Algeria, with its area of 0.9 million square miles, is the second largest country in Africa. However, 85 percent of its total land mass is occupied by the Saharan desert and is sparsely populated. Most of its current population of about 29.6 million lives along the Mediterranean coast and in the high plains, which are geographically separated from the Saharan desert by mountain chains impeding north-south communication.

Geographical, Historical, and Political Background

Algeria, with its area of 0.9 million square miles, is the second largest country in Africa. However, 85 percent of its total land mass is occupied by the Saharan desert and is sparsely populated. Most of its current population of about 29.6 million lives along the Mediterranean coast and in the high plains, which are geographically separated from the Saharan desert by mountain chains impeding north-south communication.

Virtually all Algerians are Sunni Muslims, and Islam is the official religion. However, there has always been religious freedom and no restraints are placed on worship for other religions. The population is a mixture of Arab and indigenous Berber, largely integrated. Arabic is the official language, but French is widely used. Most Algerians are bilingual. The Berber language, Tamazight, is also spoken and taught in some schools. Business is mostly conducted in French, though the use of English is increasing. The Berber people, who traditionally live in the mountains of the Rif, Kabyle, and Aurès regions in the northeast Atlas, have a different cultural and linguistic tradition. Except for the desert Tuareg (also known as blue men) who are nomads, they are farmers. Population growth in Algeria, at about 2.2 percent a year, is above average for North Africa. More than 40 percent of the population is younger than 15 years, and about one-half lives in urban areas. Emigration to Europe, once an alternative for Algeria’s unemployed, declined from the mid-1970s when France significantly restricted immigration. Life expectancy is 67 years for men and 69 years for women—about average for North Africa. Per capita income in 1996 was about $1,600, compared with $1,200 for Morocco and about $2,000 for Tunisia.

The Algerian desert holds huge hydrocarbon resources, which were first discovered in the 1950s and 1960s. Its proven reserves of crude oil of about 10 billion barrels account for about 1 percent of the world’s total reserves. By contrast, those of natural gas, estimated at about 4,000 billion cubic meters, represent close to 5 percent of the world’s known reserves. While Algeria has only a small share of world oil production, the hydrocarbon sector represents the central pillar of the Algerian economy. In 1996, it accounted for nearly 30 percent of GDP and contributed to more than 95 percent of merchandise export receipts and more than 60 percent of budgetary revenues. This high hydrocarbon dependence together with the volatility in energy prices has complicated macroeconomic management. Moreover, because of its high capital intensity, the hydrocarbon sector’s direct contribution to employment has been small (3 percent).

Most employment opportunities are provided by other sectors, in particular, by manufacturing and construction enterprises (24 percent); the civil service (28 percent); and agriculture (24 percent). The latter, which can make use of only 3 percent of Algeria’s land area, produces only one-fourth of the country’s food requirements. As a result, Algeria imports large amounts of foodstuff, in particular durum wheat, of which it is the largest importer in the world.

Algeria was originally populated by Berbers and influenced by the Phoenician and Carthaginian civilizations. It was conquered by the Romans1 in the first century B.C. and Christianized around the second and third centuries. Algeria gradually became Islamized as a result of the Arab conquest during the seventh century, which was followed by several Berber Empires. Early sixteenth century incursions by Spain were resisted by appealing to the Ottomans, who established Algeria as an autonomous region of their Empire until the French conquest, which started in 1830. From the late nineteenth century onward, integration with France increased as a result of a large presence of French settlers. Algerian movements for national independence from France resulted in the uprisings of 1954, the prelude to a war that culminated in the declaration of independence on July 5, 1962.

Algeria thereafter became a socialist, centrally planned economy ruled by a single party, the Front de libération nationale. Social unrest in 1988 led the Front de libération nationale to adopt a new constitution in 1989 permitting multiparty elections. This allowed the emergence of the Front islamique du salut, which, in 1990, won 54 percent of the vote in the municipal elections and took control of most local governments. By 1991, its popularity had waned somewhat, but the Front islamique du salut still won 47 percent of the vote in the December round of legislative elections and was poised to gain majority control of the parliament before the government canceled the second round in January 1992. This was followed by the replacement of the president, who resigned, by a “five-men presidency,” the High State Council. The Front islamique du salut was banned in March 1992 by a Supreme Court decision after terrorist attacks were linked to the party.

Since then, political developments have been dominated by the conflict between the government, the Front islamique du salut, and two more radical groups, the “Armée islamique du salut” and the “Groupe islamique armé.” This conflict is estimated to have claimed more than 65,000 lives since 1992.

In 1994, the High State Council was dissolved and Liamine Zéroual was appointed President. In late 1995, capitalizing on the public’s general desire to put an end to the violence through political reconciliation, he held presidential elections in which four other candidates participated, including one from the moderate Mouvement pour une société islamique (Hamas). The election registered a high participation rate (75 percent), and President Zéroual won about 60 percent of the vote. In December 1996, a referendum adopted a new constitution that (1) introduced proportional representation in legislative elections; (2) provided the president effectively with a virtual veto power over legislation while imposing a two-term limit; (3) explicitly established Algeria as an Islamic, Arabic, and Tamazigh (Berber) country; and (4) guaranteed the right to form political parties, while making it illegal to base such parties on religion, language, or ethnicity. Within this new constitutional framework, multiparty legislative elections took place in June 1997, and were followed by local and regional elections later in 1997.

The Prereform Economic System

At independence in 1962, Algeria was predominantly an agrarian society with a limited industrial base. During the following 25 years, Algeria pursued a socialist growth model that was inward oriented, emphasizing heavy industrialization and reduced dependency on external investment and imports. The major elements of this model were centralized planning for the economy, the reliance on public enterprises in most services and import-substituting industries, and the creation of large state farms by land nationalization. This strategy was financed by the export receipts of the nationalized hydrocarbon sector. The latter benefited from the oil booms of 1973 and 1979/81 and generated sufficient domestic savings to avoid large accumulation of external debt until the early 1980s.

Within the overall planning framework, each public enterprise had its own annual plan. Purchases of inputs and distribution of output were all approved by the central authorities; wages were fixed according to a national scale, and most prices were controlled. Public enterprise investment was, for the most part, directly financed by the treasury mainly through loans rather than equity participation. This undercapitalization was to pose a major structural problem later on, when those enterprises had to become financially autonomous. Each enterprise was allowed to operate with only one of the five specialized state-owned banks, which provided working capital virtually on demand in the form of overdrafts to fulfill the central plan’s objectives.

This strategy originally met with some success. On the one hand, the investment to GDP ratio was maintained at about 45 percent until the late 1970s and the economy grew, on average, by more than 6 percent a year in real terms, compared with 3 percent for middle-income countries as a group. Most social indicators also registered significant improvements. In particular, Algeria’s literacy rate rose from 25 percent in the mid-1960s to more than 60 percent in the mid-1980s. Infant mortality rates fell from 150 per thousand to less than 80 over the same period (see Table 1). On the other hand, because of an overvalued exchange rate and negative real interest rates, public enterprises were highly capital intensive, depended on imported inputs, and contributed little to employment creation.

Table 1.

Social Indicators

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Sources: Algerian authorities; Statistical Yearbook of Algeria 1991; United Nations Educational, Scientific and Cultural Organization, Statistical Yearbook 1996; World Bank, World Development Report 1995, and Social Indicators of Development 1996.

Percentage of age group over same age group enrolled in education.

In percent of population at least 15 years old.

For 1995, new survey data are provided.

Converted at the official exchange rate.

By the early 1980s, the drawbacks of centralized planning were becoming apparent both in public enterprises and state farms, which together accounted for most of Algeria’s nonhydrocarbon output. Despite large government investment in state farms, production and yields were not improving significantly, and Algeria’s dependence on food imports was increasing rapidly. In addition, the time lags required for completing large public investment projects had become unduly long, notably in the housing sector, which meant that capital was being immobilized for long periods without generating any income. Moreover, most of the new industrial plants were running substantially below capacity. For all of these reasons, the inefficiency of investment rose, as shown by the increase in the incremental capital/output ratio to above 8.

Meanwhile, aggregate demand was fueled by implicit consumption subsidies and high money growth, which reflected mainly the financing of public enterprises by commercial banks together with the monetization of large fiscal deficits. As demand continued to outstrip supply, rationing became prevalent. Many consumer goods were increasingly scarce or unavailable on the official market despite Algeria’s large hydrocarbon export receipts. The combination of excess liquidity with commodity shortages and the administrative allocation of foreign exchange was reflected in an increasing discrepancy between the parallel and the official exchange rates. The price of the U.S. dollar on the parallel foreign exchange market rose from two times the official rate in the early 1980s to five times in 1985.

Reverse Oil Shock of 1986 and First Attempts at Reform

The rigidities and weaknesses of the centrally planned system became much more apparent when the reverse oil shock of 1986 caused both Algeria’s terms of trade and hydrocarbon budgetary revenues to drop by about 50 percent. In response to the crisis, the authorities did not adjust the exchange rate, but initiated several measures of macroeconomic stabilization and structural reforms. At first, the pace of adjustment was sluggish and macroeconomic imbalances worsened. The overall budget deficit reached a record 13.7 percent of GDP in 1988 as cuts in government expenditure failed to compensate for the revenue decline (Figure 1). In the absence of a financial market, fiscal deficits were monetized or financed through the buildup of external debt. The ratio of external debt to GDP rose from 30 percent in 1985 to 41 percent in 1988, while the debt service to exports ratio jumped from 35 percent to 78 percent reflecting the shortening of maturities. In the presence of extensive price controls, monetization did not result in a large increase in inflation, but rather in greater rationing in the goods markets, a further buildup of excess liquidity, and higher prices in the thriving informal economy. The ratio of broad money to GDP, which stood at 76 percent in 1985, increased further to 79 percent in 1988. In addition, negative real interest rates and an overvalued currency reinforced the bias toward capital-intensive techniques and imports.

Figure 1.
Figure 1.

Overall Macroeconomic Performance

Sources: Algerian authorities; and IMF staff estimates.

Macroeconomic adjustment efforts were strengthened over 1989–91, when the authorities embarked on two IMF-supported programs (1989 and 1991) that entailed strict demand management policies and substantial exchange rate depreciation. Government expenditure restraint, together with higher hydrocarbon revenues on account of both favorable oil prices and exchange rate depreciation, resulted in the emergence of fiscal surpluses. Tight fiscal policy provided the underpinning for a marked slowdown in money growth, permitting excess liquidity to be partially absorbed.

Tighter demand policies coupled with substantial trade liberalization measures and adjustments in the nominal exchange rate resulted in a real effective depreciation of more than 60 percent between 1988 and 1991. Together with the absorption of excess liquidity, the depreciation reduced excess demand for foreign exchange, and the discount of the Algerian dinar in the parallel market was cut from a factor of five in 1988 to a factor of less than two in 1991. However, as a result of the depreciation and of the partial liberalization of domestic prices and interest rates, inflation, as measured by the consumer price index (CPI), increased to 22.8 percent in 1991 compared with 10.3 percent on average over the five preceding years.

On the external side, the combination of expenditure switching and reducing policies, together with favorable oil prices, contributed to a shift of the current account balance from a deficit of 3 percent of GDP in 1988 to a surplus of 6 percent of GDP in 1991. Developments in the capital account were less favorable as Algeria’s capacity to contract new external borrowing reached its limits, while amortization payments rose substantially in part because of the increasing reliance on suppliers’ credits of less than a three-year maturity. As a result, the debt-service ratio in 1991 was still at about its 1988 level, notwithstanding much higher oil exports proceeds in dollar terms.

The 1991 IMF-supported adjustment program could not be fully implemented owing to three main factors. First, the decision by the authorities not to resort to a comprehensive external debt rescheduling with the Paris and the London Clubs severely constrained the amount of exceptional financing available for the program. Second, part of the external financing programmed for 1991 failed to materialize, which contributed to a contraction of imports of more than 20 percent in dollar terms and a fall in output, particularly in the manufacturing and construction sectors. Third, the program was not grounded on a broad consensus among social partners. Employers felt that the exchange rate adjustment had been adverse to their operations, since it had increased the cost of imported inputs and external debt service, whereas this increase could not be passed on to domestic prices, which had been liberalized only partially. As for labor unions, they were not made a party to the agreement and were unwilling to accept the decline in real wages brought about by the devaluation of the Algerian dinar, particularly in the absence of an adequate social safety net. This forced the government to agree, just before the first round of parliamentary elections at the end of 1991, to large wage increases to be granted during 1992.

On the structural front, important reforms were introduced in the late 1980s and early 1990s to gradually decentralize the decision-making process and develop market mechanisms. The first measures took place in agriculture with the breakup in 1987 of about 3,500 large state farms into smaller private cooperatives and individual farms holding long-term usufruct rights. These reforms resulted in sharp productivity increases, turning agriculture into the engine of growth for the Algerian economy (excluding hydrocarbons). In the industrial and construction sectors, nearly all national public enterprises were granted legal and operational autonomy in 1988. This was followed by the adoption in 1990 of a program to write off a large amount of the nonperforming foreign and domestic debt of public enterprises, which had accumulated over years of direct state controls, and to recapitalize the commercial banks. The program was financed by a special restructuring fund supported by budgetary allocations and by the World Bank Enterprise and Financial Sector Adjustment Loan. Concurrently, a new legal and regulatory framework for the financial sector was established by the 1990 money and credit law. This new law devolved to the Bank of Algeria the responsibility for monetary policy and oversight of the banking system, and eliminated direct financing by the treasury of new public enterprise investment. In addition, to promote competition, the authorities authorized the creation of private banks and abolished the practice of assigning each public enterprise to a particular commercial bank. Finally, structural reforms in the labor market introduced greater flexibility in wage setting and labor contracts and authorized labor shedding for economic reasons combined with provision of severance payments.

The potential benefits of this liberalization and reform process were stymied, however, by the lack of integration of the various measures into a comprehensive framework, and the absence of some key steps indispensable for creating an efficient market economy. For instance, agricultural reform did not include the attribution of property rights, thus hindering the ability of private farmers to access commercial credit. As for public enterprises, their financial situation continued to be constrained by ongoing price controls by the Ministry of Supply and by high severance costs for labor shedding. This led to the accumulation of further losses, which could be financed by loans from commercial banks whose recapitalization was not accompanied by sufficient prudential regulations.

As a result of their piecemeal nature, Algeria’s first attempts at structural adjustment following the reverse oil shock failed to improve significantly the efficiency of resource allocation and to put the economy on a sustainable growth path. Real nonhydro-carbon GDP declined on average by 1.5 percent a year during 1986–91. This dismal outcome reflected a stagnation in manufacturing and falling output in the construction and services sectors that more than outweighed a persistently strong growth performance in agriculture.

Policy Reversal of 1992–93

Starting in 1992, against the backdrop of political uncertainties, civil strife, and dwindling access to external financing, the pace of structural reforms slowed down and macroeconomic imbalances widened. The authorities’ strategy in 1992–93 aimed at fully meeting external debt service, which had reached 80 percent of export proceeds, while supporting economic activity with an expansionary fiscal policy. In particular, government consumption increased by 2 percentage points of GDP over the period, while the ratio of government investment to GDP increased from 6 percent in 1991 to 8.4 percent in 1993. As a result, the government’s savings-investment balance deteriorated by more than 10 percentage points of GDP. These large fiscal imbalances (8.7 percent of GDP budget deficit in 1993) also reflected the lack of exchange rate adjustment—which undermined hydrocarbon and trade-related budget revenues—and widespread government subsidies on basic consumption items, which accounted for 5 percent of GDP annually during 1992–93.

The authorities’ relaxation of fiscal discipline adversely affected monetary developments through the monetization of budget deficits. Rapid monetary expansion generated inflationary pressures, which contributed to the increasing overvaluation of the Algerian dinar. Such pressures were partially repressed, particularly in 1993, when administered controls on prices and trade were tightened, and a significant drop in the income velocity of broad money signaled the reemergence of a monetary overhang.

The inconsistency between expansionary demand management policies and the reluctance to adjust the exchange rate, coupled with an external debt strategy that sought to avoid a formal debt rescheduling and declining oil prices, resulted in a deterioration in the external current account. The authorities’ response was to reintroduce trade and payments restrictions and tighten administrative controls. These measures exacerbated resource misallocation and caused a drop in capacity utilization, a drop in investment in the nonhydrocarbon sector, widespread shortages of various consumer items, and an increase in unemployment from 20 percent of the labor force in 1990 to 24 percent in 1993.

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