IBNA Special Report/Experts of the Oversight Committee of the Bank of Albania analyze the recent economic and monetary developments in the country. According to the Committee, the current monetary stance and financial conditions facilitate the return of inflation to its target in the medium term. Base interest rate continues to remain unchanged, at a rate of 2.50%
Tirana, November 6, 2014/Independent Balkan News Agency
The recent data of the Bank of Albania indicate a slowdown of the economic activity in the country, but this slowdown is considered to be a temporary one.
Nevertheless, the analysis of the data available suggests that these developments, somehow expected in terms of their intensity, are explained to a large extent by basic effects and temporary supply-side shocks.
According to the Bank, seen on this context, short term tendencies of aggregate supply and coming projections for economic growth have not seen significant changes compared to its previous projections.
The Bank of Albania expects the performance of the economy to improve, which would, in turn, create adequate premises for inflation to return to target in the medium term. Underpinned by stimulating monetary conditions, the expansion of consumption and private investment is expected to be the main driver of economic growth and facilitate the return of the economy to equilibrium.
In this context, the current monetary policy stance and the conditions it generates are appropriate. They will enable the return of inflation to target and of the economy to equilibrium within a medium term horizon, hence minimizing unwanted pressures on financial system indicators. On the other hand, these assessments are surrounded by uncertainties related to the type and quality of available information. The economic slowdown noted in the second quarter may reflect a more pronounced weakness of aggregate demand, as well as stronger or longer lasting supply-side shocks. The future verification of these scenarios would imply a comparatively slower return of inflation to target and would, in turn, require a further relaxation of monetary policy.
Inflation expectations and CPI inflation remained low
Annual inflation averaged 1.7% in the third quarter. Within the quarter, it moved upwards in the first two months and downwards in September. In line with its behavior throughout the year, in September, inflation fluctuations continued to be attributed to food price volatility and lower rent prices. From a macroeconomic standpoint, the low inflation rates continue to reflect mostly the existence of the spare production capacity. This has contributed to low growth of labor and production costs. Subdued inflation has also been affected by low inflation rates in Albania’s trading partners, decreasing inflation expectations and weak pressures from liquidity in the economy.
Inflation will rise gradually
Bank of Albania’s projections suggest that inflation will rise gradually over the period ahead, converging to target in the medium term. Economic growth is expected to pick up, accompanied by improvements in the labour market and a more sustainable increase in production costs. On the other hand, imported inflation is expected to remain low, whereas inflation expectations to shift gradually towards Bank of Albania’s target.
Supply-side shocks have led to a sluggish performance of the economy compared with initial assessments. However, the performance of consumption and private investments remains positive. According to INSTAT data, the gross value added generated in the Albanian economy contracted 0.6% in the second quarter. This outcome interrupted the growth dynamics of the previous quarters. From the sectorial perspective, the production sector – especially industry, transport, and construction – provided the highest negative impact. On the other hand, the service sector provided a high positive contribution. In terms of aggregate demand, the economy contracted mostly due to the negative fiscal stimulus and the negative impact from net exports. Private investments and consumption provided a larger positive contribution, reflecting the improvement of confidence in the economy and the easing of lending standards. The concentration of deceleration in certain sectors of the economy, whose performance is connected to supply-side shocks or statistical base effects, suggests that the deceleration in the second quarter is temporary. At the same time, this assessment is endorsed by the positive performance of private consumption and investments. Our projections and preliminary data point to positive economic growth in the third quarter of the year, driven by expanding private demand.
External environment of the economy remains challenging
The external environment of the economy remains challenging, but export expansion is expected to support economic growth in the medium term. The net exports deficit deteriorated in the second quarter primarily due to an increase in imports, despite exports maintaining their positive trend. Monthly data on foreign trade in goods show a small annual contraction of exports and a slight increase of imports in July and August. Subsequently, the trade deficit widened for these two months. In the presence of exchange rate stability, the behavior of export and imports is determined by demand for Albanian or foreign goods and services, as well as the competitiveness of our products.
The fiscal policy has generated
In line with the strategy for fiscal consolidation, the fiscal policy has generated and will continue to generate restraining impulses on aggregate demand. The fiscal consolidation has materialized in the narrowing of the budget deficit by around 53.1% in annual terms in the first nine months of the year. The narrowing of the budget deficit has reflected higher budget revenues and sluggish public expenditures, especially for investments. Likewise, fiscal data suggest that the fiscal adjustment was less pronounced in the third quarter, compared to the first half of the year. We are confident that this fiscal adjustment is the right path. This correction serves to strengthen the domestic economic and financial balances, reduces risk premia for financing the private sector, and creates more space for a stimulating monetary policy, both in the current and the medium-term context. In parallel, the Bank of Albania believes that there is room to better attend to the pace of planned budget expenditure. Our macroeconomic projections, the expected outcome across the quarters and the monetary policy response are conditioned by the enforcement of the budget expenditure plan. Any significant deviations from the plan generate unwanted effects on the economy and the financial markets.
The monetary policy
The monetary policy has remained strongly expansionary aimed at supporting the domestic demand and at enabling the sustainable return of inflation rate and inflation expectations to target. The key interest rate has been standing at 2.50%, since May 2014. The Bank of Albania has continued to use the forward guidance to steer the public and the financial markets to the direction of the expected monetary policy. Following the stimulating monetary policy, financial markets’ interest rates have declined to their historic lows. However, the real economy’s response remains sluggish. The year on year lending to the private sector increased by 2.5% in August, from a 1.8% decrease in June. The latest lending surveys and statistical data contain positive signals with regards to the easing of lending standards and the improvement of credit supply. However, credit demand remains moderate and will continue to define a sluggish credit growth in the quarters ahead.
Macroeconomic projections point to the closure of the negative output gap and the gradual return of inflation to target in the medium term. In the Bank of Albania’s baseline scenario, the annual inflation is expected to range within 1.1% – 3.7% four quarters ahead with a 90% probability of occurrence.
The Bank of Albania believes that the current monetary conditions are consistent with achieving the price stability objective. In accordance with the baseline scenario projections, the return of the inflation rate to target in the medium term will require maintaining the accommodative monetary conditions for some quarters ahead. However, as stated before, this decision is made in the context of added uncertainties linked to statistical sources as well as the nature and intensity of shocks that caused the economy to slow down in the second quarter. The confirmation of significant downside deviations from the expected developments in the economy would require a further relaxation of the monetary policy. /ibna/