Albania and the Global Crisis

Posted by on 2 April 2009

It’s not an April’s fool joke! Lack of financial markets can be a blessing in disguise. Contrary to common knowledge among academics and practitioners, being less diversified might not always work against the investor, at least that’s what Albanian case shows. This small and not sophisticated economy appears to be relatively isolated from the global financial meltdown. But can investors take advantage of this? Difficult!

 

Can lack of financial markets be a blessing?
In an article co-authored with Rene Fry, in 2005, we concluded that Albania, a small open economy in South-East Europe, escaped unscathed from the Russian and Turkish crisis of 1998 and 2001 respectively, where most of the countries in the region suffered. Our argument was that financial markets in Albania are relatively less developed than the other South-Eastern European countries in the sample, and hence are driven mainly by idiosyncratic factors providing a natural cushion against external effects.
I think I have to make that point again amid the current financial crisis. And I am not the only one. The FT on March 18th wrote a piece on how it’s not all bleak in Europe, especially for Albania and Azerbaijan. Despite being heavy commodity exporters, against which the IMF has warned that will be highly vulnerable to the crisis (Wroughton, 2009), these two countries have expected positive growth for 2009, alongside China.

 

 

A past to forget

Albania’s post-communist financial market development has been rather slow and eventful. The beginning of the 1990’s brought the flourishing of free trade and with it speculation. For several years, investors placed their savings in ‘financial foundations’ that provided high returns but did not really have any investments. Ultimately these ‘financial foundations’ were Ponzi schemes that collapsed in 1997. Their failure brought the country to its knees economically and on the verge of civil war.

 

 

The current situation

The aftermath of the 1997 crisis lead to the lack of trust in both the government and financial institutions. To date, an organized stock market does not exist and there is no corporate bond market. There is a well-developed primary market for government securities, where most banks ‘park’ their excess supply, but the secondary market for government treasuries is poorly developed. The more sophisticated market is foreign exchange. Derivatives are almost never used by corporations but they show up here and there in the commercial banks’ balance sheets in the foreign exchange sections.
So what is so special about the Albanian economy? Agriculture is still a sizeable part of the GDP compared to western economies, while construction is the largest industry. There is low concentration of production and exports, and high labor mobility. A substantial amount of income comes from remittances of immigrants working across Europe, 15% of GDP on average in the last 15 years, €950 million in 2007 and €830 million in 2008. Trade with the EU is large, over 80% of total exports.

 

 

Where does return come from?

The lack of financial market sophistication has meant that the venues for investment/speculation are rather limited. Instead, the banks provide loans for mortgages at very high interest rates or invest the treasury securities. Diversification is almost non-existent. The banking sector seems rather strong for the time being, mainly due to the lack of investment in foreign assets.
The banks have focused in the domestic market, and only 10% of their portfolio is invested in foreign markets. The return on capital in 2008 was 11.4%, lower than the 20.7% in 2007, but still quite high. About 62% of the deposits have been reinvested in loans. On average the banks in the system are holding about 17.2% of the capital.
Despite the growing crisis in countries where Albanians are employed, remittances have remained high. This is mainly due to the high deposit interest rates in domestic currency 6% pa (Lek) and foreign currency (5% Euro and 2% USD), for one year deposits. One question is in order, how can the banking sector afford to pay such high deposit rates, when there are few alternative domestic markets to invest in and foreign investments have very low returns?
One reason for the high deposit interest rates is the high target rate of the central bank, currently at 5.75%. This rate is relatively high compared to ECB (1.50%), UK (0.5%) and US (0.25%). In addition, the target rate was only recently lowered by 50pbs on the 28th of January, as a preemptive measure to the potential impact of the global crisis on consumer demand. Given the stability of the consumer price index around 2%, the central bank does not show any intention to cut rates in the near future.
In addition, the one year treasury-bill yield on government debt is rather high compared with the rest of Europe at 9.15%. Last but not least, the mortgage rates in the different currencies are very high, which is not warranted by the risk that banks are taking. One-three year loans interest rates are 15% in Lek, 8% in Euros and 8% for USD loans.

 

 

Crisis management

Some word of praise must go to the management of the economy in the last year. The government and the central bank have been quite swift in reacting to the global crisis, even though the first signs in the economy only showed up in the last quarter of 2008. The budget deficit rose from 3% in 2007 to 5.7% in 2008, most of the expenditures being capital investments in infrastructure. This is not only because the government was trying to anticipate the decrease in consumption that was to ensue, but also because local elections are approaching, in June 2009. Nonetheless, unemployment decreased from 12.9% to 12.6%.
Furthermore, the central bank together with the Ministry of Finance and the Deposit Insurance Agency have decided to increase deposit insurance to 2,500,000 Lek (€20,000) from a rather low level of 700,000 Lek (€5,400). This move was taken in order to insure jittery depositors, who were reminiscent of the Ponzi scheme collapse in 1997, and prevent account draining.

 

 

And the future?

The picture is obviously not completely rosy. Remittances are decreasing (16% in 2008), net exports are deteriorating and the exchange rate has remained quite strong. If the exchange rate does not depreciate, net exports will continue to suffer, both because of expensive exports in comparison to imports and a stable local demand for foreign goods. A depreciation of the domestic currency can heavily weigh on the foreign currency loan holders who earn in local currency. Still, the economy seems well braised to withstand the global recession, until the next wave of economic growth.
Placing foreign currency deposits seems like good business, with no risk involved. Buying treasury securities can be relatively safe given the stability of the exchange rate and the yield more than compensate for the exchange rate risk. So can foreign investors take advantage and invest? Yes, provided they can fly to Albania, carry a suitcase of money and deposit it with any of these banks! Have a good trip.

 

 

Elvira Sojli
Rotterdam School of Management, Erasmus University

 

 

References

Fry, R. and E. Sojli. 2005. Financial Crises Propagation to Albania: A Comparison of the Russian and Turkish Crises, in Evaluating the Effectiveness of Monetary Policy, Conference Proceedings, organized by the Central Bank of Albania, March 24-25, 2005, Durres, Albania.
Wagstyl, S. 2009. Glint of hope in Eastern Europe. FT, March 18.
Wroughton, L. 2009. IMF warns crisis has shifted to poor countries. Reuters, March 3.