The shallowness of the Albanian foreign exchange market may justify the Bank of Albania's occasional interventions to maintain exchange rate stability.

A study by experts from the International Monetary Fund (IMF) estimates that, in cases where markets are shallow, financial intermediaries may have limited capacity to absorb excess demand or supply for foreign exchange.

These shocks can cause significant deviations in the exchange rate from the fundamental value, with implications for macroeconomic and financial stability.

IMF experts emphasize that, with an annual volume of about Dollar 11 billion, the foreign exchange market in Albania can be considered shallow compared to the average turnover in emerging markets, of about Dollar 52 billion per year.

For the first time, last year the Bank of Albania undertook a long-term intervention in the domestic foreign exchange market, with the aim of curbing the further appreciation of the Lek.

The Central Bank purchased approximately Euro 933 million in the domestic foreign exchange market in 2024. The amount of foreign exchange purchased has increased by 249% compared to the previous year.

The total value of purchases includes those planned, to increase foreign exchange reserves, but also those related to direct interventions in the market, to prevent the further decline of the exchange rate.

The planned purchases, in function of increasing the foreign exchange reserve, actually constituted only a minority of the total amount purchased. Last year, they reached the value of Euro 283.8 million, an increase of 14% compared to the previous year.

Meanwhile, direct purchases, with the aim of preventing the further decline of the Euro-Lek exchange rate, reached a record amount of Euro 649 million. For the first time last year, the Bank of Albania undertook a long-term intervention in the foreign exchange market, to prevent further strengthening of the domestic currency.

Direct purchases began in May and continued until December, with a temporary interruption in September. The month with the highest value of purchases was October when the Central Bank purchased 169.4 million euros in the domestic foreign exchange market.

The average euro-lek exchange rate last year fell by 7.4% compared to 2023. In the absence of Bank of Albania interventions, the Euro's decline in the Lek exchange rate would have been even greater.

IMF staff analysis concludes that the exchange rate should continue to play its role as a shock absorber for external shocks to the economy, and interventions in the free exchange rate should only be used to mitigate the impact of shocks resulting from non-fundamental factors.

IMF assessment models show that the Lek's appreciation has historically been driven mainly by fundamental factors, while non-fundamental transitory factors have played a modest role in some episodes.

The study recommends maintaining the free exchange rate regime, relying on interest rate policies as the main tool for price stability.

In cases of non-fundamental shocks, the analysis suggests that interventions can be beneficial, reducing inflation volatility.