Public Information Notice No. 12/5

Public Information Notice: IMF Executive Board Concludes 2011 Article IV Consultation with Algeria

January 27, 2012

On January 11, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Algeria on a lapse of time basis.¹

Background

Despite an uncertain international economic environment, the Algerian economy has been doing relatively well. Real nonhydrocarbon GDP growth in 2010 reached 6 percent and total GDP growth was 3 percent. Overall inflation fell to 3.9 percent in 2010 due to a fall in fresh food prices, while nonfood inflation remained low. Unemployment continued to decline slightly to 10 percent at end-2010, but youth and female unemployment remain high. The generally prudent macroeconomic management during 2000–10 has enabled large external reserves to be accumulated and sizable budgetary savings to be built up in the oil stabilization fund, while substantially reducing debt levels.

In 2011, growth is estimated to have remained solid and higher oil prices are strengthening Algeria’s external balance and boosting fiscal revenues. The ripple effects of the Public Investment Program (PIP) are expected to maintain nonhydrocarbon growth at about 5 percent, and to bring overall GDP growth to about 2.5 percent. Higher international prices

for food and substantial civil service pay rises have so far not led to significantly higher inflation, because of increased subsidies for basic food products, a higher level of household savings, greater demand for imports, and a vigilant monetary policy. Overall, inflation is expected to have stayed at about 4 percent in 2011. With higher oil prices, the current account surplus will increase to 9.5 percent of GDP in 2011 and hydrocarbon fiscal revenues rise by 30 percent. Official reserves have grown by US$16 billion since end-2010, reaching US$178 billion at end-August 2011 (three years of imports). The budget will remain in deficit at around 4 percent of GDP as a 32 percent increase in total expenditure, in particular higher public salaries and transfers, will more than offset higher fiscal revenues.

The outlook remains favorable in the short term, but fiscal sustainability and financial stability over the medium term have become more dependent on volatile oil prices. Growth will continue to be supported in the short term by public investment and the national hydrocarbon company’s investment program. Nonhydrocarbon GDP could grow by 5 percent in 2012, but hydrocarbon output would continue to decline because of weak global demand, constraining overall growth to about 3–3½ percent. Inflation would remain at about 4 percent if fresh food prices remain subdued and inflationary pressures from increased wages are contained. Over the medium term, the relatively high projected oil prices would sustain a positive external balance and large fiscal revenues, but the budget balance will remain in deficit.

Nevertheless, the expansionary fiscal stance of recent years has made the fiscal position vulnerable to oil price swings as the break-even price that balances the budget now slightly exceeds US$100/barrel. Important downside risks will arise in the event of a worsening in the international economic environment and a prolonged decline in oil prices. The external and fiscal positions would be seriously weakened, likely forcing scaling down public investment and leading to slower growth and higher unemployment. Also, much smaller resources in the oil stabilization fund would be left over for future generations.

Important challenges persist, including the need for diversification of the economy, improving the business climate, reducing unemployment, as well as curtailing medium-term vulnerabilities. With public investment expected to play a less dynamic role in the economy, the private sector will need to become a stronger engine for growth and employment creation. To achieve this objective, in 2011 the authorities launched a series of consultations with social partners to improve the business environment, which is central to improving long-term growth prospects.

Executive Board Assessment

Executive Directors welcomed Algeria’s overall good economic performance in recent years amid a difficult international economic environment. Nevertheless, they noted that significant challenges persist, and encouraged the authorities to renew their efforts to preserve macroeconomic stability, restore fiscal prudence, and diversify the economy with a stronger private sector. Further reducing unemployment, especially among the young, and enhancing economic opportunities for all remain pressing needs. More decisive structural reforms are vital to achieving these goals.

Directors stressed that while high oil prices provide scope for addressing pressing social demands and maintaining social stability, this should be managed carefully to avoid inflationary pressures and preserve medium-term fiscal sustainability. They noted that the significant growth in current expenditure in 2011 has made the fiscal position vulnerable to the risk of prolonged lower oil prices. Directors encouraged the authorities to adopt fiscal consolidation measures, which could include limits on wage increases and new hires, and a better targeting of transfers and subsidies. The continuation of greater mobilization of nonhydrocarbon fiscal resources and tax administration reforms should also help reduce the budget’s dependency on hydrocarbon revenues.

Directors emphasized the importance of ensuring good quality and efficiency of public expenditure. As the budget is the main lever in using and redistributing hydrocarbon wealth, they encouraged the authorities to build on recent progress in controlling the quality of public investment and to advance more forcefully in key areas of budgetary reform.

Directors commended the Bank of Algeria for containing inflationary pressures and effectively absorbing greater systemic liquidity from higher hydrocarbon revenues and large public spending. The significant growth in liquidity has not translated into higher inflation, but the risk of inflation has increased. In addition to the moderation of current spending, Directors noted that the authorities should consider tightening monetary policy early to prevent inflationary pressures from materializing. Directors considered that the exchange rate regime has served Algeria well. They welcomed the authorities’ commitment to maintaining the real exchange rate close to equilibrium, but emphasized the need to strengthen exchange rate fundamentals, including the fiscal position and productivity gains.

Directors stressed that, to make a significant dent in unemployment, a more ambitious structural reform agenda should be implemented. While welcoming the authorities’ efforts to support SMEs financing and improve the business environment, in consultation with social partners, they emphasized that stronger measures will be necessary for diversification of the economy, improving competitiveness, and boosting growth and employment. Directors also considered that the advances in financial sector reform should continue in order to address key constraints that limit financial intermediation and access to financing for the private sector. Moreover, they noted that increases in labor costs well above productivity gains, and constraints to private investment, such as the limitations to FDI adopted in 2009, hamper competitiveness and growth prospects. Directors encouraged the authorities to ensure a better synergy between macroeconomic policies and the structural reform agenda. They also encouraged the authorities to continue to seek better integration of Algeria into the regional and global economy.