Public Information Notice No. 00/54

Public Information Notice: IMF Concludes Article IV Consultation with Algeria

August 4, 2000

On July 7, 2000, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Algeria.¹

Background

Between 1994 and 1998, Algeria was successful in restoring macroeconomic stability and implementing structural reform, owing in large part to its steadfast implementation of IMF-supported programs. Growth resumed, inflation was tamed, and the balance of payments position strengthened markedly. Progress on the structural front was also widespread, with the establishment of institutional and market mechanisms necessary to complete the transition from a centrally planned to a diversified market economy. Besides, relative prices were realigned and numerous external trade and payment restrictions were abolished. Inefficient public enterprises had to be restructured, which entailed massive layoffs and contributed to the rise in the unemployment rate.

In 1998 and the first half of 1999, the Algerian economy was adversely affected by low world oil prices. This resulted in a sharp fall in hydrocarbon export receipts. In addition, the balance of payments position was also weakened by a large deficit of the capital account reflecting limited access to new external borrowing. This resulted in a substantial loss of gross official reserves, from about 9.5 months of imports at end-1997 to slightly above 4 months in summer 1999. The authorities’ policy response was to tighten the fiscal stance, maintain high real interest rates, and let the Algerian dinar depreciate vis-à-vis the U.S. dollar. Coupled with a turnaround in oil prices in the course of 1999, this resulted in an improvement in the current account from a deficit of 1.9 percent of GDP in 1998 to a balanced position in 1999; foreign exchange reserves stabilized in the second part of 1999. Owing to net amortization, the stock of external debt declined by US$2 billion to US$28.3 billion (or 59 percent of GDP). The debt service ratio, while lower than in 1998, remained high at about 40 percent of exports of goods and nonfactor services in 1999.

The fiscal position deteriorated sharply in the first part of 1999 due to low oil prices and to an acceleration of current expenditure. In response, the authorities tightened expenditure management and, in particular, froze expenditure on new investment projects. This, coupled with the strong recovery in oil prices, resulted in an overall fiscal position better than anticipated in the budget law. Indeed, preliminary data for 1999 indicate an overall budget deficit of about 0.5 percent of GDP compared to 3.9 percent in 1998.

In 1999, activity in the nonhydrocarbon sectors slowed down while inflation performance improved. Real growth decreased to 3.3 percent in 1999 from 5.1 percent in 1998 despite a strong performance in the hydrocarbon sector (6.2 percent). Nonhydrocarbon GDP increased by only about 2.5 percent against a 5.5 percent growth in 1998. In particular, activity in the agricultural sector and in the industrial public sector decelerated, which was mainly due to adverse weather conditions and continued structural deficiencies. Against this background and owing to a labor force growth of about 3 percent per annum, the unemployment rate has probably continued to increase to about 30 percent. The consumer price index (CPI) rose by only 2.6 percent on average in 1999 following a 5.0 percent increase in 1998. Part of the 1999 disinflation is attributable to lower food prices.

No new major reform was introduced between the end of the extended arrangement in May 1998 and the end of 1999. However, some of the reforms initiated during the program period, such as the overhaul of housing policies and the opening of the banking system to new domestic and foreign banks, continued to be implemented through 1999. Similarly, minority stakes in three public sector companies were listed in 1999 on the newly-created Algiers Stock Exchange. However, changes in tariff positions and the introduction since 1997 of minimum dutiable values for selected imports have resulted in increased effective protection.

Executive Board Assessment

Executive Directors commended the Algerian authorities’ success-in particularly difficult circumstances-in restoring macroeconomic balance and implementing wide-ranging structural reforms. Implementation of the authorities’ IMF-supported programs in the mid-1990s has resulted in improved growth, a marked decline in inflation, and stronger fiscal and external positions. At the same time, the role of markets in allocating resources has increased, and the trade and exchange system has become more liberal.

Directors praised the authorities’ policy response to the challenge of falling oil prices in 1998 and the first half of 1999. Demand management was tightened by cutting budget expenditure, the exchange rate was allowed to depreciate vis-à-vis the U.S. dollar, and real interest rates were kept high. These policies were important in limiting the depletion of foreign exchange reserves and consolidating the fiscal position.

Directors considered that higher oil prices and an improved domestic political climate had created an opportunity to address Algeria’s major policy challenges decisively-namely, to reduce dependence on the hydrocarbon sector; raise living standards; reduce unemployment from its very high level; and absorb the large numbers of new entrants to the labor force, without sacrificing the hard-won gains of macroeconomic stability. A substantial increase in the growth rate is essential in meeting these challenges and will require an acceleration of structural reforms to complete the transition to a market-based economy.

Against this background, Directors broadly supported the reform program announced in early 2000. They welcomed its emphasis on accelerating reform of the banking sector and public sector companies but stressed the need for detailed implementation plans. Directors emphasized the critical role that only the private sector could play in the reform process. The economic environment-including government regulations-should be improved to promote private economic activity, including domestic and foreign investment.

Regarding policies to preserve macroeconomic stability during the period of restructuring, Directors welcomed the supplementary budget for 2000 recently passed by Parliament, and endorsed the authorities’ intention to save any hydrocarbon revenue in excess of that budgeted in a stabilization fund. They strongly endorsed the authorities’ intention to ensure transparent management of the resources allocated to this fund, which should be appropriately integrated with other fiscal activities. To ensure a strong fiscal position over the medium term, Directors emphasized the desirability of reducing dependence on hydrocarbon revenue, and encouraged the authorities to continue to broaden the tax base and to strengthen tax and customs administration. Regarding budget expenditures, Directors recognized the need for a strong safety net, partly to preserve social consensus during a period of major transition. They also recognized the need to improve basic social services, particularly health and education. Meeting these demands on public resources in a sustainable manner would require continuing efforts to orient expenditure to items of the highest priority.

Directors endorsed the authorities’ intention to pursue a prudent monetary policy geared toward keeping inflation low, while further developing the role of indirect monetary policy instruments. Directors considered that Algeria’s exchange rate policy struck an appropriate balance between safeguarding competitiveness gains and preserving price stabilization gains. They also considered that the interbank foreign exchange market should be deepened through a further liberalization of the exchange system. Directors supported the authorities’ intention to manage external liabilities more actively and to request a rating of Algeria’s sovereign risk. Continued progress in these areas would further facilitate Algeria’s integration in capital markets and attract foreign investment.

Regarding specific steps in the process of structural reform, Directors attached particular importance to early and comprehensive improvement in the efficiency and financial health of the government-owned banks. This had to proceed in step with a thorough restructuring of public enterprises, claims on which accounted for a substantial share of these banks’ assets. Directors also stressed the need to strengthen banking supervision and, in this context, welcomed the authorities’ ongoing efforts to improve compliance with Basel Core Principles. They also welcomed the establishment of the National Council for Banking Reform.

Regarding reform of public sector enterprises, Directors emphasized the importance of accelerated and steadfast implementation of the privatization program within a fair and transparent framework. They welcomed plans to liberalize the energy, transport, and telecommunication sectors. Directors noted the critical need for improved housing as well as the role which housing construction could play in boosting employment and growth. They encouraged the authorities to formulate a comprehensive strategy to further reduce housing shortages and promote private sector investment in this sector. Directors saw particular urgency in improving the availability of land for housing and business construction, as well as a need to clarify agricultural land ownership.

Directors considered that the maintenance of a high degree of protection would impede growth. They urged the authorities to accelerate trade liberalization both on a regional and multilateral basis.

Directors welcomed the emphasis in the government’s program on improving governance and transparency through, inter alia, a reduction in government intervention in the economy and judicial reform. They welcomed the authorities’ participation in the pilot project on the publication of the Article IV staff report and the publication of a Report on the Observance of Standards and Codes module on banking supervision.

Directors welcomed the authorities’ interest in the General Data Dissemination System as a framework for redressing the significant weaknesses in Algeria’s economic statistics. In this regard, they believed that additional resources should be allocated to upgrade the statistical apparatus.

Directors welcomed the authorities’ intention to maintain a close policy dialogue with the Fund and to seek technical assistance in key areas of expertise of the Fund.