The Bank of Albania has assessed that a possible decision to move to a fixed exchange rate regime would have dealt a severe blow to the country’s main macroeconomic parameters.
The Bank of Albania’s econometric assessments suggest that pursuing the intervention option to maintain a certain exchange rate level would have had negative consequences for the economy.
More specifically, in a hypothetical scenario where the exchange rate against the Euro would be held fixed during the period 2023-2025 (at the level of the first quarter of 2023, or 115.5 lek/euro), it is estimated that the inflation rate would increase to the range of 6 – 7% in the period 2024-2025, from the actual average level of 2.2% in this period.
These inflation levels would require an increase in the base rate to 7%, which would be a significant tightening of monetary policy and would impose a high cost on borrowers.
Tightening financial conditions would curb aggregate demand, reducing economic growth to 2.6%, from the current 3.9%.
The economic slowdown would increase the unemployment rate by 1.2 percentage points in 2005, bringing it to an average of 9.7%, and causing financial difficulties for businesses and individuals. The non-performing loan ratio of businesses would also increase by almost 3 percentage points, jumping from 4.6% to 7.5%.
However, the Bank of Albania notes that the change in the economic situation in the period 2024-2025 created space for its increased presence in the foreign exchange market.
More specifically, the fall in inflation below target in this period, as a result of supply shocks to commodity and oil prices, increased the potential risks that a rapid and further strengthening of the exchange rate could have on monetary stability.
In this context, a more active presence of the Bank of Albania in the market was considered necessary as a protective measure against the risk, with low probability but high cost, of the exchange rate deviating from its fundamentals, while also reducing the potential risk of inflationary expectations shifting away from the target.
However, the Bank of Albania emphasizes once again that interventions in the foreign exchange market have not aimed and do not aim to maintain the exchange rate at a certain level, but to mitigate the speed of its strengthening, in order to reduce the risks that high exchange rate fluctuations in the foreign exchange market may have on monetary and financial stability and in order to better anchor inflationary expectations.
In summary of its analysis, the Bank of Albania assesses that the free exchange rate regime and its approach to the strengthening of the Lek in recent years have enabled the country to achieve high, stable and non-inflationary economic growth.
According to the Bank of Albania, the strengthening of the Lek exchange rate represents a structural phenomenon, as long as and to the extent that the improvement in the balance of payments and the reduction in risk premiums in the financial market are assessed to be sustainable.
The structural improvements that have dictated the strengthening of the exchange rate have been reflected in the strengthening not only of the nominal, but also of the real exchange rate.
In general, according to the Bank of Albania, the strengthening of the exchange rate illustrates a faster convergence of income and prices of the Albanian economy with our European Union trading partners.
This faster pace of convergence is sustainable as long as it is based on increased productivity of the Albanian economy and reduced risk premiums in the domestic financial market.
In particular, the shift of labor towards the tourism sector and related services, sectors that are able to pay comparatively high wages, illustrates an increase in overall labor productivity in the economy.
Likewise, the tolerance that domestic investors have shown towards the relatively low levels of interest rates in the Lek, as well as the increased interest of foreign investors to invest in Albanian financial markets, are evidence of the lower risk premiums in them.
These conclusions suggest that the strengthening of the exchange rate is based on structural factors and reflects a faster convergence movement of the Albanian economy, at least in the short and medium term./ Monitor
