On March 22, 2024, S&P Global Ratings raised its long-term foreign and local currency sovereign credit ratings on Albania to 'BB-' from 'B+' and affirmed its 'B' short-term foreign and local currency sovereign credit ratings. Below the full report

The outlook is stable.

We also revised Albania's transfer & convertibility assessment to 'BB+' from 'BB'.

The stable outlook signifies that we consider risks to Albania's economic, external, and fiscal performance to be balanced.

We could lower the ratings if debt increases significantly more than we project because the government unexpectedly relaxes its fiscal stance. We could also lower the ratings if current account pressures intensify, contrary to our base case, and this leads to a substantial depletion of the Bank of Albania's foreign exchange reserves.

Upside scenario

We could raise the ratings if:

• We see a notable improvement in the government's fiscal position, for example, because revenue collection had improved;
• External performance improves--for example, because of a narrowing of the trade deficit or larger services surpluses--and this reduces external funding risks; or
• Albania strengthens its institutional framework--for example, by implementing structural reforms as a part of the country's EU accession objective.

Rationale

Albania has consistently improved its government balance sheet, despite multiple shocks in recent years. It suffered an earthquake in 2019, as well as facing the pandemic and the indirect macroeconomic effects of the Russia-Ukraine war. Albania's resilient economy has grown by 5.8% a year, on average, over the past three years. This, combined with the authorities' efforts to consolidate public finances, led to a reduction in net general government debt to an estimated 52% in 2023 from a peak of 71% of GDP in 2020. We anticipate that the moderately strong economic growth will persist and the authorities will maintain a prudent approach to public finances in line with the Organic Budget Law. This will keep public debt on a stable trajectory.

The country has also strengthened its external balance sheet. We attribute this to the accumulation of public sector assets (primarily foreign exchange reserves) and increasing services receipts from the booming tourism sector. As the tourist industry grows further, we could see some economic concentration risk emerging.

Our ratings on Albania are constrained by the country's relatively weak institutional framework, limited monetary policy flexibility, and moderate external financing needs. Over 50% of government debt is denominated in foreign currency or is short-dated. Furthermore, the economy makes extensive use of the euro and is highly informal. This, combined with shallow capital markets, impairs the Bank of Albania's ability to transmit monetary policy.

Albania's moderate growth prospects and relatively high reserves still provide some protection from potential external shocks. In addition, we anticipate that the authorities will remain fiscally prudent and will keep public debt on a stable trajectory.

Institutional and economic profile: The growth outlook remains favorable, but Albania's bid to join the EU presents domestic difficulties

• We expect growth to moderate slightly, to a still-solid 3.4% in 2024, from 3.7% in 2023, supported by sustained consumer spending, continued investments in real estate, and the rapid expansion of the country's tourism sector.
• The labor market remains tight because of the effects of emigration and aging.
• We forecast that Albania will take incremental institutional steps in support of its EU membership bid through to 2030.

Real GDP growth is supported by remittances, strong real wage growth, and tourism. Although growth is forecast to slow to 3.4% in 2024 from 3.7% in 2023, it will be bolstered by further investment, particularly in the tourism and real estate sectors. Albania has emerged as Europe's fastest-growing tourism destination--international arrivals increased by a significant 53% between November 2019 and November 2023. That said, we forecast a slight moderation in the growth of the tourism sector in 2024.

In the third quarter of 2023, average real wage growth surged by over 12% and unemployment dropped to a new low of 10.5%. Both the minimum wage and public sector pay rose in 2023. These increases, combined with moderating inflation and limited labor supply, explain the rise in salaries. Emigration exacerbates this trend by shrinking the labor pool further. Albanian citizens have been drawn to better-paying opportunities in EU countries.

Looking ahead, we anticipate that Albania's economy will expand by about 3.5% a year on average over 2024–2027. That said, our projection is vulnerable to downside risks, particularly those related to the labor market and the possibility of sustained economic weakness across Europe.

Economic growth in Albania is hindered by infrastructure gaps, the relatively weak legal framework, and corruption. The country has implemented a series of reforms to overcome these hurdles, propelled by its ambition to join the EU (it obtained candidate status in 2014). To fortify the legal system, the authorities launched judicial reforms in 2016, supported by the EU. These resulted in a surge of court cases. In addition, existing infrastructure, such as the Trans-Adriatic Pipeline (TAP), aims to diversify Albania's energy sources and reduce its reliance on hydropower. The primary role of TAP in Albania is to facilitate the transit of gas from Azerbaijan to European markets, including Italy. Albania is scheduled to start utilizing Azeri gas for its own needs in 2026, with plans underway to develop the distribution infrastructure necessary for this purpose.

Future progress on EU-backed reforms should be facilitated by the absence of bilateral and geographical disputes, and the government's parliamentary majority. At the same time, domestic challenges, particularly in the rule of law, necessitate ongoing structural reforms to align with the EU acquis (the collective set of EU legislation, across multiple areas). Without a substantial effort to speed up the pace of reform, we consider Albania unlikely to be eligible for entry into the EU before 2030.

EU accession remains a priority, as it has been for each administration since Albania obtained candidate status in mid-2014. The EU initially took a regional approach to integration, which linked Albania's path to EU membership with that of North Macedonia. Since July 2022, a strategic shift has occurred that aims to maintain Albania's alignment with the EU's political framework and has decoupled its candidacy from that of North Macedonia.

The Socialist Party of Albania (SPA) is leading the polls ahead of the parliamentary elections scheduled for 2025. SPA has governed Albania since it won a majority in the 2021 general election. Its policymaking has been stable and predictable and it has focused on fostering economic development and reducing public debt. In the May 2023 local elections, the SPA reinforced its political base by winning 53 of the 61 municipalities. That said, voter turnout dropped to a historical low of 38.2% from 47% in 2021. This marked the lowest participation rate on record.

Flexibility and performance profile: Fiscal and external pressures have continued to decrease

• Public finances are on a prudent path and we expect a fiscal deficit of 2.2% of GDP in 2024, slightly narrower than the government's official target of 2.4%.
• Albania's buoyant tourism sector underpins the structural improvement in the balance of payments.
• The banking sector faces potential risks stemming from elevated levels of euroization and the prospect of a downturn in real estate prices.

We estimate that Albania's budget deficit narrowed to 1.3% of GDP in 2023. This marked its lowest point since 1993 and was well below the official target of 2.6%. We credit the reduction to a 12% rise in revenue, supported by increased social security contributions and higher corporate income and personal tax collections. At the same time, expenditure growth was contained, at 4%.

In 2024, we forecast that the budget deficit will be 2.2% of GDP, slightly lower than the official target of 2.4%. We base our conservative forecast on our belief that revenue may surpass the authorities' targets, which are themselves typically conservative. Notably, Albania has revised down its 2024 budget deficit target twice so far in 2024, most recently because government revenue was higher than anticipated and because tourism has boosted economic activity in the year to date to a stronger level than had been expected. Nevertheless, we expect expenditure to see a moderate increase in 2024, as public sector wages rise and Albania commences work on infrastructure projects such as the Tirana Big Ring Road project.

The authorities have made amendments to existing legislation in order to increase revenue generation from both personal and corporate income taxes. They plan to finance the deficit through a mixture of domestic and foreign funding sources. For example, in June 2023, Albania tapped the Eurobond market for €600 million and used part of the proceeds to pay down part of a Eurobond due in 2025 and part to finance the 2024 budget. The government could issue another Eurobond if conditions are suitable.

Since 2019, Albania has faced several ordeals, starting with a magnitude 6.4 earthquake. Nevertheless, the government has made progress toward consolidating public finances. Therefore, we forecast that the budget deficit will remain contained, averaging 2%-3% of GDP through 2027, and aligning with the fiscal and debt brake regulations outlined in the Organic Budget Law. Under the provisions in that law, the government is required to achieve a primary balance by 2024 and then maintain it, while ensuring that the debt-to-GDP ratio is declining, if it exceeds 45%. Notably, the authorities attained a primary surplus in 2023, exceeding the initial timeline by a year. However, success in fiscal consolidation depends on sustained economic growth and continued reform of public finances. The government revenue-to-GDP ratio is about 27%, the lowest ratio in the Western Balkans, largely due to Albania's sizable informal economy and tax loopholes.

Net general government debt has been on a steep downward path since 2021. It reached roughly 52% of GDP in 2023, from 67% in 2021, based on the authorities' efforts to consolidate public finances, combined with robust nominal GDP growth. Our baseline projections indicate that net general government debt will decline to about 50% of GDP over 2024-2027.

Several risks persist around debt:

• About 45% of central government debt is denominated in a foreign currency, subjecting it to exchange-rate risk.
• Domestic debt is predominantly short-term, with an average maturity of just over two years.
• Albania's banking sector still holds a significant portion of domestic government debt, and these holdings constitute about 26% of the banking sector's total assets.

Off-balance-sheet public-private partnerships (PPPs) still present a potential fiscal vulnerability for Albania. The country has over 200 PPPs in sectors such as road infrastructure, hydropower, and health care. These represent about a third of GDP and could expose the country to fiscal risks. Spending related to PPPs is limited to 5% of the previous year's tax revenue; that said, current liabilities represent only about 2% of government revenue. Despite efforts to address Albania's infrastructure deficit, the regulatory framework governing PPPs needs to be strengthened, particularly with regard to cost transparency. Weaknesses in oversight have been highlighted recently: For example, the Special Prosecutors Office Against Corruption is investigating a PPP contract for hospital equipment sterilization. Consequently, accurately predicting and quantifying the fiscal risks associated with PPPs remains difficult. Because of the fiscal risks associated with PPPs, the Albanian government has moved away from relying heavily on them.

Inflation in Albania has been falling and reached 2.6% in February 2024 (well below the 7% reported in the same period last year). We attribute the downward trend to falling commodity prices, tight financial conditions, base effects, and the appreciation of the Albanian lek against the euro. Looking ahead, we anticipate that inflation will average 3.4% in 2024 and will remain above the Bank of Albania's target of 3%, due to a tight labor market and strong demand, driven by high real wages.

Underdeveloped capital markets hinder the effectiveness of the central bank's monetary policy transmission mechanism. Commercial banks hold 62.7% of total domestic government debt. Transmission is also hampered by the prevalence of euroization in the economy--about 53% of deposits are held in foreign currencies. The euro is still widely accepted for transactions, including in sectors such as real estate.

We anticipate that a surge in tourist activity will significantly narrow the current account deficit, to 1.9% of GDP in 2023 from 5.9% in 2022. For the first time, Albania recorded a current account surplus in the first three quarters of 2023, largely fueled by a rapid increase in services receipts. We expect the growing prominence of the tourism sector to lead to structural changes in the current account balance and generally lower deficits compared with historical periods. In 2024, we expect a worsening merchandise trade balance to cause the current account deficit to widen, to 3.3% of GDP. Thereafter, we forecast that the deficit will average 3.8% over 2025-2027. Net foreign direct investment inflows and public sector external borrowing will continue to finance the external deficit until 2027.

Given the increase in government borrowing and narrower current account deficit, foreign currency reserves rose to €5.7 billion in January 2024 from €5 billion in January 2023. Albania is using Eurobond funds to cover its budgetary needs, which will deplete reserves to a degree over the coming months. However, we project that reserves will remain stable in the next one-to-three years.

In our view, the contingent liabilities stemming from the banking sector are limited. The sector is liquid, well-capitalized, and profitable. Return on equity in the banking sector reached a new high of 17.3% in December 2023. At the same time, the regulatory tier one capital ratio was strong at 17.7% of risk-weighted assets. Nonperforming loans (NPLs) have decreased to an all-time low of 4.7% in February. On the real estate front, property prices again grew by more than 10% in 2023. Our base case assumes a slowdown in price growth. However, if Albania were to experience a sharp reversal in house prices, its financial stability could be threatened. The banking sector is still highly euroized.

Definitions: 

Savings is defined as investment plus the current account surplus (deficit). Investment is defined as expenditure on capital goods, including plant, equipment, and housing, plus the change in inventories. Banks are other depository corporations other than the central bank, whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid claims on nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. N/A--Not applicable. ALL--Albanian lek. CARs--Current account receipts. FDI--Foreign direct investment. CAPs--Current account payments. The data and ratios above result from S&P Global Ratings' own calculations, drawing on national as well as international sources, reflecting S&P Global Ratings' independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.