Albania: The Case for Strengthening the Financial Resilience of Micro, Small and Medium Enterprises Against Disaster and Pandemic Shocks

Photo Credit: Genti Shkullaku/ The World Bank

As the end of the pandemic is in sight and disaster and climate risks show no sign of easing, questions arise, such as: What could be done differently? How can the government better support firms in weathering future storms?  Against this context, building stronger financial resilience among firms is one potential avenue. In this quest, the World Bank has developed a new modeling methodology to better understand firms’ financial vulnerabilities to the pandemic and disaster shocks as well as the liquidity needs and the costs of potential government support measures to support firms in overcoming such shocks.

In a recent report ”Assessment of Firms’ Financial Resilience against Pandemic and Disaster Shocks in Albania”, the World Bank’s assessment applied the methodology to a sample of about 10,000 formal firms in Albania, using the country’s disaster risk profile and the COVID-19 shock as assumptions for potential future shocks. The assessment shows that, under the impact from pandemic and disaster shocks, and in the absence of any government interventions, firms are projected to become less liquid, more leveraged, and less profitable. Under compound shocks, the number of firms that do not have the ability to cover short-term debt is likely to increase three times: from 2,500 firms under baseline to more than 7,000 firms. In addition, firms’ profitability is projected to fall significantly: the share of profitable firms may decline from 57 percent at baseline to 23 percent under a pandemic and national-scale disaster. Dual shocks could send a large share of firms into a liquidity crunch: estimates suggest that the liquidity funding gap for all firms would rise from under 1 percent under no shock scenario to about between 13 percent and 52 percent of total GDP. Among firms, MSMEs will likely incur disproportional risk of liquidity distress. It is estimated that 35 percent of micro and 45 percent of small firms will experience profits compared to 23 percent of large firms under compound shocks.
 
At the same time, MSMEs face significant constraints regarding access to finance, exacerbating their financial vulnerability. In Albania, MSMEs tend to operate in less capital-intensive sectors (such as wholesale and retail, construction, and other service sectors). Therefore, they use more liquid assets for their operations. Data on financing structure shows that prior to the pandemic, MSMEs had a higher over-reliance on short-term liabilities, especially short-term payables. This was likely driven by their dependence on partners within their supply chains. This reliance on short-term payables makes such firms more vulnerable to revenue shocks, especially systematic shocks that affect multiple parts of the supply chain. Small firms are also less able to rely on external financing to adjust to both ex-ante and ex-post shocks. MSMEs tend to face more barriers in accessing loans, including high demand for collateral, stricter lending standards, and bank perceptions of MSMEs as risky — especially given their low business capacity and informality. In general, firms in Albania, and particularly MSMEs, also make little use of insurance products for risk management purposes.

Given the economic contribution of MSMEs and their vulnerability to shocks, the cost of not protecting MSMEs can be high. Letting MSMEs fail would mean significant costs in terms of employment losses, especially for the more disadvantaged segments of the population. Under the scenario of compound pandemic and natural disaster shocks, the simulation results show that a significant share of MSMEs (between 9 and 15 percent) would have been “at risk” of default¹. Without external support, their default could put many jobs at risk. Letting MSMEs fail also means a significant reduction in the government’s tax revenues, as well as a negative spillover into the financial sector. A compound pandemic and national scale disaster shock is also likely to plunge 74 percent of firms into debt.  It would also cut the government’s corporate income tax revenues by more than 60 percent.    
 
A strong case can be made for policy interventions to support firms following large-scale external shocks such as pandemics and disasters due to the presence of multiple market failures. The Government could consider a number of policy options as they undertake measures to support the recovery of firms from the COVID-19 pandemic. These measures could strengthen their financial resilience against future shocks. Such measures could include:

1. A strategic approach to support the financial resilience of firms following pandemic and disaster shocks as part of the government’s effort to develop a national disaster risk finance program.
2. A suite of pre-arranged financial measures including tax deferrals, lines of credit, and credit and equity guarantees, concessional lending, trade finance, increased bank lending, factoring, and tax credits and deferrals.
3. Better targeting and designing of interventions supported by analytics. Targeting support to the firms most affected and deserving can help preserve scarce fiscal resources and ensure that firms receive an adequate level of support in line with their financing needs. The Government can consider prioritizing support for financially viable firms and firms or sectors with higher potential for productive employment preservation
4. Crowding in private capital through “greening” and de-risking of instruments that will be used to support the recovery of firms. An example would be to open new windows under credit guarantee schemes to allow guarantees for new loans that meet environmental, governance, and social standards². A risk-sharing mechanism would also be embedded to lessen the exposure of these schemes to climate and disaster risks.

1. Defined as firms with an interest coverage ratio of less than 1, a current ratio of less than 1, and a liabilities-to-assets ratio greater than 0.75. Prior research has suggested these thresholds can predict firm’s exits.

2. Calice, P. 2021. “From protection to reallocation: Public credit guarantee schemes in the post-pandemic world”. World Bank. https://blogs.worldbank.org/psd/protection-reallocation-public-credit-guarantee-schemes-post-pandemic-world