Public Information Notice No. 98/63

Public Information Notice: IMF Concludes Article IV Consultation with Algeria

August 24, 1998

On July 24, 1998, the Executive Board concluded the Article IV consultation with Algeria¹.

Background

Over the past four years, Algeria has implemented a comprehensive program of economic adjustment and structural reform, supported by a stand-by arrangement and subsequently, since May 1995, by an extended arrangement that expired on May 21, 1998. In addition to Fund resources, Algeria’s program was supported by other multilateral and bilateral donors including the Arab Monetary Fund and the World Bank, and by debt relief from Paris and London club creditors. The objectives of the program included achieving macroeconomic stabilization and assisting Algeria in a process of reforms aimed at reinvigorating growth by creating a market-based and private sector-led economy integrated with the rest of the world.

Under the Fund-supported programs, Algeria was successful in restoring macroeconomic balances: inflation was lowered to 5 percent and international reserves exceeded nine months of imports at the beginning of 1998. At the same time, backed by a broad consensus between government, labor, and the private sector, a large number of reforms were implemented to dismantle the existing centrally planned system, open up the economy, and establish market mechanisms, including the liberalization of all prices and the elimination of generalized food subsidies. Moreover, the state started to withdraw from production activities, and a large number of local public enterprises have been closed or privatized. However, progress in privatizing the large public enterprises (EPEs) has been slow. This significant change in Algeria’s economic direction was achieved against a backdrop of civil unrest that muted the supply response to economic reforms.

In 1997, despite the robust performance of the hydrocarbon sector, real GDP growth slowed to 1.2 percent after two consecutive years of growth at 4 percent. Agricultural output fell in the wake of a severe drought, and industrial production continued to decline due to the ongoing restructuring process in the public sector and low foreign and domestic investment. These developments put further strain on the labor market as unemployment remained high at around 28 percent. Meanwhile, tight fiscal and monetary policies, coupled with a relatively high level of oil prices, led to a strengthening of public finances and the external position. Indeed, the authorities, as in 1996, saved most of the oil windfall. As a result, the budget surplus reached 2.4 percent of GDP while the external current account showed a surplus equivalent to 7.3 percent of GDP, contributing to a further accumulation of international reserves. Economic reforms focused on restructuring public enterprises. More than half of the small local public enterprises were liquidated or privatized, while the public sector withdrew almost completely from distribution and importing activities. In addition, in the second half of 1997 Algeria accepted the obligations of the Fund’s Article VIII and established the full convertibility of the dinar for current account transactions.

For 1998, while economic growth is likely to rebound, financial balances are expected to deteriorate due to the sharp decline in oil prices. Agricultural output should rebound in response to more favorable weather conditions and industrial production is projected to recover. Moreover, despite cuts in output to support international oil prices, hydrocarbon production is estimated to grow by about 6 percent. Nonetheless, with lower oil prices, the budget balance was projected to deteriorate. To preserve the gains obtained on the stabilization front, the authorities have taken measures to compensate for lower than expected budgetary receipts and to deal with needed additional capital expenditure on infrastructure that had been previously postponed. As a result, the outcome for 1998, on the basis of present policies, would be a budget deficit limited to 1.9 percent of GDP. As far as the external accounts are concerned, and despite lower export receipts and a projected import recovery, only a small current account deficit is expected for the year. Despite the end of external debt rescheduling as of June 1998, international reserves would decline only slightly in 1998. Structural reforms are expected to focus on the privatization of the 250 EPEs that comprise the government’s program for 1998–99, and legislation is expected to clarify private ownership rights over agricultural land. Privatization of large public enterprises should help consolidate financial sector reforms, in particular the development of the stock exchange that was opened at the beginning of 1998. Meanwhile steps to increase private participation in and modernize the operations of banks, notably the payments system, should enhance their efficiency. Efforts will continue to establish an adequate institutional and legal framework to protect property rights and to reform the public housing sector.

Although recent discoveries have boosted prospects for hydrocarbon production, Algeria’s medium-term economic prospects are clouded by the risk of low oil export prices. Therefore, creating an environment conducive to increased private sector investment and growth in thenonhydrocarbon sector is essential for employment creation and a sustained improvement in living standards.

Executive Board Assessment

Executive Directors commended the authorities for their steadfast implementation, under very difficult circumstances, of an ambitious program of macroeconomic adjustment and structural reform supported by the Extended Arrangement. They noted that over the past four years, tight macroeconomic management, favorable oil prices, and the timely implementation of a comprehensive program of structural reforms had resulted in the substantial deceleration in inflation, a strengthening of the fiscal and external position of Algeria, and further progress toward a market-oriented economy.

However, Directors expressed concern about the sluggish economic growth in 1997 in the nonhydrocarbon sector and the resulting further tensions in the labor market, and about the potential impact on the budget and the external position of the recent fall in oil prices. In that connection, they emphasized the need to maintain a tight stance of fiscal and monetary policies to preserve the stabilization gains of recent years and to accelerate structural reforms to achieve the ambitious growth and employment objectives outlined in the government’s medium-term program.

Executive Directors praised the authorities’ determination to save the windfall from higher oil prices in 1996 and 1997 which, coupled with firm expenditure restraint, had led to fiscal and external current account surpluses. They underscored that those prudent policies would make Algeria better prepared to weather the current external oil price shock.

Directors recognized the unavoidable deterioration in the budgetary and external position, owing to the recent fall in oil prices. They therefore supported the authorities’ revised fiscal plan for 1998. However, they emphasized the need for the authorities to be ready to take supplementary spending and revenue measures in the event of a further deterioration in oil prices, so as to contain the internal and external imbalances that might emerge. Over the medium term and in order to reduce the budget’s heavy dependence on hydrocarbon revenues, Directors also emphasized the importance of further broadening the tax base through reform of the value-added tax and reducing tax and customs exemptions. They also recommended that the authorities contain public sector wages and pursue the reform of the civil service so as to allow adequate budgetary allocation for priority expenditure in key social sectors.

Directors endorsed the authorities’ intention to pursue a prudent monetary policy geared toward keeping inflation low and strengthening external reserves, while providing adequate financing to the private sector. They welcomed the authorities’ intention to conduct monetary policy mainly through open market operations.

Directors recognized the difficult political and social context that had slowed to a certain extent the current structural reform process. Nevertheless, they underscored the need to deepen and accelerate structural reforms, in particular the privatization of public enterprises, land, financialintermediaries, and housing. Those reforms would help to promote private sector participation in the economy. In that regard, Directors welcomed the progress made in dismantling and privatizing local public enterprises and the courageous measures aimed at restructuring all public enterprises, while noting that those actions had resulted in numerous liquidations and widespread labor retrenchment. They were concerned about delays in privatizing the 250 public enterprises announced in September 1997, and especially the large ones, and urged the authorities to move swiftly in that area. They stressed that a rapid implementation of the program would help boost confidence and signal the government’s commitment to reform. Directors also underscored the beneficial role that the law on privatization of agricultural land could have in promoting investment in the agriculture sector, and urged the authorities to act promptly to adopt that legislation.

Directors welcomed the measures taken in recent years to strengthen the financial position of banks. They encouraged the authorities to speed up the auditing process of state-owned banks in order to proceed rapidly with their privatization and to preserve a sound financial system, as a key element for improved resource allocation and economic development. In that regard, Directors stressed the need to strengthen banking supervision. Directors welcomed the steps taken to deepen financial markets, including the establishment of a stock market and the associated regulatory institutions for its operations. Those developments should help promote investment, especially foreign direct investment, and encourage savings.

Directors emphasized the need to preserve an adequate social safety net, which would also help to maintain the social consensus in support of economic reforms. In particular, they emphasized the need to maintain the financial viability of the unemployment insurance scheme, which had come under pressure in the wake of higher unemployment following the restructuring of the industrial public sector. In addition, Directors urged the authorities to take rapidly the required steps to restore the financial soundness of the pension system. Also, Directors underscored the critical role of the housing sector for employment creation, promoting private-sector-based growth and alleviating urgent social needs. While Directors welcomed the creation of new financial institutions, they urged the authorities to pursue the needed reforms in that sector.

Directors welcomed the strengthening of the external accounts, with the official foreign exchange reserves reaching almost a year of imports at end-March 1998. They underscored, however, that the medium-term balance of payments prospects are now less favorable than at the time of the last review under the Extended Arrangement, because of the much lower prevailing oil prices, while alternative sources of external financing remain scarce as Algeria has yet to regain full access to foreign financing on appropriate terms. These developments illustrate the vulnerability of Algeria’s external position and underscore the need to develop nonhydrocarbon exports. Directors stressed the need for an exchange rate policy in line with the economic fundamentals so as to avoid a real effective appreciation of the dinar on a sustained basis, in order to support the diversification of the economy and increased openness without undermining the inflation objective. They welcomed the steps taken to open the economy and commended the authorities for the removal of all restrictions on the convertibility of the dinar for current transactions. Directors encouraged the authorities to undertake furthernonpreferential tariff reductions to increase competition, improve resource allocation, lay the basis for export development, and pursue the opening of the economy.

Directors observed that major challenges remain to be addressed in order to ensure the transformation of Algeria into a full market economy. They hoped that the continued close cooperation with the Fund, including further technical assistance, would contribute to the transition process. In that context, some Directors indicated that the Fund should remain open to a request from the authorities for a more intensive policy dialogue.