potential and the continuing dynamics in the exchange rate on the appreciation trend limit the build-up of inflationary pressures from the real economy.

The capacity utilisation rate in the economy resulted 74.3% in 2019 Q3. The indicator fell 1.0 percentage point from the previous quarter, driven mainly by the lower capacity utilisation rate in production sectors. Yet, capacity utilisation in the economy remains 1.5 percentage points higher than in the same period in the previous year and 0.7 percentage points higher than the historical average.

Main indicators of the labour market continued to improve their dynamics in 2019 Q2. Employment in the economy accelerated the pace of annual growth to 3.4% from 1.4% a quarter earlier.32 Even in quarterly terms, the number of employed persons recorded higher growth rates, around 2.1% from 0.6% in the previous quarter. The faster growth of employment was sustained by all the main sectors of the economy. Services remains the main contributor to the overall employment growth, followed by Industry and Construction sectors. Participation in the labour force appeared in line with the dynamics of employment. It resulted 69.8% in Q2, around 0.8 percentage point higher than in the previous quarter. Also, the growth of employment is associated with a further fall in the unemployment rate. The downward trend in this indicator is determined mainly by developments in demand for jobs.33 The unemployment rate continued to fall to historical low levels, in Q2, around 11.5%. Trending down at 0.9 percentage point in annual terms and 0.6 percentage point in quarterly terms, points to a faster decline in this indicator.

32 The analysis of employment and unemployment is based on the “Quarterly Labour Force Survey” (QLFS), and refers to indicators for those 15 years and older. Participation in the labour force represents the group 15 - 64 years old, to prevent the impact from the retired persons (according to the explanatory note of INSTAT in the QLFS for 2019 Q2).

33 In examining the factors that drive the formation of the unemployment rate are analysed the performance of employment, on the demand side, and the labour force participation rate and population in working age, on the employment offer side.

Chart 38 Indicators of the cyclical situation of the economy*

*The output gap is the average of several measurements on which the method of moving average is applied. The capacity utilisation rate gap is estimated as a deviation of the

current value from the relevant historical average, and then the moving average method is applied. The unemployment rate gap is assessed as an average of unemployment gaps

according to three methods, which assess the equilibrium or structural level of unemployment (NAIRU or NAWRU). The unemployment rate gap is stated as the

difference of the equilibrium unemployment rate to the actual unemployment rate and then the moving average method is applied.

Source: INSTAT and estimations of the Bank of Albania.

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2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019Core in�ation (%Output gap (% of potential output)Unemployment rate gap (in p.p.)Capacity utilisation rate in the production sector (in p.p.)


50Bank of Albania

The gross monthly average salary per employee in Albania34 increased by 4.5% in 2019 Q2. This resulted slightly slower than the 4.9% growth recorded in the previous quarter. Deflated by annual inflation, the increase of the average wage was 3.1% from 3.3% in the previous quarter. The performance of the average wage in the economy was sustained also by the increase in the level of the minimum wage in the country and wages in the public sector for certain categories.35 Nonetheless, the upward dynamics of the average wage by sector remains slightly faster in the private sector compared to the public sector. The average monthly wage in the private sector was higher than in the same period a year earlier by 4.9% in nominal terms and 3.5% in real terms. In the meantime, in the public sector this indicator was up by 4.3% in annual nominal terms and 2.9% in real

terms. The rise in wages by economic activity was driven to a large extent by the positive performance of wages in the services sector.

Chart 40 Average wage indicators (left) and annual �attened average changes of labour cost and their breakdown (right)


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Ndryshime vjetore, në %

Minimum approved wageAverage monthly wage per employeein the public sectorAverage monthly wage per employeeAverage monthly wage per employeein the private sector

34 This indicator refers to the gross monthly average wage received by an employee and is based on the payroll information declared at the General Directorate of Taxation. This wage consists of the base salary, additions to the salary for management positions, additions for years of work, additions for work hardships, and other additions related to titles, degrees and bonuses. It includes all the economic activities, both in the public and the private sectors, for all paid employees working in Albania, as well as foreign residents.

35 The minimum monthly base salary for employees nationwide increased from ALL 24,000 to ALL 26,000 in 2019 Q1. In annual nominal terms it rose 8.3%. According to INSTAT data, around 28% of contributing employees receive a wage up to the official minimum wage. Among other decisions of the Government related to public sector wages is to increase them for certain categories,. The decision entered into force in 2019 Q2 and is estimated to have contributed to the up side of the average monthly wages in the economy.

Chart 39 Participation in labour force, employment level and unemployment level in

economy

Source: INSTAT.

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Participation in the labour force (%)Employment rate (%)Unemployment rate (%, rhs.)


51 Bank of Albania

The Unit Labour Cost36 accelerated slightly its upward trend in 2019 Q2, up by 1.2% in annual terms from 0.9% increase in 2019 Q1. Such performance of the Unit Labour Cost continues to be mainly attributed to the slightly upward trend of the average real wage proxy for activities covered by short-term statistics.37 In the meantime, labour productivity resulted in low levels, largely unchanged from a year earlier.

The performance of other production costs remained on the upward trend in Q2, albeit at lower rates. Prices of industrial output for products in the domestic market slowed down slightly their annual growth, at 0.8% from 0.2% in the previous quarter. However, the Industrial Production Index in total remains 0.3% lower than in the previous year, driven by export prices. Producer costs in construction showed also weak upward dynamics.38

Against the closing trend of the negative output gap, long-term and domestic inflationary pressures picked up slightly during 2019 Q3. Core inflation and net non-tradable inflation increased slightly from the previous quarter, 0.9 and 1.3%, respectively, providing the main contribution to headline inflation. The respective contributions to headline inflation resulted as steady.

Short-term components’ contributions to inflation were weak compared to the previous quarter and the same quarter in the previous year. Non-core inflation hit 2.5% whereas tradable inflation of basket items was very close to previous quarter figures, 1.8%.

Chart 41 Long-term in�ation expectations (left) and short-term expectations (right)


-1.5-0.50.51.52.53.54.55.56.57.58.59.5

10.511.512.5

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36 Proxies of labour productivity, unit labour costs and average wage in accordance with short-term statistics are calculated by the Bank of Albania using the total series of Short-Term Statistics (SHTS, INSTAT, 2019 Q2). Their calculation includes: the index of paid employees, the net sales volume and total wage fund for the total of activities covered by the survey of SHTS. The reported growth rates are in real terms and refer to the four-terms moving average of the annual changes of the indicator.

37 For activities covered by the Short-term Statistics, see the respective methodology (INSTAT).38 They increased 0.3% from 0.4% in the previous quarter. Construction cost index for apartments

includes prices of building materials, labour force and other capital expenditures used for the construction of a typical building of 8-10 floors.


52Bank of Albania

The stability of core inflation is considered as a positive development in its performance over the first nine months of 2019, although its values remain still low and below the long-term average.

Over July-August 2019, the imported inflationary pressure index (IIPI)39, narrowed on average by 0.5% in annual terms. It also reflects opposing dynamics from foreign prices and the exchange rate, but at almost the same magnitude. Hence, the appreciation of the nominal effective exchange rate (NEER) in annual terms registered 3.6%, against the expansion of Import Price Index (IPI)40, by around 3.1%. As a result, the deceleration effect of the exchange rate prevailed against the opposite effect from foreign prices.

Chart 42 IIPI and contributions of its components (left). Contributions of imported in�ation and domestic in�ation to annual headline in�ation (right)


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Signals from the IIPI were confirmed also by estimates in terms of contribution by imported inflation to headline inflation during Q3. For the second consecutive quarter, the respective contribution to headline inflation is relatively lower than the domestic one, standing at 34.6% against 65.4%. Pressures from the exchange rate appreciation have been transmitted mostly through the imported part. The exchange rate effect on domestic inflation continued to slow down due to the closing trend of the negative output gap.

39 It is a proxy on imported inflationary pressures, which aggregates in one single indicator the information from import price indices (IPI), with the information from the developments in the in nominal effective exchange rate (NEER). IIPI is calculated as the annual growth of IPI and NEER for the respective period. IIPI is assessed to affect domestic inflation approximately after a 5 months’ time lag.

40 It is a proxy of imported inflation pressures, comparable to tradable goods sector inflation of Albania’s CPI basket. The import price index is based on the values of: the inflation of “Food, beverages, tobacco” for the 18 main countries; and the inflation of “Items” (i.e., not only foods) for Bulgaria, Germany, Greece, Italy and Turkey.


53 Bank of Albania

BOX 2 LABOUR MARKET DEVELOPMENTS AND WAGE DYNAMICS IN THE ECONOMY*

Developments in the labour market have followed positive trends in the recent years, as mirrored by higher employment, the rise in the labour force participation, and a continuous decline in the unemployment rate. The marked improvement is in line with our estimates regarding the unemployment rate gap, according to which labour is being utilized at its potential. Meanwhile, the growth of the average wage in the economy during this period has been moderate, although the labour market is operating under the conditions of a higher utilization of spare capacities in this market. In the context of the importance of the labour market and wage developments analysis on estimating domestic inflationary pressures originating from labour costs, this Box focuses on addressing labour market and wage dynamics**. It shows in particular developments that may explain the relatively lower wage response to rising employment and falling unemployment.

Employment in the economy has been increasing since 2014, at an average annual rate of 3.5%, while the economy has grown at a 2.9% annual pace. After increasing by 1.3% in 2014, employment accelerated its annual growth rate to 4.8% and 6.5% during 2015 – 2016, to continue growing at lower rates of 3.3%, 3.0% and 3.4% in respectively 2017, 2018 and the second quarter of this year (Chart 1.1). Employment growth has been driven by the services sector, with a major contribution from the branch “Trade, transport, hotels, business and administrative services”. In addition, a positive impact on employment average growth over the years is attributed to manufacturing. By employment status, the high employment growth over 2015 – 2016 was largely driven by the expansion of the self-employed category. Meanwhile, since 2017, employment growth in the category of employees has largely supported employment performance (Chart 1.2). In terms of gender composition, despite the rise in female employment, which has also been in line with the rapid increase in their participation rate, men still occupy the highest share of the created employment (during 2017 – 2018 about 54.9% of employees). The increase in employment represents largely full-time employment.

Chart 43 Average wage indicators in economy


Agriculture

employed with a wage

ManifacturingSelf- employed

Otherindustries

Contributing familyworkers

Trade, transport, hotels, business and

administrative services

-2-1.5

-1-0.5

00.5

11.5

22.5

33.5

By economic activities By employment status

Other servicesConstruction

Chart 1.2Contributions, in p.p. in the average annual growth rate of employment 2014 - 2018

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Chart1.3

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Long-term unemployment rate


54Bank of Albania

The improved labour market performance is also reflected in the decline in the unemployment rate and the long-term unemployment rate at the lowest historical levels, respectively 11.5% and 7.4%, (Chart 1.3). The strong employment growth has contributed to the rapid decline in the unemployment rate, which since 2014 has fallen by 6.0 percentage points. Despite the increase in the labour supply, including both the effects from the working age population and those from the labour force participation, the fall in the unemployment rate has reflected the relatively higher employment expansion versus the increase in the labour force (Chart 1.1). However, the unemployment rate in the country remains high for certain categories such as youth, showing dispersion not only by age category (Chart 1.4), but also by geographical area, education level and gender.

Average wage growth in the economy has been moderate, despite the positive dynamics in the labour market. The average monthly gross wage per employee in the economy increased on average by 2.5% in nominal terms and by 0.7% in real terms over the period 2015 – 2019 Q2. During this period, the indicator grew on average at a slightly higher rate in the public sector compared to the private sector (Chart 2.1). Wage growth by economic activities has been relatively faster in branches of the service sector such as “Real estate, professional activities and support services” (on average by 5.5%) and “Trade, transport, accommodation and food service” (on average by 4.3%) (Chart 2.2). By gender, the average wage for males not only remains higher than for females (Chart 2.3), but has also increased at a slightly higher average annual pace. Meanwhile, during 2017 and 2018, the wage indicator rose on average by 3.0% and 3.1%, while in the first half of this year the annual growth was higher, about 4.7%. An impact to this increase is attributed to the rise in the minimum wage in the country, as well as the increase in the average wage for certain segments of the public sector employees.

Chart 44 Average wage indicators in economy


90

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2014 2015 2016 2017 2018 2019 T2

Indexes, 2014 = 100

Agriculture, forestry and �sheriesIndustryConstructionTrade, transport, accomodation, food servicesInformation, communicationFinancial and insurance servicesreal estate, professional activities, facilitiesPublic administration, education, healthOther services

Chart 2.2

Agriculture, forestry, �sheries

Industry

Construction

Trade, transport, accomodation,

food services

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Financial and insurance

services

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Public administrationeduaction, health

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0 20000 40000 60000 80000 100000 120000

Average monthly wage per employee in Albnia (in ALL)

Average annual wage change 2015 - 2019 T2, në %

Chart 2.4

Average wage in economy, 2014-2019 Q2

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2015 2016 2017 2018 2019 6M I

Annual change, in %

Average monthly wage per employeein the public sectorAverage monthly wage per employeein the private sector

Chart 2.1

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2014 2015 2016 2017 2018

në %

Gender gap in wages

Chart 2.3

Our estimations suggest that the economy is operating under the conditions of an extensive utilization of spare capacities in the labour market. Given the lagged wage response to the closing of the unemployment rate gap in the recent quarters, in the future wage growth pressures are expected to increase, contributing to the return of inflation to the target in the medium run. However, the analysis of labour market dynamics highlights some developments that could potentially, over time, lead to deviations from this forecast:


55 Bank of Albania

(i) continuous formalization of the labour marketDespite the positive trends suggested by standard labour market indicators, it should be highlighted that the dynamics emerging in the market over the last five years have also been affected by the formalization process.

In 2015 Q3, the government started a campaign against informality in the economy, which has prompted the declaration of informal employment. This is also suggested by administrative sources, which show that employment in the private non-agricultural sector recorded the strongest annual growth since 2001, with 13.1%, 14.5% and 15.2% during 2015, 2016 and 2017, respectively. In line with this are also signals from the employment structure, such as: - the continued decline in the share of employees in the agricultural sector (from 43% in 2014 to 36.5% in the second quarter of 2019); the decrease in the share of part-time employees (from 27.5% in 2014 to 17.2% in the second quarter of 2019); and the higher average annual rise in employment in certain sectors, such as industry and services (by 10.3% and 6.3%, respectively, during the period 2014 – 2018), compared to their increased value added (on average by 3.7% and 4.3% during the period 2014 – 2018); which can be attributed to some extent to the effects of formalization. Aside from the potential impact on employment and unemployment indicators, the continued formalization of labour market can potentially affect the observed average wage growth in the economy, as the majority of formalized workers belong to segments with wages below the average level.

(ii) labour market structure and employment compositionThe low wage response in the economy may also be influenced by the labour market structure itself and the composition of employment, such as higher employment growth in economic activities with wage levels relatively lower than the average wage in the economy. Thus, for example, the average wage increase over the period 2015 – 2019 Q2 has been relatively faster in the service sector3, not only in branches with wages above the average level in the economy (“Real estate, professional activities and support services”), but also in branches with wages below the average wage level in the economy (“Trade, transport, accommodation and food service”) (Chart 2.4).

(iii) other structural factors such as high concentration of the population in the urban areas, the gender pay gap, skill mismatch in the labour market

A number of structural factors, such as the rise of the share of the population allocated in urban areas, the higher female labour force participation rate as long as they are paid at a lower average wage than men, as well as the phenomenon of skill mismatch, may also determine the dynamic of wages in the domestic economy.

Under the conditions of structural changes, the continuation of the formalization process in the labour market and the use of spare capacities, developments in the labour market will continue to be closely monitored for their impact on wage growth in the economy.

* This box has been prepared by Iris Metani, Monetary Policy Department.** The analysis is based on labour market data from the Labour Force Survey and data on

the average monthly gross wage in the economy. These data, published by INSTAT on a quarterly basis for the first time on June 11, 2018, are based on the list of payments of

entities from the General Directorate of Taxation, starting from the first quarter of 2014.


56Bank of Albania

INFLATION EXPECTATIONS41

Expectations on inflation remain higher than the actual published figure on inflation. Compared to Q2, inflation expectations are upward from consumers and downward from enterprises and financial agents. Expectations of the latter have been downward by around 0.1 percentage point for the three time horizons. Enterprises expectations on one-year-ahead inflation are down by 0.2 percentage point and consumers’ expectations were revised upward by 1.4 percentage points in 2019 Q3.42

Chart 45 One-year-ahead in�ation expectations, businesses and consumers (left) and �nancial agents, according to three horizons (right), annual change in %


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Actual in�ationConsumers’expectationsBusinesses’expectations

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Actual in�ationFA 3 year

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41 The analysis on inflation expectations is based on the results of the business and consumer confidence survey, as well as on the financial agents’ expectations survey.

42 Starting from 2019 Q1, inflation expectations from enterprises and consumers is measured through questions that require a point quantitative assessment on inflation are reported, and not as intervals of values for inflation. The time series of this question starts from 2016 Q2. The series used afterwards questions with answers pointing to interval values. The change in the form of the question, (from interval values to open quantitative points) has evidenced higher volatility in the series. The last value revised upwards notably, is related to the upward assessment on expected inflation by groups of the sample that belong to quartiles with higher income and individuals from the group of professionals. Time series of inflation expectations from businesses and consumers, with both measurement methods, together with a note on the methodology, are published on Bank of Albania’s website.

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