Albania: Weak Lek Makes Headlines

UNCLAS SECTION 01 OF 02 TIRANA 000742 SENSITIVE SIPDIS DEPT FOR EUR/SCE E.O. 12958: N/A TAGS: ECON EFIN EINV ZL AL SUBJECT: Albania: Weak Lek Makes Headlines TIRANA 00000742 001.2 OF 002 SENSITIVE BUT UNCLASSIFED - PLEASE TREAT ACCORDINGLY ¶1. (SBU) SUMMARY: The recent period of high volatility of the Albanian lek versus the euro has made headlines and shaken market confidence. The contributing factors are short-term and more psychological and speculative such as reactions to the Prime Minister's comments on adopting the euro. Long term factors, including the current account and budget deficits have put weak but steady downward pressure on the lek throughout the year. As the new 2010 budget is approved and growth continues to lag, the situation is not expected to improve in the near term, and the lek has steadily remained near its all time low of 137 lek to the euro. Although a weak lek might boost Albanian exports to the euro zone, it also drives up imports, including food imports which account for nearly half of Albania's food requirements. Moreover a weak lek could dramatically increase repayment costs for consumers holding euro-denominated loans, which is nearly 70 percent of all loans outstanding in Albania. End Summary ¶2. (U) On September 24, the lek reached an all-time low of 137.83 lek to the euro. The national currency had tumbled 2.6 percent in a matter of days. As the currency market panicked and the buy/sell spread widened, both the Central Bank (Bank Of Albania) Governor and the Minister of Finance appealed for calm and tried to convey confidence. Their intervention stabilized the high fluctuations, but not for long. Over the following weeks and to date, the exchange rate has mildly fluctuated and the historically strong lek continues to have an average rate of 137.64 to the euro. "Deadlines and Headlines Push Lek Down" -------------- ¶3. (SBU) Two unique factors occurred that could explain the high volatility. The Albanian exchange market historically trades at a low volume which does not regularly exceed 20 million euros. Massive purchases of euros in late September in order to pay stock dividends, particularly from Vodafone, caused a sharp decline in the lek/euro exchange rate and touched off the initial panic in the market. On the political front the Prime Minister also announced in early October that Albania must start the process of adopting the euro, independent of the status of its candidate application for the EU. Some observers blamed Berisha's comments for further weakening the already wobbly lek. "GOA Spending Makes it a Tough Year for the Lek" -------------- -- ¶4. (SBU) Following years of relative stability and steady appreciation the lek has been under continuous pressure for all of ¶2009. In the first nine months of the year, the lek has fallen 10 percent. Some experts have blamed government spending, particularly in the pre-June election run-up, as a main cause of downward currency pressure. The political opposition has continuously blamed the government for the fall of the lek. Higher spending combined with lower levels of remittances, lower exports and lower than expected public revenues have significantly increased the current account deficit to 15 percent, resulting in more demand inside Albania for euros, and less demand for lek. "A Continuing Headache" -------------- ¶5. (SBU) Lek depreciation will continue to strain corporate bank customers who have euro denominated loans and lek revenues. The euro has become the main currency for large transactions in Albania, and most consumers have taken advantage of preferential euro loan rates for mortgages and personal loans. The average interest rate for euro denominated loans has been 5 points lower than loans denominated in lek. As of August 2008 31 percent of outstanding loans were in lek and 61.7 percent in euro. The gap widens in the real estate sector, where 22.5 percent of loans are denominated in lek. ¶6. (SBU) The devaluation of the lek is not expected to have a direct impact on the other Balkan economies. It will, however, put more strain on the commercial banks operating in Albania as more consumers are forecasted to have difficulty making loan payments. This could further increase the amount of bad (over 31 days late) loans past their current peak level of 9.8 percent. In an attempt to balance the outstanding loan stock, BOA has repeatedly called on consumers to obtain their loans in the currency of their revenues to mitigate foreign exchange risk. ¶7. (SBU) Comment: Most observers believe that the current exchange rate of 137 lek to the euro is sustainable and no cause to panic. Most economists, however, view 140 lek to the euro as the point where the Albanian economy could begin to suffer, including serious hardship for consumers with euro denominated loans. While the Government has sought to reassure the public about the support for the lek, there has been a continued insistence that the lek will find a new, lower equilibrium and that there is full support for the free floating regime though it may be painful at times. The true cause of the lek devaluation is a combination of factors, and lower remittances and lower growth have removed the cushion that traditionally protected the economy from sharp currency fluctuations. The sharp one day decrease of 2.9 percent startled TIRANA 00000742 002.2 OF 002 the public and encouraged speculation, but was in line with the general downward trend of the lek. Looking to the end of the year it appears that even with the revised 2009 budget, the government will fall short on revenues and will need to use currency reserves or lending to make up the shortfall, which could apply further downward pressure to the lek.