The effects of Devaluation Foreign Currencies versus the National Currency, possible impacts on the economy, April 2023. History 2003 – 2023

The official Lek/Euro exchange rate reached a historic low of 110.98 Lek in April 2023. Similarly, the American dollar (USD) and the British pound (GBP) have reached historic low rates against the Lek, being exchanged at 100.46 Lek and 125.33 Lek, respectively. The strengthening of the lek against foreign currencies has a significant impact on the economy, both on consumer purchasing power and on government and business finances in general. Open Data Albania is conducting a research regarding the progress of the official exchange rates of the main currency, euro, in order to underscore the potential effects.    

Official exchange rate and monthly average exchange rate of foreign currencies

Albania applies a free regime of exchange rates, which means that the value of the national currency Lek, against foreign currencies, is determined by supply and demand in the domestic foreign exchange market. The official exchange rate of the two main currencies EUR and USD is determined daily by the Bank of Albania, based on the quotations of ten banks participating in the interbank market, whereas the exchange rate of other currencies, such as GBP, is calculated with indexation against the US dollar, as the reference currency in the international market. In the last year (April 2022-April 2023), the lek has strengthened by 8-9 percent against EUR and USD, which means that the value of the two main currencies has fallen significantly in the domestic market, influenced by the high offer for sale of the currency within the country, against the increased demand for purchasing the national currency lek. The overvaluation of the lek is even more sensitive for the 10-year period 2013-2023, with the fall in value of 22-25 percent of the two main currencies against the lek.

Source: Bank of Albania
Comments and Analyses: Open Data Albania

In the history of average monthly exchange rates in the domestic foreign exchange market, three main periods of performance of the euro currency against the lek can be identified:

1. 2003-2008 rapid strengthening of the lek against the euro in 2003 (rate drop from 140 to 125 lek), followed by a 5-year period of stable exchange rates (121-128 lek/Euro). The year 2003 coincides with the beginning of negotiations for the Stabilization and Association Agreement towards Albania’s EU membership, as well as with the local elections in Albania.
2. 2009-2017 rapid strengthening of the euro against the lek in 2009 (rate increase from 121 to 140 lek), followed by an 8-year period of stable exchange rates (134-141 lek/Euro). The year 2009 marks two important events for Albania in the international arena, membership in NATO and the signing of the Stabilization and Association Agreement, as well as parliamentary elections being held.
3. 2018-2023: rapid strengthening of the lek against the euro in 2018 (the lek/euro exchange rate falls from 135 to 125), followed by the 2-year period of the pandemic, which marked stability of exchange rates. In 2018, opposition parties boycotted the Parliament on the eve of the 2019 local elections, while the European Council decided to postpone the opening of EU membership negotiations, requiring Albania to fulfill certain preconditions. 2022-2023 marks further strengthening of the lek not only against the EUR (the lek/euro exchange rate falls from 125 to 112), but also against other main currencies in the domestic market. The highest monthly drop was reached in July 2022 (-2.5%), whereas the lowest historical exchange rate in the domestic market was reached in April 2023 (111 ALL/Euro), 3 weeks before the local elections. 

Source: Bank of Albania
Comments and Analyses: Open Data Albania

Source: Bank of Albania
Comments and Analyses: Open Data Albania

Some of the internal factors that can influence the rapid strengthening of the lek, asside from geopolitical and macroeconomic factors, are:

• the increase of the informal economy and the entry of undeclared foreign currency capital
• declaration, ahead of time, by the government of the significant increase in budget expenditures, such as the increase in the average salary in the 2-year period, or
• possible speculations by actors participating in determining the official exchange rate.

The intervention of the Bank of Albania in the foreign exchange market

Without violating the free regime of exchange rates, the Bank of Albania can intervene in the internal foreign exchange market, with the objective of adapting the exchange rate to macroeconomic factors, or to increase the foreign exchange reserve. The bank has held frequent auctions for the purchase of foreign currency in the domestic market in 2018-2023, with the objective of increasing the foreign exchange reserve, in the total value of 551 million Euros, namely 124 million Euros in 2018, 155 million Euros in 2019, 117 million Euros in 2021  and 142 million euros in 2022. Based on the plan, the Bank of Albania will buy 160-220 million euros in 2023. This intervention, beyond the objective of increasing the foreign exchange reserve, affects the performance of the domestic market by withdrawing excess currency and increasing the amount of lek in circulation. 

Source: Bank of Albania
Comments and Analyses: Open Data Albania

Positive effects of the strengthening of the national currency lek

The strengthening of the lek has a positive effect on borrowers in foreign currency. The State as Borrower. The stock of gross external debt reached 9.8 billion euros at the end of 2022. The over 8 percent fall in the value of the euro is accompanied by the reduction of obligations, expressed in Lek, for the stock of external debt, by way of which we benefit of about 90 billion Lek. Most of the weight, 48% of the external debt, is shouldered by the government, which makes it the main beneficiary of the strengthening of the lek (around 44 billion lek less liabilities for the external debt), given that the income is generated in lek and the payments are made in euros. Another short-term benefit for the government is the reporting in euros of improved fiscal and macroeconomic indicators, such as indicators of income and gross domestic product per capita, or the indicator of external debt to gross domestic product. Other beneficiaries are businesses and families that hold loans in foreign currency, but whose income is in Lek. Foreign currency credit in banks reached over 3 billion euros in February 2023, accounting for 48 percent of the total credit of 6.3 billion euros. The strengthening of the lek reduces the monthly installment obligations in lek, for the repayment of the loan in foreign currency from the Government, by about 27 billion lek in total. Except for cases where the parties have a credit, where they foresee a review in the way the installment is calculated, the according to the Base Rate. As lending interest rates have increased significantly in the last 6 months, the positive effects from the exchange rate are partially offset by the negative effects of interest rates for businesses/individuals.

Source: Bank of Albania
Comments and Analyses: Open Data Albania

The strengthening of the lek has a positive effect on the imports of goods and services, which become more competitive in the domestic market, due to the drop in prices from the exchange rate.For 2022, the payments’ trade balance (imports minus exports) was 4.3 billion euros. The gains, going in favor of importers, can be estimated at around 38 billion lek in total, but the impact on consumers is not expected to be similar, as traders do not immediately pass on the price differences to the final consumer.

The negative effects of the strengthening of the national currency lek

The strengthening of the lek and the favoring of imports is bound to burden companies and local production, both in terms of coping with the increased competition from imports, and for maintaining the export market, especially in sectors that find it difficult to raise prices to compensate for the loss. The medium-term effect will be an increase in the competition with imported products, making it difficult to export domestic products and worsening the balance of payments. The strengthening of the lek may weaken the Albanian tourism sector, as tourists will have 8 percent less spending power in Albania, compared to last year. On the other hand, the situation will be more favorable for Albanians who travel and rest abroad.

Foreign direct investments and income from remittances are also negatively affected. In 2022, foreign direct investments were 1.2 billion euros and income from remittances 840 million euros. The loss from the exchange rate is estimated to be around 10 billion ALL for foreign direct investments and 7 billion ALL for families living on remittances. The negative effects affect not only the budgets of businesses and the beneficiary families, but the loss from the exchange rates will be transmitted to the taxes paid, reducing the income of the state budget, as well as worsening the business climate with foreign capital. The effects are also negative for businesses, organizations and individuals operating in Albania, but whose source of income is in foreign currency. An individual who receives income in foreign currency in Albania has exchange rate losses of over 8 percent, beyond the negative effects of inflation, reducing the total purchasing power by more than 15 percent.

The strengthening of the lek negatively affects the value of savings and deposits in foreign currency. The stock of foreign currency deposits reached 6.5 billion euros, accounting for about 57 percent of the total deposits in the banking system. The devaluation of currencies, in principle, reduces the counter value in lek of deposits and savings in foreign currency, for an estimated value of about 58 billion lek. Individual depositors do not feel the negative effect in the short term, due to the Euroization of the domestic economy. As long as the deposits are not withdrawn from the banking system, the effect will be positive for depository banks, who recognize a lower obligation in lek for deposits in foreign currency, against the loss they have from lending in foreign currency. Materialization of loss for individuals and businesses occurs in case of exchange or use of foreign currency deposits.

Source: Bank of Albania
Comments and Analyses: Open Data Albania

In conlcusion, the strengthening of the lek also negatively affects Albania’s international reserves. The foreign exchange reserve stock was about 5.3 billion USD as of February 2023, with an estimated loss in Lek of about 40 billion Lek from the exchange rate. These are unrealized losses, but they worsen the Bank of Albania’s reserves and capital index, increasing the need to purchase foreign currency on the domestic market.

For more details, you can access the Excel document attached.

Download excel: The effects of Devaluation Foreign Currencies versus the National Currency, possible impacts on the economy, April 2023. History 2003 – 2023
Comments and Analyses: Open Data Albania
Contributed by:E. Golemi
Translated by: Rezarta Cushaj