Albania: Quarterly Monetary Policy Report - January 2017

Transcription

1. Quarterly Monetary Policy Report , 2017/I Bank of Albania QUARTERLY MONETARY POLICY REPORT 2017/I THE REPORT REFERS TO THE BANK OF ALBANIA’S MONETARY POLICY STATEMENT 2016 H2, ADOPTED BY THE SUPERVISORY COUNCIL’S DECISION NO.02, DATED 01.02.2017 1 Bank of Albania
2. Quarterly Monetary Policy Report , 2017/I Data from this publication may be used, provided the source is acknowledged. Published by: Bank of Albania, Sheshi “Skënderbej”, Nr.1, Tirana, Albania Tel.: + 355 4 2419301/2/3; + 355 4 2419401/2/3 Fax: + 355 4 2419408 E-mail: public@bankofalbania.org www.bankofalbania.org Printed in: 270 copies Printed by: Bank of Albania 2
3. Quarterly Monetary Policy Report , 2017/I C O N T E N T S OBJECTIVE7 FOREWORD BY THE GOVERNOR 9 1. PRICE STABILITY AND MONETARY POLICY 12 2. EXTERNAL ECONOMIC ENVIRONMENT 15 2.1. Global economy 2.2. Main commodity prices in global markets 2.3. Financial markets 15 19 19 3. FINANCIAL MARKETS AND MONETARY DEVELOPMENTS 21 3.1. 3.2. 3.3. 3.4. 3.5. Financial market developments Deposit and credit interest rates and financing standards Credit to the private sector Public sector financing Deposits and monetary supply in the economy 21 24 27 29 29 4. INFLATION AND ECONOMIC GROWTH 32 4.1. 4.2. 4.3. 4.4. 4.5. Inflation Gross domestic product and the trend of aggregate demand Cyclical situation of the economy and domestic inflationary pressures Imported inflation Inflation expectations 32 34 48 53 54 3 Bank of Albania
4. Quarterly Monetary Policy Report , 2017/I BOXES Box 1: Box 2: Box 3: Price performance in the housing market 42 Balance of Payments 2016 Q3 47 Potential output, the natural rate of unemployment and the respective gaps, conclusions based on the assessments in the case of Albania 49 TABLES 2. External economic environment Table 1 Selected macroeconomic indicators Table 2 Economic figures for countries in the region 16 18 4. Inflation and economic growth Table 3 Contribution of key categories to annual inflation Table 4 Balance of Payments indicators 34 47 Bank of Albania 4
5. Quarterly Monetary Policy Report , 2017/I CHARTS 1. Price stability and monetary policy Chart 1 Main interest rates in Albanian financial markets 13 Chart 2 Composite Leading Indicator (CLI) of GDP and Industrial Production in main countries and inflation in main countries 15 2. External Chart 3 Chart 6 economic environment Composite output index (PMI) and quarterly GDP and business and consumer confidence indicators and economic sentiment Selected global financial indicators 3. Financial markets and monetary developments Chart 7 Interbank rates and their deviation from the policy rate Chart 8 BoA open market operations and trading volume in the interbank market Chart 9 The exchange rate trend Chart 10 Primary market yields Chart 11 New deposits interest rates Chart 12 New credit interest rates, 6-months moving average Chart 13 Credit standards Chart 14 Lending to private sector Chart 15 Credit to households Chart 16 Credit to enterprise Chart 17 Budget deficit and its financing instruments Chart 18 Monetary indicators Chart 19 Deposits against GDP and by currency Chart 20 Deposits by maturity Chart 21 Annual inflation and target. Inflation in the region and the EU 4. Inflation Chart 22 Chart 23 Chart 24 Chart 25 Chart 26 Chart 27 Chart 28 Chart 29 Chart 30 Chart 33 Chart 34 Chart 35 Chart 36 Chart 37 Chart 38 Chart 39 Chart 40 Chart 41 Chart 42 Chart 43 Chart 44 Chart 45 5 16 20 22 22 23 24 25 25 26 27 28 29 29 30 31 31 32 and economic growth Contribution to headline annual inflation by food and non-food categories 33 Annual and quarterly GDP 35 Gross domestic Product from production and confidence indicators 36 Contribution of branches and capacity utilisation rates to the service sector 36 Added value in construction and capacity utilisation rate 37 Contributions of branches in added value in industry and capacity utilization rate 38 Economic sentiment indicator and structure of domestic demand 39 Private consumption 40 Indirect indicators on the performance of private consumption in Q4 40 House price and rent indexes and their ratio 42 Fiscal policy orientation 43 Budget expenditures 43 Budget revenues 44 Contribution of net exports to aggregate demand 45 Annual Brent oil prices, domestic oil export, metal price index and domestic metal export 45 Orientation of imports and exports by category 46 Cyclical indicators of the economy situation 48 Output and unemployment rate gap 51 Hammered annual average changes of productivity, labour costs and production 52 Long-term inflation and short-term inflation trends 53 Contribution of imported and domestic inflation to annual headline inflation. IIPI and the contributions of its components 54 Inflationary expectations of economic agents 55 Bank of Albania
6. Quarterly Monetary Policy Report , 2017/I Bank of Albania 6
7. Quarterly Monetary Policy Report , 2017/I OBJECTIVE Bank of Albania’s primary objective is to achieve and maintain price stability. Promoting long-term investments, maintaining the purchasing power of money, enhancing the efficiency of fund allocation in the economy and safeguarding the financial stability are some of the benefits of an economic environment characterized by stable prices. Stability is the greatest contribution by the central bank to sustain a steady and long-term economic growth. In line with its approved Monetary Policy Document, the Bank of Albania is committed to achieving and maintaining annual inflation at 3.0% in the medium term. The announcement of the quantitative inflation target aims at anchoring economic agents’ expectations and reducing the risk premiums. In view of achieving this goal and enhancing its transparency, the Bank of Albania prepares and publishes the Monetary Policy Report quarterly. This Report is the main instrument of the Bank of Albania to communicate its monetary policy to the public. It provides a thorough assessment of the latest macroeconomic developments and the factors expected to contribute to consumer prices in Albania. The Report refers to the Bank of Albania’s Monetary Policy Statement 2016 H2, adopted by the Supervisory Council’s Decision No.02, dated 01.02.2017. The economic, financial and monetary analyses in this Report are based on the latest data avaiable as at 20 January 2017. 7 Bank of Albania
8. Quarterly Monetary Policy Report , 2017/I Bank of Albania 8
9. Quarterly Monetary Policy Report , 2017/I FOREWORD BY THE GOVERNOR The information analysed in this report confirms previous assessments of the Bank of Albania on the actual situation and the outlook of the Albanian economy. Available data suggest that economic activity at home continues to expand. This improved economic activity led to better labour market indicators and is reflected in a gradual rise of inflation towards the target. The accommodative monetary policy, as reflected in the reduction of financing costs and risk premia, remains a determinant factor in this development landscape. The outlook for the future remains positive. The Bank of Albania expects economic growth to pick up over the next two years and inflation to return to target within 2018. Inflation has been trending upward in recent months, settling at 2.2% in December. In terms of composition, during the fourth quarter, inflation rose due to the increase in food and oil prices. From the macroeconomic perspective, during this period, the upward trend of inflation reflects the added inflationary pressures from the domestic environment and the reduction of disinflationary pressures from the external environment. According to INSTAT data, the Albanian economy grew 3.3% in the first nine months of the year and 3.1% in the third quarter. Growth reflected the expansion of consumption and private investments and the increase in revenues from tourism. Domestic demand was supported by the stimulating monetary conditions, improvement of confidence, increase in employment and expansion of foreign direct investments. On the other hand, foreign demand contributed positively to the export of services, but the export of goods continued to show poor performance, as a result of still low commodity prices in international markets. In our judgment, economic growth in the fourth quarter will be higher than in the preceding quarter. Economic growth for 2016 will be similar to that recorded in the first nine months, and higher than in 2015. The expansion of aggregate demand has led to the increase in employment and decrease in unemployment. Data for the third quarter point to 8.5% increase in employment and a decrease of the unemployment rate to 14.7%. Economic and financial developments have reflected the combined effect of the consolidating fiscal policy and the accommodative monetary policy implemented during the year. The fiscal balance of the first 11 months resulted in ALL 7.1 billion surplus. The increase of revenues by 7.3% and reduction of expenditures by 2% contributed 9 Bank of Albania
10. Quarterly Monetary Policy Report , 2017/I to this result. This fiscal policy stance has kept the direct contribution of public expenditure to aggregate demand at low levels, but it has created more space for the pass-through of our monetary policy to the financial markets. Our monetary stimulus has provided favourable financing conditions, even though the exchange rate appreciated from the previous year. The low policy rate has contributed to the reduction of interest rates across the board for financial products offered to the private sector. In particular, the average interest rate on lek loans in November was 0.6 percentage points lower than in the previous year. On the other hand, the yields on government securities in the primary market moved upward in recent months. This movement was partly due to a correction of their rapid decline in the first half of the year, and partly due to the effects from the supply and demand fluctuations in the auctions. The upward trend is expected to decelerate for as long as the monetary policy and the fiscal policy remain unchanged. Moreover, available data suggest that this trend has not resulted in a tightening of the price of credit to the private sector, and has not distorted the monetary policy pass-through. In response to this policy, and reflecting the recovery in economic activity, the credit to the economy has been increasing. Excluding the effect of the loss loans write off from the balance sheets, the portfolio of loans to the private sector in November stood 3.4% higher than in the previous year. In more detail, the 10.4% domestic currency credit growth offset the contraction by 1.4% in foreign currency credit portfolio. The Bank of Albania expects crediting to improve further in 2017. The expectations are based on the signals for a gradual recovery of credit demand and the positive effects on the supply side from the materialisation of measures for the reduction of non-performing loans. Data show that the ratio of nonperforming loans fell to 18.2% in December. The reduction reflects the combined effects of the improvement of the economic situation, credit restructuring and loss loans write-off from balance sheets. Our analysis suggests that economic and financing conditions are adequate for the return of inflation to target. Economic growth is expected to strengthen further in the next two years, creating adequate conditions for the return of the economy to equilibrium and of inflation to target within 2018. Meanwhile, for 2017, the Bank of Albania expects average inflation to hit 2.3% from 1.3% in 2016. The realisation of this scenario requires maintaining the accommodative stance of the monetary policy in the medium-term horizon. However, the intensity of the monetary stimulus in this period will follow the improving trend in the economy, adapting to the needs of maintaining macroeconomic balances. Based on the available information and judging on the balance of risks, which remains on the down side, the Supervisory Council deems that the intensity of the monetary stimulus will not diminish before the fourth quarter of 2017. Bank of Albania 10
11. Quarterly Monetary Policy Report , 2017/I This path of the monetary policy stance is in line with the accomplishment of our price stability objective. In parallel, the accommodative monetary policy also creates adequate conditions for the implementation of structural reforms. Such reforms are necessary - among others - for further expanding the production capacities of Albania and increasing the resilience of the economy against potential shocks. 11 Bank of Albania
12. Quarterly Monetary Policy Report , 2017/I 1. PRICE STABILITY AND MONETARY POLICY The monetary policy of the Bank of Albania is formulated and implemented in view of the price stability objective. The cyclical weakness of the economy and low inflationary pressures has dictated the implementation of an accommodative monetary policy stance over the recent years. The Bank of Albania has reacted through consecutive lowering of the policy rate and liquidity supply to the banking system. Monetary stimulus has contributed to the reduction of financing costs and improvement of economic agents monetary flows. In parallel, the open communication on maintaining low interest rates contributed to the reduction of risk premia. Through the implementation of these instruments, the monetary policy has been crucial for boosting the private domestic demand, strengthening economic growth and shifting inflation towards a convergence with the target. The accommodative monetary policy stance was maintained throughout 2016, thus contributing to economic recovery, rise in inflation and better anchoring of inflationary expectations. Economic activity performed positively over 2016 H2. We expect these trends to strengthen in the medium term. Monetary stimulus is assessed as sufficient to support the economic activity towards the equilibrium and the return of inflation to target within 2018. Notwithstanding this positive scenario, down-side risks continue to dominate in the medium term. In this regard, the monetary policy will remain accommodative, but the monetary stimulus intensity will adapt to the need to maintaining the macroeconomic equilibrium. Economic activity in Albania continued to perform positively and showed strengthened inflationary pressures. INSTAT data showed that Gross Domestic Product grew by 3.1% over 2016 Q3, while inflation reached 2.2% at the end of year. Inflation rose mainly attributable to the increase of inflation in food and oil prices. The other basket items provided lower contributions. The upward trend of inflation reflects the increase in domestic inflationary pressures, the deceleration of external disinflationary pressures and the better anchoring of inflation expectations. We assess monetary conditions as adequate to support economic growth and the return of inflation to target. Economy grew at a steady pace over the first three quarters of 2016. Consumption and investment are the main sources to growth, supported by the simulating monetary conditions, the improved economic agents' confidence, the increased employment and the expanded foreign investments. Services exports provided an important contribution in 2016 Q3, with a strong increase in tourism income. Our preliminary estimations show that this profile was maintained during the fourth quarter. In 2016, the economic activity expanded at a higher rate than in 2015. Bank of Albania 12
13. Quarterly Monetary Policy Report , 2017/I The simulating monetary policy improved the financing conditions in the economy and sustained its growth. The monetary stimulus was transmitted through the monetary policy rate, the injection of liquidity and the forward guidance. The policy rate was lowered by 0.50 percentage points in 2016 H1, and stands at 1.25%, the lowest historical level. Financing conditions improved across all financial market segments. The average interest rate on lek loans fell at 7.5% in 20161, standing 0.6 percentage points below the average of 2015, and 1.1 percentage points below the average of 2014. The average yield fell at 1.8% in 2016, 1.5 percentage points lower than in 2015 and 1.6 percentage points lower than in 2014. Lending standards were eased for households and small and medium-sized enterprises, while they remained tight for large enterprises. Intermediation in the domestic currency continued to increase, in the context of economic growth acceleration and low financing costs. Lending in lek continued to trend upward, being the only contributor to credit growth to the private sector in 2016, as well. Annual credit growth in lek stood at 10.4% in November, from 5% a year earlier. Chart 1 Main interest rates in Albanian financial markets 7.0 % Average interest on new time deposits in ALL 6.0 % Average 12-M yield, T-Bills 10.0 15.0 9.0 14.0 8.0 13.0 5.0 7.0 4.0 6.0 3.0 4.0 12.0 11.0 5.0 2.0 1.0 0.0 10.0 8.0 1.0 7.0 0.0 6.0 12m T-bill yield Historical average 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 9.0 2.0 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 3.0 Historical average Average interest on deposits in ALL (3M m.a.) % Average interest on new loans in ALL Historical average Weighted av.interest on loans (6M m.a.) Source: Bank of Albania and MPD's estimates. The rapid growth of economic activity and aggregate demand activated a part of spare capacities in the economy, thus increasing the production capacity utilization rate, and employment and lowering the unemployment rate. The higher capacity utilisation rate contributed to the increase of internal inflationary pressures and of the core inflation. These trends are expected to continue during this year, by supporting the gradual increase of inflation towards the central bank's target. Inflation is projected to average 2.3% in 2017, from 1.3% in 2016. Inflation is expected to return to target within 2018, supported by the accommodative Data for 2016 are available till November. 1 13 Bank of Albania
14. Quarterly Monetary Policy Report , 2017/I monetary policy. Maintaining an accommodative monetary policy over the medium-term horizon conditions the fulfilment of expectations. This implies maintaining interest rates below those in equilibrium. Risk balance around the baseline scenario improved in the short run, affected positively by faster than expected improvement of economic agents' confidence and external trade. In the medium term, down-side risks are dominant, mainly related to uncertainties in the external environment and the acceleration of credit recovery. The confirmation of our short-term expectations and their risk balance suggests that the current monetary policy stance is adequate. Bank of Albania 14
15. Quarterly Monetary Policy Report , 2017/I 2. EXTERNAL ECONOMIC ENVIRONMENT The external economic and financial environment has improved. Economic activity expanded and expectations on its performance are positive. Financial markets in the euro area stabilized after Brexit and the financial indicators reflected the divergences in the monetary policy stance implemented by the main central banks.2 Positive perspective of the euro area is surrounded by increased uncertainties, which mainly relate to the expected political developments this year. The economies of our trading partners grew at positive terms, but at a more decelerated pace. Low prices in international markets are transmitted into low inflationary pressures to regional prices. Inflation in regional countries is expected to increase in the next year, due to the expectations for an increase in commodity prices and strengthened economic growth. 2.1.GLOBAL ECONOMY Global economy showed a higher growth pace over 2016 H2. Economic activity appears more recovered in advanced economies. Also, the economic growth pace has improved in emerging economies. Preliminary indicators suggest this performance will continue in 2017 H1. The global composite output and economy index3 and the leading GDP indicator increased in the last Chart 2 Leading Indicator (CLI) of GDP and Industrial Productionl* in main countries (left) and inflation in main countries** (right) 0.0% 3.600 98 -2.0% 1.800 96 -4.0% .00 94 -6.0% -1.800 92 -8.0% -3.600 2016 2014 2012 2010 2008 2006 12/16 100 06/15 5.400 12/13 2.0% 06/12 102 12/10 7.200 06/09 4.0% 01/08 104 Industrial production OECD Greece Eurozone CLI OECD Italy OECD *Industrial production is a monthly change, while CLI long-term is 100. **OECD countries and Brazil, China, Russia, India and South Africa. Source: OECD, (Organisation for Economic Co-operation and Development). In June 2016, through a popular referendum, United Kingdom voted for exit from the European Union, which created temporary tensions in the financial markets. Also, Fed has started the cycle of the key rate increase, while the ECB has confirmed the extension of monetary facilities in economy, driving to the change of interest rates direction for the USD and Euro currencies. 3 The global composite output PMI, Markit, October, November and December 2016. 2 15 Bank of Albania
16. Quarterly Monetary Policy Report , 2017/I months of 2016, affirming the positive performance of the economic activity. Inflationary pressures remain low, partially due to the prices effect in oil and energy products. Inflation forecasts show that it will increase during 2017, reflecting the slight increase in oil and energy prices4. Table 1 Selected macroeconomic indicators Countries GDP change Quarterly Annual Inflation rate Unemployment rate December 2016 December 2016 November 2016 December 2015 USA 0.8 1.6 4.7* 0.3 2.1 Euro area 0.3 1.7 9.8 0.5 1.1 Germany 0.2 1.7 4.1 0.1 1.0 France 0.2 1.1 9.5 0.3 0.8 United Kingdom 0.5 2.3 4.8† 0.5 1.6 Source: ECB, Fed, Eurostat and respective statistical institutes. *December 2016; †September-November 2016 interval. Q3:2016 Q3:2016 Nëntor-16 Euro area economy Euro area economy expanded in 2016 Q3, by slightly accelerating the annual growth rate. The recovered domestic demand was the main factor contributing to economic growth. Consumer spending reflected a constant positive performance, affected by the improved labour market. The continuing easing of the monetary policy and its transmission in the financial markets drove to more favourable financing conditions and is translated into expanded private investments, particularly in construction. Fiscal policy was stimulating across the whole euro area. The external sector, affected by the fall in the global trading activity, reflected a downward contribution to economic growth. Inflation continued to trend up since Q2, recording the annual value of 1.1% in Chart 3 Composite output index (PMI) and quarterly GDP (left) and business and consumer confidence indicators and economic sentiment (right) 60 % Commodity price index (IMF) Annual change 0.5 0.4 0.3 0.2 20 0.1 0 -0.1 -20 -0.2 -0.3 2016M9 2016M5 2015M9 2015M1 2014M5 2013M9 2013M1 2012M5 2011M9 International oil price Domestic oil price -0.4 2011M1 09/16 05/16 01/16 09/15 05/15 01/15 09/14 05/14 01/14 09/13 05/13 01/13 09/12 05/12 01/12 09/11 05/11 01/11 -60 USD/ALL exchange rate Food price index Metal price index Source: Markit, Eurostat, EC. Consensus Forecast, January 2017. 4 Bank of Albania 16
17. Quarterly Monetary Policy Report , 2017/I December. This trend is expected to continue in 2017, by offsetting the base effect of low prices in food and energy at the beginning of the previous year. In the forthcoming period, the accommodative monetary policy and the increase in corporates' profit, in addition to the improvements of industrial production and labour market indices, are expected to contribute to positive growth, albeit moderated, of the economic activity. Nevertheless, risks to these expectations are on the down side and stem from the political situation in Europe5. From geographical point of view, Germany, France, Spain and some peripheral economies have supported the regional economic growth. The economies of Albania’s main trading partners, such as Italy and Greece, showed positive growth in 2016 Q3, after a negative performance in the previous quarter. The economy of Greece grew due to the consumer spending and improvement in trading activity, while investments continue to provide negative contribution. Economic activity in Italy is driven by consumer spending, investments and government spending. The financial sector in Italy remains fragile, due to the high level of non-performing loans in one of the main banks in the banking system. Inflation rose in Greece in December, shifting away from the negative territory, albeit standing at low rates. Also in Italy, inflation recorded low rates, but it shows an upward trend in the last quarter. United States economy The US economy improved further in 2016 Q3, recording higher growth rates than in 2016 H1. The improvement in both domestic and external demand drove to the expansion of the economic activity. Strong growth in exports exceeded the marginal increase in imports, providing a positive contribution of net exports to GDP growth. Also, non-residential investments provided a high contribution. Consumer and central government spending’s contribution was positive, but manifested slight slowdown. The positive growth trend is expected to continue also in Q4, reflecting the consolidation of the main economic indicators. Inflation continued to follow an upward trajectory, started at the middle of the year. It settled at 2.1% in December. Labour market showed positive performance and unemployment rate was low, below 5%. These developments, in addition to a higher expected fiscal stimulus in 2017, are expected to drive Federal Reserve to more rapidly tighten the monetary policy. United Kingdom will officially trigger Article 50 of the Lisbon Treaty in March 2017, which is officially the start of the negotiations for Britain to leave the EU. Also, elections will take place in some main euro area countries during 2017. France, Germany, Netherlands. 5 17 Bank of Albania
18. Quarterly Monetary Policy Report , 2017/I Regional economies6 Overall, regional economies grew at positive terms in 2016 Q3, but at different dynamics in the development of the economic activity. Turkey was an exception from this trend, whose economy contracted in annual terms. Overall, consumer spending, investments and external demand contributed positively to the economic growth of regional countries. The economy of Turkey showed negative annual growth rates in 2016 Q3, for the first time in seven years. Government spending was the only item contributing positively to economic growth, while the political situation affected both the external and the internal demand negatively. The economy of Macedonia slowed down the growth pace in 2016 Q3. Consumer spending and net exports contributed to economic growth. Investments shrank, reflecting the political stalemate and the lack of a new Government in Macedonia. Economic activity in Kosovo expanded in 2016 Q3, driven by the rapid increase of consumer spending and investments. Government spending shrank, and, in addition to exports' performance, contributed to deceleration of economic growth. In Serbia, economic growth accelerated in Q3, reflecting the two-digit growth in exports and the expansion of investments. Consumer and government spending, albeit growing positively, have slowed down the growth pace. Inflation rates in the region continue to stand at low levels, but they show an upward trend in Q4. In Kosovo and Serbia, inflation stood at low, but positive rates, while in Macedonia it continues to stay in negative territory. Inflation in Turkey recorded high values, reflecting the nominal rise of wages at the beginning of 2016. The region is expected to show higher economic growth rates in the period ahead. Inflation will continue to trend upward, driven by the reduction of the effect from the low foods and oil prices in international markets in the previous year and the improvement of the economic activity. Table 2 Economic figures for countries in the region neigbouring countries Annual change of GDP Annual inflation 2016 Q2 2016 Q3 December 2016 Italy 0.8 1.0 0.5 Greece -0.9 1.8 0.3 Macedonia 3.1 2.4 -0.1 Serbia 1.9 2.6 1.6 Turkey 4.5 -1.8 8.5 Croatia 2.0 2.7 0.7 Kosovo 3.3 3.8 1.3 Albania 3.4 3.1 2.2 * November 2016; †October 2016 **2016 Q2. Source: Respective statistical institutes. Countries Unemployment rate 2016 Q3 11.9* 23.0† 23.4 13.8 11.4 11.4* 26.2** 15.2 Main trading partners in the Balkans, non-EU members. 6 Bank of Albania 18
19. Quarterly Monetary Policy Report , 2017/I 2.2.MAIN COMMODITY PRICES IN GLOBAL MARKETS Commodity prices increased in Q4, following the trend started in the middle of 2016. The index of primary commodity prices (excluding energy) recorded a two-digit increase in November and December, by reflecting the deceleration of the base effect of low prices in the previous year. Food price index showed a similar trend, reflecting demand growth in emerging economies. Within this group, cereals prices stood unchanged, after the increased supply by the larger producers of these agricultural products. Metal price index increased rapidly, reflecting the effect of demand growth, due to the expansion of global economic activity. Chart 4 Annual changes in commodity prices 60 % 50 40 30 20 20 10 0 -10 -20 -20 -30 2016M11 2016M6 2016M1 2015M8 2015M3 2014M10 2014M5 2013M12 2013M7 2013M2 2012M9 2012M4 2011M11 USD/ALL exchange rate 2011M6 -40 2011M1 01/16 International oil price Domestic oil price 01/15 01/14 01/13 01/12 01/11 -60 Food price index Metal price index Source: EIA, IMF, authors’ calculations. Brent oil price recorded positive increase in Q4, after some quarters of negative increase. This dynamic follows the Opec and Non-Opec countries agreement to cut oil output. Oil price, in the forthcoming period, is expected to trend up, at least till the end of 2017. Chart 5 Key interest rates of selected central banks 7.00 6.00 5.00 4.00 3.00 2.3.FINANCIAL MARKETS 2.00 1.00 01/16 11/14 10/13 BoJ 09/12 07/11 Fed 06/10 05/09 ECB 03/08 02/07 19 0.00 01/06 The Federal Reserve raised the key interest rate by 0.25 percentage point to a range of 0.50% and 0.75%. The other major central banks kept their key interest rates unchanged, respectively: the European Central Bank at 0.0%, the Bank of England at 0.25% and the Bank of Japan at -0.10%. BoE Source: Central banks (ECB, Fed, Bank of Japan and Bank of England) Bank of Albania
20. Quarterly Monetary Policy Report , 2017/I The interest rates on money market instruments in the euro area continued to decrease. Libor interest rates on US dollar increased, reflecting the increase of the key rate from Fed. In US capital markets, yields on long-term bonds increased, mainly reflecting the signals of shrinking the monetary easing, the effects of election results and the economic agents’ medium-term inflation expectations. In euro area capital markets, the increase of yields on long-term bonds was contained, reflecting the effect of the ECB’s monetary policy. The ECB's decisions in its December meeting to pursue an accommodative policy until the end of 2017 seem to have calmed down the financial market agents in the euro area. Yields spread on government bonds of euro area peripheral member states with securities with maximum rating expanded in the last quarter, by reflecting high risk premia for these countries. In Q4, the euro depreciated against the US dollar, by reflecting the expansion of spreads of interest rates between the euro area and the USA. In December, the euro depreciated by 6.0% against US dollar, compared to September. Chart 6 Selected global financial indicators Euribor and Libor 2.5% 8.0% 40% 6.0% 30% 4.0% 20% 2.0% 10% 0.0% 0% 2.0% 1.5% 1.0% 0.5% 0.0% 12/16 12/15 12/14 AAA bonds Spain 12/13 12/12 01/12 01/11 Euribor-3m Libor Usd-3m 01/10 12/16 01/16 03/15 05/14 06/13 08/12 09/11 11/10 01/10 -0.5% Italy Greece (right) Source: Bloomberg, Reuters and Eurostat. Bank of Albania 20
21. Quarterly Monetary Policy Report , 2017/I 3. FINANCIAL MARKETS AND MONETARY DEVELOPMENTS7 In 2016 Q4, developments in financial markets confirmed the trends observed in 2016 Q3. Costs on banks’ funds and over 1-year credit price continue to reduce. These developments reflect the full pass-through of monetary policy signals to financial markets. Nevertheless, the lowering of interest rates, in the fourth quarter has been contained compared to the previous quarter, affected also by the yields rise in the primary market. Developments in the primary market showed the expected correction of their values and the imbalance between demand and supply. At the end of the year, yields on government securities were at similar rates to the previous year. Crediting followed the positive seasonal behaviour in October and November, remaining at moderate growth rates. Lek crediting and the stable growth of credit to households drove to the expansion of credit portfolio. Lending standards to enterprises continued to be tight. Households, in addition to lower interest rates on the credit, have benefited also from the easing of its non-price standards. Such a performance is reflected also in the moderated expansion of broad money. These developments affirm that monetary-sector pressures on inflation remain low. 3.1.FINANCIAL MARKET DEVELOPMENTS Interbank market Interbank rates performed steadily. Liquidity pressures were contained, while the accommodative monetary policy since May has favoured maintaining low interest rates in the market. The Bank of Albania was present in money market by injecting liquidity through the Reverse Repo agreements. Interest rates in the interbank market did not change from the previous quarter. Interest rates on weekly and overnight transactions are close to the policy rate and maintain low volatility levels8, in line with the operational line of the monetary policy. The general volume traded by banks increased slightly, nevertheless remaining below the level in the first half of year. The volume of interbank transactions continues to be dominated by seven-day transactions. The Bank of Albania has increased liquidity injections in the market, in response to higher demand by the banking system. Besides the main instrument, the seven-days REPO, in this period the one and three-month maturities have been also used. The interest rates in the respective auctions have always stood close to the policy rate. The analysis of financial and monetary developments is based on the financial and monetary data, which from September 2016, are compiled according to ESA2010 methodology. For analysis purposes, the prolongation of series is performed with statistical estimations. 8 Standard deviation of overnight interest in the interbank market was 0.0752 in 2016 Q4, from 0.0598 in the third quarter. 7 21 Bank of Albania
22. Quarterly Monetary Policy Report , 2017/I Chart 7 Interbank rates (left) and their deviation from the policy rate (right) 7.50 0.80 6.00 0.40 0 4.50 -0.40 3.00 -0.80 1.50 -1.20 - 12/16 1-day policy rate (repo) 10/15 09/14 07/13 05/12 03/11 01/10 12/16 10/15 7-d rate 09/14 07/13 05/12 03/11 01/10 1-day -1.60 7-day Source: Bank of Albania. Chart 8 BoA open market operations (left) and trading volume in the interbank market (right), in ALL billion 20.0 10.0 18.0 16.0 14.0 (10.0) 12.0 10.0 8.0 (30.0) 6.0 4.0 2.0 (50.0) Q4 16 Q1 16 Q2 15 Q3 14 Q4 13 Q1 13 Q2 12 T3 11 Q4 10 excess reserves Repo 1-; 3-m Q1 10 12/16 06/16 01/16 07/15 01/15 07/14 02/14 08/13 O/N deposit Repo 7-d 0.0 Daily volume Weekly volume Source: Bank of Albania. Domestic foreign exchange market Domestic currency continued to appreciate against main trading partners' currencies in Q4, but at a slower pace than in Q3. The nominal effective exchange rate (NEER)9 appreciated about 3.2% in Q4, year on year. While the real effective exchange rate (REER)10 appreciated by 4.1% in the same period. Lek appreciation, against the Turkish lira and the Chinese renminbi, played an important role in this dynamic, by reflecting the depreciation of both The nominal effective exchange rate (NEER) is calculated against the currencies of the five major trading partners (Italy, Greece, Germany, Turkey and China), using the relevant market weights. For the purpose of calculating the lira/lek and the renmibi/lek rates, the official reference rates remain those of the Turkish lira and the Chinese renmibi against the US dollar. 10 The real effective exchange rate (REER) is calculated similarly to the nominal, but it considers the domestic inflation and those in the trading partners, as well. 9 Bank of Albania 22
23. Quarterly Monetary Policy Report , 2017/I currencies against the US dollar. The annual appreciations in the composed indices, corrected for this effect, NEER and REER, by trading weights would have been 1.1% and 2%, respectively. Chart 9 The exchange rate trend 0.06 Annual changes of NEER and REER Exchange rates in the domestic market % change vs: NEER 140.0 144.0 0.04 ALL/TRY 0.02 142.0 140.0 0 ALL/CNY 138.0 -0.02 ALL/EUR 136.0 -0.04 ALL/USD 110.0 100.0 90.0 12/16 05/15 10/13 03/12 08/10 2016Q3 vs 2016Q2 2016Q4 vs 2015Q4 2016Q4 vs 2016Q3 120.0 134.0 132.0 4.0 2.0 0 -2.0 -4.0 -6.0 -8.0 -10.0 -12.0 -14.0 12/16 12/15 REER NEER 12/14 12/13 12/12 12/11 12/10 -0.06 130.0 ALL/EUR (lhs) ALL/USD (rhs) Source: Bank of Albania. The performance of lek bilateral exchange rate by main currencies has showed almost the same picture. Thus, the trend of the lek’s exchange rate against the euro has appreciated continuously, peaking at 134.4 in the last days of December. This level was the lowest in the last five years. This performance was affected by a high euro supply from trading flows11, remittances inflow for the year- end celebrations and large projects of foreign investments. The low exchange rate drove to higher euro demand, which was accommodated by a high supply. In quarterly average terms, lek’s appreciation by 0.4% against the euro appears considerably less reduced than the seasonality of summer months (1% appreciation in Q3). The lek/usd exchange rate showed an opposite performance in Q4. In this period, one US dollar averaged ALL 126, compared to the lek/usd average of 122 in Q3. Lek’s depreciation of 2.8% against the US dollar in Q4 reflected the US dollar appreciation against the euro in the international markets. The increase of the key rate by Fed, accompanied by the expectations for a strengthening of this trend in the future, against the further easing of ECB’s monetary policy and the expectations on a continuation of this trend, was reflected in the appreciation of the US dollar against the euro in interbank markets12. Trading data of December show a rather high annual increase in the export of goods (22.5%), mainly driven by the increase of the export of minerals and metals. Imports increased by about 4.4%. Thus, trade deficit narrowed by 4.7%. 12 In December euro/usd rate in international market averaged 1.05, or 5.6% euro depreciation against the average in Q3. 11 23 Bank of Albania
24. Quarterly Monetary Policy Report , 2017/I Primary market T-bill and bond yields continued to increase in Q4, by confirming the upward trend observed in Q3. Yields increased in general, which is reflected in the rise of the level and the gradient of the yield curve. Yields growth reflected the correction of yields rapid fall in the first half of year, the increased demand for financing from the government and the contraction of banking system supply in auctions. Chart 10 Primary market yields* Yields 8.0 12% 6.0 10% 4.0 8% 2.0 6% 0.0 4% -2.0 2% Yields in the primary market 0% 10yrs Change from Sept. 2016 Dec.16 12 M 7 yrs 2 yrs 10 yrs 12/16 7yrs 10/15 5yrs 08/14 2yrs 06/13 12m 04/12 6m 02/11 3m 01/10 -4.0 5 yrs Source: Bank of Albania. *The chart includes the auctions conducted until 12 October 2016. The average yield of 12-months T-bills increased at 3.02% in December, from 1.60% at the end of September. It stood at 3.22% in the last auction of the month. Similar trends were shown in the bond yields as well, which registered growth in every auction. Banks' supply in auctions frequently was below the issues, by strengthening the pressures for an increase on required yields. The yield on the 2-year bond increased at 3.60% in December, from 2.00% in September. In the 5- and 7-year bond auctions, the yields stood at 5.25% and 5.98%, up by 1.0 percentage point, respectively. At the end of November, the Ministry of Finance organised an auction on the issue of 2-year bonds in euro. The demand of banks to invest was high, thus, the average interest of 0.75% was considerably lower than the 3.23% rate in the last years’ auction. 3.2.DEPOSIT AND CREDIT INTEREST RATES AND FINANCING STANDARDS13 Interest rates for new deposits in lek in October and November resulted almost at the same level with the third quarter. The average interest rate resulted at 0.82%, from 0.81% in Q3. Interest rates on 3- and 24-month deposits The latest official data about interest rates in new deposits and loans are from August 2016. 13 Bank of Albania 24
25. Quarterly Monetary Policy Report , 2017/I decreased in November, while interest rates on 1-and 6-month deposits increased. The 12- month deposits’ interest rates, which have the main share in time deposits, did not change in these months, standing at 0.69%. Interest rates for new deposits in euro reflected a similar performance to new deposits in lek. The average interest rate of the two last months (October and November) is close to the one in Q3. After increasing at 0.19% in August, they averaged 0.16%, in the following three months. Similar to deposits in lek, the interest rate on 12-month deposits in euro was low in these months. Chart 11 New deposits interest rates deposit in lek, % 10.00 8.00 4.000 6.00 3.000 4.00 2.000 2.00 1.000 11/16 11/15 11/14 11/13 12/12 12/11 12/10 dep 12m 12/09 12/08 - 01/08 11/16 11/15 11/14 11/13 dep 3m dep total 12/12 12/11 12/10 12/09 12/08 01/08 0.00 deposit in euro,% 5.000 Lek-euro deposits interest rate spread Euro deposits rate Source: Bank of Albania. Interest rates for new credit in lek showed a slight increasing trend in October and November, being affected by their growth in the short-term segment. On the other hand, the interest rate on credit of longer than one year maturity continued to decrease in these two months. The general interest rate in October Chart 12 New credit interest rates, 6-months moving average 16.00 Lek lending rates 10.00 Euro lending rates, % 8.00 12.00 6.00 8.00 4.00 4.00 11/16 10/15 09/14 07/13 06/12 05/11 03/10 02/09 0.00 01/08 11/16 1-5 years 11/15 11/14 11/13 <1year > 5-years 12/12 12/11 12/10 12/09 12/08 01/08 0.00 2.00 lek-euro interest rate spread Euro lending rate Source: Bank of Albania. 25 Bank of Albania
26. Quarterly Monetary Policy Report , 2017/I and November averaged 8.21% and 7.64%14, respectively. In the enterprises segment, interest rates decreased on loans for investments, and increased on loans for liquidity. In the households segments, interest rates slightly decreased on loans for consumption financing, while they did not change on mortgage loans. The average interest rate for credit to households resulted slightly lower than in Q3 and, 1.89 percentage points lower than in the previous year In average terms, the interest rate on new credit in euro results at the same levels as the previous quarter. It decreased on loans for investments and increased at the same level on loans for liquidity. Thus, the average interest rate on credit to enterprises remained unchanged. Interest rates in euro to households slightly increased for mortgage loans, while they did not change for consumer loans. The spread of the average rate of credit in lek against that in euro decreased slightly compared with the third quarter. Bank Lending Survey 2016 Q4 shows that banks continued to implement conservative credit policies to enterprises through non-price elements of credit. By enterprise size, banks stated that they have further tightened the credit standards to large enterprises, while they maintained unchanged the credit standards to small and medium-sized enterprises. The tightening of credit standards was expressed in the increase of collateral requirements, while the conditions for other non-price elements remained almost unchanged. Banks stated to have continued to ease credit standards to households, in particular on consumer credit. The main instruments used for easing the standards to households, in the fourth quarter, were the extension of credit maturity, the decrease in debt-to-income ratio and the decrease of commissions. Chart 13 Credit standards (for enterprises left, for households right) 20 8 15 6 10 4 5 2 0 0 -5 -2 -10 -4 -15 -6 instalment/income ratio Q4 '15 Q3 '16 loan maturity collateral requirements Q3 '15 Q2 '16 loan size Q1 '16 Q4 '16 -8 commissions loan maturity Q4 '15 Q3 '16 collateral requirements Q3 '15 Q2 '16 loan size commissions margin for high-risk loans -25 margin for high-risk loans -20 Q1 '16 Q4 '16 Source: Bank lending survey, 2016 Q4. The average in Q3 stood at 7.52% 14 Bank of Albania 26
27. Quarterly Monetary Policy Report , 2017/I 3.3.CREDIT TO THE PRIVATE SECTOR15 Lending increased at a moderate pace in 2016 Q4. In October and November, credit to the private sector increased on average by 3.2%, year on year. This rate is similar to the previous quarter. Nevertheless, net monthly flows are higher than in Q3, in line with the seasonal behaviour of these two months. In this period, credit stock to the private sector was up by about ALL 5.3 billion, mostly affected by the expansion in November. As a ratio to GDP, credit to private sector was about 37.4%. This level is slightly higher than the end of the previous year. Economic activity recovery and the improved confidence of economic agents is reflected in the increase of credit demand, but still it is not reflected on the credit recovery due to the still tightened supply. Chart 14 Credit to private sector 18% Annual change (%) Credit demand and supply according to BLS (Index Q42009) 100 50 13% 0 8% -50 -100 3% -150 -2% -200 -250 Q4 '16 Q4 '15 Q4 '14 Q4 '13 Q4 '12 Q4 '11 Q4 '10 2016M11 2016M07 2016M03 2015M11 2015M07 2015M03 2014M11 2014M07 2014M03 2013M11 2013M07 2013M03 2012M11 2012M07 Lek credit Credit to private sector Fc credit Q4 '09 -7% Credit standards-enterprises Credit standards-households Credit demand-enterprises Credit demand-households * The chart to the right represents the net balance, based on the BLS 2016 Q4. Source: Bank of Albania. The positive performance of credit portfolio is driven by crediting in the domestic currency. The annual growth rate of this portfolio accelerated at 10.4%, from 7.5% in Q3. This growth offset the annual shrinkage of portfolio in foreign currency (-1.4%). At the end of November, credit in lek accounts for 43.2% of credit portfolio, up by 2.5 percentage points over the year. These developments are driven by the fall in the financing cost of borrowing in lek for more than two years, and the awareness of economic agents on the exchange rate risk. By economic agents, the high pace of credit growth to households drove to the expansion of credit. In October and November, credit to households increased on average by 5.1%, compared to the average of 3.7% in the previous quarter. The improvement of conditions in labour market, the strengthening of Credit analysis is based on monetary data adjusted for written-off loans from the balance sheets. The total of written off loans from balance sheet in the first 11 months of the year is about ALL 9 billion. 15 27 Bank of Albania
28. Quarterly Monetary Policy Report , 2017/I confidence and the increase of disposable income favoured the increase of credit demand. Furthermore, the continuous easing of credit standards from banks to this segment has supported the positive developments in crediting. Credit portfolio to households reflected the good performance of consumer credit, which grew annually by 11.4%. Meanwhile, house purchase credit performance was sluggish. Its annual growth rate fell at 3.3% compared to 3.6% in the third quarter. The structure of this portfolio has shifted to crediting in lek over the year. Chart 15 Credit to households 2 15% Annual change Monthly average net flows 1 miliardë 10% 5% 0% 1 0 -1 -5% 2016Q4 2015Q4 2014Q4 2013Q4 2012Q4 2011Q4 2010Q4 2016M11 2016M07 2016M03 2015M11 2015M07 2015M03 2014M11 2014M07 2014M03 2013M11 2013M07 2013M03 2012M11 2012M07 Mortgage credit Consumer credit Credit to households -1 Consumer credit Housing purchase credit Source: Bank of Albania. Credit to enterprises continues to be fragile being affected by both tight/ conservative supply and slow recovery of credit demand. The 2.6% annual growth rate of this portfolio in November is below that of the two previous quarters. Nevertheless, compared to the developments in Q3, in October and November, the monthly dynamic of credit to enterprises has improved, driven by the credit for investments. In November, the annual growth pace of this portfolio improved at 2.5%. Credit for liquidity slowed the annual growth pace at 2.8%, from 3.5% in the previous quarter. The slow recovery of credit to enterprises was driven by tight crediting standards, in particular to large enterprises, which ash the highest share in this portfolio and by the slow recovery of the demand for financing from qualitative customers. The high level of non-performing loans remains one of the main concerns of banks and conditions a tight supply for credit to enterprises. Bank of Albania 28
29. Quarterly Monetary Policy Report , 2017/I Chart 16 Credit to enterprises 15% Annual change 6 10% 4 miliardë 5% 0% -5% 2 (2) 2016Q4 2016Q2 2015Q4 2015Q2 2014Q4 2014Q2 2013Q4 2013Q2 2012Q4 2012Q2 2011Q4 Liquidity credit Credit to enterprises Investment credit 2011Q2 (4) 2010Q5 2016M11 2016M07 2016M03 2015M11 2015M07 2015M03 2014M11 2014M07 2014M03 2013M11 2013M07 2013M03 2012M11 2012M07 -10% Monthly average net flows 8 Liquidity credit Investment credit Source: Bank of Albania. 3.4.PUBLIC SECTOR FINANCING The consolidating fiscal policy implemented during the first 11 months of 2016 is reflected in a fiscal surplus of ALL 7.1 billion. Despite the positive values for the budget balance, borrowing in the domestic market and foreign markets continued during the first 11 months of 2016. These developments have materialized in a high value of government liquidity. Chart 17 Budget deficit and its financing instruments, in ALL billion (cumulative) 100 80 60 40 20 0 -20 -40 -60 2016M11 2016M09 2016M06 2016M03 2015M12 2015M09 2015M06 2015M03 2014M12 2014M09 2014M06 2014M03 2013M12 2013M09 2013M06 2013M03 2012M12 2012M09 2012M06 2012M03 2011M12 2011M09 2011M06 2011M03 2010M12 2010M09 2010M06 2010M03 Similar to the first nine months of 2016, the government’s policy during October and November was oriented toward long-term instruments (5, 7, and 10-year bonds). Domestic borrowing resulted in ALL 5.6 billion. It consisted entirely in long-term instruments, (offsetting the reduction by ALL 14.3 billion of the T-bills’ portfolio) serving thereby to extend the maturity of domestic debt. Net foreign borrowing at the end of November 2016 amounted to around ALL 14.7 billion. Domestic borrowing Foreign borrowing Privatization receipts 3.5.DEPOSITS AND MONETARY SUPPLY IN THE ECONOMY The monetary supply performed better in October-November 2016. The broad money indicator, the aggregate M3, grew by around 2.8% in annual terms, against the 2% in the third quarter of the year. The banking system’s net foreign assets remain the main contributor to the growth of broad money, although 29 Bank of Albania Budget deficit Other Eurobond Source: Ministry of Finanace.
30. Quarterly Monetary Policy Report , 2017/I lesser than in the previous quarter. The monetary supply expanded also due to the improvement of the contribution of the public sector borrowing to creating money. The monetary aggregate in lek, M2, decelerated gradually the downward pace, influenced mainly by the consolidating fiscal policy pursued during 2016. In November, the M2 aggregate increased by 0.1% in annual terms. The liquid money indicator, the M1 aggregate, recorded upward annual rates, averaging 11.3% in October-November, reflecting the rapid growth of deposits. The ratio of currency outside banks to the M2 aggregate, adjusted for resettlement in other instruments outside M2, stood at 26.5% unchanged from the end of the third quarter. Chart18 Monetary indicators 15% Annual contributions 25% 10% 5% 0% Annual changes (%) 35% 20% 30% 15% 25% 10% 20% 5% 15% -5% 0% 10% -10% -5% 5% 2016M11 2016M5 2015M11 2015M5 2014M11 2014M5 2013M11 2013M5 2012M11 2016M11 2016M5 2015M11 2015M5 2014M11 2014M5 2013M11 2013M5 2012M11 Net claims to Government Credit to economy Net monetary assets Other net in M3 growth COB/M2 (rhs) M1 M2 Source: Bank of Albania. The growth rate of deposits in the banking system continued to improve gradually.16 At the end of November, the total deposit stock was about 4.5% higher than the year before, against the annual rate of 3.8% at the end of the third quarter. The ratio of total deposits to GDP is estimated to be around 72.7% in November. Deposits expanded mainly in the form of foreign currency deposits, which increased by 7.7%, year on year, in October-November. Deposits in lek are expanding at more moderate rates, growing 1.1% on average, over the same period. The deposits’ performance according to economic agents confirms the steady growth of households’ deposits (2.6%), and rapid expansion of business deposits (14.7%), mainly in foreign currency. The structure of deposits continued to shift toward demand deposits, which in November amounted to around 38.7% of the total stock. Such shifts were also noticed in deposits of over 2 year maturity, but at a lesser extent. Total deposits include deposits with maturity of over two years that are not part of the calculation of M3aggregate. 16 Bank of Albania 30
31. Quarterly Monetary Policy Report , 2017/I Chart19 Deposits against GDP and by currency Annual change of deposit by currency (%) 2016M11 2016M5 2015M11 Deposits, ALL Deposits,total Deposits total/GDP 2015M5 2014M11 2014M5 2013M11 2013M5 2012M11 2016Q3 2015Q4 2015Q1 2014Q2 2013Q3 -5% 2012Q4 40% 2012Q1 0% 2011Q2 50% 2010Q3 5% 2009Q4 60% 2009Q1 10% 2008Q2 70% 2007Q3 15% 2006Q4 80% Deposits,FX Source: Bank of Albania. In monthly absolute terms, deposits expanded by about ALL 9.4 billion overall in October-November, of which about ALL 7.5 billion resulted in foreign currency deposits. Chart 20 Deposits by maturity Annual change in deposits Deposits by maturity (in All billion) 40% 1.200 30% 1.000 800 20% 600 10% 400 0% 2016M11 2016M10 2016M9 2016M8 2016M7 total > 6 months < 2 years 2016M6 2016M5 2016M4 2016M3 2016M2 2016M1 0 2015M12 2016M11 2016M5 Demand deposits Time deposits 2015M11 2015M5 2014M11 2014M5 2013M11 2013M5 2012M11 2012M5 2011M11 -10% 200 1 year 2 years Demand Source: Bank of Albania. 31 Bank of Albania
32. Quarterly Monetary Policy Report , 2017/I 4. INFLATION AND ECONOMIC GROWTH Annual inflation averaged 1.9% in 2016 Q4, similar to the previous quarter. These developments have reflected the strengthening of domestic inflationary pressures, due to the improvement of aggregate demand and the cyclical position of the economy, as well as the weakening of foreign disinflationary pressures. Economic growth in the third quarter resulted around 3.1%, driven mainly by the growth of investments and net exports. Positive contributions were also generated by population and public consumption. Available data suggest that economic growth will accelerate slightly in the fourth quarter, driven by domestic demand and net exports. The acceleration of economic growth in the medium term will help the economy return to equilibrium, accompanied by a gradual growth of domestic inflationary pressures. Foreign inflationary pressures are expected to remain weak, but more substantial than before. Economic agents expect inflation to trend upward, and gradually approach the target. These factors will contribute to the return of inflation to target within the medium-term horizon. 4.1.INFLATION Inflation averaged 1.85% in 2016 Q4, largely unchanged from the previous quarter. The inflation rate decreased in October, but it rose again in the next two months of the quarter, resulting at 2.2%, in December, the highest rate for 2016. The upward trend of inflation in 2016 H2 resulted in line with the forecasts and similar to the inflation profile in the region and beyond. Chart 21 Annual inlation and target (left). Inflation in regional and EU countries (right) 2.5 0.05 0.045 2 0.04 0.035 1.5 0.03 1 0.025 0.5 0.02 0.015 0 0.01 -0.5 0.005 2016M11 2016M9 2016M7 2016M5 2016M3 2016M1 2015M11 2015M9 2015M7 2015M5 2015M3 -1 2015M1 Annual inflation Av. inflation on annual basis Target 2016M10 2016M02 2015M06 2014M10 2014M02 2013M06 2012M10 2012M02 2011M06 2010M10 2010M02 0 Albania Region EU Source: INSTAT and Bank of Albania calculations. Bank of Albania 32
33. Quarterly Monetary Policy Report , 2017/I Annual inflation in Q4 was formed mainly by the contribution in the ‘Food’ and ‘Non-food consumer goods’ categories, while the contribution of other categories was very low. In particular, the inflation of ‘Processed food’ and ‘Non-food consumer goods’ has been upward. In 2016 Q4, no negative contribution was noted from any of the categories in the headline inflation. This behaviour has consolidated its upward trend. The ‘Food’ group contributed by around 80% to the formation of the headline inflation. The ‘Non-processed food’ category was characterized, as always, by high rates of monthly inflation during the holiday season. However, the seasonal effect of December had a higher intensity compared with its average through the years. This category contributed on average by 0.9 percentage point to headline inflation. The category of “Processed food” contributed by 0.6 percentage point to headline inflation. During this year, the inflation of these products has been up continuously, in monthly terms, but this effect showed higher intensity in the last two months of the year. This category contributed to headline inflation around 1 percentage point higher during NovemberDecember compared with the first quarter of the year. The most prominent increases have been noted in "Bread and grains", which also has the highest share within this category. Chart 22 Contribution by food and non-food categories to headline inflation 5% 4% 3% i 2% 1% 0% 16_M10 16_M05 15_M12 15_M07 15_M02 14_M09 14_M04 13_M11 13_M06 13_M01 12_M08 12_M03 11_M10 11_M05 10_M12 10_M07 10_M02 -1% The category ‘Non-food consumer goods’ contributed Contribution of food inflation by 0.3 percentage point to headline inflation. This Contribution of non-food inflation contribution was 0.4 percentage point higher than Total Source: INSTAT and Bank of Albania calculations. in the previous quarter. After a long period with negative contribution (December 2014 – August 2016), this category has recorded a positive value since September. This development is due mostly to the low comparative base of the last year against a growth of oil prices in the domestic market. Meanwhile, the prices of some specific goods within this category have fluctuated as well17. Within this category, the index of prices of “firewood” has seen significant volatility, which in November suffered an unusual increase followed by a decrease in December. 17 33 Bank of Albania
34. Quarterly Monetary Policy Report , 2017/I Table 3 Contribution of key categories to annual inflation (in p.p.)* Q4:14 Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Processed food (pp) 0.2 0.3 0.2 0.1 0.0 -0.4 0.1 0.4 0.6 Bread and grain (pp) -0.1 0.0 0.0 0.0 -0.1 -0.2 -0.1 0.0 0.1 Alcohol and tobacco (pp) 0.3 0.3 0.3 0.3 0.2 0.1 0.1 0.1 0.1 Unprocessed food (pp) 0.8 1.7 1.8 1.8 2.6 1.5 0.9 1.2 0.9 Fruits (pp) 0.4 0.5 0.8 0.8 0.9 0.7 0.6 0.4 0.2 Vegetables (pp) 0.2 1.1 0.9 0.9 1.7 0.8 0.3 0.8 0.6 Services (pp) 0.2 0.1 0.0 0.0 0.0 -0.1 0.0 0.2 0.0 Goods with regulated prices (pp) 0.1 0.1 0.1 0.1 0.0 0.1 0.1 0.1 0.0 Fuels and energy (pp) 0.0 0.0 0.0 0.0 -0.1 0.0 0.1 0.1 0.1 Housing (pp) 0.1 0.1 -0.1 0.0 -0.2 -0.2 0.0 0.0 0.0 Non-food consumer goods 0.0 -0.4 -0.2 -0.2 -0.3 -0.3 -0.3 -0.1 0.3 Durable consumer goods (pp) 0.0 0.0 0.0 0.0 0.0 0.1 0.1 0.1 0.1 Consumer Price Index (annual change %) 1.3 1.9 1.8 1.8 2.1 0.7 0.7 1.9 1.9 Source: INSTAT and Bank of Albania. *The table presents some of the main items. The recovery of economic growth during the first three quarters of 2016, supported by the transmission of the accommodative monetary policy, confirmed our assessment for an increase of inflationary pressures during Q4. The effects of the above factors are expected to extend their effect on inflation over the coming periods as well, thanks to the upward dynamics of consumption and private investments. On the supply side, these developments are expected to be reflected in: higher utilization of the spare capacities of labour and capital; more optimistic expectations of market agents for the economic activity; mitigations of economic uncertainties; and continuation of the upward trend in inflation towards the target. 4.2.GROSS DOMESTIC PRODUCT AND THE TREND OF AGGREGATE DEMAND According to INSTAT data, the Gross Domestic Product (GDP) registered 3.1% real annual growth in 2016 Q3. The growth rate resulted slightly lower than in the first and second quarters of 201618. In sectorial terms, the main positive contributions came from the services sector. The producing sector also gave a positive contribution, supported by construction and agriculture. In terms of aggregate demand, the highest contributions were made by the gross fixed capital formation and net exports. Meanwhile, population and public consumption also made positive contribution. According to INSTAT, the GDP grew by 3.1% and 0.9% in annual and quarterly terms, respectively, in 2016 Q3. The growth of the annual rate resulted slightly lower than in the previous quarter (3.4%). The services sector gave the main positive contribution to GDP growth. The construction sector and, slightly, the agriculture sector made positive contribution as well. On the This is also affected by the revision of the time series of the national accounts in the previous years. 18 Bank of Albania 34
35. Quarterly Monetary Policy Report , 2017/I other hand, industry has shown contraction in annual terms. Negative growth rates have characterized the extractive industry as well as manufacturing. Chart 23 Annual and quarterly GDP 7.0 3.1 3.5 0.9 0.0 -3.5 2016** Q3 2016** Q1 2015** Q3 2015** Q1 2014* Q3 2014* Q1 2013 Q3 2013 Q1 2012 Q3 2012 Q1 2011 Q3 2011 Q1 2010 Q3 -7.0 2010 Q1 The analysis of demand components shows a further positive contribution from domestic demand, mainly from the increase in investment, and less from increased consumption. Meanwhile, net exports have shown a high contribution in economic growth unlike in the previous quarters, driven primarily by the good performance of services export. Gross Domestic Product, in real terms % The available information for 2016 Q4 shows the Quarterly changes, s.a positive rates of economic growth continue, with a Annual changes stronger dynamic from previous quarters. Domestic Source: INSTAT and Bank of Albania. demand is expected to preserve the growth rates, with positive contribution from all components, mainly from capital formation. Also, the effect of the private and public consumption is expected to support real growth. The contribution of net exports is projected to be positive, similar to Q3. Services exports are expected to maintain the annual growth rates, and foreign trade statistics show an acceleration of exports of goods in Q4. 4.2.1. PRODUCTION BY SECTOR19 Economic performance in 2016 Q3 continued to rely largely on the positive developments in the services sector. The added value of the sector, albeit slowing down the growth dynamism, is calculated to have contributed by 2.0 percentage points to the annual growth of the GDP. At the same time, the improvement of the producing sector contributed only 0.7 percentage point to economic growth. This trend is attributed mostly to the expansion of construction and the positive pace of agriculture, forestry and fishing, whose contribution is calculated to be 0.8 and 0.2 percentage point to GDP growth, respectively. Meanwhile, the contraction of the added value of industry gave e negative contribution of 0.3 percentage point. The net taxes component continues to generate a positive contribution of around 0.4 percentage point, compared with 0.5 percentage point in the previous quarter20. The GDP and the gross added value trend by sectors are treated in terms of real annual changes. The analysis is based on the latest GDP data, according to the method of production for 2016 Q3 published by INSTAT on 12 January 2017. The differences between the growth rates of the sector in this publication and those analysed in the previous Quarterly Monetary Policy Report are a result of the revision of the series. 20 The net taxes component continues to be affected mainly by the item of taxes on products, whose contribution is calculated around 0.3 percentage point to economic growth. 19 35 Bank of Albania
36. Quarterly Monetary Policy Report , 2017/I Chart 24 Gross domestic product by production and confidence indicator 7 Contributions of economic activities in the annual growth rate of real GDP 30 Diference from longterm average 5 15 3 1 0 -1 -15 -3 2016 T3 2016 T1 2015 T3 indicator, indicator, indicator, indicator, 2015 T1 2014 T3 Confidence Confidence Confidence Confidence Industry Agriculture, forestry and fishing Services Taxes minus subsidies Construction 2014 T1 2013 T3 2013 T1 2012 T3 2012 T1 2011 T3 -30 2011 T1 2016** T3 2016** T1 2015** T3 2015** T1 2014* T3 2014* T1 2013 T3 2013 T1 2012 T3 2012 T1 2011 T3 2011 T1 -5 industry construction services trade Source: INSTAT and Bank of Albania. *Data are preliminary. ** A preliminary assessment The added value from the services sector recorded 4.1% annual growth in 2016 Q3, a slower pace compared with the increase registered in the first two quarters of the year (4.9% and 5.8%, respectively). However, the performance of the sector continues to be above the 3% average historical rate, supported mainly by the branch ’Trade, hotels, restaurants and transport’ by 2.3 percentage points. The activity of this branch continued the upward trend, with the added value expanding by 6.7% in annual terms. ‘Financial and insurance activities’ and ‘Other services’ showed stronger growth in terms of added value in the quarter under review, contributing by 0.9 and 0.6 percentage point, respectively, to the annual growth of the services sector. The added value of the activities related to ‘Real estate’ and ‘Public Chart 25 Contributions by branches and capacity utilization rate in services 9 Annual changes (%) and contributions (p.p.) 88 6 80 3 76 0 72 -3 68 2016 Q3 2016 Q1 2015 Q3 2015 Q1 2014 Q3 2014 Q1 2013 Q3 2013 Q1 2012 Q3 2012 Q1 Bank of Albania 2011 Q3 Trade, hotels, restaurants and transport Financial and insurance activities Professional and administrative services Other services Information and communication Real estate activities Public administration, education and health Services value added 64 2011 Q1 2016** Q3 2016** Q1 2015** Q3 2015** Q1 2014* Q3 2014* Q1 2013 Q3 2013 Q1 2012 Q3 2012 Q1 2011 Q3 2011 Q1 -6 %, capacity utilisation rate 84 Trade Services, excl. trade Source: INSTAT and Bank of Albania. 36
37. Quarterly Monetary Policy Report , 2017/I administration, education and healthcare’ registered low annual growth (1.5% and 1.2%, respectively), translated in 0.2 and 0.3 percentage point, respectively, contribution to the services trend. Meanwhile, the slight contraction of the added value of ‘Professional activities and administrative services’ and ‘Information and communication’ affected the trend of the added value of the sector contributing negatively by 0.2 percentage point. The significant increase in the confidence indicator and the capacity utilization rate in services, excluding trade, give positive signals on the developments in the service sector in 2016 Q4. Chart 26 Value added in construction and capacity utilisation rate 30 80 % % 20 75 10 70 0 65 -10 60 -20 -30 55 -40 50 2016 Q4 2016 Q1 2015 Q2 2014 Q3 2013 Q4 2013 Q1 2012 Q2 2011 Q3 2010 Q4 2010 Q1 2016** Q3 2016** Q1 2015** Q3 2015** Q1 2014* Q3 2014* Q1 2013 Q3 2013 Q1 2012 Q3 2012 Q1 2011 Q3 2011 Q1 2010 Q3 2010 Q1 Annual changes Quarterly changes, seasonally adjusted Capacity utilisation rate Source: INSTAT and Bank of Albania. The activity of the construction sector picked up in the 2016 Q3, after slowing down the growth rates in the previous four quarters. The added value of the sector increased by 8.3% in annual terms, standing higher than the 1.8% annual rate in the previous quarter21. The positive trend of the public contribution22 and the growth of FDI inflows are estimated to have supported the increased performance of the sector. Meanwhile, the proxy values of construction permits increased in annual terms, reflecting a growth in all the construction categories: engineering works, residential buildings construction and other buildings23. In line with the performance of the sector there is also the turnover volume and the index of production volume dynamics, which accelerated the pace of annual growth by 5.7% and 7.9% in 2016 Q3, respectively, from 2.9% and 1.0% registered in the previous quarter. 22 As suggested by the increase in budgeted capital expenditures during 2016 Q3. 23 The growth of the proxy value in construction permits in the engineering works category (which includes “Transport infrastructure”, “Water supply, electricity and telecommunication lines”, “Complex construction in industrial plants” and “Other works”) is attributed mainly to the works related with water supply, electricity and telecommunication lines. 21 37 Bank of Albania
38. Quarterly Monetary Policy Report , 2017/I The slight improvement of the confidence indicator in construction suggests a moderate growth of the constructing activity during 2016 Q4 compared with the previous period24. Chart 27 Contribution by branch to value added in industry and capacity utilisation rate 30 Annual changes (%) and contributions (p.p.) 80 % 20 76 10 72 0 68 -10 64 -20 2016 Q3 2016 Q1 2015 Q3 2015 Q1 2014 Q3 2014 Q1 2013 Q3 2013 Q1 2012 Q3 2012 Q1 2011 Q3 2011 Q1 2016** Q3 2016** Q1 2015** Q3 2015** Q1 2014* Q3 2014* Q1 2013 Q3 2013 Q1 2012 Q3 2012 Q1 2011 Q3 2011 Q1 Mining and quarring, electricity, water supply and waste management Processing industry Industry 60 Capacity utilisation rate Source: INSTAT and Bank of Albania. The industry sector was characterized by down side developments in 2016 Q3. The added value of industry resulted 2.4% lower than in 2015 Q3, after recording 3.3% annual growth in the previous quarter. Breakdown by branches shows that ‘Mining and quarrying, energy, water and waste management’ contributed downward by 2.4 percentage points to the performance of the sector, while the contribution of the processing industry had almost negligible results. More specifically, the added value of ‘Mining and quarrying, energy, water and waste management’ shrank by 4.7% in annual terms, reflecting mainly the continuation of the downward trend of the mining and quarrying industry25. Meanwhile, the added value of the ‘Refining industry’ deepened further the slowing down trend during the quarter under review, registering an annual decrease by 0.3%, after the low increase of 0.3% in the previous quarter26. Despite the decrease of the construction capacity utilization rate during Q4 compared with Q3, it continues to remain above the historical average and the level it had in the same period the previous year. 25 According to indirect data, the index of industrial production registered a high annual decrease by 39.3% in the mining and quarrying branch, continuing the strong shrinkages of the first two quarters of the year, by 39.4% and 35%, respectively. Also, foreign trade data for this industry oriented mainly by exports show that the performance of exports in foreign currency remain downward for the groups “Mineral fuels, mineral oils and products of their distillation" (-31.2% in Q3 from -51.5% in Q2) and "Salts, sulphur, oxides, lime and cement" (-6.3% in Q3 from -0.3% in Q2), while the group “Ores, slag and ash” signed an annual growth in the third quarter of 2016. Meanwhile, the industrial production volume index reflects the continuation of the positive developments in the branch “Electric power supply, gas, steam and air conditioning ", marking an annual growth of 22.1% in the referenced quarter. 26 Exports of products related to the textile, clothing, leather and footwear, with the highest share in the branch of the processing industry, slowed the pace of annual growth, suggesting a support of the processing industry to a lesser extent by these activities in the third quarter of 2016. 24 Bank of Albania 38
39. Quarterly Monetary Policy Report , 2017/I The confidence indicator and the capacity utilization rate in industry remain above the historical average, during 2016 Q4. Also, the growth in value of some groups of industrial products export signals improvements of the industry sector in the fourth quarter. 4.2.2. AGGREGATE DEMAND Aggregate demand continued to increase during the third quarter of 2016, supported by both domestic and foreign demand. Capital formation showed to be the main determinant in this regard. Alongside, population consumption and public consumption generated growing positive contributions. Net exports offered a high positive contribution supported by the performance of services related mainly with tourism activity. Data by indirect indicators suggest the aggregate demand continued to grow during the fourth quarter of 2016. Domestic demand increased by 4.0% during Q3, similarly to Q2. The main positive contribution came from the fixed capital formation, whose flow increased by 11.9% in real annual terms. Consumption made additional positive contribution. Within this category, population consumption increased by 1.6%, while public consumption increased by 2.8%. Quantitative and qualitative indirect indicators related to foreign trade, financial sector, surveys data and the fiscal sector suggest that domestic demand will continue to grow during 2016 Q4. Chart 28 Economic sentiment and structure of domestic demand Long-term average =100 Contribution to domestic demand growth, in p.p. 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 2016Q3 2016Q1 2015Q3 2015Q1 2014Q3 2014Q1 2013Q3 2013Q1 2012Q3 2012Q1 -8.0 2011Q3 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -14 -16 2011Q1 2016Q3 ESI (lhs) Domestic demand, yoy, (rhs)) 2016Q1 2015Q3 2015Q1 2014Q3 2014Q1 2013Q3 2013Q1 2012Q3 2012Q1 2011Q3 2011Q1 120 115 110 105 100 95 90 85 80 75 70 65 60 Private consumption Gross fixed capital formation Public consumtion Domestic demand, yoy * Indices built on a 4M moving average of of real values. Source: INSTAT and Bank of Albania Private consumption registered growth for the fifth quarter consecutively. It grew by 1.6% in 2016 Q3. This rate was lower than in Q2, due to a higher comparative base as well27. The growth of private consumption, in Q3, contributed by 1.3 percentage points to the growth of aggregate demand. Private consumption registered growth in all three component categories, consumer goods, services In 2015 Q3, population consumption increased by 3.1% after decreasing 3.3% in Q2. 27 39 Bank of Albania
40. Quarterly Monetary Policy Report , 2017/I and durable goods, based on indirect indicators28. The growth of disposable income provided positive contribution to consumption growth, mostly owing to employment growth, positive rates of the wages fund index, and the expansion of remittances during 2016 Q3. In real terms, disposable income growth was supported by the presence of low levels of inflation. Also, confidence29 and interest rates decrease has contributed positively to the propensity of consumers to spend. The easing of credit standards during the last two years has been another factor with a positive contribution to the growing trend of consumer loans. In November, its growth reached 11.4%, thus bolstering a positive consumer trend. Chart 29 Private consumption 10 Annual change 8 6 4 2 0 -2 2016Q3 2016Q1 2015Q3 2015Q1 2014Q3 2014Q1 2013Q3 2013Q1 2012Q3 2012Q1 2011Q3 2011Q1 2010Q3 2010Q1 -4 Private consumption Source: INSTAT and Bank of Albania.. Various consumer spending indicators support the assessment for a further growth of the private consumption in 2016 Q4. On balance, the qualitative indicators from the surveys present a more optimistic view than indirect quantitative indicators. Thus, confidence indicators in the services and trade sectors remain above the historical averages in Q4. Based on the lending survey, banks have eased lending standards and they report that consumers’ demand for loans has grown in Q4. The consumer confidence indicator also registered growth. Quantitative data that support consumer spending growth are the growth in nominal terms of food imports and the motor vehicles for passengers import; consumer credit, which was judged on data from October and November 2016, has continued to support households spending. Chart 30 Indirect indicators on private consumption, Q4 Annual changes, in % 10 M.A. change from l-t average 4 3 5 2 0 1 0 -5 -1 -10 -2 -3 -15 -4 2016Q3 2016Q1 2015Q3 2015Q1 2014Q3 2014Q1 2013Q3 2013Q1 2012Q3 2012Q1 2011Q3 Import of food items VAT revenues Consumer credit -20 2011Q1 2016Q3 2016Q1 2015Q3 2015Q1 2014Q3 2014Q1 2013Q3 2013Q1 2012Q3 2012Q1 2011Q3 2011Q1 2010Q3 2010Q1 35 30 25 20 15 10 5 0 -5 -10 -15 -20 -5 Confidence in services Confidence in trade Consumer confidence Source: INSTAT and Bank of Albania. Judging by the annual growth of the food retail trade index, the import of automobiles and the added value of the services sector. Quarterly national accounts do not publish results for disaggregated consumption by the composing categories. 29 The consumers’ confidence indicator, measured through the Confidence Survey, was in a downward trend during the year, after reaching its highest value in 2016 Q1. 28 Bank of Albania 40
41. Quarterly Monetary Policy Report , 2017/I Investments continued to grow in 2016 Q3, being the main determinants of the expansion of aggregate demand. The growth of investments (11.9%) in Q3 was 5.8 percentage points higher than in 2016 H1. This component formed 65% of domestic demand. The growth of investments in total reflected the growth in its two major components: investment in construction and in machinery and equipment30. The factors that contributed positively to investments during Q3 were: the gradual recovery of consumption demand for products and services, the improvement of businesses confidence, the easing of financial conditions, the increase of the number of construction permits, as well as foreign direct investments. Sources of investments financing were supported by the improvement of the financial condition of firms31, Chart 31 Gross fixed capital formation, the increase of loans for investment purposes, as well annual change as by the increase of the inflows of foreign direct annual changes, in % investments. 20 15 Indirect data signal that investments will continue to positively contribute to the growth of the aggregate demand in Q4. The capacity utilization rate in the main sectors of the economy has grown and remains above the historical average during 2016 H2. A leading indicator for the development of investments is the increase in the number of construction permits during the previous year, the growth of loans for investment purposes, and the improvement of the financial situation of the firms. 10 5 0 -5 -10 -15 -20 15 10 5 0 0 71 -10 70 -10 69.5 -15 69 -20 68.5 -25 70.5 -20 -30 -5 2016Q3 2016Q1 2015Q3 2015Q1 2014Q3 2014Q1 2013Q3 2013Q1 2012Q3 2012Q1 2011Q3 2011Q1 2016Q3 2016Q1 2015Q3 2015Q1 2014Q3 2014Q1 2013Q3 2013Q1 2012Q3 2012Q1 2011Q3 2011Q1 Imports of machinery and equipment, yoy (lhs) Capacity utilization rate, ma (rhs) Businesses financial situation, BCS, dif from av. Credit for investments, yoy Source: INSTAT and Bank of Albania. Investment categories are published by INSTAT only with annual frequency. The expansion of the added value in the construction sector and the growth of machinery and equipment imports during the third quarter testify for the growth of investments. 31 Measured through the business confidence survey. 30 41 2016Q3 71.5 2016Q1 72 10 2015Q3 72.5 20 2015Q1 20 73 2014Q3 25 73.5 2014Q1 30 74 4Q mov.avg. Source: INSTAT Chart 32 Short-term indicators of investment, Q4 40 2013Q3 2013Q1 2012Q3 2012Q1 2011Q3 2011Q1 Gross fixed capital formation Bank of Albania
42. Quarterly Monetary Policy Report , 2017/I BOX 1: PRICE PERFORMANCE IN THE HOUSING MARKET I In 2016 Q3, the increase in the house price index stopped, but in Q4 it increased again by 4%. During 2016, the price index grew by 4.6% in annual average terms. The rent index also grew by 3.3% in Q4. In average terms, during 2016, the rent index decreased by 4.4%. The price to rent ratio shifted slightly upward in 2016, reflecting the opposing trends of the house price and rent indexes. Chart 33 House Price and Rent Indices and their ratio 20 mov. av. of changes 3.0 15 2.5 10 2.0 5 0 1.5 -5 1.0 -10 Rent index Q4-16 Q4-15 Q4-14 Q4-13 Q4-12 Q4-11 Q4-10 Q4-09 Q4-08 Q4-07 Q4-06 Q4-05 Q4-04 Q4-03 Q4-02 Q4-01 Q3-16 Q4-15 Q1-15 Q2-14 Q3-13 House price Q4-12 Q1-12 Q2-11 Q3-10 0.0 Q4-09 0.5 -20 Q1-09 -15 HPI/Rent index ratio (4Q mov av.). Source: The Bank of Albania. I The analysis of house price and rent is based on data only on prices and rents in the city of Tirana. Public sector demand and fiscal policy32 According to data published for the first 11-months of 2016, fiscal policy has been consolidating, reflected in high budget surplus. Unlike the first half of the year, the fiscal adjustment was supported mainly by the increase in tax revenues during July-November 2016. On the other hand, during the second half of the year, budget expenditures favoured the process of fiscal consolidation at a lesser extent. In the first half of the year, expenditures fell by 6.8% yoy, while during July-November period they increased annually by 3.5%. The latest available fiscal data until 18 January 2017 from the Ministry of Finance for the 11-month period of 2016, published in the link below: http://www.financa.gov.al/al/ raportime/programimi-ekonomiko-fiskal/raporte-dhe-statistika-fiskale-mujore/statistika-fiskalemujore. 32 Bank of Albania 42
43. Quarterly Monetary Policy Report , 2017/I Chart 34 Fiscal policy orientation* 8 6 4 2 0 -2 -4 11M '16 3M '16 6M '15 9M '14 12M '13 3M '13 6M '12 9M '11 12M '10 Fiscal impulse -6 3M '10 Oct-Nov '16 Q3 '15 Q2 '14 Q1 '13 Q4 '11 Q3 '10 Q2 '09 Q1 '08 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 Moving sum of budget deficit/GDP in% *The chart shows the change of the primary deficit created within a year (4Q mov.sum) in terms of GDP, yoy. Changes in positive axis imply a fiscal impulse, and vice-versa. Source: Ministry of Finance, INSTAT and BoA's staff estimates. The budget surplus at the end of the 11-months period was estimated at around 0.5% of GDP. Positive values for the budget balance for most of the year was encountered only in 2007. However, the end of the year is expected to have a budget deficit, thus reflecting the high concentration of budget expenditures in this period. Budget expenditure during October and November amounted to about ALL 73.2 billion, or 4.2% higher, yoy. As in Q3, expenses for the local government continued to drive the increase of total expenditures, in October and November. On the other hand, capital expenditures slightly declined by 2%, yoy. Government final consumption is estimated to have contributed positively to the growth of aggregate demand in 2016 Q4. Chart 35 Budget expenditures Annual change of expenditures by contribution of main categories Annual change in %, main expenditure items 50 40 160 40 40 30 120 30 30 20 80 20 20 10 10 10 40 50 0 0 0 0 Oct_Nov'16 Q1 '16 Q2 '15 Current exp. Interests Q3 '14 Q4 '13 Q1 '13 Q2 '12 Q3 '11 Q4 '10 Capital (ra) Current (ra) Q1 '10 Oct_Nov'16 Q1 '16 Expenditures, annual change in % Other transfers (ra) Q2 '15 -80 Q3 '14 -20 Q4 '13 -20 Q1 '13 -20 Q2 '12 -40 Q3 '11 -10 Q4 '10 -10 Q1 '10 -10 Soc. sec. Capital exp. (ra) Source: Ministry of Finance. 43 Bank of Albania
44. Quarterly Monetary Policy Report , 2017/I In the first 11 months of 2016, budget expenditures were around ALL 361.2 billion, or 2% lower, yoy. Payment of arrears in 2015 continues to have a considerable impact on the annual changes of expenditures in 2016. Excluding their impact, budget expenditures for the first 11 months of 2016 are 2.8% higher, yoy; current expenditures contributed 91% to this increase. Budget revenues in October and November amounted to about ALL 69.8 billion, up 9.2% yoy. Revenues grew in these two months mainly due to the performance of social securities and revenues from the profit tax. On the other hand, revenues from the value added tax and personal income tax, contributed negatively to the growth of total revenues during the period. Chart 36 Budget revenues Total revenues annual change by main categories contribution 20 Main tax items annual change 20 15 15 10 10 5 5 0 0 -5 -5 50 40 30 20 10 0 -10 -20 oct-Nov'16 Q1 '16 Q2 '15 Q3 '14 Q4 '13 VAT Social sec. Q1 '13 Q2 '12 Q3 '11 -30 Q4 '10 Total revenues annual change, in% 60 Q1 '10 Oct-Nov'16 Q1 '16 Q2 '15 Q3 '14 Tax revenues Grants Non-tax revenues Q4 '13 Q1 '13 Q2 '12 -15 Q3 '11 -15 Q4 '10 -10 Q1 '10 -10 70 National taxes PIT Source: Ministry of Finance For the 11-months period, budget revenues were ALL 368.3 billion, with an annual increase of 7.3%. During 2016, revenues are supported by contributions from social security and profit tax. On the other hand, the contribution of revenues from the value added tax33 saw a gradual slowdown during the year. Legal arrangements undertaken for this budget year, the business formalization process, economic environment as well as the performance of imports remain the determinants for the trajectory of fiscal revenues during this year. Foreign demand and foreign trade Real trade deficit in goods and services narrowed in 2016 Q3. In real terms, the annual narrowing is estimated at 16.8%, mainly determined by the growth of services export, which increased by 25.4% in real annual terms. On the other hand, exports of goods continued to shrink, down by 1.7%, yoy. Imports Income from VAT, account for a high share of about 32% in total revenues. 33 Bank of Albania 44
45. Quarterly Monetary Policy Report , 2017/I expanded by 5.6%, mainly due to the growth in imports of goods, 7.0%. Also, imports of services increased by 3.1% in annual real terms. Chart 37 Contribution of net exports to aggregate demand (in p.p.) 8 Data on exports and imports of goods for 2016 include statistics for Q4. The trade deficit in goods shrank by 6.8%, yoy, mainly driven by export growth. 6 4 2 0 -2 120 150 100 80 100 60 40 50 20 0 0 -20 -50 -40 -100 -60 2016:Q3 2016:Q1 2015:Q3 2015:Q1 2014:Q3 2014:Q1 2013:Q3 2013:Q1 2012:Q3 2012:Q1 2011:Q3 2011:Q1 2016:Q3 2016:Q1 2015:Q3 2015:Q1 2014:Q3 2014:Q1 2013:Q3 2013:Q1 2012:Q3 2012:Q1 2011:Q3 2011:Q1 Oil exports (value) Oil price per barrel Metal exports (value) Metal price index Source: INSTAT, IMF, EIA. Import increased by 1.6%, yoy, yet it slowed down compared with the previous quarters. The main positive contributions were from ‘Textile and footwear’, ‘Chemicals and Plastics’ and ‘Construction materials and metals’. 45 Bank of Albania 2016Q3 % 2016Q2 140 2016Q1 % 2015Q4 200 2015Q3 Chart 38 Brent oil prices, export of domestic oil (left), metals price index and domestic metals export (right) 2015Q2 2015Q1 2014Q4 2014Q3 2014Q2 2014Q1 -4 Export of goods in value expanded by 15.5% -6 yoy. Increase in export of the category "Textile -8 and footwear" was the main contribution to this -10 performance". The category "Minerals, fuels and electricity" also contributed to the increase of exports. Exports Imports This phenomenon is associated with very high exports Real net exports contribution to aggregate demand of ore in November and December, mainly towards Source: INSTAT and Bank of Albania. China and Turkey. The encouragement of local manufacturers to export is linked to the significantly growth of the prices offered by partners (especially from China) during these two months. In December, in the same category there have been some positive signals (in terms of annual growth) in the sub-group "Fuel". The category "Construction and metal materials" also contributed positively as a result of the exports growth of this category in December toward neighbouring countries. Lastly, the positive contributions of the "Food, drinks and tobacco" continued during the fourth quarter. The determinants of this dynamic were the high exports of fruits (in October) and vegetables (in November and December).
46. Quarterly Monetary Policy Report , 2017/I Unlike previous quarters, imports of ’'Machinery, equipment, and spare parts’ decreased compared with a year earlier. On the other hand, imports of ‘Minerals, fuel, electricity’ continue the deceleration trend in terms of annual growth. Chart 39 Import and export orientation by item (in ALL million) Food, beverages and tobacco Exports Others Machinery and spare parts 120000 100000 80000 60000 40000 20000 Minerals, oil and electricity Others Chemical and Machinery and plastic products spare parts Leather and related product Construction materials and metals Textiles and footwear Food, beverages and tobacco Imports Wood and paper products 140000 120000 100000 80000 60000 40000 20000 Chemical and plastic products Leather and related products Construction materials and metals Textiles and footwear 2014 2015 2016 Minerals, oil and electricity Wood and paper products 2014 2015 2016 Source: INSTAT. By geographical orientation, there are new developments in export activity. The shares of China and Turkey increased in November and December, due to high exports of ore. Growth in exports of ’construction materials and metals’ led to increased shares for Kosovo and Macedonia. Also, increasing exports of agricultural productions continue to contribute to the increase of the shares of neighbouring countries. Regarding developments throughout 2016, the trade deficit widened by 6.8% compared with 2015. This performance is determined by the annual growth of imports at 6.3%. The categories ‘Machinery, equipment, spare parts’, ‘Textile and footwear’ and ‘Construction materials and metals’ were the main contributors to the increase of imports. Other categories contributed positively as well, except for ‘Minerals, fuels, electricity’ whose imports decreased in annual terms. On the other hand, in 2016, exports increased by only 0.1% compared to the previous year. ‘Textile and footwear’ gave a significant positive contribution with additional contributions from the category ‘Food, drinks and tobacco’ On the other hand, the two major categories: ‘Minerals, fuels, electricity’ and ‘Construction materials and metals’ show negative annual changes, despite several positive signals during the last two months of 2016. Bank of Albania 46
47. Quarterly Monetary Policy Report , 2017/I BOX 2: BALANCE OF PAYMENTS 2016 Q3 The net position of the current account recorded a deficit of EUR 207.6 million in 2016 Q3, narrowing by about 33.6%, y-o-y. It was estimated at 7.7% of nominal GDP, approximately 4.4 percentage points lower than in the same quarter of the previous year. According to the component items of the current account, improvements related to secondary revenues and services accounts, with additional contributions from the primary revenues, contributed to the narrowing side. On the other hand, account of trade in goods contributed to the expansion side. Exports of goods and services expanded by 18.1%, whilst imports increased by 6.1% in annual terms. The positive net balance of the secondary revenues expanded by 18.9%, yoy. Remittances account was the main contributor to this expansion. Remittance inflows trended upward in annual terms for the first time after a year, expanding by 13.5%. The primary income deficit narrowed, yoy, contributing to the decreasing side on the annual performance of the current account deficit. In structural terms, as measured by the national gap between savings and investments, the private sector played a key role in the deepening of the current deficit. The reserve assets of the balance of payments reduced by EUR 56.1 million. The stock of the foreign exchange reserve was around EUR 2.76 billion at the end of 2016 Q3. This level was sufficient to cover 6.8 months of imports of goods and services and 170% of short-term gross external debt. Table 4. Balance of Payments indicators (data in EUR million)   Current account (in EUR million) y-o-y (%) / GDP (%) Goods and services y-o-y (%) Exports, f.o.b. y-o-y (%) Imports, f.o.b. y-o-y (%) Net Travel Primary income Credit Debit Income from net- direct investments Secondary income Credit Debit Net remittances y-o-y (%) Capital account Net borrowing/net lending Financial account y-o-y (%) / GDP (%) Direct investments y-o-y (%) Portfolio investments Financial derivatives Other investments Reserve assets Errors and omissions Source: Bank of Albania. 47 Q1 '15 -230.9 -20.7 -10.2 -372.9 -7.2 593.5 2.9 966.4 -1.2 43.6 -38.8 36.4 75.2 -50.5 180.7 211.9 31.2 141.8 19.9 26.0 -205.0 -163.5 -32.7 -7.2 -253.9 20.3 -74.7 0.0 53.3 111.8 41.5 Q2 '15 -163.2 -48.6 -6.0 -360.6 -24.8 705.9 -1.0 1066.5 -10.5 76.4 -12.9 34.5 47.4 -26.4 210.2 243.3 33.0 161.7 17.6 21.3 -141.9 -177.1 -17.9 -6.5 -196.5 45.0 -66.8 0.0 70.0 16.2 -35.2 Bank of Albania Q3'15 -312.7 5.7 -12.1 -476.3 1.3 785.0 -2.3 1261.4 -1.0 64.5 -12.8 40.0 52.8 -27.7 176.4 219.1 42.6 139.7 -15.4 45.6 -267.1 -126.6 -30.9 -4.9 -248.1 2.4 -11.2 0.0 -179.7 312.5 140.5 Q4 '15 -397.7 4.0 -14.7 -564.5 4.4 714.7 -0.7 1279.1 1.5 51.6 -34.2 43.9 78.1 -31.7 201.0 247.2 46.2 153.9 -10.0 32.8 -364.8 -243.3 -16.8 -9.0 -120.0 -46.1 -172.1 0.0 -120.3 169.1 121.5 Q1 '16 -224.2 -2.9 -9.4 -403.3 8.2 608.5 2.5 1011.9 4.7 67.3 10.0 50.8 40.7 -3.8 169.1 205.0 35.9 135.7 -4.2 6.6 -217.7 -163.7 0.1 -6.8 -143.6 -43.4 107.5 0.0 -77.9 -49.6 54.0 Q2 '16 -353.8 116.7 -12.6 -555.2 54.0 716.8 1.5 1272.0 19.3 72.8 -15.1 44.9 60.1 -23.9 216.6 249.7 33.2 153.6 -5.0 7.2 -346.6 -253.6 43.2 -9.1 -240.1 22.2 -8.7 0.0 -4.8 0.0 93.0 Q3'16 -207.6 -33.6 -7.7 -410.9 -13.7 926.9 18.1 1337.8 6.1 153.1 -6.5 42.7 49.2 -21.7 209.8 250.3 40.5 159.1 13.9 3.1 -204.5 -71.9 -43.2 -2.7 -276.4 11.4 -2.1 0.0 262.7 -56.1 132.7
48. Quarterly Monetary Policy Report , 2017/I 4.3.CYCLICAL SITUATION OF THE ECONOMY AND DOMESTIC INFLATIONARY PRESSURES Updated analyses and evaluations on the economic performance in Albania, suggest for a continuation of the narrowing trend of the negative output gap throughout 2016. Economy shifting toward the potential has stimulated the upward trend of the core inflation. In the medium term, the gradual improvement of the economic growth and the more intensive use of production factors are expected to add the pressures for wages increase, other manufacturing costs and core inflation, and also contribute in returning the inflation to target. The short-term dynamics of the capacity utilization rate in the economy decreased during 2016 Q4, by 1.3 percentage points compared to the previous quarter. However, this indicator remains 74%, which is about 1.6 percentage points above the capacity utilization rate in the same period a year earlier, and 0.5 percentage points above its historical average. Developments in the capital and labour market remain in the same line with estimates for the improvement of the cyclic situation of the economy in the perspective of potential output and the output gap. Chart 40 Economy cycle indicators 5 4 Difference from long term average, moving average 4 3 3 2 2 1 1 0 0 -1 -1 -2 -2 -3 -3 -4 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 2016 Q3 2015 Q4 2015 Q1 2014 Q2 2013 Q3 2012 Q4 2012 Q1 2011 Q2 2010 Q3 2009 Q4 2009 Q1 -4 2010 2011 2012 2013 2014 2015 2016 Annual core inflation (in%) Capacity utilisation rate Output gap (in% vs potential) Unemployment rate *Output gap is the average of a number of measurements on which the moving average method is applied. The capacity utilization rate gap is calculated as the deviation of the actual value from the historical average, while the gap of presented unemployment rate is the difference of the average historical rate with actual value. Source: INSTAT and Bank of Albania. Developments in the labour market continued to be positive in 2016 Q3. Data from the labour force survey show the trend of employment indicators and Bank of Albania 48
49. Quarterly Monetary Policy Report , 2017/I unemployment in the economy continued to improve34. In Q3, employment rate was 8.5% higher than in the same period a year earlier, continuing the upward trend that had begun in 2015 Q435. In view of economic activities, employment growth was mainly supported from the services and industry sectors, where the number of employees annually increased respectively by 8.2% and 13.6%. Even in 2016 Q3, the downward trend of unemployment continued to be driven by positive dynamics of employment36. Unemployment rate was 14.7% in the quarter under review, about 0.7 percentage point lower than in the previous quarter and 2.5 percentage points below the unemployment rate in the same period a year ago. These developments place the indicator near the average unemployment rate during 2007-2015. As a result, the trend of the negative gap of unemployment37tends to narrow, thus signalling for an increase of inflationary pressures from wages. BOX 3I: POTENTIAL OUTPUT, THE NATURAL RATE OF UNEMPLOYMENT AND THE RESPECTIVE GAPS, CONCLUSIONS BASED ON THE ASSESSMENTS IN THE CASE OF ALBANIA This box summarizes the estimates of potential output, the natural rate of unemployment, and the respective gaps in the case of Albania. Previous assessments have concluded that the financial and debt crises in some countries of the EU (2008) shifted the potential output downward and contributed to the increase of natural rate of unemployment in Albania. These studies analyse the structural factors that explain the break in the trend of economic growthII /a,b,c . Highlighting the importance of these concepts for the monetary policy in the second half of the box will be presented assessments on the actual trend of these indicators, based on the methodologies used by the Bank of AlbaniaII/d, e. Analysis of employment and unemployment is based on the data of the quarterly survey of Labour Force, and it refers to the indicators for those 15 years old and older. According to these statistics, the number of employed continued to accelerate the annual decline to 9.8% in Q3 from 4.8% a quarter earlier. Meanwhile, their quarterly dynamics decelerated the downward rates to 2.6%, mainly as a result of unemployment growth for the age group 30-64 years, whilst youth unemployment continued to fall. According to administrative data, unemployment rates continue to rapidly decline (by 25% yoy and 8% qoq) At some extent, this reflects the impact of legislative amendments that entered into force, which among other things aim at precisely identifying that part of the population which is interested and willing to be employed. (Law no. 146/2015 "On job seekers", dated 17/12/2015 and procedures for its implementation, instruction of the Minister of Social Welfare and Youth no. 4, dated 15.02.2016, published in the Official Journal dated 22 February, 2016). 35 Employment grew by 3.6%, 5.2% and 6.8% in annual terms, respectively in 2015 Q4 and first two quarters of 2016. Meanwhile, from administrative sources, employment in total has slowed down the pace of annual growth in Q3, mainly as a result of the offsetting of the comparison effect with a low base a year ago (referring to the influence of the formalization process undertaken by the government in 2015 Q3 and was reflected in the strong expansion of employment rates in the non-agricultural private sector from this quarter to 2016 Q2). 36 This is a result of the review of employment performance, changes in the working age population and participation rate in the labour force. 37 Assessed as the margin of the balance unemployment rate with the factual unemployment rate. 34 49 Bank of Albania
50. Quarterly Monetary Policy Report , 2017/I Potential growth and natural rate of unemployment The literature considers the concept of potential output as the product which is generated utilizing optimally the production factors (labour, capital and total factor productivity). The optimal level of utilization of production factors ensures potential economic growthIII. The economy may face short-term fluctuations above or below the potential output. If these situations last, it means that the economy is operating above or below its potential. The first case is often referred to as a state of “overheat”, which produces high inflationary pressures On the contrary, when the economy “cools down” or faces cyclical weaknesses, situations that produce low inflationary pressures from the demand side. Both situations are undesirable for the economy. The natural rate of unemployment is a concept closely related to potential output. Theoretically, when unemployment remains around its natural rate, potential output would define the productive capacity of the economy. The natural rate of unemployment implies the utilization of the labour factor to the extent that it does not exert additional pressures on wage growth (in the case of NAWRU) or on inflation (in the case of NAIRU). Lower or higher rates of actual unemployment against the natural rate for relatively long periods of time represent adverse economic conditions that require adjustment through economic policies. In principle and in simple terms, both the potential output and the natural rate of unemployment indicate long-term trends of these two indicators. Short-term fluctuations above and below these levels do not pose substantial problems which may put into question the long-term equilibrium of the economy. On the other hand, these levels are not necessarily achieved at the same time as a result of the different dynamics in each market: goods and services market, and labour market, which often differ from one another. Overall, economic policies should aim to achieve and maintain such levels of production and unemployment, in order to ensure models of sustainable growth. The problem lies in assessing these levels, because it is clear that different models will provide different results even though they follow similar trends. In these case, it is important IV to evaluate the gaps of output and unemployment rateV. Finally, taking into account the methodological limitations in evaluating these non-observable indicators, the economic judgement helps in reaching a consensus for their values and the objectives of macro-economic policies. Natural rate of unemployment and output gap in Albania Global or regional economic and financial crises are an important element to be taken into consideration when assessing the above-mentioned indicators. If the effects of the crises persist, the potential growth levels might be reduced. Regarding the labour market, the trend shows an increase in the natural rate of unemployment. More specifically, the global economy, the EU, the economies of the region and Albania itself, are suffering the consequences of the 2008 crisis. The associated shocks have shifted the output and potential employment downwards and have reduced their growth rates, generating negative gaps, and thus producing weak inflationary pressures for relatively long periods of time. The latest re-assessments for output and potential growthIII/d, for NAIRU and NAWRU and for the respective gaps in the case of Albania, show that the cyclical weakness after 2009 has primarily affected the market of goods and services and later on, the labour market. Bank of Albania 50
51. Quarterly Monetary Policy Report , 2017/I Chart 41 Output and unemployment gap (methods average) 2016 Q3 2015 Q4 2015 Q1 2014 Q2 2013 Q3 2012 Q4 2012 Q1 2011 Q2 2010 Q3 2009 Q4 5 4 3 2 1 0 -1 -2 -3 -4 -5 2009 Q1 After 2009 the potential growth is estimated around 3.0% - 3.3% on average: half as high compared with the pre-crisis period. In parallel, the output gap moved to negative territory and followed a clear deepening trend until 2014. Faced with this development, the labour market reacted more slowly in the first post-crises years. This was due to a relative flexibility coupled with pressures from the presence of informality in this market. Unemployment rate gap initially fluctuated near zero and around small negative values until 2012 H1. This conclusion is supported by assessments according to different methodologies and on various available series of unemployment rate published by INSTATVI. 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 Output gap (%) Unemployment gap (p.p.,rhs.) Source: Authors’ estimates. Estimates average by different Small fluctuations in negative territory were replaced approaches for each indicator. Moving average applied with 4 by significant negative values during 2013-2015. terms, MA(4), to eliminate volatilities. (*) Volatility in Q3’12 – Q2’13, reflects methodological changes in measuring unemployDuring the first three quarters of 2016, unemployment ment rate. rates have marked a downward trend, suggesting for a tendency toward a closing gap of unemployment rate and the output gap simultaneously. This trend has been accompanied by improved economic sentiment, growth of capacity utilization rates and an upward trend of inflation, especially in core inflation during 2016 Q2. However, estimates suggest that the economy is still operating below optimal utilization levels both in terms of the output gap as well as the unemployment gap. References: I II II II II II III IV V VI 51 Authored by: Evelina Çeliku; Enian Çela; Iris Metani. (Monetary Policy Department, Bank of Albania). /a-Bank of Albania quarterly monetary policy report, Q1-2011 Box 2. “Potential output and output gap”. /b- Bank of Albania quarterly monetary policy report, Q1-2014, Box 2. “The trend of potential output and potential growth prospects” (by E. Çeliku); /c-E Çeliku, “Studying the key determinants of potential growth trend in Albania during 2003-2013” article, the Bank of Albania Bulletin of Economics, pp. 165-177; /d-Bank of Albania “Scientific Novelties January-June 2016” Presentation of the research project results: “Potential growth; growth and unemployment gap in the case of Albania - a comparative analysis of recent assessments “(E. Çeliku, E. Çela, I. Metani and E. Yzeiraj); /e-E. Çela and L. Skufi, “Natural Rate of Unemployment: Reduced Form Approach”, Conference Proceeding, 8th South-Eastern European Economic Research Workshop, 3 December 2014, Tirana, Albania. The optimal level is usually lower, from the total or maximum utilization of output factors. The difference between the actual and potential output in percentage against the potential output. Negative/positive gap indicates that the economy is operating below/above its potential. As the difference between NAIRU or NAWRU with the actual rate of unemployment. Negative/positive gap indicates that the labour market operates under/above the potential labour factor. Administrative rate and rates according to the Labour Force Survey (LFS). Bank of Albania
52. Quarterly Monetary Policy Report , 2017/I The unit labour costs indicator recorded38 an annual growth of 3.7% in 2016 Q3, slowing down compared to the previous period. This performance was influenced by the relative deceleration of the decline of labour productivity against that of the average wage in the activities covered by relevant statistics. Labour productivity remains on the down side, albeit more moderate, mainly driven by higher expansion of employment against the growth of the turnover in volume. On the other hand, other production costs, like the prices of industrial production, decelerated the rates of decrease resulting 0.8% lower than a year earlier. Meanwhile, production costs in construction39 increased slightly by 0.1% yoy, after falling by 0.2% in the previous quarter. Chart 42 Hammered annual average changes in productivity, labour costs and production* 2016 Q3 2016 Q1 Labour productivity Wages and salaries index Unit labour cost Production prices index (rhs) 2015 Q3 -5.0 2015 Q1 -20 2014 Q3 -2.5 2014 Q1 -10 2013 Q3 0.0 2013 Q1 0 2012 Q3 2.5 2012 Q1 10 2011 Q3 5.0 2011 Q1 20 Note:*Four-terms moving averages are applied to mitigate occasional fluctuations on annual changes of indicators. Source: INSTAT and Bank of Albania calculations. The determinant role of core inflation for maintaining the upward trend in headline inflation reinforced during this quarter, thus verifying the assessments for an increase of long-term and domestic pressures in the economy as a result of gradual mitigation of cyclical weaknesses. Annual core inflation was 1.05%, up during the quarter and contributing by 0.75 percentage point to the formation of the headline inflation of 2016 Q4. During 2016 Q2, core inflation shifted toward positive upward values, reaching 1.2% in December. This is the highest level of the last four years. Non-tradable inflation of CPI basket showed similar developments, for this quarter (1.2%) The upward trend of these inflation components reflected the gradual improvement of domestic demand and its impact on the narrowing of the output gap. Short-term components also contributed positively to the headline inflation during this quarter. However, their intensity did not create unforeseen fluctuations, like those in the beginning of the year. Non-core inflation resulted at around 3.9%, with an upward trend during the quarter. It contributed by around 1.1 percentage points to the formation of headline inflation. The trend was followed by the inflation of tradable items of the CPI basket, resulting at 2.2% this quarter and close to 3% in December. Proxy indicators of labour productivity and labour costs per unit, are measured by the Bank of Albania by using the total series of short-term statistics (SHTS, INSTAT, Q3 2016). Their calculation includes the index of the number of paid employees, of the turnover volume and wage fund for the total activities covered by the survey of SHTS. 39 It refers to the construction cost index, which includes prices of construction materials, labour force and other capital costs used for the construction of a typical residential buidlging of 8-10 floors. 38 Bank of Albania 52
53. Quarterly Monetary Policy Report , 2017/I Chart 43 Long-term (left) and short-term inflation trends (right) 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 16_Q3 16_Q1 15_Q3 15_Q1 14_Q3 14_Q1 13_Q3 13_Q1 12_Q3 12_Q1 11_Q3 11_Q1 10_Q3 Core Inflation Inflation of Net-Nontradables 10_Q1 16_Q3 16_Q1 15_Q3 15_Q1 14_Q3 14_Q1 13_Q3 13_Q1 12_Q3 12_Q1 11_Q3 11_Q1 10_Q3 10_Q1 -2.0 13.0 12.0 11.0 10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 Non-core inflation Inflation of Tradables Source: INSTAT and Bank of Albania's calculation. 4.4.IMPORTED INFLATION Imported inflation is estimated to have contributed by 0.8 percentage point to the headline inflation in Q4. The foreign disinflationary pressures noted during the previous quarters according to the imported inflationary pressures index (IIPI), did not fully materialize in Q4. Meanwhile, domestic inflation contributed by around 1.0 percentage point, a value similar to that of the previous quarter. IIPI has shown an upward trend in annual average terms during October and November 2016. This trend is different compared with the previous nine months of the year. The “imported price” index40 grew in average by 3.9% during the two months. The main influences in this regard are related to inflationary pressures from Turkey, able to compensate for the still low effects by European Union countries and neighbouring countries in the region. For the same period, appreciation of lek in effective nominal terms (3.1% average annual increase during October-November 2016) continued to significantly contribute in slowing down the transmission of foreign inflationary pressures The foreign indicator of inflationary pressures (IIPI) is designed to capture our partners’ internal price inflationary pressures and those of the effective nominal exchange rate. The foreign price index is based on the values: of the inflation of the “Food, drinks and tobacco" for 18 major states; the inflation of “Goods” (thus, not only Food) for Bulgaria, Germany, Greece, Italy and Turkey. Some of the goods marked an annual price growth, while the share of imports has grown as well in the respective states. Thus, the final value of the indicator (the weighted average of the aforementioned CPIs with their monthly import weight) has registered a significant growth. IIPI is calculated as the annual growth of the imported price index and the REER index of the relevant month. Imported inflationary pressures are estimated to influence inflation with 1-3 months lag. 40 53 Bank of Albania
54. Quarterly Monetary Policy Report , 2017/I into the Albanian economy41. As a consequence, IIPI grew by around 0.7% in average annual terms. Chart 44 Contribution of imported and domestic inflation to headline inflation (right). IIPI and its components’ contributions (left). 5.5 12 10 4.5 8 3.5 6 4 2.5 2 1.5 0 0.5 -2 -4 -0.5 2016M11 2016Q3 2016Q1 NEER (a.g., %) Foreign prices (a.g., %) IIPI (a.g., %) 2015Q3 2015Q1 2014Q3 2014Q1 2013Q3 2013Q1 2012Q3 2012Q1 2011Q3 -6 2011Q1 Imported Inflation Domestic Inflation Headline inflation 16_Q3 16_Q1 15_Q3 15_Q1 14_Q3 14_Q1 13_Q3 13_Q1 12_Q3 12_Q1 11_Q3 11_Q1 10_Q3 10_Q1 -1.5 Source: INSTAT and Bank of Albania's calculations. The above estimates are in line with the developments of the core inflation, showing that the upward trend in inflation is driven significantly by the more positive developments in domestic demand. 4.5.INFLATION EXPECTATIONS42 Short-term inflation expectations of the three main economic agents groups – businesses, consumers and financial agents – registered a growth of 0.1 percentage point in 2016 Q4. One year ahead businesses and consumers inflation expectations remain at the same level as in those 2015 Q4, respectively at 1.5%. Financial agents expect inflation to be 2.1% for the same time horizon. Extending the time horizon to two and three years, their expected inflation registers 2.4% and 2.5%. Overall, inflationary expectations show an upward trend. Short-term expectations, having a very adaptive nature remain below target, influenced by past and current values of inflation. Meanwhile, longer-term expectations represent a better anchoring towards the medium-term As mentioned before, the foreign inflationary pressures indicator includes the source prices of goods and the exchange rate. Elements of transport costs, travel and freight travel insurance are not included. This is one of the reasons of the discrepancies between the foreign pressures measured according to this index and the imported inflation that affects the inflation of Albania. However, the developments of these pressures must be monitored because, given the delays of delivery time, the contributions of imported inflation in the coming months can come to reduction. 42 The analysis on inflation expectations are based on the results of the business and consumer confidence survey, as well as in the financial agents’ expectations survey. 41 Bank of Albania 54
55. Quarterly Monetary Policy Report , 2017/I inflation target, reflecting a more rational expected behaviour of the markets. The accommodative monetary policy and the forward guidance on maintaining low interest rates has affected the better anchoring of the medium-term expectations for the inflations as well. It has created the main stimulus for the domestic demand growth, in conditions where fiscal policy was and remains committed to fiscal consolidation. The increase of domestic demand, stimulated by the increase of consumption and of private investments, is translated in steady economic growth rates. Also, it has enabled a better utilization of production capacities in the economy and created pressure for sustained inflation, reflected in the increased level of core inflation. Chart 45 Inflation expectations from different economic agents 3 2.5 2 1.5 1 0.5 0 2013 2014 2015 Businesses Q3 Businesses Q4 Financial agents Q3 Financial agents Q4 Our preliminary estimates indicate that positive trends in economic activity will continue during 2017 as well. Increased domestic demand will exert further pressure on inflation, bringing it close to target. Inflation is projected to grow at 2.3% for 2017 and to approach equilibrium level of 3.0% during 2018. In our assessment, the monetary conditions are adequate to support economic activity and rising inflation. Monetary policy will continue to be accommodative, but the intensity of the monetary stimulus will be adapted to the dynamics and the speed of the return of the economy to equilibrium. 55 Bank of Albania 2016 2017 2018 2019 Consumers Q3 Cosnumers Q4 Inflation Source: Bank of Albania
56. Quarterly Monetary Policy Report , 2017/I Bank of Albania 56