Growing Fiscal Differentiation in Europe and Central Asia: What does it mean for Albania?

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1 Growing Fiscal Differentiation in Europe and Central Asia: What does it mean for Albania? Indermit Gill Chief Economist Europe and Central Asia Region World Bank Albania ABCDE Tirana, June 1-2, 21

2 Main points 2 1. Before the crisis, fiscal outcomes improved across the region, including Albania Revenues rose, deficits fell, and fiscal policies improved with few exceptions 2. During the crisis, fiscal policy responses differed in the east and west Reliance on automatic stabilizers in most countries Fiscal stimulus programs in resource-rich economies. 3. After the crisis, fiscal adjustment priorities will be even more differentiated Education and infrastructure in much of region, including Albania Social insurance in Central and Southern Europe Reduced stimulus and energy subsidies in middleincome Former Soviet Union

3 Outline Backdrop to fiscal focus 1. Before the crisis 2. During the crisis 3. After the crisis 4. Fiscal consolidation 3

4 Backdrop Emerging Europe and Central Asia hit harder than other developing regions Growth and fiscal prospects for the region are bleaker than for others Growth stayed positive in Albania during crisis but increase in fiscal deficit 4

5 Weakest growth prospects Real GDP Growth, annual percentage rate (25-213) Africa Developing Asia Latin America Middle East Europe and Central Asia Albania 5 average average

6 Worst fiscal performance Fiscal Balance, Percentage of GDP (25-213) Africa Developing Asia Latin America Middle East Europe and Central Asia Albania 6 average average

7 Before the crisis Revenues rose rapidly as trade and consumption based tax collections increased Spending rose almost as fast in aggregate, but steady as share of GDP Fiscal balances improved across the region, with a few exceptions, with improvements in Albania 7

8 Revenues rose Steady increase as share of GDP, but aggregate increased from $7bn in 2 to $1.2 trillion in General Government Revenue, 2-27 (% of GDP) Albania Emerging Asia Latin America S.E. Europe + Turkey (excl. Albania) Other CIS EU-1 Oil Exporting CIS

9 Expenditures contained 5 General Government Expenditure, 2-27 (% of GDP) Albania Other CIS Emerging Asia EU-1 Latin America Oil Exporting CIS S.E. Europe + Turkey 6/3/21

10 Fiscal balances got better Spending increased in east, more controlled in the west 14 Composition of changes in the fiscal balance, 2-27 (% GDP) EU-1 SEE+Turkey (excl. Albania) Albania Oil Exporting CIS Other CIS Change in expenditure Change in revenue Change in fiscal balance

11 Most of ECA entered the crisis in strong fiscal position On the whole, most of ECA was in surplus in 27 yet Albania ran a deficit of nearly 4% of GDP EU-1 Oil Exporting CIS S.E. Europe + Turkey (excl. Albania) Latin America Other CIS Emerging Asia Albania 11 Revenues Expenditures Balance 6/3/21

12 During the Crisis Government revenues fell everywhere, but more in the east Public spending rose as a share of GDP, but stable in aggregate Fiscal balances deteriorated everywhere, but more in the east as oil and gas exporters implemented fiscal stimulus programs, A deterioration in Albania s fiscal stance 12

13 Big fiscal imbalances emerged Expenditures responsible for rising deficits everywhere; big revenue declines in SE Europe and parts of the CIS 15 Contributions of changes in deficits in 27-21, share of GDP EU-1 SEE+Turkey (excl. Albania) Albania Oil Exporting CIS Other CIS 13 Change in spending Change in revenue Change in fiscal balance

14 All relied on automatic stabilizers There was deterioration in the fiscal stance in Albania with increased spending on infrastructure, wages, and pensions Contributions of changes in deficits, 28-29, % of GDP, median values EU-1 SEE+Turkey (excl. Albania) Albania Oil Exporting CIS Other CIS EU-15 East Asia Latin America 14 Fiscal stance Automatic stabilizers Fiscal balance

15 Social benefits and wage bills are high in the west Spending more contained in Albania though interest payments are high EU-1 SEE+Turkey (excl. Albania) Albania Oil Exporting CIS compensation of employees use of goods and services interest subsidies grants social benefits Other CIS Economic Classification of Expenditure, 28 (% GDP) 15 6/3/21

16 Capital spending and pensions increased during the crisis During the crisis, as portion of GDP, capital spending and pensions rose, partly due to elections in ,8 5,7 5,8 6,7 7,1 7,1 8,5,4 2,5,4 2,6 2,7,2 2,8 2,8 2,6 2,9 3,2 6,3 6 6,2 5, Personnel expenditures Interest Operational & Maintenance Subsidies Social insurance outlays Capital expenditures 4,2 8,7 4,6 8,4 Composition of Government Expenditures in Albania (% GDP) 16 6/3/21

17 And Albania has entered a danger zone of high public debt Public debt in Albania will be over 6 percent of GDP in 21 Projected public debt, % of GDP EU p 21p SEE+Turkey (excl. Albania) 28 29p 21p Albania 28 29p 21p Oil Exporting CIS 28 29p 21p Pre-crisis Other CIS 28 29p 21p April 21

18 Composition in change in public debt to GDP (y/y %) Public Debt to GDP Increased public debt driven by deterioration in primary deficit Albania s primary deficit deteriorated by about 4 pct points of GDP from 26 to primary deficit real interest rate real exchange rate growth other factors public debt/gdp, pct (rhs) /3/21

19 After the crisis Growth not projected to recover to pre-crisis levels Pressures to increase spending on education and infrastructure Projected divergence in spending and revenue trends within the region 19

20 Lower growth post-crisis GDP growth in 21 will be about 5 percentage points lower than what was expected for this year before the crisis Projected economic growth rates, before and after crisis 1 EU1 1 SEE+Turkey (excl. Albania) 1 Albania p 21p p 21p p 21p 1 Oil Exporting CIS 1 Other CIS p 21p Pre-crisis p 21p April 21

21 Pressure to invest in education More enterprises were complaining that the skills of workers are becoming an obstacle for business Middle Income CIS Low/Lower Middle Income CIS SE Europe EU1 Albania Source: BEEPS 25 & 28; percentage of firms indicating that skills and education of available workers is some form of constraint on business.

22 Even more pressure to invest in infrastructure More enterprises were complaining that electricity was becoming an obstacle for doing business Middle Income CIS EU1 Low/Lower Middle Income CIS SE Europe Albania 22 Source: BEEPS 25 & 28; percentage of firms indicating that Electricity is some form of constraint to business

23 Divergence in region will grow Albania will have to adjust expenditures Forecasted Adjustments (29 to 213) Expenditure Revenue EU-1 SEE+Turkey (excl. Albania) Albania Oil Exporting CIS Other CIS East Asia Latin America

24 Fiscal consolidation Requires a closer look by country Requires making social sector reform a priority in many countries Requires reducing energy subsidies in much of the former Soviet Union Requires exit strategies from fiscal stimulus in oil and gas exporting countries 24

25 Post-crisis pressures Slower growth likely for most economies ECA may not go back to pre-crisis growth rates soon Many governments will be fiscally weaker Public debt levels will be higher after the crisis, and tax revenues possibly structurally diminished More pressure to address climate change Pressure on emerging Europe to mitigate, on Eurasian countries to adapt 25

26 Government Expenditure, % of GDP Governments in ECA are bigger Government spending in Albania is greater than in Latin America and Emerging Asia today (and Germany in 196) Share of Spending in GDP, latest year 6 5 EU-15 median 4 ECA median 3 Albania Germany 196 Latin America median Emerging Asia median GDP per capita, PPP (thous) Note: Plot values reflect ECA countries

27 Seven cases Automatic stabilizers and discretionary spending helped boost economies during 29, except in Ukraine Composition of change in fiscal balance, 29 (% GDP) Change in fiscal stance Automatic stabilizers Fiscal balance (change from 28) Russia Armenia Poland Turkey Ukraine Kazakhstan Albania 27

28 Priorities differ by country Social security and education needs reform in many, combined with idiosyncratic mix of priorities Social Sectors Productive Sectors Other Pensions Education Health Energy Subsidies Producer Subsidies Infrastructure Fiscal Stimulus Revenue Mobilization Albania X X X X Poland X X X X Turkey X X X Ukraine X X X Russia X X X Kazakhstan X X X Armenia X X X Source: World Bank Public Expenditure reviews and Development Policy Loan documents; see annexed case study summaries. 28

29 Albania: Eight years of fiscal discipline, undone in two Like many of its neighbors, prudent fiscal policies from 2 till 27 Better revenue administration, and lower interest payments Fiscal deficit halved, public debt fell by 1 pct points of GDP Unlike most of its neighbors, big deterioration in fiscal stance since 27 Fiscal deficit doubled during the crisis from-3.5% in 27 to -7. in 29, due to spending on wages and pensions and Rreshen-Kalimash road project. Public debt has risen from 53% of GDP in 27 to 6% in 29, a much higher level than other SEE. Greek crisis could result in higher borrowing costs and slower revenues as a result of reduced remittances. 29 6/3/21

30 Albania: it s mostly fiscal Risk of disorderly fiscal adjustment without credible commitment to restoring fiscal stance Small primary deficits of -.5 %GDP range needed, compared with ten year -1.5% average, to maintain current debt levels (already high) Increased interest rates or slower growth would require primary surplus to avoid greater risks of debt distress Need to re-establish credibility of fiscal policies Recent fiscal deterioration strains credibility (e.g, unrealistic fiscal forecasts) and could raise borrowing costs Need to contain spending on infrastructure and public sector wages and pensions, especially post-election 3 6/3/21

31 Some lessons from Greece Keep one set of books Credible commitment to fiscal reform requires fiscal accounts and assumptions that markets can believe Don t see fiscal rules as a magic bullet Fiscal discipline requires a lot more than a formal rule Broaden the revenue base A good revenue administration and concerted efforts to improve collection of taxes Keep public debt levels low In middle-income countries, risk of debt distress rises sharply between 4 and 6 percent of GDP 31 6/3/21

32 Conclusion: 21 will be a tough year for Albania Before the crisis: Between 2 and 27, buoyant revenues allowed spending increases but fiscal balances were improved. During the crisis: Revenues fell in much of the region, spending was steadied by automatic stabilizers in most and stimulus spending in a few fiscal balances deteriorated in Albania. After the crisis: Crisis not yet over for Albania, but has already made fiscal reform priorities clearer fiscal futures could diverge even more after