Public Information Notice No. 06/28

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Algeria

March 9, 2006

On February 13, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Algeria.¹

Background

The Algerian economy continues to benefit from abundant and increasing hydrocarbon revenues. Real GDP growth is expected to continue at about 5 percent in 2005, led by increased output in the hydrocarbon sector and sustained activity in the construction and services sectors. Inflation is projected to remain low, mainly due to a decline in food prices, and the unemployment rate continued to decline.

Boosted by high oil prices, the external position strengthened further. Despite a continued surge in imports, the external current account surplus is projected to increase further in 2005, reflecting a rapid increase in oil prices as well as an expansion of oil production. Gross external reserves grew by US$20 billion since end-2003 to US$53 billion at end-September 2005, covering more than 1½ year of imports. With continued early debt repayment, the external debt-to-GDP ratio is expected to decline further from 26 percent in 2004 to 16/ percent in 2005.

In the context of buoyant hydrocarbon revenue and the need to address infrastructural bottlenecks, the government decided in 2005 to boost public spending and launched a Growth Consolidation Plan for 2005-09 amounting to US$50 billion. In June 2005, the program was revised upward to US$57 billion. As a result, the nonhydrocarbon primary deficit is expected to widen from 28 percent of nonhydrocarbon GDP in 2004 to 31½ percent in 2005. Nevertheless, higher oil prices would allow for a stronger overall fiscal position, with the overall surplus increasing almost twofold from 6.9 percent to 12.6 percent of GDP.

Monetary policy remained prudent with the Bank of Algeria (BA) adopting several measures to mop up the rapidly increasing liquidity in the banking sector. As a result, BA was able to absorb most excess bank liquidity. However, BA's policy interest rate remains negative in real terms, despite an increase from ¾ percent in 2004 to 1¼ percent in July 2005. Annual broad money growth continued at about 12 percent through September 2005. Credit to the economy accelerated in the first half of 2005, while the level of nonperforming loans remained high.

Important progress was achieved in structural reforms. The Association Agreement with the European Union (AAEU) became effective in September 2005, and negotiations towards Algeria's accession to the World Trade Organization are in their final stages. The authorities strengthened performance contracts of public bank managers and shareholder oversight, initiated the privatization of a public bank, and made progress in modernizing the payments system. A new hydrocarbon law was adopted that further liberalizes investment in this sector. The government has also submitted an anti-corruption law to parliament.

Executive Board Assessment

Executive Directors commended the authorities for their prudent macroeconomic policies and welcomed Algeria's robust economic performance in recent years, noting the decline in the unemployment rate, continued strong economic growth, low inflation, and comfortable external and fiscal positions in the wake of high world energy prices.

Looking forward, Directors agreed that prospects are favorable for sustaining strong economic growth and further reducing unemployment, especially among the young. In view of the greater competition resulting from further external trade liberalization, Directors underlined the importance of speeding up priority reforms aimed at encouraging private sector investment and job creation, and accelerating the transition to a market economy. The considerable increase in hydrocarbon revenue provides an excellent opportunity to step up the pace of economic and social development.

Directors noted the authorities' decision to use part of the fiscal space created by the higher hydrocarbon revenues to increase public investment. The investment program appropriately envisages building much-needed public infrastructure, developing human capital, improving public services, supporting economic activity, and expanding housing. While some caution was expressed concerning the somewhat front-loaded distribution of investments in light of constraints on absorptive capacity, Directors generally supported the authorities' strategy of making upfront expenditure authorizations as a signal to economic agents that investment resources will be available over a longer time horizon. At the same time, Directors stressed that the high quality of public spending needs to be assured. In this context, they welcomed the authorities' intention to take into account the recommendations of the ongoing public expenditure review undertaken in cooperation with the World Bank.

Directors welcomed the authorities' resolve to maintain fiscal sustainability over the medium term. They stressed the importance of preparing comprehensive medium-term budget projections, and limiting increases in real wages to increases in productivity in the non-hydrocarbon sector in order to preserve Algeria's competitiveness as the economy opens up further.

Directors emphasized that sound management of hydrocarbon wealth will be critical to maintaining macroeconomic stability and enhancing the competitiveness of the nonhydrocarbon sector, and advised setting fiscal policy within a long-term framework. Appropriate coordination between fiscal and monetary policies and the continued transparent use of hydrocarbon revenues will also be needed. Directors welcomed the authorities' intention to reconsider the role of the oil stabilization fund—the Fonds de régulation des recettes (FRR)—including transforming it into a savings/financing account; such an account should be fully integrated into the budget. Some Directors encouraged Algeria to participate in the Extractive Industries Transparency Initiative.

Directors commended the authorities for the prudent conduct of monetary policy that has kept inflation under control. However, the planned increase in public investment and the current strong growth of credit to the economy could complicate monetary management. Directors encouraged the authorities to consider tightening the monetary stance by raising the Bank of Algeria's (BA) policy interest rate to a positive level in real terms, and to strengthen the BA control over base money.

Directors welcomed the authorities' commitment to continue implementing the managed float of the exchange rate of the dinar in a flexible manner. They noted the pressures for a real appreciation resulting from the increase in oil prices and the current economic growth. Directors encouraged the authorities to continue their commendable work toward ensuring the free convertibility of the dinar for international current transactions, in line with recent Fund technical assistance recommendations.

Directors welcomed the authorities' reform program to develop a stronger and more efficient banking system. They urged the authorities to push ahead with the privatization of several public banks, improve the management and governance of the remaining public banks, and promote competition in the sector. Continued improvement of the operational framework for financial intermediation, including by ensuring that the banking commission can enforce prudential regulations effectively, will be critical. Directors encouraged the authorities to continue the ongoing modernization of the payments system, as well as their capacity building efforts in banking supervision, with Fund technical assistance.

Directors welcomed Algeria's commitment to trade liberalization and the ratificationof the AAEU in 2005. They encouraged the authorities to step up the negotiations for the country's accession to the World Trade Organization. They considered that regional trade facilitation and integration would enhance the positive impact of the AAEU and help attract foreign direct investment.

Directors urged the authorities to take advantage of the current favorable economic conditions to accelerate their efforts at improving the business environment to support private sector-led growth. Adequate resources need to be mobilized in support of further market-based reforms, including to limit the social cost of priority reforms in the public banking and public enterprise sectors. The tax system should be streamlined by eliminating exemptions, and the tax burden on businesses should be reduced in order to stimulate investment and job creation. Directors recommended reducing further the state's direct involvement in the productive sectors, and subjecting all remaining public enterprises to annual external audits in line with international standards, and publishing the results.

Directors praised the authorities' policy to prepay external debt, and welcomed Algeria's voluntary advance repurchase to the Fund. They encouraged the authorities to continue their efforts to seek a settlement of bilateral debt issues with Russia.

Directors welcomed the authorities' support for the HIPC Initiative, but encouraged their full participation in the Initiative.

Directors welcomed the authorities' decision for Algeria to participate in the General Data Dissemination System (GDDS). They encouraged them to continue their efforts to improve data coverage, quality, and timeliness, in order to support effective policy making.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.