Public Information Notice No. 05/10

Public Information Notice: IMF Concludes 2004 Article IV Consultation with Algeria

January 28, 2005

On January 12, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Algeria.¹

Background

Faced with low growth and high unemployment—and in the context of buoyant hydrocarbon revenue—Algeria adopted a four-year fiscal stimulus plan in 2001. Real GDP growth has strongly recovered from its slowdown in 2000. Inflation has remained subdued, and the country's external position has strengthened significantly. The pick-up in growth has also led to a considerable drop in the still high unemployment rate, while the fiscal stimulus could increase fiscal vulnerability.

Algeria's economic performance was favorable in 2004. Real GDP growth is expected to decrease to about 5½ percent in 2004 from 7 percent in 2003, due to a slowdown in the expansion of hydrocarbon output and in agriculture following the 2003 bumper crop. As a result, the unemployment rate is expected to continue to decline.

The rise in the oil price on international markets has further strengthened Algeria's external position. Despite strong import growth, the external current account surplus is projected to increase further in 2004, reflecting higher hydrocarbon export prices. Gross external reserves increased to US$37.3 billion by end-September, covering almost two years of imports. After early debt repayment of about US$900 million to the African Development Bank and Saudi Arabia, the external debt-to-GDP ratio is projected to decline from 35 percent in 2003 to 25 percent this year.

The fiscal stimulus to overall demand persisted in 2004. The government's fiscal policy is expected to lead to an increase in the primary nonhydrocarbon budget deficit from 29½ percent of nonhydrocarbon GDP in 2003 to almost 32 percent in 2004. Nevertheless, higher oil prices are expected to allow for an overall stronger fiscal position.

Monetary developments were characterized by a significant rise in the amounts of the central bank's liquidity absorption, in the context of a substantial increase in net foreign assets. Broad money growth is expected to be contained to about 16 percent in 2004, and inflation to remain below 4 percent.

While structural reforms remained slow, some progress was achieved in banking reform and trade liberalization. The authorities have strengthened public banks' performance contracts and advanced in modernizing the payment system. They also revised part of the legislative framework in line with WTO rules, while pursuing negotiations towards Algeria's WTO accession.

Following presidential elections, the government strengthened its resolve to push ahead with external trade liberalization and other structural reforms, including in the banking sector. The fiscal policy proposed in the 2005 budget represents a turning point in the direction of government finances. With the control of public expenditure outlined in the budget, the nonhydrocarbon primary deficit in percent of nonhydrocarbon GDP is projected to be reduced gradually over the medium term.

Executive Board Assessment

Executive Directors commended Algeria's strong macroeconomic performance in recent years, which has been marked by higher economic growth, low inflation, and rapidly growing international reserves. Unemployment has come down gradually, although it remains very high. Favorable world energy prices played a major role in achieving these results, but a fiscal stimulus also added impetus to economic growth. Furthermore, Algeria's economic outlook for 2005 and beyond remains favorable.

Going forward, Directors called on the authorities to seize the opportunity provided by the current favorable economic climate and improved security situation to consolidate macroeconomic stability, sustain high economic growth, and significantly reduce unemployment. The key challenges in achieving these objectives will be to accelerate the transition to a market economy, diversify the sources of economic growth, and establish a framework for sound management of the country's hydrocarbon wealth. To meet these challenges successfully, the Algerian authorities will need to accelerate the implementation of structural reforms, with emphasis on strengthening the financial sector, creating a business environment conducive to private investment, and increasing the competitiveness and resilience of the economy.

Directors acknowledged that achieving the appropriate balance between using large hydrocarbon revenues for investment in physical and human capital to accelerate the transition to a more diversified market economy and saving the hydrocarbon wealth for future generations represents a key challenge for a natural resource-rich economy. In this context, they considered that within a fiscally prudent framework, the Algerian authorities should persist in their efforts to transform the economy. They welcomed the steps taken by the authorities to set fiscal policy within a long-term framework that delinks public spending from fluctuations in hydrocarbon revenue. Many Directors supported the idea of transforming the current hydrocarbon stabilization fund into a savings/financing account that is fully integrated into the budget.

Directors commended the authorities for the prudent medium-term fiscal policy presented in the 2005 budget. They noted that the planned fiscal consolidation will put the public finances on a path that is compatible with the sustainable spending of hydrocarbon resources. Directors regarded the containment of spending in 2005 as a first step towards reducing fiscal vulnerability. They acknowledged that priority capital and social spending should be protected, including programs for human capital development, and noted the sizeable capital budget planned for the medium term. However, they stressed that the investment process will need to be carefully managed to reduce waste, minimize the impact on current spending in the future, and enhance transparency. They underscored the importance of careful selection of public investment projects on the basis of efficiency and absorptive capacity considerations. In this context, Directors welcomed the authorities' readiness to conduct a public expenditure review in cooperation with the World Bank. They also supported the development of an adequate social safety net to help cushion the adverse short-term impact of reforms. Directors also emphasized the importance of increasing non-hydrocarbons revenue through strengthening tax administration and broadening the tax base.

Directors welcomed the authorities' continuing resolve to focus monetary policy on maintaining low inflation. They reiterated their concern about the potential impact of the high excess liquidity on macroeconomic stability and financial system soundness. Therefore, most Directors encouraged the authorities to deal with the hydrocarbon company's deposits outside the money market and to mop-up the residual excess liquidity.

Directors observed that managed float of the exchange rate continues to serve the country well. They welcomed the Bank of Algeria's commitment to continue implementing the managed float in a flexible manner to bolster resilience to external shocks and export diversification prospects. Directors supported the authorities' request for Fund technical assistance to improve the exchange system and develop the foreign exchange market to help reduce the large spread between the official and parallel market exchange rates.

Directors urged the authorities to give priority to developing an efficient and sound banking system. They drew attention to the adverse impact on the banks' balance sheets stemming from lending to loss-making state-owned enterprises. Directors therefore welcomed the tighter control of public bank managers and the inclusion of subsidies in the 2005 budget to replace some loans to loss-making enterprises. They emphasized, however, that these subsidies should be temporary and set in the context of a public enterprise restructuring program. Directors also called for implementation of the other recommendations made in the 2003 Financial System Stability Assessment. They urged the authorities to reverse the decree prohibiting public entities from dealing with private banks, to move ahead with the privatization of a number of public banks, and to significantly strengthen bank supervision. They welcomed the establishment of a Financial Intelligence Unit, and encouraged the authorities to press ahead with the implementation of legislation to combat money laundering and terrorism financing.

Directors commended the important progress achieved in trade liberalization and the authorities' commitment to reform trade within a multilateral framework, ahead of joining the World Trade Organization. In particular, they welcomed the continuing implementation of the comprehensive tariff reform since 2001 and look forward to early ratification of the EU Association Agreement. They encouraged the authorities to improve customs administration in order to combat corruption and smuggling more effectively, and to strengthen regional cooperation.

Directors encouraged the authorities to reduce the state's direct involvement in the productive sectors through more rapid and extensive privatization of state-owned enterprises. They cautioned that making privatization conditional on the maintenance of jobs and activity could hinder the privatization program, and recommended replacing these conditions with social safety net measures. More generally, Directors called for a clear articulation of Algeria's privatization strategy so as to provide unambiguous signals to private investors.

Directors encouraged the authorities to continue efforts to improve governance, which they considered crucial to improve the investment climate and prospects for private sector-led growth. They welcomed the preparation of a draft organic public finance law to improve fiscal transparency, and urged the authorities to take further steps to improve transparency, including implementation of the recommendations of the 2004 Fiscal Report on the Observance of Standards and Codes (ROSC).

Directors welcomed the authorities' active debt management and looked forward to an early resolution of bilateral debt issues with Russia. Several Directors saw room for a more ambitious approach to the pre-payment of external debt, given Algeria's high level of foreign reserves. Although commending the authorities' decision to grant debt relief on a case-by-case basis to HIPC-eligible countries, Directors encouraged Algeria to participate fully in the enhanced HIPC Initiative.

Directors welcomed the ongoing efforts to address Algeria's statistical weaknesses. They urged the authorities to strengthen data coverage, quality, and timeliness, particularly with respect to banking sector data. In this regard, Directors encouraged the authorities to join the General Data Dissemination System, with a view to subscribing subsequently to the Special Data Dissemination Standard.