Buoyant Capital Spending and Worries over Real Appreciation: Cold Facts from Algeria

IMF Working Papers, December 1, 2007

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The Government of Algeria has pursed a relatively expansionary fiscal policy in recent years, thanks to rising oil prices and revenues.
The paper explores the potential effects of such a stance on real exchange rate and uncovers a relatively small appreciating effect of increased government capital expenditure.
A significant share of capital spending falls into tradable imported goods, which helps explain the relatively small appreciating effect.
The envisaged increase in capital spending, if well designed and implemented, might in the long-run translate into rising operations and maintenance expenditure—mostly nontradable goods—thereby causing a higher real appreciation.
This implies that Algeria should carefully consider the implications of its public investment program on recurrent expenditure.

Increased government capital expenditure → large share directed to tradable imported goods → limited immediate pressure on real exchange rate.
Over the long run, successful capital projects can raise operations and maintenance (O&M) expenditure.
O&M expenditure is largely on nontradable goods → higher demand for nontraded sector → potential for higher real appreciation.

Consider the composition of public investment: distinguish between capital spending on tradable imported goods and capital spending that will generate future nontradable recurrent costs.
Evaluate the long-run fiscal implications of capital programs, including projected operations and maintenance expenditure.
Design and implement capital spending programs with attention to their recurrent-expenditure footprint to mitigate risks of real appreciation.