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Economic and financial challenges: prospects of Albania. Ardian Fullani Governor of Bank of Albania Athens October 2009. Preview. Policy Framework & Long run Quest for Stability Addressing domestic external vulnerabilities Crisis hits region Channels of transmission Economic impact
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Economic and financial challenges: prospects of Albania. Ardian Fullani Governor of Bank of Albania Athens October 2009
Preview • Policy Framework & Long run Quest for Stability • Addressing domestic external vulnerabilities • Crisis hits region • Channels of transmission • Economic impact • Short term outlook • Long run implications 2
Policy Framework Inflation is the final objective • From Monetary targeting (intermediate targets: M3) to Implicit inflation targeting (Two pillar strategy with leading indicators: Forecasted inflation and M3 growth) • Open Market operations • Weekly Repo. Rate • Reserve requirements • Free floating exchange rate. • Exchange rate acts as shock absorber. 3
Long Run Quest for Stability Emphasize and focus on long run sustainable equilibrium: • Prudent monetary policy, aiming to preserve macroeconomic stability and promote savings in the economy. • Free floating exchange rate. • Encourage fiscal consolidation and policy coordination (Fiscal Rule). • Approve New Banking Law and Repurchase Agreement Law and the respective regulatory framework. • Establish a continuous dialogue with the market participants. • Improve commercial bank governance, transparency and internal control and Better risk management. • Warn banks and take regulatory measures against fast credit growth, especially in foreign currency. 4
Vulnerabilities Before Crisis • Consumption led growth due to fast credit expansion. • Increasing fiscal deficits. • Growing trade and current account deficits. • EU main trade partner. 5
Crisis: Channels of Transmission and Economic Impact • Foreign and domestic demand slows. • Remittances slow. • Deposit withdrawals. • Liquidity problems for banks. • Credit stops; • Private investments & consumption suffers. • Exchange rate depreciates. • Agents realize the problem of borrowing in foreign currency. • Commodity prices drop prevents automatic adjustment of CAB. • Depreciation is not passed to prices and inflation stays within the Bank of Albania objective. 6
Crisis: Policy Response • Bank of Albania • January 2009 Repo Rate cut 50bps; • Provide all needed liquidity in domestic currency; • Contain exchange rate volatility and agents emotional response to market fluctuations; • Increase efficiency and Micro management in the foreign exchange market; • Downward economic forecasts for economic activity; • Share information with other supervisory authorities aiming to coordinate and customize policy response in line specific market conditions. • Fiscal • Increase capital expenditure • Privatization and foreign commercial borrowing; • Aggressive borrowing in domestic markets with signs of crowding out. 7
Crisis: Policy Response Shift focus toward financial stability • Open market operations: • Change the form of Repo auctions from fixed amount to fixed price; • Extend the average maturity of Central Bank liquidity injection; • Reduce the margin of overnight lending from + 175 bps to + 75 bps; • Expand the range of collateral: from TBiIls with up to 1 year maturity to securities with days to maturity up to one year; • Increase the daily use of the required reserve from 20 to 40 percent. • Exchange rate interventions: • Reduce extreme exchange rate volatility and other market imperfections, while domestic agents adjust to new equilibrium. • Encourage banks to credit the economy. 8
Policy Response and Economic Impact • Inflation stays low. • Aggregate demand slows down; • Deflation in the commodities prices offsets the FX depreciation on inflation. • Government deficit grows. • Yield curve Steppes with possible crowding out effects. 9
Long Run Implications: Possible Structural Effects • Monetary policy • Slower growth in M3 due to reduced velocity (less credit in foreign currency). • Less credit demand due to portfolio rebalancing and bank tougher standards. • Fiscal policy • Larger and persistent fiscal deficits. • Difficult refinancing. • Emergence of twin deficits. • Financial Stability • Rebalance of saving & consumption behavior in favor of domestic currency. 12
Long Run Policy Implications • Structural shifts (Unit root vs. mean reverting) in: • Structure of credit • Structure of money • World GDP growth • Monetary policy implications of future developments in GDP, and money supply • Implications for transmission mechanism and monetary policy reformulation (monetary indicators). • Structural reforms needed in several areas. 13