ANALYSIS OF DEVELOPMENTS IN THE EXTERNAL SECTOR OF THE ECONOMY

B a n k of A l b a n i a ANALYSIS OF DEVELOPMENTS IN THE EXTERNAL SECTOR OF THE ECONOMY 216 Q4 Enian Çela Monetary policy department May 217 The views expressed herein are solely of the author and do not necessarily reflect those of the Bank of Albania. Bank of Albania 1

2 Bank of Albania

C O N T E N T S I. BALANCE OF PAYMENTS HIGHLIGHTS 4 II. CURRENT ACCOUNT 6 II. CAPITAL ACCOUNT 1 III. FINANCIAL ACCOUNT 11 IV. PROFILE OF CURRENT DEFICIT FINANCING 14 Bank of Albania 3

I. BALANCE OF PAYMENTS HIGHLIGHTS 1 1The net position of the current account recorded a deficit of EUR 24.3 million in 216 Q4, narrowing by around 39.6% in annual level. It was estimated at 8.3% of nominal GDP, or around 6.4 percentage points lower than in the same quarter of the previous year. By items of the current account, a narrowing contribution was provided by the improvements in all subcategories, particularly in goods and services. The exports of goods and services expanded by around 19.9%, while imports increased by around 1.1%, in annual terms. The net positive balance of secondary income expanded by 11.6%, in annual level. The remittances and public sector accounts provided the main contribution to this performance. Remittance inflows expanded by 7.9% in annual terms, continuing the tendency registered in the previous quarter. Meanwhile, primary income deficit narrowed by around EUR 6.4 million, in annual terms. Under the structural approach, as measured by the national gap between savings and investment, the private sector defined the narrowing of the current deficit. Table 1 Balance of payments indicators (EUR million) Q2 '15 Q3'15 Q4 '15 Q1 '16 Q2 '16 Q3'16 Q4'16 Current account (in EUR million) -163.2-312.7-397.7-223.8-359.6-26.1-24.3 yoy (%) ) -48.6 5.7 4. -3.1 12.3-34.1-39.6 /GDP (%) -6. -12.1-14.7-9.4-12.9-7.7-8.3 Goods and services -36.6-476.3-564.5-43.3-555.1-41.9-436.9 yoy (%) -24.8 1.3 4.4 8.2 54. -13.7-22.6 Exports, f.o.b. 75.9 785. 714.7 68.5 717.2 926.8 857. yoy (% -1. -2.3 -.7 2.5 1.6 18.1 19.9 Imports, f.o.b. 166.5 1261.4 1279.1 111.9 1272.3 1337.6 1293.8 yoy (%) -1.5-1. 1.5 4.7 19.3 6. 1.1 Net Travel 76.4 64.5 51.6 67.3 72.8 153.1 95.7 Primary income -12.9-12.8-34.2 1.4-21.3-5.5-27.8 credit 34.5 4. 43.9 5.8 38.1 42.5 45.7 Debit 47.4 52.8 78.1 4.3 59.4 48. 73.5 Net Direct Investment income -26.4-27.7-31.7-3.8-3.5-21.3-29.8 Secondary income 21.2 176.4 21. 169.1 216.8 21.3 224.4 Credit 243.3 219.1 247.2 25. 25.1 25.7 255.4 Debit 33. 42.6 46.2 35.9 33.2 4.5 31. Net remittances 161.7 139.7 153.9 135.7 153.8 159.6 165.4 yoy (%) 17.6-15.4-1. -4.2-4.8 14.2 7.4 Capital account 21.3 45.6 32.8 6.6 7.2 3.1 49.4 Net borrowing/net lending -141.9-267.1-364.8-217.3-352.4-23.1-19.9 Financial account -177.1-126.6-243.3-17.5-255.2-9. -149.2 yoy (%) -17.9-3.9-16.8 4.3 44.1-28.9-38.7 / GDP (%) -6.5-4.9-9. -7.1-9.1-3.3-5.1 Direct investments -196.5-248.1-12. -148.1-233.6-295.8-28.9 yoy (%) 45. 2.4-46.1-41.7 18.9 19.2 134. Portfolio investments -66.8-11.2-172.1 16. -1.9.6 18.9 Financial derivatives....... Other investments 7. -179.7-12.3-78.8-1.8 261.3-13.5 Reserve assets 16.2 312.5 169.1-49.6. -56.1 153.3 Errors and omissions -35.2 14.5 121.5 46.7 97.2 113.1 41.8 1 The latest data on the Balance of Payments are as at 216 Q4. As of 28 Q1, the Bank of Albania prepares the Balance of Payments Statistics, in compliance with the IMF s BPM6 standards. The main differences between the actual and previous methodologies are synthesised in the Commentary for changes in the publication of external sector statistics according to BPM6: https://www.bankofalbania.org/web/ pub/1_commentary_for_changes_in_the_publication_of_external_sector_statistics_according_to_bpm6_ june_214_6689_1.pdf For the purposes of analysis, the Balance of Payments data from 22 to 27 are reclassified in line with the new methodology by the Monetary Policy Department 4 Bank of Albania

Net inflows in the capital account amounted EUR 49.4 million, around EUR 16.5 million higher compared to the same quarter in the previous year. The net position in the financial account shows a narrowing of debt position by around 38.7%, in annual level. Net inflows in the capital and financial accounts covered 82.6% of the current account deficit. Errors and omissions financed the rest of this deficit. Net direct investment expanded by around 134%, in annual terms. Other investment position reflects the net liabilities of EUR 13.5 million. Net assets held in the form of portfolio investment stood at EUR 18.9 million. In terms of the current deficit financing, non-debt creating flows remain the major contributors. The overall balance of payments resulted in the expansion of foreign reserve assets by around EUR 153.3 million. At the end of 216 Q4, the stock of foreign exchange reserves was around EUR 2.94 billion, sufficient to cover 7.2 months of import of goods and services, and 165% of the short-term gross external debt. Bank of Albania 5

II. CURRENT ACCOUNT The net position of the current account resulted in a deficit of EUR 24.3 million in 216 Q4, narrowing by around 39.6% in annual level. It was estimated at 8.3% of nominal GDP, around 6.4 percentage points lower than in the same quarter of the previous year. According to the gap approach between national savings and investments, it was the gap between savings and investments in the private sector 2 that provided the main impact on the formation of the current account deficit. This trend had also characterized the formation of the current deficit in previous quarters. Private sector gap shifted to positive values during 216 Q4, estimated at 1.5% of nominal GDP. This ratio is 5.7 percentage points lower compared with the same quarter in the previous year. The increase in private savings provided the main impacts in this dynamic. Their ratio to nominal GDP stood at 26.4%, expanding by around 5.7 percentage points, in annual level. On the other hand, private investment were estimated at 24.8% of GDP, almost at the same level with the same quarter in the previous year. Public savings expanded by around 1. percentage point in their ratio to GDP, meanwhile public investment increased by.3 percentage point in their ratio to nominal GDP. Chart 1 Annual spread in p.p. of savings-investment gap of private and public sectors to GDP (left) and their contribution to the annual current account deficit (right) 15 2 1 15 5-5 1 5-5 -1 216Q4 216Q3 216Q2 216Q1 215Q4 215Q3 215Q2 215Q1 214Q4 214Q3 214Q2 214Q1 213Q4 213Q3 213Q2 213Q1 212Q4 212Q3 212Q2 212Q1 211Q4 211Q3 211Q2 211Q1 21Q4 21Q3 21Q2 21Q1 Primary income Services Goods Current account Secondary income -1 29Q1 29Q3 21Q1 21Q3 211Q1 211Q3 212Q1 Priv. savings Pub. savings Pub. investments 212Q3 213Q1 213Q3 214Q1 214Q3 215Q1 215Q3 216Q1 216Q3 Priv. investment Current Account (% annual) Source: Bank of Albania, Ministry of Finance. 2 An alternative, but equivalent measuring of the current account net position for a specific period is the gap method between savings and national investment. Thus, the net realized position of the current account is equal to the amount of the gap realized between savings and public and private investment in period t. CA t =(S publike -I publike ) t +(S private -I private ) t 6 Bank of Albania

National savings provided the main contribution to the narrowing of the current deficit. They were estimated at 25.8% of GDP, increasing by 6.7 percentage points, year-on-year. National investment were estimated at 34.1% of GDP, around.3 percentage point higher, compared to the fourth quarter of the previous year. In terms of contributions, the expansion of surplus in services account broadly determined the annual narrowing of the current account. The other composing sub-accounts provided their effects in the same direction. Chart 2 Contribution by category (in p.p.) to the annual current deficit (%) 15 1 5-5 -1 216Q4 216Q3 216Q2 216Q1 215Q4 215Q3 215Q2 215Q1 214Q4 214Q3 214Q2 214Q1 213Q4 213Q3 213Q2 213Q1 212Q4 212Q3 212Q2 212Q1 211Q4 211Q3 211Q2 211Q1 21Q4 21Q3 21Q2 21Q1 Services Goods Secondary income Primary Income Current Account The net balance of services account recorded an expansion of its surplus during the period under review. Net income from services resulted in around EUR 229.6 million, from around EUR 141.1 million in the same quarter of the previous year, increasing by around 62.8%. The expansion of exports in services by around 17.%, in annual level, mainly defined its performance. At the same time, services imports increased by around 3.8%. In terms of the nominal GDP, the net balance of services surplus was estimated at around 7.9%, with travel services providing the main contribution. Net income from travel services, including the net flows from tourism, resulted higher compared to the previous year. The net position expanded at EUR 95.7 million, from EUR 51.6 million in the same period of the previous year. Bank of Albania 7

Chart 3 Main items in services account (net flows in EUR million) 6 4 2-2 -4-6 -8-1 216Q4 216Q3 216Q2 216Q1 215Q4 215Q3 215Q2 215Q1 214Q4 214Q3 214Q2 214Q1 213Q4 213Q3 213Q2 213Q1 212Q4 212Q3 212Q2 212Q1 211Q4 211Q3 211Q2 211Q1 21Q4 21Q3 21Q2 21Q1 Compensation of employees Investments income Primary income The net balance of the primary income account was negative. Net foreigncurrency inflows in this account resulted in EUR 27.8 million deficit, from EUR 34.2 million, in the same period a year earlier. The recorded deficit was estimated at around 1.% of nominal GDP, mainly determined by the account of investment income. Chart 4 Balance of primary income (net flows in EUR million, left) and direct investment income (net flows, in EUR million, right) 6 4 2-2 -4-6 -8 2-2 -4-6 -8-1 216Q4 216Q3 216Q2 216Q1 215Q4 215Q3 215Q2 215Q1 214Q4 214Q3 214Q2 214Q1 213Q4 213Q3 213Q2 213Q1 212Q4 212Q3 212Q2 212Q1 211Q4 211Q3 211Q2 211Q1 21Q4 21Q3 21Q2 21Q1 Primary income Investments income Compensation of employees -1 216Q4 216Q2 215Q4 215Q2 214Q4 214Q2 213Q4 213Q2 212Q4 212Q2 211Q4 211Q2 21Q4 21Q2 29Q4 29Q2 28Q4 28Q2 27Q4 27Q2 Net Direct Investment Income Trend The net balance in the surplus of secondary income account expanded compared to the same quarter a year earlier. The relevant surplus was estimated at EUR 224.4 million, up by around 11.6% in annual level. The higher net inflows of the public sector and of remittances, by EUR 18.5 and 11.4 million, respectively, annually, provided the main contribution in this regard. Remittances increased by around 7.9% in annual level. 8 Bank of Albania

Chart 5 Remittances (net flows, in EUR million, left) and financing of trade deficit from net primary and secondary income and from services (right) 3 25 2 15 1 5 216Q3 216Q1 215Q3 215Q1 214Q3 214Q1 213Q3 213Q1 212Q3 212Q1 211Q3 211Q1 21Q3 21Q1 29Q3 29Q1 28Q3 28Q1 27Q3 27Q1 26Q3 26Q1 25Q3 25Q1 Workers remittances Trend 9 8 7 6 5 4 3 2 1 216Q3 216Q1 215Q3 215Q1 214Q3 214Q1 213Q3 213Q1 212Q3 212Q1 211Q3 211Q1 21Q3 21Q1 29Q3 29Q1 28Q3 28Q1 27Q3 27Q1 26Q3 26Q1 25Q3 25Q1 Trade deficit financing Trend Net cumulative income from services account, primary income account and secondary income account financed around 63.9% of the trade deficit in goods. This ratio expanded by 2.3 percentage points compared to 215 Q4, but it is around 5.7 percentage points lower compared to 216 Q3. Bank of Albania 9

II. CAPITAL ACCOUNT The capital account debits and credits all the transactions on the acquisition and disposal of non-produced, non-financial assets/goods and the capital transfers 3 between residents and non-residents (on which there is no economic value in the exchange) In 216 Q4, the capital account s positive surplus was around EUR 49.4 million, higher by around EUR 16.5 million, compared to the previous year. Net capital flows in this account are estimated at 1.7% of nominal GDP. Net capital transfers for the account of central government resulted with a positive surplus of EUR 28.8 million, while those in financial and non-financial corporations, households and non-profit institutions serving household, were 2.6 million. The combination of net transactions of the current and capital account provides the net position of the domestic economy, as net lender (surplus), and net borrower (deficit) against non-resident economies. In quantitative terms, our economy represents a net borrower position, around EUR 19.9 million, which is financed by the financial account and errors and omissions item. 3 Capital transfers consist of: 1. debt forgiveness; 2. non-life insurance claims; 3. grants; 4. guarantees; 5. taxes (for inheritance, gifts, etc.); 6. Other capital transfers. 1 Bank of Albania

III. FINANCIAL ACCOUNT The financial account records a debtor position of EUR 149.2 million for 216 Q4. This result represents a narrowing of the net borrowing position of residents against non-residents, by around 38.7%, in annual terms. Net foreign currency flows of this account were estimated at around 5.1% of nominal GDP, and financed around 62.1% of the current deficit, recorded during the period under review. Chart 6 Financial account, errors and omissions (net flows, in EUR million) 2 1-1 -2-3 -4 21Q1 21Q2 21Q3 21Q4 211Q1 211Q2 211Q3 211Q4 212Q1 212Q2 212Q3 212Q4 213Q1 213Q2 213Q3 213Q4 214Q1 214Q2 214Q3 214Q4 215Q1 215Q2 215Q3 215Q4 216Q1 216Q2 216Q3 216Q4 Errors and omissions Financial account Borrowing/Net lending Financial inflows in the form of residents liabilities to non-residents amounted EUR 22.7 million, EUR 114.9 million lower compared to the same quarter in the previous year. This dynamic was broadly determined by the reduction of liabilities in portfolio investment and others. On the other hand, liabilities in the form of direct investment, increased. Total of outflows in the form of residents rights against non-residents, during this quarter, was EUR 71.6 million, around EUR 2.7 million lower compared to the same quarter in the previous year. The expansion of assets in other investment and direct investment determined this performance. On the other hand, assets in the form of portfolio investment and reserve assets increased. Bank of Albania 11

Chart 7 Financial account components (net flows, in EUR million) 4 3 2 1-1 - 2-3 - 4-5 - 6 21Q1 21Q2 21Q3 21Q4 211Q1 211Q2 211Q3 211Q4 212Q1 212Q2 212Q3 212Q4 213Q1 213Q2 213Q3 Direct investments portfolio investments Other investments Financial derivatives Reserve assets Financial account 213Q4 214Q1 214Q2 214Q3 214Q4 215Q1 215Q2 215Q3 215Q4 216Q1 216Q2 216Q3 216Q4 The net foreign direct investment showed expanding trends in annual terms, like in the two previous quarters. The annual growth recorded 134.%. Net Direct Investment to nominal GDP ratio was estimated at 9.7%, standing 5.3 percentage points higher than in the same period in the previous year. Chart 8 Composition of FDIs (flows in EUR million, left) and covering of current deficit from net FDIs (right) 4 35 3 25 2 1 15 1 5 216Q3 216Q1 215Q3 215Q1 214Q3 214Q1 213Q3 213Q1 212Q3 212Q1 211Q3 211Q1 21Q3 21Q1 29Q3 29Q1 28Q3 28Q1 27Q3 27Q1 26Q3 26Q1 FDI Inflow w/o Privatisations Privatisation Income 216Q3 216Q1 215Q3 215Q1 214Q3 214Q1 213Q3 213Q1 212Q3 212Q1 211Q3 211Q1 21Q3 21Q1 29Q3 29Q1 28Q3 28Q1 Net Direct Investment/Current Account In the long run, Direct Investment constitute an important foreign currency inflow in financing the current deficit of Albania. In 216 Q4, the ratio of net Direct Investment flows financed 116.9% of the recorded current deficit. This ratio was 86.7 percentage points higher than in the same quarter a year earlier, and 26.6 percentage points lower compared to 216 Q3. 12 Bank of Albania

Net portfolio investment recorded a positive balance of EUR 18.9 million, or EUR 281.1 million higher compared with a year earlier. This increase was determined by the growth of domestic assets by around EUR 155 million, and the decrease of liabilities by EUR 126 million. Both, the increase of assets and the decrease of liabilities are related with the debt sub-account. The net balance of other investments account shows a net borrowing position of EUR 13.5 million. Albanian assets invested abroad stood at EUR -189.6 million, while liabilities to non-residents were estimated at EUR -59.1 million. "Net currency and deposits sub-item resulted in a net negative balance of EUR 242.6 million, from EUR 113.4 million in the same period in the previous year. Total liabilities in the form of loans recorded EUR -22.7 million, down by EUR 45.9 million compared to a year earlier. The account of other sectors was the main determinant of this performance. The overall balance of payments resulted in the expansion of foreign reserve assets by EUR 153.3 million. At the end of December 216, the stock of foreign exchange reserve was around EUR 2.94 billion. This level was sufficient to cover 7.2 months of imports of goods and services and 165% of the short-term gross external debt. As a result of problems that may be encountered in information sources and during the preparation of external sector statistics, the balance of payments may feature discrepancies. In the balance of payments, these discrepancies are summarized in the errors and omissions item, which is determined as residual (difference between the financial account balance and the current account balance plus the balance of the capital account). In 216 Q4, net errors and omissions recorded the positive rate of EUR 41.8 million, estimated at around 1.4% of nominal GDP. Chart 9 Errors and omissions/nominal GDP (left) and financing of current deficit with net inflows classified as errors and omissions for the fourth quarters, over the years (right) 1 % 6 5-5 -1-15 Errors and omissions 216Q3 216Q1 215Q3 215Q1 214Q3 214Q1 213Q3 213Q1 212Q3 212Q1 211Q3 211Q1 21Q3 21Q1 29Q3 29Q1 28Q3 28Q1 4 2-2 -4-6 -8 28Q4 29Q4 21Q4 211Q4 212Q4 Net errors and ommissions to current account deficit 213Q4 214Q4 215Q4 216Q4 Bank of Albania 13

IV. PROFILE OF CURRENT DEFICIT FINANCING Regarding the profile of the current deficit financing, it is important to monitor the reliance on debt-creating inflows rather than on the more desirable nondebt-creating inflows 4. Thus, non-debt-creating financial flows from net foreign direct investment and from the capital account were estimated at 11.4% of nominal GDP, around 5.7 percentage points higher compared to the previous year. The debt-creating financial flows were estimated at.7% of nominal GDP, reducing by around 1. percentage points, compared to the previous year. The overall financing of the current deficit is calculated by adding net errors and omissions to net debt-creating and non-debt creating foreign-currency flows. During the quarter under review, the ratio of current account financing stood at 163.8%, implying an increase in the foreign exchange reserve assets, by EUR 153.3 million. Chart 1 Financial debt-creating and non-debt-creating flows to nominal GDP (left) and total financing of current account deficit (right) 25 2 2 15 1 5 1-5 -1-15 216Q3 216Q1 215Q3 215Q1 214Q3 214Q1 213Q3 213Q1 212Q3 212Q1 211Q3 211Q1 21Q3 21Q1 29Q3 29Q1 Current Account/GDP Debt creating flows Non-debt creating flows 216Q3 216Q1 215Q3 215Q1 214Q3 214Q1 213Q3 213Q1 212Q3 212Q1 211Q3 211Q1 21Q3 21Q1 29Q3 29Q1 MA (4 quarters) Current Account Financing 4 This breakdown serves to monitor the impact of financial and capital flows on Albanian s external debt. Non-debt creating flows include Direct Investment and net flows of the capital account, whilst debt-creating flows include portfolio investment and other net investment. 14 Bank of Albania

Bank of Albania 15