Public Information Notice No. 13/10

Algeria: IMF Executive Board Concludes 2012 Article IV Consultation

January 25, 2013

On January 16, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the 2012 Article IV consultation with Algeria.¹

Background

Algeria’s economic performance in 2012 is expected to remain solid. Growth is projected at 2.5 percent in 2012, supported by a buoyant nonhydrocarbon sector bolstered by public spending. It is forecast at 3.4 percent in 2013, underpinned by domestic demand and a recovery in the hydrocarbon sector. The current account surplus is expected to reach 8.1 percent of GDP in 2012, as higher hydrocarbon prices offset lower export volumes, and 7.0 percent of GDP in 2013. In 2012 and 2013, foreign exchange reserves will remain comfortable, at about three years of imports, and external debt levels will remain low. The oil stabilization fund, net of public debt, will be hovering at 26 percent of GDP. Risks to the economy are mainly tilted to the downside, as Algeria is vulnerable to a prolonged fall in oil prices, rising food prices on international markets (notably wheat), a worsening of the global economy, particularly in the euro zone, and increasing domestic pressure to use hydrocarbon rents. Outward spillovers from Algeria are expected to be limited.

Inflation surged to 8.4 percent in 2012, reaching a 15-year high, from 4.5 percent in 2011. Price increases were mainly seen in food and manufactured goods, spurred by excess liquidity resulting from the surge in current public spending that was financed by draw-downs from the oil fund, and possibly also by inefficiencies in the distribution chain. In May 2012, Banque d’Algérie raised the required reserves rate from 9 to 11 percent and increased liquidity absorption by 250 billion dinar (23 percent), thereby reducing free liquidity, but this was not sufficient to contain inflation.

Fiscal vulnerability increased as a result of the fiscal expansion of recent years. The fiscal balance is expected to deteriorate to 3.6 percent of GDP in 2012, from 1.3 percent in 2011, as a result of the full effect of increases in civil service wages and current transfers decided in 2011. As a consequence, the breakeven oil price is projected at $121 per barrel in 2012, up from $109 in 2011, reflecting an increased vulnerability to hydrocarbon prices. The new budget law for 2013 phases out the wage back payments, and allows for fiscal consolidation; the fiscal deficit is consequently expected to improve to 1.3 percent of GDP in 2013. Although the nonhydrocarbon deficit is projected to decrease to 40 percent in 2013 from 45.6 percent of nonhydrocarbon GDP in 2012, the real wealth per capita will continue to decline in the long run.

Growth is insufficient to dent unemployment. It is highly dependent on the public sector, funded by the hydrocarbon windfall, and it lacks diversification. Negative growth in the hydrocarbon sector over the past few years dragged down overall growth. Public investment has been growing at a slower pace since 2009, contributing to the slowdown in nonhydrocarbon growth. The real effective exchange rate appreciated in 2012, weighing on the external competitiveness that is needed to foster the contribution of net exports to growth. Despite recent efforts, the business environment remains cumbersome and hampers private investment, both domestic and foreign. Foreign direct investment, in particular, faces severe constraints on ownership. The banking sector is sound, but access to financing remains limited. Financial markets are underdeveloped. Unemployment has declined from a high of almost 30 percent in 2000 to 10 percent in 2011, but youth and female unemployment rates remain high, at 21.5 percent and 17 percent, respectively.

Executive Board Assessment

Executive Directors commended Algeria’s continued strong economic performance despite the difficult external environment. Directors noted, however, that rising inflation, continued heavy reliance on the hydrocarbon sector and public spending, and vulnerability to a prolonged decline in the oil price, as well as high unemployment pose significant challenges. Against this background, they encouraged the authorities to take measures to preserve macroeconomic stability, ensure long-term fiscal sustainability, and promote strong nonhydrocarbon growth.

Directors welcomed the authorities’ efforts to curb inflation, notably through increased liquidity absorption and higher required reserves by the Banque d’Algérie, and the fiscal consolidation embedded in the 2013 budget. However, to bring average inflation down to the targeted level, they recommended further tightening of monetary policy by mopping up excess liquidity and raising the discount and repurchase facility rates. Avoiding any further increase in public sector wages, and issuing government bonds to cover cash-flow needs, instead of reliance on the oil fund, will also play an important role. In addition, Directors saw scope for structural measures to help contain price pressures stemming from the supply side.

Directors noted staff’s assessment that the real effective exchange rate is in line with fundamentals. They welcomed the authorities’ intention to address the high parallel market premium. Directors considered that increasing foreign exchange ceilings for travelers will be a step in the right direction. They encouraged the authorities to further develop the interbank foreign exchange market.

Directors emphasized that further fiscal consolidation will be key to ensuring fiscal sustainability. In this context, policy efforts should gear towards containing current spending, especially the wage bill, better targeting subsidies, reviewing tax exemptions, and bolstering nonhydrocarbon tax revenues. Directors noted that explicitly considering an annual cap on drawdowns from the oil fund, set in the budget law, would strengthen the existing oil price fiscal rule. They stressed the need to enhance public financial management and to implement a full-fledged medium-term budget framework.

Directors welcomed the improvements in financial stability and called for steps to consolidate these gains. They encouraged efforts to strengthen bank intermediation by lifting the ban on consumer credit and supported the authorities’ plans to deepen the financial markets. Directors called for measures to address the remaining shortcomings in the AML/CFT (Anti-Money Laundering and Combating the Financing of Terrorism) framework and fully implement the action plan agreed with the FATF.

Directors emphasized the need for wide-ranging reforms to diversify the economy, improve the business climate and competitiveness, increase productivity, and boost growth, especially nonhydrocarbon growth. Efforts should also focus on promoting private investment, further liberalizing trade, and supporting a more efficient and knowledge-driven economy. Directors recommended safeguarding public investment and improving its quality and enhancing the public sector’s absorptive capacity. They encouraged the authorities to review and amend the restrictive FDI (Foreign Direct Investment) regime. Directors agreed that policies aimed at improving the jobs/skills match and enhancing labor market flexibility, along with effective active labor market interventions, will help increase employment, especially for the young and women.