Albania: Upgrade from 5/7 to 4/7 for MLT political risk

Since 2016, Albania’s political risks have been on a steadily improving trajectory, which only paused during the Covid-19 shock. This continual progress reflects lower external debt ratios and greater economic resilience to external shocks, even though Albania’s economy was badly hit by a devastating earthquake and the pandemic in 2020. The MLT outlook is supported by a stronger tourism sector and improved long-term prospects of EU membership, acting as a catalyst for continuing the necessary structural reforms. In December, Credendo therefore decided to upgrade Albania’s MLT political risk from 5/7 to 4/7.

Gradual strengthening of macroeconomic fundamentals

After a sharp post-pandemic recovery, GDP growth reached 4.8% in 2022, was expected to be 3.6% last year, and is forecasted to be around 3.4% on average in the MLT (i.e. as in 2016–2019). Macroeconomic fundamentals have gradually strengthened. Public finances have room for improvement with a fiscal balance around 3% of GDP in the MLT, and public debt that may fall and remain around the 60% of GDP threshold as from this year, having jumped to 75.8% of GDP in 2020.

Public interest payments are acceptable and forecasted to rise above 10% of revenues as from this year. The economic situation has benefited greatly from the booming tourism industry, confirming that Albania has become and should be an attractive destination in the Mediterranean area in the future. After a historic year in 2022, during which tourism accounted for one third of total current account receipts, the year 2023 saw tourism record by far its best-ever season, far exceeding pre-Covid levels.

While this highlights confidence and the country’s improved image and stabilisation, it may also allow the current account deficit to remain contained at around 5% of GDP in the future. In addition, Albania can rely on the remittances of its large diaspora (which is bigger than the population in Albania) as a strong and stable source of current account receipts, particularly in crisis situations. Albania is the European country that receives the highest amount of remittances from EU countries. In 2022, remittances accounted for around 15% of Albania’s current account receipts. As a result of these strong sources of current account receipts, foreign exchange reserves are quite comfortable and increased decisively in 2023 (up by 14% year-to-date in October 2023). Hence Credendo’s short-term political risk rating is expected to remain unchanged at a good 3/7 in the near term. Foreign exchange reserves remained stable at 6 months of imports, though imports swelled with the impact of the war in Ukraine, making food and energy more expensive.

That being said, in the case of Albania, the impact of the war in Ukraine was largely felt through a weakening of the EU economy, and a 20-year high average inflation (6.7% in 2022). However, this is below the EU average and less pronounced than in some other Balkan countries. Indeed, Albania’s full reliance on hydropower energy allowed the negative energy impact of the war in Ukraine to be mitigated.

Improved external debt sustainability

Financial risk dominates Albania’s MLT political risk. However, this has gradually declined thanks to contained external borrowing and strong current account receipts and economic performance. As a result, external debt ratios fell continually between 2020 and 2023 and are forecasted to stabilise well below 60% of GDP in the MLT. Despite higher levels forecasted in the MLT, external debt service is still expected to be maintained at acceptable levels. The short-term debt ratio is in the same order of magnitude, having amounted to less than 12% of current account receipts and five times the foreign exchange reserves at the end of 2022. The impact of higher global interest rates should therefore be manageable.

EU economic recession and climate change are two major downside risks

Looking ahead, Albania’s economy is faced with several downside risks. First, the continuing impact of the war in Ukraine on inflationary pressures – although the inflation rate eased to around 4% in the second half of 2023, compared to 7.4% at the end of 2022 – and on the EU economy, upon which Albania largely relies. The poor EU outlook could harm trade and remittances from its diaspora. In this context, Albania’s business environment risk rating is unlikely to improve beyond a currently moderate D/G in the coming months. Secondly, several structural risks will make the future challenging: its ageing population, continued net emigration (see graph below) and climate change. Albania is indeed very exposed to accelerating climate change through coastal tourism, the specific vulnerability of Mediterranean countries, hydropower as largely the dominant energy source (which makes it vulnerable to droughts as we saw again in 2022, leading to rising electricity imports), and the importance of agriculture.

A revived EU enlargement process provides an impetus to government policies

The outlook may become brighter with EU enlargement. Indeed, in a context of heightened geopolitical tensions, the EU has recently given fresh impetus to enlargement regarding Western Balkan countries, setting a target date of 2030. Even though this goal will depend not only on progress achieved by candidate countries, but also on the EU Member States themselves and necessary EU reforms, enlargement looks set to have been put on a likelier trajectory. After accession talks between Albania and the EU opened in July 2022, the recent EU commitment should boost the reform process which has been moving forward at a slow pace until now. Political continuity under PM Rama – who has been serving for 10 years, and whose socialist party continues to benefit from a fragmented opposition – and the population’s support for EU membership are positive factors for undertaking the necessary reforms. However, in recent years, the government has faced frequent protests against vested interests, living standards and also lack of reforms, especially when it comes to corruption and the judiciary. In spite of some progress over the past decade, Albania’s weak institutional standards remain important risk factors, particularly regarding the rule of law and controlling corruption, which are low by European and even Balkan standards. Organised crime, notably involving drug trafficking and money laundering, is another persistent risk. Tackling corruption and organised crime are among the government’s priorities for its prospective EU accession, and any success in this area would improve Albania’s economic outlook, as these factors remain a brake to FDI and an incentive for youth emigration.

Analyst: Raphaël Cecchi – r.cecchi@credendo.com