Public Information Notice No. 10/29

Public Information Notice: IMF Executive Board Concludes 2009 Article IV Consultation with Algeria

February 23, 2010

On January 8, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Algeria on a lapse of time basis.¹

Background

Algeria has enjoyed several years of strong economic performance driven by public spending, but continues to face important challenges. Nonhydrocarbon growth has been robust, inflation low and the government has accumulated large savings in the oil stabilization fund (FRR) to finance a sizeable public investment program (PIP) while reducing public and external debts to very low levels. However, the fall of global demand for hydrocarbons has exposed Algeria’s vulnerabilities. Despite the recent recovery of oil prices and the improvement of medium-term financial perspectives, the economy remains too dependent on hydrocarbon exports, unemployment, although declining, is still relatively high, and productivity and the business climate lag behind main trading partners. Nonhydrocarbon growth and job creation are largely sustained by public spending, highlighting the pressing need to accelerate structural reforms to diversify the economy and let a competitive and outward-oriented private sector emerge.

Algeria has faced the global slowdown from a position of relative strength. Growth in the nonhydrocarbon sector will likely reach 9 percent in 2009, reflecting an excellent cereal harvest and the continued strength of PIP-led service and construction sectors. Hydrocarbon production will decline further this year (by 6–7 percent) due to lower global demand, bringing overall growth down to about 2 percent. Headline inflation reached 5.8 percent (y-o-y) in September 2009 due to a 25 percent surge in fresh food prices, reportedly caused by structural shortcomings in the supply chain. With a small current account surplus, official reserves have grown by $3 billion since end-2008, reaching $146 billion at end-September 2009 (3 years of imports). Following the fall in hydrocarbon revenues, Algeria will post a fiscal deficit of 8 percent of GDP in 2009, following a surplus of 8 percent in 2008. This deficit should be largely financed with domestic nonbank resources. The real effective exchange rate continued to be close to its equilibrium level.

The outlook remains favorable in the short term, but is sensitive in the medium term to future levels of oil prices. Growth will continue to be sustained in the short term by large public spending and the acceleration of the national hydrocarbon company’s investment program. Nonhydrocarbon GDP could grow by 5½ percent in 2010, and hydrocarbon output should improve with the international recovery, contributing to overall growth of around 4½ percent. Inflation should come below 5 percent if fresh food prices stabilize. Higher projected international oil prices would improve the external and fiscal balances, but these would remain well below the large surpluses recorded in the past few years. A worsening world economy and a significant new decline in energy prices would present important downside risks in the medium term, as it would weaken the external and fiscal positions, force a scaling back of the PIP and other investments, and imply slower growth and higher unemployment. The medium-term outlook also rests on decisive actions to promote private sector development and economic diversification, as public spending alone cannot ensure long-term growth.

Structural reforms have been timid, and the business climate needs to be improved. The authorities have launched various initiatives aimed at increasing the banking system’s lending capacity and the efficiency of public spending, including increasing the minimum capital requirement for banks, reducing the level of nonperforming loans (NPLs) through financial restructuring of public enterprises, and improving fiscal management and budget system. However, the new regulations for foreign direct investment and the slow pace of regional and multilateral trade negotiations could hamper Algeria’s effort to ensure a sustainable export-oriented diversified growth. The perception of the business climate has not improved, and continues to be ranked behind those of most regional competitors.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They welcomed Algeria’s strong economic performance in recent years, with solid nonhydrocarbon growth and low inflation. In particular, they commended the authorities for prudent financial policies that have enabled a significant increase in reserves, the reduction of public and external debts to low levels, and the accumulation of large fiscal savings which will sustain the current fiscal stance in 2010. Nevertheless, they noted that the fall in oil prices and the ensuing deterioration in financial balances show that Algeria continues to face important medium-term challenges. Sustained efforts are needed to improve productivity, diversify the economy to reduce its high dependence on the hydrocarbon sector, and reduce high youth unemployment.

Directors supported maintaining the current fiscal stance in 2010 but encouraged the authorities to revert to a sustainable fiscal path over the medium term. They endorsed continued implementation of the PIP and support to SMEs, and noted that the sizable fiscal savings can be used to that effect. Nonetheless, Directors stressed that a thorough overhaul of the current and capital spending would free up budgetary resources, better preserve hydrocarbon wealth in the medium term and maintain fiscal space in case of adverse shock on oil prices. They welcomed the authorities’ commitment to prioritize execution of the current and future PIPs based on the fiscal outlook, and advised to firmly contain current expenditure, in particular the wage bill, to make room for additional maintenance costs related to the new infrastructure. They noted that the authorities’ ongoing advances to reform the revenue administration should boost further budget revenues, provided that growth in tax incentives is contained.

Directors stressed the critical importance of ensuring the quality and efficiency of public spending, which has become an important driver of Algeria’s nonhydrocarbon economic growth. In that respect, they welcomed the authorities’ program to modernize budget systems and the work done by the now fully operational projects evaluating agency.

Directors commended the authorities’ prudent monetary policy which helped contain inflationary pressures. They noted, however, that abundant liquidity associated with the hydrocarbon sector and public spending demands continued vigilance, and that the authorities should stand ready to tighten monetary policy if inflationary pressures from excess liquidity were to materialize.

Directors considered that Algeria’s exchange rate policy is consistent with medium-term external stability. They agreed with the staff’s assessment that the exchange rate is broadly aligned with fundamentals. Nevertheless, Directors urged the authorities to accelerate structural reforms to improve external competitiveness. While commending the authorities’ efforts to improve infrastructure, they stressed that these efforts are not sufficient to improve the investment climate. Directors noted that the new regulations for FDI projects could deter foreign investors to open subsidiaries in Algeria, preventing much needed technology transfer.

Directors encouraged the authorities to speed up financial sector reform to strengthen and improve the efficiency of financial institutions. In particular, recommendations of the 2007 FSAP Update of the financial sector could be implemented more forcefully, seeking to clarify the role of public banks and further strengthen their governance. Directors considered that possibilities for resuming the privatization process of major public banks could be explored, with the objective to increase the efficiency of the banking sector based on international best practices. They believed that ongoing efforts to reduce NPLs should continue, bringing their levels closer to those in comparable countries. Directors viewed the ban on consumer lending (except mortgages) as a potential hurdle to financial sector development, and suggested that it be removed once the household credit registry becomes operational.