Artan Gjergji, Senior Expert in Financial Markets and Services
In Albania, there is unfortunately, no coordination between the fiscal policies of the Government and the monetary policies of the Bank of Albania (central bank). While facing a dangerous overvaluation of the national currency LEK, due to the increase in the supply of the EUR currency in the domestic market, here it comes the cherry on the cake. The Government announces the auction of the 15-year T-Bond nominated in LEK. In other words, in conditions where there is no LEK in circulation, the Government enters the market and withdraws the small pennies in LEK that is left.
What are the negative effects of EUR devaluation in the Albanian domestic market?
There are at least 6:
1. Given the Foreign Exchange Offices have reduced the exchange rates to the maximum because the banks refuse to buy an infinite amount of EUR, the withdrawal from the market of the amount of LEK (about 2 billion LEK or 19 million EUR), will worsen the situation causing an appreciation still deeper of LEK (EUR devaluation) in the domestic market,
2. Given the lack of LEK in circulation, the market operators interested in buying the 15-year T-Bond will be very few (only pension + investment funds and very few banks), and this will lead to an increase in the interest rate offered causing the Government to borrow from the market at a relatively higher cost,
3. The continuous overvaluation of the LEK (the devaluation of the EUR in the domestic market) is not expected to stop the pace because after the elections starts the tourist season, which according to experts is expected to be prosperous. This means more foreign currency (mainly EUR) in circulation which will depreciate more and more. If we also add to this picture the foreign exchange flows for investments in real estate (boom in the construction sector), the expectations for the further devaluation of the EUR are very high,
4. The over evaluation of LEK at this speed is dangerous, as it affects a good part of the families who live based on the remittances of family members from abroad. So, in a way, the cost of the (illogical) devaluation of the EUR falls on the shoulders of the population that depend on the euro income. The same cost falls on those subjects (mainly citizens) who have their savings in EUR, and according to Bank of Albania more than 55% of deposits in the banking system are in EUR (around EUR 6 billion),
5. The overvaluation of the LEK has left it at the mercy of fate and is destroying the fragile export sector, which has been hit from time to time with populist fiscal policies for the ill-conceived increase in the minimum wage,
6. The overvaluation of the LEK, slightly discourages the attraction of Foreign Direct Investments (FDIs), making the country’s economy not at all competitive, apart from the fact that we are the country with the highest Corporate Income Tax in the Region. This is also a fiscal policy not well thought out by the Government.
What should be done under the conditions of this abnormal phenomenon in the country’s economy?
In the conditions of the free-market economy and the free exchange rate regime that Albania has in place, neither the Government nor the central bank can intervene in the market to determine an ideal exchange rate. Everyone knows and accepts this. But we have to accept that both the Government and the central bank are very important actors in the financial markets. As such, they can be active for the benefit of the financial stability of the country, without violently interfering in the market mechanism.
Besides the need for a coordination of the Government’s fiscal policies with the monetary policies of the central bank (usually Governments deviate for political pressures and benefits), there are also other active instruments to improve this market distortion. For example:
a. Issuance of Treasury Bonds Denominated in EUR – In the conditions of the high supply of EUR in the domestic market, the Debt Management Directory at the Ministry of Finance should consider the issuance of T-Bonds denominated in EUR. Thus, it would attract a significant amount of currency, calming the markets, and at the same time, it would borrow very cheaply, reducing the cost of external debt in a smart and efficient way.
b. Money from the Helicopter, a non-traditional monetary policy – the Bank of Albania (BoA) may consider issuing the LEK currency in a gradual manner, though staying within the legal ceiling. In order not to negatively affect inflation (due to the increase in money supply in LEK), BoA can buy EUR from the market, increasing the foreign exchange reserve. This monetary policy instrument called “Helicopter Money” is a policy proposed 4 decades ago by the famous Nobel prize economist, Milton Friedman and widely used by the Federal Reserve during the COVID crisis. Although rarely used by central banks, it is a quite efficient policy in the short term to correct market distortions from unexpected external effects.
To conclude, it must be said that the free-market mechanism should not be compromised and this is a universal principle. But in the conditions when this mechanism receives shocks from external factors without real connection with the economic logic, it creates often very large market and price distortions (overpricing or underpricing). And in these conditions, the important operators in the market should not be passive, but try their best and take actions to absorb shocks and correct market distortions. Conversely, market distortions turn into price bubbles, and their bursting creates many times greater costs in a later period.