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Algeria: Selected Issues Paper

Author(s):
International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
December 2014
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Fostering Export Diversification in Algeria1

Algeria’s heavy dependence on the hydrocarbon sector is unsustainable, and will lead to a major worsening of the country’s external position absent a comprehensive export diversification strategy. A successful diversification strategy would entail macroeconomic policies that are geared toward supporting external competitiveness and avoiding real exchange rate swings and real overvaluation, an opening of the trade regime, and wide-ranging structural reforms to improve the business climate, including a comprehensive export-promotion strategy. Reforming the implicit subsidies on hydrocarbon products would help the economy navigate the transition by extending the lifetime of the resource.

A. Introduction

1. Algeria’s development model relies heavily on the exhaustible hydrocarbon sector. With 98 percent of its exports, 30 percent of its GDP, and 38 percent of its fiscal resources stemming directly from the hydrocarbon sector in 2013, Algeria is a highly oil-dependent country. However, the expected lifetime of the hydrocarbon resource does not match the dependency level: assuming no new discoveries, oil resources are expected to be depleted in 20 years, and gas in 55 years.

No-Policy Change Long-Term Scenario

Source: IMF staff calculations.

2. Under a no-policy-change scenario, Algeria’s currently strong external position is expected to worsen considerably. The depletion of the hydrocarbon resource will lead to a current account deficit and a rapid worsening of the external position if nonydrocarbon exports and capital inflows fail to increase much from their current low levels (see Box 1 for the simulation assumptions).

3. To ensure long-term external sustainability and secure the living standard it has achieved for its population, Algeria needs to reduce its reliance on hydrocarbon exports. This paper explores policies to achieve long-term external sustainability. Section B describes the status of hydrocarbon dependency. Section C underscores the risks to further delays in diversifying exports. Section D identifies Algeria’s strengths and weaknesses against the experience of successful diversification stories; section E offers policy recommendations.

B. Algeria’s Hydrocarbon Dependence: Stylized Facts

4. Algeria’s economy is dependent on the hydrocarbon sector. The hydrocarbon sector accounted for 30 percent of GDP and 60 percent of government revenues in 2013. Although these shares are smaller than in most Middle East, North Africa, and Central Asia (MCD) oil exporters, nonhydrocarbon GDP is largely dependent on hydrocarbon revenue–financed public spending: for example, the construction sector is largely financed by the public sector, and public consumption is a large share of GDP.

Hydrocarbon Revenue

(In percent of total revenue, 2013)

Source: IMF staff calculations.

Hydrocarbon GDP

(In percent of total GDP, selected oil-rich countries, 2002-12)

Sources: WEO; and IMF staff calculations.

5. Hydrocarbon dependency is particularly marked for exports. Hydrocarbon exports account for 98 percent of total exports in Algeria. This is large in comparison to other oil exporters: for instance, the share of hydrocarbon exports in MCD oil exporters was 78 percent (non-weighted average) in 2013. The high export dependency and relatively contained share of the hydrocarbon sector in GDP in Algeria are atypical in MCD oil exporters.

6. Nonhydrocarbon exports are dominated by chemical products and agriculture. These flows are extremely small and scattered across a large number of product categories, reflecting a lack of strong industries or products on which to build export diversification. Services exports also appear underdeveloped, notably compared to non-oil-exporting countries, and are largely related to hydrocarbon exports.

HC dependency and NHGDP

(MCD countries, 2013)

Sources: WEO; and IMF staff calculations.

Composition of nonhydrocarbon exports

(In percent of total nonhydrocarbon exports, 1998—12)

Sources: WITS; and IMF staff calculations.

Services in total exports

(Share of total exports, in percent)

Sources: WEO; and IMF staff calculations.

Number of export partners

(2008-2012 average)

Sources: WITS; and IMF staff calculations.

7. Algeria has a diversified set of export partners.

  • During 1998–2007 Algeria steadily increased the number of its export partners, and has maintained a stable number of partners since then. As a result, Algeria has a somewhat more diversified set of export partners than other oil-exporting countries. Although oil dominates bilateral exports, this relatively large set of partners offers a strong base on which nonhydrocarbon exports could grow. It is, however, considerably smaller than in non-resource-rich countries such as other countries in the Middle East and North Africa.
  • The EU remains Algeria’s main export partner, with a share that has been hovering close to 60 percent since the late 1990s, but trade with Asia has been rising recently. The share of exports to the United States has been declining quickly since its peak in 2007, largely because of the decline in U.S. hydrocarbon imports resulting from the exploitation of nonconventional oil, which is highly substitutable for Algeria’s oil products. Diversification toward Asia accelerated in the mid-2000s, largely driven by exports to China. Sub-Saharan Africa remains marginal among Algeria’s export partners, but represents a large untapped potential.

Exports to the EU and US

(In percent of total exports, 1998-2012)

Sources: WITS; and IMF staff calculations.

Exports to Asia and Africa

(In percent of total exports, 1998-2012)

Sources: WITS; and IMF staff calculations.

8. Algeria’s trade is characterized by a very limited number of export categories per partner, and suffers from a lack of sophistication of the export basket.

  • More than 60 percent of bilateral exports are made of at most five product categories (HS6 level of disaggregation), a share that has remained broadly stable over the past decade. By contrast, the average number of HS6 products traded by partner in other Middle Eastern and North Africa (MENA) countries is much higher, and the share of bilateral trade flows that count five products or fewer is much lower.
  • Data also point to the lack of sophistication of Algeria’s export basket. The export quality index for Algeria, which was relatively high at the start of the 1990s, has been declining since. This trend was largely driven by developments in mineral fuel exports, while the quality of nonhydrocarbon exports declined compared to oil and non-oil exporters in the second half of the 2010s. In 2010, the quality of exports was in line with the average quality index for oil exporters, but had fallen below the average of non-oil exporters, reflecting a worsening of the specialization structure of the country which can be seen in the low level of high-tech products in Algeria’s manufacturing exports. The analysis of the product space of exported goods by Hausmann and others (2010) suggests that the country is highly specialized in products that offer very little opportunity to expand the export basket. In the middle of the 2000s, the share of new exports in the basket was very low.

Average number of traded HS6 products

(Selected MCD and other countries, 2008-12)

Sources: WITS; and IMF staff calculations.

Share of bilateral trade flows including less than 5 HS6 products

(In percent of the number of bilateral trade flows, 2008-12)

Sources: WITS; and IMF staff calculations.

Overall export quality index

(1990-2010)

Source: IMF diversification toolkit.

High technology exports

(Percent of manufactured exports, 2013)

Source: World Bank, World Development Indicators.

C. The Urgent Need for Export Diversification

9. Finding new sources of growth and exports. Algeria’s extreme dependence on hydrocarbon exports is out of line with its proven reserves, underscoring the fragility of its growth model and the unsustainability of the current account over the long term. Even though Algeria is a large producer—notably for gas—the lifetime of existing reserves is limited. Unless significant new reserves are found in the next few years, it is urgent that the country’s development and growth model rely on a more diversified productive basis. Progress achieved over the past decades in terms of development would otherwise be at risk.

Duration of oil reserves

(In years of 2012 production)

Source: BP Statistical Review of World Energy.

Duration of gas reserves

(In years of 2012 production)

Source: BP Statistical Review of World Energy.

10. Creating jobs. The large increase in the workforce, expected in the next 25 years, makes the issue of job creation even more pressing, and calls for a rapid diversification of the production structure. Limited gains in employment can be expected from commodity specialization, as shown by recent experience in Algeria and other oil-exporting countries. Hydrocarbon production is highly capital intensive, and its potential for employment creation is limited: in Algeria, employment in the extractive industries only accounts for 2 percent of total employment. The large hydrocarbon revenues support significant hiring in the public sector (notably in noncommercial services) but, as noted in Jewell (2014) and Tapsoba (2013), the level of current spending is inconsistent with long-term sustainability, given the short expected life of hydrocarbon reserves. Therefore, a model of employment financed by the hydrocarbon rent is not a long-term option for employment creation, making diversification of production and exports an absolute and urgent necessity.

Employment share by sector

(In percent of total employment, 2011)

Source: ONS, Enquete emploi aupres des menages 2011.

Employment in Nongovernment Services

(In percent of employment by category, 2013)

Source: ONS.

11. The implications of hydrocarbon dependency are especially dire for the external position, as indicated in a simple long-term scenario (Box 1 summarizes the assumptions underlying the simulation).

  • Under this baseline scenario, new discoveries allow the hydrocarbon reserves to grow at their historical rate, the current use of hydrocarbon reserves (consumption and exports) is unchanged until they are depleted, and export diversification remains limited. Foreign exchange reserves are progressively depleted to finance growing current account deficits, until they stabilize at 3 months of imports and external debt is used to fill the current account gap. This baseline scenario leads to a very rapid worsening of the international investment position starting in 2035, when oil production ends.
  • An alternative scenario explores the easing of the external constraint that would be brought by a one-off 50 percent increase in proven reserves (both oil and gas). Under unchanged production and domestic consumption assumptions, the production horizon increases somewhat, but as soon as hydrocarbon reserves run out, the international investment position worsens, switching from surplus to a 120 percent of GDP deficit in eight years, underscoring that one-off new reserves discoveries bring no structural change to the long-term outlook. Because the adjustment has been delayed by the hydrocarbon discovery, imports are higher when oil reserves run out, and the international investment position deteriorates more quickly.
  • A diversification scenario assesses the impact of changes to the economy’s productive structure. This scenario combines structural reforms to improve Algeria’s competitiveness and a relaxation of capital controls to attract foreign direct investment (FDI) in the nonhydrocarbon sector. Those measures, in turn, lead to the diversification of both production and exports. The assumptions are loosely calibrated on the macroeconomic performance of Vietnam, an oil-exporting, fast-growing economy, over 1990-2012. The scenario assumes that FDI inflows reach 5 percent of GDP per year for 20 years, before slowing down smoothly and stabilizing at 2 percent of GDP.2 This critical mass of structural reforms supports higher nonhydrocarbon GDP growth (6.8 percent for 20 years, slowing down smoothly to 3 percent a year at the end of the projection period). Hydrocarbon production, exports, and consumption are unchanged compared to the baseline scenario. Nonhydrocarbon exports increase, reaching 20 percent of GDP at the end of the projection period.3 Even though higher FDI increases imports and the development of the economy also raises somewhat the GDP elasticity of imports, the trade balance improves toward the end of the projection period, and the worsening in the international investment position is contained. Further increasing nonhydrocarbon exports by 5 points (to 25 percent of GDP) yields a much improved international investment position.
  • These stylized scenarios underscore the unsustainability of Algeria’s external account under fundamentally unchanged policies. Extending the lifetime of oil and gas reserves relaxes the constraints somewhat but fails to relax the external constraints under the model’s assumptions. External sustainability clearly depends on export diversification brought by a diversification of the productive structure through increased openness to FDI and trade.

Box 1.Main Assumptions of the Baseline Long-Term Scenario

The following assumptions are used for the long-term macroeconomic model:

  • Gas and oil reserves grow at the annual average historical rate of 0.6 percent and 1.2 percent respectively (BP data from 1980).
  • Real NHGDP growth stabilizes at its long-term potential of 4.5 percent by the end-2020, and slows down progressively over the long term to 2 percent in 2055.
  • The exportable surplus of oil and gas is constrained by domestic consumption, which increases by 2 percent for oil and 4.5 percent for gas, while production grows by 2 percent per year.
  • Nonhydrocarbon exports slowly grow as a share of GDP, but remain small (4.4 percent of GDP by the end of the projection period). The other source of foreign exchange, FDI, also increases slowly and stabilizes at 2.5 percent of GDP.
  • Reserves are kept at a minimum of 3 months of imports of goods.
  • Debt builds up to ensure payment of imports and the stabilization of reserves.

Figure 1.Algeria: External Sustainability Scenarios

D. Policies to Diversify Away from Natural Resources: Algeria in the Light of Existing Policy Lessons

12. Cross-country experience suggests that successful diversification hinges on a combination of policies. Those range from providing a stable macroeconomic environment that preserves the competitiveness of nonresource exports; offering an enabling business climate; and developing export-promotion strategies. Measures need to be taken beyond traditional macroeconomic policies, and include, notably, labor market, financial sector, and education or innovation policies.

Supportive macroeconomic policies

13. Sound macroeconomic management is critical to contain the effects of the natural resource rent on the economy. Resource-rich countries are prone to the so called “Dutch disease,” which results in relative price distortions that penalize the exportable sector, stimulate imports, and lead to a diversion of productive resources away from the exporting sectors towards the nontradable sectors.

14. Overvaluation needs to be avoided for diversification strategies to succeed. Overvaluation penalizes exports and stimulates imports that compete with domestic production (Gelb, 2010). Algeria’s exchange rate policy is appropriately designed to target a real effective exchange rate close to its fundamental value. However, the real effective exchange rate has been at times, on the strong side, notably when large increases in current spending in 2011–12 led to high inflation that was not sufficiently offset by nominal exchange rate depreciation.

15. Procyclical fiscal policies should be avoided. Procyclicality leads to overheating and risks triggering excessive real appreciation when the price of the resource and associated fiscal revenues are high. Fiscal rules that provide an anchor to fiscal policies are a useful tool for demand management; they ensure that part of the resource rent is saved, to smooth the effect of price volatility and/or to save for future generations. Algeria’s policy of saving a large part of its hydrocarbon proceeds has helped to manage domestic demand but has not been adequate at containing procyclical spending. The large wage increase of 2011, however, illustrating the limit of a policy that is not set into a binding framework, led to declining oil savings as a percent of GDP.

Procyclicity of public spending

(Spending in DZD billion)

Sources: Algerian authorities; and WEO.

Oil savings and oil price

(2000-13)

Sources: Algerian authorities; and IMF staff calculations.

16. Domestic liquidity should be insulated as much as possible from the effects of inflows from the natural resource sector.

  • Large foreign currency inflows from natural resource exports increase liquidity and can fuel inflation, leading to excessive real appreciation of the currency. In Algeria, the banking sector is not fully insulated from natural resource inflows, because hydrocarbon receipts are legally required to be held in dinars in commercial banks. As a result, deposits from the hydrocarbon sector appear to drive excess liquidity. Although the BA does have mopping-up instruments, excess liquidity suppresses interest rates and complicates monetary policy by depriving the monetary policy toolkit of use of the interest rate transmission channel.
  • To insulate the economy from the effect of large swings in natural resource revenues, one option is to invest abroad part or all of the savings from the resource sector. This restrains liquidity shocks stemming from large inflows from the resource sector, and supports effective domestic demand management by containing procyclical spending, thereby helping prevent real overvaluation. A number of countries have set up sovereign wealth funds to this end.4 In Algeria, the oil savings fund (Fonds de Régulation des Recettes—FRR) helps to sterilize part of the excess liquidity stemming from the hydrocarbon resource, but the possibility of almost unrestricted government drawdowns limits the effectiveness of the sterilization.5

Hydrocarbon sector resources and liquidity

(In DZD billion)

Source: Algerian authorities.

17. The composition of spending matters for management of external competitiveness.

  • Large increases in current spending—notably through increases in public sector wages—can have a detrimental effect on competitiveness: they weigh directly on the real exchange rate through their effect on domestic demand and relative prices; they also weigh on cost competitiveness through the diffusion of public sector wage increases to the private sector. In Algeria, the recent wage increases were not matched by productivity improvements, and have led to a rise in unit labor costs.
  • Conversely, productivity-enhancing public spending is likely to support competitiveness: for instance investment that reduces transportation or transaction costs for businesses, or social expenditures that increase long-term productivity by enhancing human capital. Algeria has undertaken significant efforts to increase public investment, and ranked high in 2013 in terms of public investment to GDP. However, the country’s investment efficiency is relatively weak in terms of both the quality and quantity of its infrastructure, as suggested by an efficiency frontier analysis (Albino-War and others, 2014). Algeria’s investment efficiency score of 0.29 (in terms of investment quantity) suggests that, under ideal circumstances, Algeria could have built up to 71 percent more infrastructure with the same amount of investment.

Wages vs. Productivity

(Index, 2005 = 100)

Sources: Algerian authorities; and IMF staff calculations.

Investment Efficiency Score

(Infrastructure quantity)

*Commodity exporters with strong institutions (WGI>90).

Source: Albino-War et al. (2014).

Openness to trade and capital flows

18. Trade openness supports diversification through a lower cost of inputs and competition.

  • High tariffs on imported inputs, while they may protect some infant industries, may also raise production costs in other sectors, creating distortions that prevent a rapid diversification. In addition, long-lasting protection of domestic production behind elevated trade barriers can prevent the productivity gains and innovations that are needed to promote diversification over the long term, particularly in sectors where imported inputs incorporate significant technological progress.
  • Against this background, Algeria’s trade openness appears limited. This is partly the result of a protective trade policy that has historically focused on import substitution as the backbone of Algeria’s diversification strategy. As a result, both tariff and nontariff barriers are high, and participation in free trade agreements limited. In particular, Algeria has not joined the WTO.

19. FDI can play a crucial role in promoting export diversification and needs to be encouraged.

  • The role of FDI in export diversification is a priori ambiguous: on the one hand, FDI into the natural resource sector may further tilt the export structure towards hydrocarbons; on the other hand, other FDI flows may spur output and export diversification. FDI to serve the domestic market may not affect the export structure immediately but may increase domestic output diversification and open the possibility for more diversified trade flows later; FDI to serve external markets leads more directly to export diversification. Gourdon (2012) provides evidence that FDI significantly reduced trade concentration in a panel of 127 countries during 1998–2006.
  • Against this background, Algeria’s very low levels of FDI inflow appear as a lost opportunity. This is compounded by the fact that a large share of FDI flows (more than 50 percent on average over 2009-13) is directed towards the hydrocarbon sector, suggesting that FDI flows have so far had a limited contribution to diversifying exports. Although the underlying reasons for the low level of FDI are probably manifold, the legal provision that FDI projects be majority-owned by Algerian partners (the so-called “49/51 rule”) appears as an important impediment. Indeed, Algeria was the only country of a sample of 88 to impose an overall restriction on FDI ownership, while other countries tend to have provisions for strategic sectors (World Bank, Investing Accross Borders, 2010).

Net FDI inflows

(In percent of GDP)

Sources: WEO; World Development Indicators; and IMF staff calculations.

Favorable business climate

20. Business climate issues go beyond governance and the conditions for starting a business, and include financial sector conditions and labor market conditions. Low impediments to trade (both exports and imports), access to finance, and access to a large pool of well-skilled workers, are all elements that contribute to supporting the export sector.

21. In Algeria, business climate indicators are disappointing and underscore the difficulties faced by exporters. The limited development of the financial sector, the high cost of starting a business, and the cumbersome procedures all impede business development, and affect both the domestic and export-oriented sectors. In addition, the exporting sector further suffers from the high cost of trading,6 and capital controls can further complicate businesses’ attempts to expand their activities abroad.

Impediments to Trade
Cost (in US$ per

container, 2013) of
Time to (in 2013)Logistics

Performance

Index
ExportImportExportImportRank, 2014
Algeria1,2701,330172796
Morocco5959701116n/a
Tunisia7758601317110
Egypt6257901215n/a
Turkey9901,235131430
Iran1,4702,1002537n/a
Source: World Bank, Doing Business; and Logistics Performance Report 2014.
Source: World Bank, Doing Business; and Logistics Performance Report 2014.

Figure 2.Algeria’s Trade Openness

22. An environment that fosters productivity is instrumental, as demonstrated by the experience of successful countries that were able to target both productivity increases and large employment gains. Algeria has important strengths, such as a large, educated labor force; but the country suffers from skills mismatches because education is not well targeted to businesses’ needs. In addition, Algeria’s innovation capacity appears limited, another impediment to developing products and services that can be competitive on international markets.

Number of students in tertiary education

(Per 100,000 inhabitants, 2011)

Source: World Bank, World Development Indicators.

WEF Rankings on Innovation

(2014)

Source: World Economic Forum Competitiveness Report 2014/15.

Export strategies

23. Export promotion strategies can help increase the volume and the variety of exports. A World Bank study (López-Cálix and others, 2010) suggests that export promotion strategies should focus—beyond ensuring macroeconomic stability and a sound business climate—on reducing the anti-export bias and improving trade facilitation and access to services. This implies reducing the information asymmetry exporters face when trying to enter new markets. Export promotion policies generally include support in identifying markets, meeting quality requirements in target markets, or designing an appropriate marketing policy.

24. Policies to foster export diversification should focus on supporting “first movers” as they enter the market (as opposed to supporting already established actors). Existing experience includes the Egyptian private association ExpoLink approach of identifying strong entrepreneurial producers of traditional goods, creating small business clusters and providing targeted training on exporting. The Tunisian Famex provides grants and technical assistance to firms with no previous export experience, to exporters of new products, and to exporters who seek to penetrate new markets.

Entrepreneurship

(2004-2012 average)

Source: World Bank, World Development Indicators.

1/ Number of newly registered companies with limited liability per 1,000 working-age people.

2/ Number of newly registered corporations during the calendar year.

25. Industrial policies can also be considered to support selected sectors, although caution is called for in light of the risks associated with “picking winners.” There can be a case for industrial policies when dynamic economies of scale or knowledge spillovers affect a sector; when coordination failures prevent a sector from developing; or when informational externalities also prevent the development of a sector (Pack and Saggi, 2006). The international experience of the past 50 years suggests “picking winners” and supporting infant industries can be difficult, because excessive government protection tends to lower incentives to seek productivity improvements and enhance international competitiveness. Industrial policies should, therefore, be carefully focused on sectors with high export potential and strong integration into international value-added chains. These sectors should be supported by policies that foster backward linkages; technology spillovers can be useful in supporting industrial development and export diversification. Other “soft” industrial policies, consisting for instance, of increasing openness to FDI, or setting up industrial clusters and export processing zones, can also be instrumental, as shown in the case of the Indian software industry.

Energy policies: Diversification takes time.

26. Cherif and Hasanov (2014) stress that countries like Indonesia, Malaysia, and Mexico—all relatively successful cases of diversification away from hydrocarbon resources—prepared the ground for diversification before oil revenues started falling. In took 28 years (with data starting in 1970) for Indonesia to increase the share of nonhydrocarbon exports in GDP by 20 percentage points; 20 years for Malaysia; and 40 years for Mexico (starting from a low exports-to-GDP ratio). In the case of Algeria, the lifetime of the hydrocarbon resource appears short, and the exportable surplus is increasingly jeopardized by a rapidly growing domestic consumption that is supported by very low domestic prices. Slowing down the rate of growth of domestic consumption may help buy time to undertake the necessary reforms. A scenario simulating the impact of lowering domestic implicit subsidies to contain the growth of domestic demand shows that although such a policy would not prevent the exhaustion of the hydrocarbon rent, it would help contain the worsening of the external position, giving the authorities some space to implement the policies for supporting nonhydrocarbon sector exports (Box 3).

Box 2.Algeria’s Untapped Potential for Diversification

  • International evidence suggests that a successful diversification strategy hinges on both horizontal and vertical differentiation. In the oil-exporting countries that achieved successful diversification, the policy mix included the promotion of vertical diversification in sectors where they had a comparative advantage (oil, gas, petrochemicals) and horizontal diversification beyond those sectors, with an emphasis on technological upgrade and competition on international markets.
  • Algeria has important potential for vertical diversification in the hydrocarbon sector. Hydrocarbon exports are mostly made of crude oil and gas, with limited exports of refined products or hydrocarbons byproducts, suggesting that the potential for vertical diversification into higher value-added products is sizeable. Indeed, beyond the country’s obvious edge in fuel exports, revealed comparative advantages point to potential strengths in the mineral and chemical industries.
  • The potential for horizontal diversification is also sizable, and not fully reflected in Algeria’s revealed comparative advantages. These point to large potential in the agribusiness sector.1 Relatively high rates of higher education suggest that the country may also develop a potential in human-capital-intensive activities. There are also areas of largely unfulfilled potential, notably in tourism, where receipts fall way below those in neighboring countries, despite Algeria’s considerable resources.

Revealed comparative advantages

(2012)

Tourism Receipts

(In percent of GDP)

Sources: World Development Indicators; and IMF staff calculations.

1/Hausmann and others (2010) offer an in-depth statistical analysis of sectors where Algeria has a potential to diversify. Those sectors include meat, dairy, and fishery products; agro-industrial products and chemicals; steel and aluminum; metal products; and shipbuilding.

Box 3.Buying Time: The Role of Implicit Hydrocarbon Price Subsidies

In the medium term, external sustainability is closely related to the large implicit hydrocarbon subsidies. These have a two-pronged effect on external sustainability. First, they disconnect domestic prices from international prices, which leads to informal trade and smuggling, and loss of (notably tax) resources through lower formal exports. Second, they feed the rapid growth of domestic consumption that weighs on hydrocarbon exports.

A progressive adjustment of domestic prices that curbs consumption growth in the long term to just 1 percent a year would not reverse the worsening of the international investment position that will ensue from the exhaustion of the hydrocarbon resource, but it will significantly contain the buildup of net debt.

It is therefore important to contain the growth of domestic energy consumption by phasing out implicit subsidies. The most vulnerable segments of the population can be protected through appropriate compensation measures, such as targeted cash transfers. In the meantime, a policy to diversify energy sources—notably through the development of renewable energy—would help to ensure the provision of sustainable energy for the country.

Hydrocarbon Subsidy Scenario

Source: IMF staff calculations.

E. Policy Recommendations

27. Macroeconomic policies should be geared toward supporting external competitiveness and avoiding real exchange rate swings and real overvaluation.

Box 4.Strengthening Algeria’s External Competitiveness Monitoring

The BA’s exchange rate policy of keeping the real effective exchange rate close to its fundamental value is appropriate and has served Algeria well. Algeria has avoided large swings in the real effective exchange rate, and the currency has remained broadly in line with fundamentals over the past few years, though sometimes on the strong side.

The real exchange rate target is built from an Algeria-specific, backward-looking equation. It is derived from an Algeria-specific econometric estimate that tracks the behavior of the real effective exchange rate against its fundamentals over the past, with regular updates. The methodology is useful for assessing the path of the exchange rate against its predicted value from the behavior of the fundamentals, but cannot identify the optimal exchange rate path in the context of the country’s needed diversification. It is also limited in its ability to provide information on Algeria’s competitiveness relative to its main competitors, because it focuses largely on the country’s competitiveness against its main trading partners.

Algeria’s exchange rate policy would gain from a widening of the set of available tools. For instance, assessing the real equilibrium exchange rate within a panel of countries would provide useful information regarding the desirable level of the exchange rate. Monitoring Algeria’s competitiveness relative to a set of potential competitors in the nonhydrocarbon sector would also provide useful additional information to the BA in its endeavor to maintain the real effective exchange rate at an appropriate level. Finally, cost competitiveness should also be monitored (see Jewell, 2014).

  • The BA should maintain its policy of targeting the real effective exchange rate in line with its equilibrium level. It will be important for the authorities to complement the existing assessment tool with additional instruments that could provide useful information as to the country’s competitiveness in a broader context, or in comparison to its most important competitors in nonhydrocarbon exports (Box 4).
  • A full-fledged fiscal rule would help manage the risks of procyclical fiscal policies. Implementing a fully-fledged fiscal rule, such as the one proposed by staff in 2013,7 would help both move the country’s fiscal saving toward a sustainable path and improve demand management, thereby containing overvaluation risks.
  • Domestic liquidity needs to be insulated from the hydrocarbon sector. Setting up a full-fledged sovereign wealth fund would not only increase the government’s earnings from its oil savings, but would also ensure a better insulation of the economy from the hydrocarbon resources. Revising the rules that require Sonatrach deposits to be held in dinars in Algeria would also help by reducing the excess liquidity in the banking sector.
  • Public wage Increases need to be contained and linked to productivity improvements. This would help contain adverse developments in unit labor costs that impede competitiveness.
  • Over the medium term, the focus should be on Improving the efficiency of public investment. Efforts to improve the appraisal, selection, implementation, and ex-post evaluation of public investment will be required. The transition to a medium-term budget framework will be critical for addressing fiscal vulnerabilities and aligning investment projects with strategic government priorities.

28. Greater openness to trade and capital flows is needed to improve Algeria’s international integration.

  • Progressively opening the economy would create incentives for productivity gains and diversification. Algeria should swiftly join the WTO and address the high cost of tariff and nontariff barriers. An appropriate export promotion strategy should accompany this opening.
  • Attracting FDIand, notably, export-oriented investorsis key. This would require, in addition to the measures geared toward supporting Algeria’s export competitiveness, a revision of the “49/51” law, to limit its application to strategic sectors, while opening nonstrategic sectors to foreign investment.

29. Wide-ranging structural reforms are needed to improve the business climate.

  • The cost of starting and operating a business needs to be lowered, including through a reduction in the number of administrative procedures and their simplification to reduce the time and costs required for compliance. An overhaul of the business taxation system is needed, notably to eliminate the tax on turnover (Taxe sur l’activité professionnelle, TAP) and replace it with a more efficient source of revenue. Access to finance—notably for SMEs—also needs to be enhanced, which would notably require a more effective guarantee system, and a full-fledged credit information registry for SMEs. All these measures would support a faster rate of new business creation, which is needed for the private sector to thrive.
  • Public investment should be targeted to infrastructure and sectors with positive spillovers to the rest of the economy, such as logistics, transportation, power supply, and ICT, with a view to supporting private sector productivity. Further, the quality of public investment should be carefully monitored.
  • These measures should be framed by an export-promotion strategy that would address all aspects of the export process, and notably the cost of trade. An export promotion policy, covering not only the marketing of Algeria’s products but also quality and supply chains policies, would help export-oriented entrepreneurs
  • Policies are also needed to enable innovation. These include continued investment in education and better cooperation between higher education and businesses. The institutional environment should be made more inviting to capital venture firms and angel investors, who play an instrumental role in financing innovation.
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1Prepared by Amina Lahreche.
2MCD countries recorded average FDI inflows of 5 percent of GDP during 2000–12. The long-term average FDI inflow of 2.5 percent of GDP is comparable to FDI inflows to Asian emerging countries over the same period (Honk Kong and Singapore excluded).
3During 2000–13, the oil exporters that managed to increase the share of nonhydrocarbon exports in total GDP did so by 8 points of GDP on average; the dispersion of experience is large, as the standard deviation of nonhydrocarbon exports increases as a share of GDP is 12 percent. An increase in nonhydrocarbon exports by 20 points of GDP, although on the high side, remains within the standard deviation. Over the period, Bolivia managed to increase its nonhydrocarbon exports from 14.4 percent to 38 percent of GDP. In the United Arab Emirates, nonhydrocarbon exports went from 21.6 percent to 66.4 percent of GDP.
4In MCD countries, Azerbaijan, Bahrain, Iran, Kazakhstan, Kuwait, Libya, Qatar, and the United Arab Emirates have sovereign wealth funds.
5In addition, the effective return on the FRR (about 2 percent in 2013) is very small compared to returns of sovereign wealth funds, which creates an opportunity cost.
6In a study of African countries, Freund and Rocha (2010) notably underscore the fact that transit delays have the most economically and statically significant effect on exports.
7The rule or proposed framework includes a realistic reference price for savings, a floor on the primary structural balance, and a full-fledged investment strategy for hydrocarbon savings. See the 2013 Staff Report on the Article IV consultations, IMF Country Report No. 14/32 (http://www.imf.org/external/pubs/cat/longres.aspx?sk=41304.0).

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