1. Living through crisis! Where is the guide please ? Altin Tanku Bank of Albania May 2010 The opinions expressed in this presentations are those of the author and do not represent the opinions of the Bank of Albania. The global Financial crisis and SEE: Lessons for macroeconomic policy and financial stability Bank of Greece

2. Preview Macroeconomic Policy Challenges, the policy makers view: –Past: Preconditions Domestic and External vulnerabilities Channels of transmission –Current: Impact of the crisis Short term outlook –Future: Long run implications –Conclusions

3. Preconditions Strong persistent growth (on average 6%) fueled by a strong aggregate demand and credit growth.* Source: Albanian Institute of Statistics * Bank of Albania Annual Reports and Monetary policy Declarations 2006-2009

4. Preconditions (cont.) Source: Bank of Albania

5. Preconditions (cont.) Most of credit is in foreign currency Source: Bank of Albania

6. Preconditions (cont.) Fast growing credit based on strong deposits Source: Bank of Albania

7. Preconditions (cont.) Well capitalized Banking system Source: Bank of Albania

8. Preconditions (cont.) –EU is the main trade and financial partner Source: Bank of Albania

9. Preconditions (cont.) Large trade and current account deficits with heavy reliance on remittances Source: Bank of Albania

10. Preconditions (cont.) Persistent Lek appreciation Source: Bank of Albania

11. Crisis begins in USA and Europe September-October 2008 –Banks failures become a reality in US and Europe. –Full deposit insurance in Europe. –Slowdown in global economic activity. Expectations: –No real impact in Albanian banking and financial system, but suspicion and fear. –Significant effect in the real sector of the economy.

12. Financial crisis reaches Albania Fear contagion hits public. Deposit withdrawals begin due to: –Fear –Full deposit insurance in Europe Insurance arbitrage possibilities Banks experience liquidity problems in foreign currency. –Overall credit slowdown, Credit in foreign currency eventually stopped.

14. Financial crisis reaches Albania Fear contagion hits public. Deposit withdrawals begin due to: –Fear –Full deposit insurance in Europe Insurance arbitrage possibilities Banks experience liquidity problems in foreign currency. –Overall credit slowdown, Credit in foreign currency eventually stopped.

15. Source: Bank of Albania

16. Real sector crisis spreads to Albania Remittances and Trade activity shrink due to slowdown of real activity in EU Consumption & investments Exchange rate starts to depreciate accompanied by increased volatility Expected high pass-through to inflation* Source: Bank of Albania * Tanku, Vika and Gjermeni (2007); and Istrefi and Semi (2007)

17. Crisis: Back to Financial Channels Non performing credits increase from 4.6 to above 10 percent due to*: –Exchange rate depreciation for unhedged borrowings in foreign currency, –Decrease in economic activity, –Slow down in credit growth. Policy objective shifts toward financial stability. –Exchange rate is believed to be the most important and imminent threat to financial stability. Banks face liquidity problems, but capital adequacy ratio remains above 17%. * Shijaku H., and Ceca K., (2009)

18. Policy Response Deal with liquidity problems From fix amount to fix price repo. auctions Reduce interest rate to 5.25 Shift focus to financial stability Increase deposit insurance carefully Limited intervention in Forex market Less than 60 million euro For fixed period Introduce temporary restrictions on profit distribution March 2009 – March 2010 Ask banks for recapitalization if needed (two cases)

20. Policy Response Deal with liquidity problems From fix amount to fix price repo. auctions Reduce interest rate to 5.25 Shift focus to financial stability Increase deposit insurance carefully Limited intervention in Forex market Less than 60 million euro For fixed period Introduce temporary restrictions on profit distribution March 2009 – March 2010 Ask banks for recapitalization if needed (two cases)

21. Preconditions (cont.) Important historical events March 1997 April 2002 Source: Bank of Albania

22. Policy Response Deal with liquidity problems From fix amount to fix price repo. auctions Reduce interest rate to 5.25 Shift focus to financial stability Increase deposit insurance carefully Limited intervention in Forex market Less than 60 million euro For fixed period Introduce temporary restrictions on profit distribution March 2009 – March 2010 Ask banks for recapitalization if needed (two cases)

24. Short term effects New economic trends Monetary base grows but Credit does not Monetary base grows but Money growth slows down Private investments slows Remittances decrease Credit slowdown stops the money creation in FX resulting in reduced FX supply Exchange rate depreciates; inflation stays within objective –due to decline of commodity prices –due to slowdown in economic activity * Bank of Albania estimation

25. Crisis: Back to Real economy

26. Outlook assessment Source: Bank of Albania macro econometric model MEAM

28. Short run Financial Stability Outlook Deposits recover trend but credit doesn’t. Credit slowdown continues –NPL growth slows, but continues to grow (above 11 percent) Exchange rate is estimated to be close to its short run equilibrium –Based on monetary approach

29. Short run Financial Stability Outlook Current Account Deficit remains a problem despite a relatively fast adjustment in trade balance –Twin deficits; –Bank of Albania model shows slow or no adjustment unless inflation kicks in; –Supply side shocks are important; –Wealth effects adjustment is not happening

31. Short run Financial Stability Outlook Current Account Deficit remains a problem despite a relatively fast adjustment in trade balance –Twin deficits; –Bank of Albania model shows slow or no adjustment unless inflation kicks in; –Supply side shocks are important; –Wealth effects adjustment is not happening

33. Long run Outlook First: be Positive Second: watch out for –Current account deficits, –Fiscal developments, New fiscal rule –Potential persistent shocks Risks to potential growth Unit root vs. Mean reverting nature of current shocks.

34. Positive Shocks to Outlook ScenarioOutlookInvestment shockEur/Lek shockExport shock Inflation (pp)0.680.711.140.69 Source: Bank of Albania macro econometric model MEAM

38. L-R implications of S-R actions To credit or not to credit-that is the question –Credit is good for investment, consumption and growth –Credit is bad for non performing loans New model of growth –What model? –Regional model? –Bank of Albania opens the debate!

39. LR implications, SR actions Monetary policy similar to ECB –Two pillars approach, Implicit inflation targeting with leading indicators: –Forecasted inflation –M3 Money multiplier has slowed down significantly due to current credit crunch. If current changes were structural, then policy must adjust and reset targets for M2 or shift to M2. Shift operational targets from money to interest rate

40. Conclusions Crisis affected Albanian economy immediately in financial and real sector. –Small open economies are at the mercy of global developments. Albanian economy is fully financially integrated, if not in all markets segments and products, it is in sentiments. –Toxic assets and/or hot money are not necessary conditions for crisis. Understanding the nature and persistence of current shocks is important not only for SR economic recovery but also for LR policy. –Price stability versus Financial stability; –Monetary Policy may need to readjust to new realities.

41. Studies & Data Bank of Albania, Annual Report, 2006–2008. Bank of Albania, Monetary Policy Declaration, 2006–2009. Dushku, E., (2008). “Financial markets development and economic growth” Bank of Albania Working Papers, Forthcoming. Gëdeshi, I., (2009). The relationship between migration and socio-economic changes in Albania CSES WP, 2009 “Albania Fact Sheet”, Nexus Migration Development Initiative. Presented at the “Friday Seminar Series” of the Bank of Albania, February 2009. Kota, V., Elona D., Jakab, Z. M., (2007). “The Macro-econometric Model of Albania (MEAM): A follow-up.” Monetary Policy Strategies for Small Economies, ed. Fullani A., Bank of Albania, June 2009. Shijaku, H., and Kliti C., “Indirect credit risk stress-testing in Albania.” Bank of Albania Working Papers, Forthcoming Tanku, A., Vika, I., and Gjermeni, M, (2007). “The role of the Exchange Rate in Inflation Targeting – What do we do?” Monetary Policy Strategies for Small Economies, ed. Fullani A., Bank of Albania, June 2009. Vika, I., (2006). “Measuring import and export functions in Albania.” Bank of Albania Working Papers, March 2009. Bank of Albania Institute of Statistics (INSTAT) Center for Social and Economic Studies, Tirana, Albania