V Monetary Policy and Financial Sector Reforms
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Ms. Nicole Laframboise
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Ms. Patricia Alonso-Gamo
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Mr. Alain Feler
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Mrs. Stefania Bazzoni
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Mr. Karim A. Nashashibi
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Sebastian Paris Horvitz https://isni.org/isni/0000000404811396 International Monetary Fund

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Language:
English
Print Publication Date:
06 Aug 1998
Keywords:
OP; government; reform program; public enterprise; Algeria's achievement; bank audit; housing bank; financial situation; restructuring effort; private bank; Commercial banks; Bank credit; Public enterprises; Credit; Inflation; Global
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Abstract

In the late 1980s, Algeria’s financial sector was small and segmented, operating de facto as a financing instrument for public sector investment—with little linkage between risk assessment and credit allocation—while financial markets were virtually nonexistent. The five commercial banks and the savings-housing bank (Caisse nationale d’epargne et de prevoyance (CNEP))—all government-owned—had no commercial activity. They collected household and enterprise savings through an extensive network of branches, and channeled these resources to finance imports and public enterprise operations. The latter were assigned to specified banks under a policy of domiciliation. This system, under which each financial institution carried out transactions in certain sectors or dealt with specific clients, led to market segmentation, limited expertise, and lack of competition. Nonbank financial intermediaries included a few insurance companies and pension funds, also publicly owned.

Background

In the late 1980s, Algeria’s financial sector was small and segmented, operating de facto as a financing instrument for public sector investment—with little linkage between risk assessment and credit allocation—while financial markets were virtually nonexistent. The five commercial banks and the savings-housing bank (Caisse nationale d’epargne et de prevoyance (CNEP))—all government-owned—had no commercial activity. They collected household and enterprise savings through an extensive network of branches, and channeled these resources to finance imports and public enterprise operations. The latter were assigned to specified banks under a policy of domiciliation. This system, under which each financial institution carried out transactions in certain sectors or dealt with specific clients, led to market segmentation, limited expertise, and lack of competition. Nonbank financial intermediaries included a few insurance companies and pension funds, also publicly owned.

The key role in the financial sector was played by the treasury, which mobilized most of the country’s savings through post office savings accounts and the issue of development bonds subscribed on a compulsory basis by the insurance companies and the CNEP. These resources were used mainly for financing new projects by public enterprises, which were generally undercapitalized and relied on bank borrowing for their investments. The central bank of Algeria played a subordinate role, and interest rates were set administratively at levels that resulted in negative real interest rates, steering managers to-ward capital-intensive investments.

In this environment, where output targets were more important than relative prices or profitability, financial institutions played a passive role. There was neither competitive savings mobilization nor credit allocation according to risk-weighted commercial criteria. Under these conditions, the absence of market-based prudential regulations on banking was of little immediate consequence. The central bank had little supervisory activity, and its rediscount window was just an instrument to provide banks with liquidity. The rediscount system was complex, including several categories of commercial paper to which different ceilings applied, and preferential rates for credit to some sectors. Limits were mostly mandatory and preferential rates favored lending to agriculture, real estate, and major investment projects. Algeria’s capital markets were virtually nonexistent, reflecting the small size of the private sector and that government bonds were nonnegotiable. Due to the presence of exchange restrictions on both current and capital account transactions, there was no integration with world financial markets.

The abundance of foreign exchange during the 1970s and early 1980s, coupled with limited reliance on market signals, allowed major imbalances in resource allocation to emerge. These misallocations resulted in low investment efficiency and an underutilization of productive capacity, as evidenced by high incremental capital output ratios. Public enterprises, operating under soft budget constraints and subject to government price and employment objectives, accumulated large debts. With mounting debt-service obligations and persisting inefficiencies, their financial situation turned precarious and, eventually, a large share of their debt became nonperforming. In 1986, with the downturn of world oil prices, the crippling effect of nonperforming assets on the balance sheet of commercial banks became apparent.

Weak financial intermediation was reflected in a ratio of currency to broad money (M2) of 40 percent and excess money balances, with a high liquidity ratio (M2/GDP) that peaked at 84 percent in 1988 (Table 7). The share of commercial bank resources accounted for by deposits was low (50 percent). As a result of the excess liquidity, parallel markets for many rationed products and for foreign exchange emerged, with prices frequently several times those on the official markets.

Table 7.

Monetary Survey

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Sources: Bank of Algeria; and IMF staff projections.

For comparison purposes, the data on credit to the government for December 1993 and December 1997 would need to be adjusted downward by DA 275.5 billion and DA 186.7 billion, respectively, representing the conversion into government bonds of public enterprises’ commercial bank debt, as part of a package of financial restructuring. Data on credit to the economy need to be adjusted upward by the same amount.

Includes the Societe nationale des transports ferroviaires, Sonelgaz, and the 10 food-importing agencies.

This includes part of the debt rescheduling proceeds that is not credited to the treasury account but instead blocked on a special account at the Bank of Algeria.

This increase appears large because of the debt swap operations in 1993 (see footnote I).

This drop is due to a change in the series as explained in footnote I. Excluding this effect, credit to the economy would represent about 40 percent of GDP in 1996.

Liquid liabilities are defined to include money, quasi-money, and savings deposits at the housing bank (Caisse nationale d’epargne et de prevoyance).

Financial Sector Reforms in 1989–93

In the context of Algeria’s transition to a market-oriented economy, the modus operandi of the financial sector was radically modified in 1989–91. Financial sector reforms were aimed at increasing reliance on market forces and competition, consistent with other market-oriented reforms. In response to the increasingly complex economy, the financial system had to be transformed from a mere conduit of funds from the treasury to public enterprises into a system that would play a dynamic role in resource mobilization and allocation. The key elements of such a transformation were the move to market-based instruments of monetary policy, the liberalization of interest rates, the progressive liberalization of current and capital account transactions, and the adoption of a more flexible ex-change rate policy.

The first stage of reform was to establish an appropriate institutional framework. The first major step was the decision in 1987 that the treasury would with-draw from financing the economy, and from then on, would only finance investment in infrastructure and “strategic” sectors. In 1987–88, several actions were taken to increase competition: most significantly, the government abolished the requirement of allocating clients to their specific banks depending on their sectoral activity and allowed financial institutions to work in different fields. In May 1989, a money market was instituted among commercial banks, which in turn were granted autonomy from the state. The central bank intervened in this money market through the newly introduced pension mechanism, a system of repurchase agreements between commercial banks and the central bank for short-term financing.

A watershed was reached in 1990, with the passage of the law on money and credit. This law (1) granted the central bank autonomy from the Ministry of Finance to conduct monetary policy (the central bank underwent an administrative reorganization that enabled it to meet its new responsibilities and was renamed the Bank of Algeria); (2) established the Council on Money and Credit, the monetary authority responsible for formulating credit, monetary, foreign exchange, and external debt policies;8 (3) introduced transparent rules to govern the relationship between the treasury and the financial system; and (4) established the principle of equal treatment for public and private enterprises in terms of access to credit, central bank refinancing, and interest rates, while commercial paper from the two sectors became subject to the same eligibility criteria.

Within this new institutional framework, a number of additional reforms were introduced in 1991 and 1992—a ceiling on the total access of commercial banks to central bank refinancing, while direct ceilings on commercial banks’ credit to the economy were abolished, as was the case for sector-specific rediscount rates.

The Bank of Algeria introduced financial programming in 1991, but monetary policy continued to rely on four direct instruments: (1) ceilings on bank credit to enterprises and on the amount of rediscounting by banks; (2) ceilings on net bank credit to 23 large public enterprises under financial restructuring; (3) subceilings on rediscounting of bank credit to these enterprises; and (4) discretionary ceilings on Bank of Algeria interventions in the inter-bank money market.

A major policy shift took place in 1992. The Bank of Algeria ceased to impose credit ceilings on commercial bank lending and started relying totally on central bank refinancing of the economy. The Bank of Algeria went a step further at the end of 1993 when it started redirecting a substantial portion of commercial bank refinancing toward the money market and away from the rediscount facility. Notwithstanding these improvements, bank-by-bank ceilings on access to the rediscount window and repurchase operations imposed on each bank remained the main instruments of monetary policy.

Important steps to expand the scope of the interbank money market were taken in 1992–93. First, participation was broadened to include nonbank financial institutions (e.g., insurance companies), which were allowed to lend out their excess funds; and second, the repurchase instrument was refined to allow the Bank of Algeria greater flexibility of intervention.

Conduct of Monetary Policy Since 1994

Notwithstanding these institutional changes, Algeria’s financial system was still saddled, in early 1994, by the legacy of several decades of administrative economic management. In particular, direct controls kept interest rates below market-clearing levels and limited the scope of indirect instruments of money and credit control. Moreover, the banking system, including the housing bank (CNEP), could not operate under market norms as long as many of their clients (public enterprises) were insolvent. Financial sector reforms could only succeed if public enterprise reforms were implemented at the same time. Substantial progress has been achieved on all these fronts since early 1994, when Algeria embarked on an ambitious IMF-supported program.9

Shift to Indirect Instruments of Monetary Management

By early 1994, the Bank of Algeria still controlled liquidity in the banking system by imposing ceilings on individual banks on the global amount of refinancing, and through the rediscount facility or repurchase agreements on the interbank money market. These two instruments, however, were still heavily geared to individual banks’ needs and were provided at the initiative of commercial banks. As a result, it was difficult for the Bank of Algeria to control liquidity effectively, while the bank-by-bank ceilings led to severe distortions in the allocation of resources.

To address these weaknesses, starting in October 1994, the Bank of Algeria imposed a reserve requirement on commercial banks, representing 3 percent of bank deposits (excluding foreign currency deposits) and remunerated at 11.5 percent—a substantial level, considering that in some neighboring countries, reserves were not remunerated at all. The efficiency of indirect monetary control was further strengthened in May 1995 when the Bank of Algeria started repurchase auctions to provide liquidity to commercial banks.10 These auctions aimed at increasing the role of interest rates by allowing for more competitive market practices and by providing greater transparency regarding the criteria for credit allocation.11 Under the auction system, the Bank of Algeria announced a minimum interest rate prior to the auction; subsequently, banks bid in terms of rates and volumes. Initially, the Bank of Algeria awarded refinancing at a single interest rate (standard auction), but in late 1995, it moved to a type of Dutch auction, awarding bids at the interest rates actually offered by banks. Auctions were initially held every six weeks but, in view of their increasing importance as the main refinancing instrument, since early 1996, they have been held every three weeks. By the end of 1996, refinancing through repurchase agreements and auctions accounted for about one-half of total refinancing, compared to about one-tenth at the end of 1994.

As a further step toward deepening financial markets, the government instituted in late-1995 a formal auction system (adjudication) to sell negotiable treasury bonds on the money market. Interest rates on these bonds reached 22.5 percent in early 1996 before declining to 17.5 percent at the end of 1996, reflecting the slowdown in inflation. Participants in the auctions include banks and nonbank financial institutions. The system facilitated the introduction of open-market operations by the Bank of Algeria in December 1996.12

Interest Rate Deregulation

Commercial bank deposit rates were liberalized in May 1990, but commercial banks’ lending rates still remained subject to a 20 percent ceiling a year. As a result, both types of rates remained negative in real terms in 1993–94, since they were not allowed to reflect the increasing inflationary pressures arising from the substantial relaxation of demand management policies that occurred in 1992–93. An important step taken under the 1994 reform program was, therefore, the abolition of the ceiling on commercial banks’ lending rates to the public. It was accompanied by the temporary imposition of a cap of 5 percentage points on commercial bank interest rate spreads, with a view to preventing an excessive increase of lending rates as a result of possible collusion among the five commercial banks. This cap on banks’ spreads was eliminated in December 1995. The deregulation of interest rates, together with the deceleration of inflation brought about by tighter demand management policies, eventually led to the emergence of positive real interest rates since the beginning of 1996 (see Table 8 and Figure 6).

Table 8.

Structure of Interest Rates

(In percent per year)

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Sources: Algerian authorities, central bank of Algeria, and Ministry of Finance.

Central bank overnight rate.

The ceiling on money market rates (18 percent) was abolished in April 1994.

In May 1990, deposit rates were liberalized, but remained in pratice constrained by ceilings on lending rates.

No interest is paid on sight deposits; interest on term deposits is subject to a 15 percent securities revenue tax, whereas government bond yields are tax exempt.

Prior to May 1990, lending rates were not allowed to exceed 3 percentage points above banks’ average cost of resources; starting from that date, they were subject to a ceiling of 20 percent a year. This ceiling was removed in April 1994, but a maximum margin of five points was imposed on banks until December 1995.

Free for banks to determine on the basis of LIBOR plus 150 basis points.

Based on the average cost of resources plus five percentage points.

Figure 6.
Figure 6.

Interest Rates

(In percent)

Source: Algerian authorities.

The interest rates on Bank of Algeria lending to commercial banks also evolved—rediscount rates, which offered preferential treatment to certain sectors, were replaced by a uniform rate in 1992; the ceiling on money market interest rates was removed in April 1994 as well.

Foreign Exchange Management

Several measures where taken in 1989–91 to liberalize the trade and exchange regimes (see Section VII). This initial set of reforms turned out to be insufficient, and in the face of a sharp deterioration of Algeria’s external situation from 1992 onward, the authorities intensified trade and exchange controls. The reform program initiated in April 1994 included trade and payments liberalization combined with a large depreciation of the Algerian dinar. Fixing sessions for foreign exchange at the Bank of Algeria were superseded by the establishment of an interbank foreign exchange market in December 1995. In December 1996, the Bank of Algeria authorized the establishment of foreign exchange bureaus. These institutional changes have greatly enhanced the Bank of Algeria’s capacity to manage monetary policy, increasing effective control of liquidity, and have enhanced transparency and efficiency in credit allocation with the increased reliance on market and price mechanisms and the shift away from direct controls. These changes have also complemented and supported recent reforms in other sectors, improving resource allocation and paving the way for the introduction of current account convertibility at the end of 1997.

Monetary Developments Since 1991

Monetary developments since 1991 can be decomposed into two contrasting periods that reflect a dramatic change in the macroeconomic stance. During 1992–93, monetary policy was essentially expansionary, geared to financing large budget deficits and credit needs of public enterprises. Moreover, a sizable share of the increase in bank credit during the period could be ascribed to the needs of the Rehabilitation Fund, established to finance public enterprise restructuring. By contrast, starting in 1994, monetary policy was tightened significantly with the aim of reducing inflation and supporting exchange rate stability.

During 1992–93, as a result of the lack of fiscal discipline and concomitant monetary loosening, the stock of total outstanding credit to government almost trebled (Table 7). At the same time, credit to the economy increased markedly in response to high demand from enterprises, whose financial situation had deteriorated owing to large wage increases and a general slowdown in the economy. In addition, banks had no choice but to extend credit to enterprises to enable them to meet their external debt obligations.

Consequently, broad money increased annually by 22 percent over 1992–93, largely reflecting domestic credit expansion—international reserves were stable over the period and thus played a limited role. Fiscal expansion and wage increases, coupled with shortages owing to import compression, led to excess liquidity and a monetary overhang, as reflected by an increase in the liquidity ratio by more than 4 percentage points from the end of 1991 to the end of 1993. During 1991–93, however, inflation actually declined, from 25.5 percent in the 12 months to December 1991 to about 20.5 percent on average for 1993. But the consumer price index did not reflect underlying inflation, particularly in 1993, because of the imposition of price controls and the emergence of shortages, which led in turn to the emergence of black markets and a large premium between the official and the parallel exchange rate. By contrast, the extensive price adjustments and liberalization and the Algerian dinar depreciations that took place in 1994 led to a sharp temporary increase of the CPI that year, to a peak of 38.4 percent by the end of December 1994, which was accompanied by a rapid increase in velocity (Figure 7). The marked decline in the share of currency in M2 during the period is noteworthy, as households attempted to protect the value of their savings against inflation (see Box 5).

Figure 7.
Figure 7.

Monetary Indicators

Source: Algerian authorities.1Defined as the ratio of M2 to GDP.

Starting in 1994, in the context of the reform program, monetary policy was tightened to achieve a rapid reduction in inflation. This policy was supported by the dramatic turnaround in the fiscal position, with a reduction in the budget deficit by more than 4 percentage points of GDP in 1994 and 3 percentage points of GDP in 1995. Fiscal restraint and the emergence of surpluses contributed to the steady decline in the stock of outstanding credit to government, which by the end of 1996 stood at about one-half of the December 1991 level. Credit to the rest of the economy plummeted in 1994, but gradually increased thereafter, along with the recovery in economic activity. In support of macroeconomic adjustment, the external debt relief granted in 1994 and 1995—as well as more favorable world oil prices in 1996 and 1997—allowed for an impressive strengthening of Algeria’s external position. Indeed, international reserves rose from $1.5 billion by the end of 1993 to $8.0 billion by the end of 1997.

Accordingly, broad money expansion slowed down in 1994–97. The excess liquidity created during the previous period was rapidly absorbed, and the liquidity ratio (M2/GDP) declined from 49 percent in December 1993 to below 37 percent in December 1997. The tighter monetary conditions resulted in a substantial reduction in inflation, from 39 percent in 1994 to 21 percent in 1995 and 15 percent in 1996, and below 6 percent by the end of 1997—a remarkable performance, particularly in light of the 50 percent devaluation that took place at the outset of the program period. That a substantial output recovery could materialize over 1995–97—despite the significant tightening of monetary conditions—bears witness to the fact that, under the new monetary policy, it was possible to channel credit efficiently toward more productive activities.13

Commercial Bank Restructuring Efforts

Before the reforms, Algerian commercial banks lacked the institutional framework and the experience to promote efficient financial intermediation. They were burdened by a legacy of compulsory lending to public enterprises, sectoral credit specialization, and inadequate prudential regulations, which weakened the quality of their portfolios considerably. The solvency of the banking sector deteriorated greatly over the years, to the extent that, by 1990, 65 percent of banks’ assets were nonperforming, and recourse to central bank refinancing was increasing at an alarming rate. To address these problems, a major financial reform package was adopted in May 1991 to restructure the banking and public enterprise sectors. This reform was supported financially and technically by the World Bank’s Enterprise and Financial Sector Adjustment Loan, which recognized the close financial interlinkages between banks and public enterprises. Under this reform package, in 1992–93, the government took over DA 275 billion of nonperforming banks’ claims on public enterprises (equivalent to 60 percent of the outstanding bank credit to the economy and 23 percent of 1992 GDP)14 in exchange for government bonds bearing annual interest rates of 10 percent with 12 years’ maturity.15

Starting in 1994, efforts were aimed at ensuring that commercial banks conformed to upgraded standards for banking operations and accounting and initiated a program of internal and financial restructuring. All existing banks were required to reapply for certification with the Bank of Algeria, which, as noted earlier, started imposing reserve requirements in October 1994. Subsequently, the authorities conducted audits, in collaboration with the World Bank, to determine the banks’ recapitalization needs to meet a minimum capital/risk-weighted assets ratio of 5 percent in 1996. This is to be increased to 8 percent by 1999, in line with Bank of International Settlements standards.16 At the end of 1994, audits of balance sheets had been completed for four of Algeria’s five commercial banks, indicating that, of the five state-owned banks, only the Banque Nationale d’Algérie did not need additional capital. On the basis of audits for 1995 and more recent supervision data collected by the Bank of Algeria, some additional recapitalization needs were identified for three public banks in 1998.17

Determinants of Inflation

In the 20 years up to 1990, when price liberalization started, annual inflation in Algeria averaged about 9 percent. Inflation only surged once, after the first oil shock in the early 1970s, reflecting higher import prices and strong demand pressures in the nontradables sector owing to the oil windfall. But price stability was only apparent: large budget deficits were being monetized, causing a monetary overhang, and inflationary pressures were repressed by pervasive price controls—in 1990, more than 50 percent of the items in the consumer price index (CPI) were subject to either price ceilings or margin limits—which resulted in widespread supply shortages. In the early 1990s, large devaluations led to increasing inflation, but also growing import and external debt-servicing costs, leading to higher budget deficits and mounting public enterprise losses. These imbalances were financed through money creation and, by the end of 1992, the 12-month inflation rate was 28 percent.

The 1994 stabilization program included a large up-front devaluation geared to improving competitiveness and restoring external viability over the medium term. The devaluation contributed to an initial increase in inflation, which reached 39 percent at the end of 1994, but a restrictive fiscal policy, a tight incomes policy and a nonaccommodating monetary stance soon led to sharp declines. By the end of 1996, the 12-month rate of inflation was down to 15 percent, and to 7 percent by the end of March 1997. This performance was all the more remarkable in the midst of price liberalization: administered prices more than doubled over 1994–96, and by early 1996, only less than 15 percent of the items in the CPI were regulated. While price liberalization allowed for the realignment of relative prices, its inflationary impact was minimized by a prudent monetary stance, which made room for those adjustments without feeding inflationary pressures. The recovery in money demand, in the wake of the successful stabilization effort, also contributed to the favorable inflation outcome.

Share in the CPI of Regulated Prices

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The government’s public sector wage policy was instrumental in reducing inflation. Wages declined in real terms by more than 30 percent over 1993–96, which helped to restore competitiveness. Wages were adjusted not on the basis of past inflation, but taking into consideration inflation expectations based on external prospects and productivity gains and, in the event, wage awards were consistently below inflation. The absence of widespread indexation mechanisms also contributed greatly to curb inflationary inertia. Furthermore, in early 1997, a two-year agreement for moderate wage increases in the civil service was reached, while wage increases in public enterprises were effectively delinked from civil service wage increases, and are to be based on the financial situation of each enterprise.

A simple econometrics exercise using ordinary least squares (OLS) attempts to identify some of the determinants of inflation in Algeria. From the second quarter of 1988 to the fourth quarter of 1996, three variables were found to be significant and influence price developments: changes in the money supply (M2), the nominal effective exchange rate, and movements in world oil prices.

Some Determinants of Inflation

(tratios in parentheses)

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Over 1991–96, commercial banks received DA 217 billion in cash, of which about 80 percent compensated for foreign exchange losses incurred on past external borrowing contracted on behalf of the state, while the remaining 20 percent went almost entirely for banks’ recapitalization. The Banque Extérieure d’Algérie and the Crédit Populaire d’Algérie were recapitalized in 1995 through budgetary contributions of DA 10 billion. The recapitalization has been financed by additional government interventions:

  • first, in 1996, the government issued DA 24.9 billion of 20-year bonds to recapitalize four of the five public commercial banks (excluding the Banque Extérieure d’Algérie);

  • second, during April 1997, DA 8 billion were disbursed by the budget to recapitalize the CNEP upon its transformation into a housing bank;

  • third, during the first quarter of 1997, the government swapped DA 187 billion of nonper-forming bank loans for 12-year treasury bonds (also in exchange for the nonperforming loans of the Société nationale des transports ferroviaires, Sonelgaz, and food- and pharmaceutical-importing agencies). This operation amounted to 24 percent of the stock of commercial bank credit to the economy at the end of 1996, and led to an increase in interest payments in the 1997 budget of about 0.6 percent of GDP.

The recapitalization of each bank was accompanied by the signing of performance contracts between the government and bank managers. Performance contracts hold the bank managers directly and solely responsible for respecting the capital adequacy ratios established by the Bank of Algeria. The banks, in turn, are being provided with increased autonomy with respect to operational decisions, notably the allocation of credit and, mainly, the denial of credit to high-risk enterprises.18 In this context, commercial banks started in 1996 to reschedule some of the debt of certain public enterprises by converting short-term overdrafts into medium-term loans. These debt restructuring operations have been conditioned upon the liquidation of a number of nonviable units within otherwise viable enterprises, the implementation of performance contracts by public enterprise managers, and equity participation from commercial banks (see Box 6).

In addition, in early 1995, the Bank of Algeria started to implement new prudential regulations that limit risk concentration and establish clear rules for loan classification and provisioning. In particular, banks are now required (1) to limit over-drafts to the equivalent of 15 days’ turnover (compared with 45 days previously); (2) not to register overdue interest payments as revenues; and (3) to establish provisions for off-balance sheet claims. This new framework is expected to tighten the budget constraint on banks and increase the incentives for bank managers to mobilize financial savings, improve the allocation of credit, and search for potential private partners.

Several measures were also taken to promote competition in the banking sector. An amendment to the Investment Code was introduced in 1994 to allow foreign participation in the capital of domestic banks and, although the five major commercial banks remain government-owned, the government is actively seeking a buyer for the Banque de Developpement Local (the existing 49 percent limit to private ownership does not apply if a foreign investor is buying a bank in its entirety). Further-more, a new private bank was chartered in September 1995 (Union Bank), along with the Caisse nationale de mutualité agricole, owned by private agricultural cooperatives. More private banks were authorized in 1997, including Citibank and Arab Bank.

Agenda for Further Reforms

Substantial progress has been made in the last few years in addressing the problems of the financial sector: establishing a sound and market-based system of bank intermediation; moving toward the use of indirect and market-based instruments for the conduct of monetary policy; and ensuring the use of market-based mechanisms for the mobilization of domestic financing for the budget (see Box 7). In-deed, indicators reveal that the volume and efficiency of financial intermediation grew considerably in the course of the reforms.19 Nonetheless, further reforms are still required to boost financial savings and promote an efficient allocation of resources.

Bank-Enterprises Mechanism

  • Prereform financial practices resulted in the accumulation of a massive amount of nonperforming loans by the banking sector. The adjustment and liberalization process exacerbated the problem, as inefficient state enterprises, unable to withstand competition and their external debt-service costs, which had more than doubled owing to the Algerian dinar devaluation, saw their financial position deteriorate further. To address the problem, banks were progressively recapitalized and public enterprises received large transfers from the treasury transfers mainly through the Rehabilitation Fund created in 1991. These partial measures, however, did not suffice. Public enterprises continued to lose market share while their low productivity impaired their ability to meet future financial obligations and to make adequate use of new financial resources. In view of the rapidly mounting restructuring costs, the Algerian authorities embarked on a new strategy that would move away from financial transfers from the budget and be geared toward protecting the strength of the financial sector and restoring the medium-term profitability of public enterprises in a market-driven economy. As part of the new strategy, the bank-enterprises mechanism was set up in September 1996, while the Rehabilitation Fund ceased operations at the end of 1996.

  • The bank-enterprises mechanism’s immediate objective was to address the mounting overdrafts at high interest rates of public enterprises and then restore progressively their financial situation. After a comprehensive audit of the enterprises’ accounts, the commercial banks and the 11 holdings that now group all large public enterprises, together with representatives from the central bank and the treasury, identified viable and nonviable production units. A plan was set up to normalize the financial relationship between economically viable enterprises and the banking system, with a large share of the overdrafts consolidated into medium-term loans at lower interest rates. The amount to be consolidated was estimated at DA 89.8 billion, equivalent to 14.1 percent of the end-March 1997 stock of total credit to the economy (excluding the 12 food-importing agencies and the utilities company and the railways). At the same time, stringent programs were adopted to compel enterprises to increase their productivity and to provide them with financial autonomy. Accordingly, the plan included the establishment of more than 502 subsidiary units with competitive prospects operating under tight bank supervision by the end of 1998 (of which 307 were in place by the end of December 1997). The operation was viewed by the authorities as a first step to-ward their privatization, expected to take place before the end of 1998.

  • Nonviable enterprises are being liquidated: from the end of November 1996 to the end of September 1997, 76 enterprises and 64 production units were liquidated. The reduction of excess labor in public enterprises is expected to lead to an increase in productivity. As of the end of December 1997, 158,936 employees had been laid off (see table below).

Impact on Holdings of Bank-Enterprises Agreements Through December 1997

(Excluding local enterprises)

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Source: Algerian authorities.

Monetary Control and Financial Reforms

In the context of Algeria’s transition to a market-based economy, the modus operandi of the financial sector has been radically modified during the last years. From a mono-bank-type system, where the treasury played a direct role in financing the economy by directing credit through state-owned commercial banks to inefficient, loss-making public enterprises, Algeria is moving progressively toward a modern market-based financial system.

Monetary regulation. In the late 1980s, a first round of measures was taken to improve the functioning of the banking sector, including the creation of a money market among commercial banks. The latter were granted autonomy from the state, and the system of repurchase agreements between commercial banks and the Central Bank of Algeria for short-term financing was introduced. In 1990, the Law on Money and Credit established a new monetary framework, which made some headway to-ward laying the institutional foundation of an independent central bank. In 1992, the Central Bank of Algeria ceased to impose credit ceilings on commercial bank lending and started relying totally on central bank refinancing of the economy. In October 1994, the Central Bank of Algeria imposed a remunerated reserve requirement on commercial banks (at 3 percent of deposits, excluding foreign currency deposits). Repurchase auctions to provide liquidity to commercial banks were introduced in May 1995. These aimed at increasing the role of interest rates by allowing competitive market practices to prevail and by ensuring greater transparency regarding the criteria for credit allocation. The number of auctions has increased steadily and they are now held every three weeks. Finally, open market operations were formally introduced at the end of 1996, although activity remains low because of excess liquidity currently present in the banking system and the limited supply of tradeable securities available to deepen the market. As regards interest rates, they were progressively liberalized during this process. Ceilings on lending rates were replaced by controls on interest rate spreads, then all controls were removed. Positive real interest rates emerged in early 1996.

Foreign exchange management. Fixing sessions for foreign exchange at the Central Bank of Algeria were superseded by the establishment of an interbank foreign exchange market in December 1995. To improve access to foreign exchange, the Central Bank of Algeria authorized the establishment of bureaux de change in December 1996. These have proliferated in 1997.

Bank restructuring/the regulatory framework. To strengthen financial intermediation in the economy, a major effort has been made to revamp the banking sector. In 1992–93, the government took over DA 275 billion of the banks’ nonperforming claims on public enterprises (equivalent to 60 percent of outstanding bank credit to the economy and 23 percent of 1992 GDP) in exchange for government bonds. The Rehabilitation Fund was closed at the end of 1996; the last disbursement (DA 10 billion) took place in December 1997, ending the recapitalization of banks. Since 1995, new prudential norms have been implemented, including limits on the concentration of risk and clear rules for loan classification and provisioning. At present, banks have to meet a capital/risk weighted asset ratio of 4 percent, which will increase to the BIS norm of 8 percent by 1999. To ensure that banks are complying with the new requirements, all banks will need to be relicensed by the Central Bank of Algeria. Two have already been relicensed, including a newly created private bank. To complete this process, bank audits are under way and are expected to be finalized by the end of 1997. Financial discipline imposed by banks in state enterprises has led to an improvement of bank loan portfolios. Moreover, to improve the operation of the banking system and to protect depositors, a limited deposit guarantee mechanism was introduced in December 1997. Finally, a program to modernize the payments system, aimed in particular at expediting intra- and interbank transactions, will be carried out with the technical support of the World Bank.

Broadening of financing instruments. To increase the number and type of financial instruments available, a stock market is expected to be operational before the end of 1997. The Commission for Stock Market Organization and Supervision has been created, as well as the Securities Exchange Management company. In this regard, Algeria has benefited from technical assistance provided by Canada, France, and Tunisia for personnel training. The first bond quotations should appear in December 1997, and stocks are expected to trade on the market in February 1998.

Housing finance. The housing bank (CNEP) was transformed into a mortgage bank, operating on a commercial basis in April 1997. A mortgage refinancing company and a mortgage guarantee company were created in September and December 1997, respectively. These two companies should help to broaden the financing possibilities for housing, including by enticing other financial institutions into the market.

First, high in the reform agenda is the deepening of the secondary market for government paper. Such a deepening would establish yield curves that would act as a benchmark to help guide intertemporal decisions and facilitate the conduct of open-market operations by the Bank of Algeria.

Second, efforts at strengthening the financial position of existing banks will have to continue so that they can achieve their targeted capital adequacy ratios and become profitable, which would facilitate their privatization. In this connection, steps will have to be taken to prevent the recurrence of large-scale nonperforming loans to public enterprises: on the one hand, success in banking reform will depend crucially on the consolidation of the public enterprise sector and the Bank of Algeria’s continued monitoring of commercial banks. On the other hand, competition among banks will need to be fostered, by the development of nonbank (stock and bond) financial markets. In this regard, further liberalization of entry into the sector, as well as privatization and increased foreign participation, would add dynamism to the sector by encouraging the adoption of new management practices and the acquisition of foreign expertise. The process of liberalization and deepening of domestic financial markets should eventually culminate with the liberalization of capital movements and a move to full convertibility that would expose domestic financial markets further to competition from world markets.

Third, steps will have to be taken to broaden the availability of long-term financing, by fostering the development of markets for commercial paper, mortgages, and other long-term instruments. In this respect, high priority must be given to completing CNEP restructuring, which is under way (see Section VI).

Finally, a stock market is being established. As a first step, a Commission for Stock Market Organization and Supervision was established in early 1997. Functioning equity markets are essential to promote a modern private sector, since they mobilize savings and constitute an alternative source of equity financing for enterprises as they help overcome the constraints of family-based traditional enterprises. They may also become a major instrument in mobilizing domestic and foreign savings to finance privatization—as illustrated by Egypt’s and Morocco’s successful experiences—and would be a key element for the success of privatization operations.

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Cover Algeria
Algeria
Stabilization and Transition to Market
ISBN:
9781557756916
ISSN:
0251-6365
Publication Date:
06 Aug 1998
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781557756916.084
Pages:
92
Figure 6.

Interest Rates

(In percent)
Figure 7.

Monetary Indicators