Abstract

The severe imbalances inherited from previous years deteriorated further at the beginning of 1994, when a further fall in oil prices, coupled with growing civil strife and the drying-up of external financing brought the economy to the brink of balance of payment crisis. This deterioration compelled the authorities to formulate a comprehensive structural adjustment program that received the support of the IMF in May 1994, with a one-year Stand-By Arrangement and, from May 1995, with a three-year arrangement under the Extended Fund Facility. This section summarizes the main objectives and reform strategy pursued under this program as well as Algeria’s macroeconomic performance during 1994–97. Sections IV to VII examine in greater detail economic developments in each major policy reform area.

The severe imbalances inherited from previous years deteriorated further at the beginning of 1994, when a further fall in oil prices, coupled with growing civil strife and the drying-up of external financing brought the economy to the brink of balance of payment crisis. This deterioration compelled the authorities to formulate a comprehensive structural adjustment program that received the support of the IMF in May 1994, with a one-year Stand-By Arrangement and, from May 1995, with a three-year arrangement under the Extended Fund Facility. This section summarizes the main objectives and reform strategy pursued under this program as well as Algeria’s macroeconomic performance during 1994–97. Sections IV to VII examine in greater detail economic developments in each major policy reform area.

Objectives and Economic Policy Strategy

The adjustment program in place since early 1994 was structured around four major objectives: (1) to promote a high rate of economic growth so as to absorb the increase in the labor force and gradually reduce unemployment; (2) to ensure a rapid convergence of inflation toward rates prevailing in industrial countries; (3) to mitigate the transitional costs of structural adjustment on the most vulnerable segments of the population; and (4) to restore balance of payments viability while ensuring adequate levels of foreign exchange reserves.

In pursuit of these objectives, Algeria decided to ease the immediate constraint arising from its high external debt service with a comprehensive debt rescheduling amounting to more than $17 billion over the four program years. This was to be complemented by an additional amount of $5.5 billion in exceptional balance of payments support from the IMF, other international and regional institutions, and bilateral donors. The availability of such a large amount of external financing allowed an increase in absorption during the first program year as reflected by a shift in the external current account balance from a surplus of 1.9 percent of GDP in 1993 to a deficit of 4.3 percent of GDP in 1994. In this regard, Algeria’s experience is somewhat different from the typical adjustment process that entails an initial contraction of aggregate demand.

The temporary relaxation of the external constraint was also to provide enough breathing space for the timely implementation of a three-pronged medium-term structural reform strategy, which consisted of the following (Table 2).

Table 2.

Chronology of Structural Reforms and Economic Policy Measures

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  • the realignment of relative prices and the abolition of external trade and payment restrictions to alleviate the shortages in a number of basic goods and achieve efficient resource allocation;

  • public expenditure restraint and a tight monetary policy designed to contain aggregate demand and bring about, over time, internal and external balance; and

  • the establishment of the institutional and market mechanisms necessary to complete the transition from a centrally planned to a diversified market economy (Table 3).

    Table 3.

    Selected Economic and Financial Indicators

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    Sources: Algerian authorities; and IMF staff estimates and projections.

    GDP at market prices.

    In U.S. dollars terms.

    Twelve-month changes in the total trade-weighted IMF Information Notice System index. A decrease in the index implies a depreciation.

    Annual change as a percentage of broad money at the beginning of the period.

    The percent changes for the 12-month periods ending December 1993 and December 1997 exclude the impact of two financial restructuring packages involving the swap of government bonds for public enterprises’ commercial debt. The amounts involved are respectively DA 275.5 billion in 1993 (or 53.4 percent of end-December 1992 money stock) and DA 186.7 billion in the first quarter of 1997 (or 20.3 percent of end-December 1996 money stock).

    Ratio of the average broad money (M2) stock during the year to GDP.

    Including dividends on current profits paid by Sonatrach.

    Including grants.

    Including special accounts, net lending, and allocation to the Rehabilitation Fund.

Realignment of Relative Prices and External Trade Liberalization

The realignment of relative prices was pursued with an active exchange rate policy and further liberalization of domestic prices. At the onset of the program, a 50 percent exchange rate devaluation corrected for the overvaluation of the Algerian dinar that had developed in 1992 and 1993, when the nominal exchange rate had remained broadly stable despite growing inflationary pressures. This was followed by a gradual shift in the exchange rate regime from a peg to a basket of major currencies to a managed float, which allowed for greater flexibility in the event of adverse terms of trade shocks. In addition, to increase the role of market forces in the determination of the exchange rate, an interbank foreign ex-change market was introduced at the end of 1995. Overall, between 1993 and 1996, the real effective exchange rate depreciated by about 30 percent as a result of nominal depreciation combined with tight demand management and incomes policies. This gain in external competitiveness should help foster greater diversification of the economy toward nonhydrocarbon tradable activities.

As for domestic relative prices, the adjustment process entailed the liberalization of administered prices and interest rates and the replacement of a generalized and inefficient system of subsidies by targeted transfers. Notwithstanding a partial liberalization in the early 1990s, interest rates were still negative in real terms at the beginning of 1994, thereby distorting relative factor prices and resource allocation. The first measure toward market-determined interest rates consisted in abolishing, in 1994, the ceiling on commercial banks’ lending rates to the public. However, this was combined with the introduction of a temporary cap on banks’ interest rate spreads—to prevent excessive lending rates in the event of collusion among banks—which was eliminated in December 1995. The deregulation of interest rates, together with the deceleration in inflation brought about by tight demand management policies, led to the emergence of positive real interest rates in 1996.

At the beginning of 1994, Algeria had a generalized system of subsidies that cost the budget more than 5 percent of GDP and had led to speculative inventory accumulation, shortages, and parallel markets. In addition, large quantities of subsidized goods were smuggled to neighboring countries. The elimination of these subsidies required a major liberalization of the price system as well as substantial increases in administered prices. In 1994, prices of all inputs for agriculture and housing construction were freed, and controls on retail prices and profit margins were lifted for most goods and services except for a limited number of products including a few essential food staples, energy products, and public transportation fares that remained subsidized. The generalized subsidies on these goods were eliminated over the following two years as prices were raised toward their opportunity cost. This was done progressively so as to mitigate the social impact and repercussions on the general price level. Over 1994–96, prices of subsidized food and petroleum products had to be increased on average by almost 200 percent to reach international prices. For petroleum products, the implicit subsidy was eliminated, as the transfer price from the national oil company to the refineries was set at the world price level, with adjustments every six months in line with international oil prices and exchange rate developments. The small remaining subsidy on gas and electricity consumer tariffs (less than 1 percent of GDP in 1996) was completely eliminated in 1997.

To cushion the impact of the exchange rate depreciation and the elimination of generalized subsidies on the most vulnerable social groups, the authorities embarked in 1994 on a reform of the social safety net. The previous system, introduced in 1992, consisted of cash transfers that were both poorly targeted and costly to the budget. It was replaced by a decentralized public works program compensating those able to work for their participation in a public activity on a full-time basis. This compensation was set at a level lower than the minimum wage to target the truly unemployed whose opportunity cost was below the compensation received. The new social safety net system also provided an increase in the transfers received by pensioners and disabled who are unable to work (see Section VI).

To provide appropriate market incentives to the productive sector, the realignment in relative prices was accompanied by a major liberalization of the external trade and payments system (see Section VII). In 1994, the authorities dismantled the cumbersome system of controls that had been introduced during the policy reversal of 1992–93. In particular, they abolished the administrative foreign exchange allocation that was established in 1992 for authorized imports. This gave importers free access to foreign exchange for all but a short list of imports that were temporarily prohibited. The negative list was eliminated at the end of 1994, and today, Algeria’s trade system remains free of quantitative restrictions. To support the trade liberalization program, the authorities lowered the maximum custom duty rate from 60 percent in 1994 to 45 percent as of January 1, 1997, and reduced the number of tariff rates. Significant progress was also achieved toward the current account convertibility of the Algerian dinar with the liberalization of all invisible payments. Tourism expenses were liberalized by the end of 1997, achieving current account convertibility.

Macroeconomic Policies and Performance

To achieve the macroeconomic objectives of the program, the government relied primarily on strong fiscal adjustment supported by a strict incomes policy and an active exchange rate policy. This was complemented by a tight monetary policy and the emergence of positive real interest rates.

The central government overall fiscal balance shifted from a deficit close to 9 percent of GDP in 1993 to a surplus of more than 3 percent of GDP in 1996 and 2.4 percent in 1997.2 This achievement, which contributed markedly to reducing the economy’s saving-investment gap, was made possible by a broad consensus among the government, labor, public enterprises, and the private sector. The strong fiscal performance reflected both government revenue increases, which benefited greatly from the depreciation of the Algerian dinar and, in 1996, from favorable world oil prices. Firm public expenditure restraint—especially with respect to wages, subsidies, and investment also contributed to this outcome. The emergence of a fiscal surplus was intended to decrease the budget’s vulnerability to potential oil price declines and to provide flexibility in addressing potential claims on public resources during the rest of the transition period, as well as making more resources available for the development of the private sector.

Fiscal retrenchment provided the underpinning for a tight monetary policy that resulted in a fall of the liquidity ratio from 49 percent in 1993 to 36 percent in 1996, thereby eliminating the liquidity overhang that had accumulated during 1992–93. Ceilings on money markets and commercial banks’ lending rates were abolished in the context of a shift toward the use of indirect instruments of liquidity control. To this end, the Bank of Algeria imposed a reserve requirement on commercial banks in 1994 and, subsequently, introduced a repurchase auction system for bank refinancing as well as open market operations.

The program that Algeria implemented from 1994 achieved impressive results in stabilizing the macroeconomic situation. Inflation, which reached 39 percent in 1994, mostly on account of the impact of the large initial depreciation of the Algerian dinar and adjustments of administered prices of subsidized commodities, decelerated to 6 percent at the end of 1997. The tightening of demand management policies coupled with the depreciation of the Algerian dinar and the availability of a large amount of exceptional financing also resulted in a significant strengthening of Algeria’s external position, with gross official foreign exchange reserves increasing from $1.5 billion at the end of 1993 (1.8 months of imports) to $2.1 billion at the end of 1995 (2.1 months of imports), and further to $8.0 billion at the end of 1997 (8 months of imports), partly owing to favorable oil prices. Moreover, the 2 percent decline in real GDP in 1993 was reduced to 1 percent in 1994 before giving way to real growth rates of about 4 percent in 1995 and 1996. This improved growth performance, which was driven by a strong exportled expansion in the hydrocarbon sector, a rebound of agriculture after two consecutive drought years, and an expansion in the construction and service sectors, led to an increase in per capita income in both 1995 and 1996 after a five-year decline. The increase was reinforced in 1996 by an improvement of more than 16 percent in Algeria’s terms of trade. Nevertheless, manufacturing output continued to decline, partly because of import liberalization that exposed Algerian products to foreign competition, and partly because of the impact of macroeconomic policies that reduced domestic demand. Structural problems related to the obsolescence of capital equipment and product lines in many public enterprises, as well as poor management, foreshadowed a difficult and long process of modernization and restructuring for Algerian manufacturing enterprises. Growth was still positive in 1997, but yet again adversely affected by a drought.

Structural and Institutional Reforms

Until the beginning of 1994, resource allocation in Algeria had been governed mostly by administrative decisions and direct state controls on prices, production, and credit. Beyond the realignment of prices and the liberalization of the external trade and payment systems, Algeria introduced measures aimed at changing the role of the state from the producer of most goods and services to the provider of administrative services, education, health, and a regulatory framework that is essential for the proper functioning of an efficient market economy. In particular, headway was made in restructuring public enterprises to facilitate their privatization, in strengthening property rights to promote private sector development, and in restructuring the financial sector to ensure more efficient credit allocation.

Efforts had been made prior to 1994 toward the restructuring of public enterprises. In particular, most public enterprises were granted legal and financial autonomy while being financially rehabilitated through debt forgiveness by the treasury and the swap of government bonds for nonperforming debt to commercial banks. These reforms, however, proved insufficient for two main reasons. First, they could not prevent the accumulation of further losses by public enterprises, given that many of these enterprises could not set their prices freely but continued to enjoy easy access to commercial bank credit. Second, reforms did not involve the physical restructuring of public enterprises. From 1994, these shortcomings were addressed mainly by subjecting all public enterprises to harder budget constraints. Moreover, for the 23 largest loss-marketing enterprises that accounted for close to 15 percent of the value added in industry and construction, a ceiling was imposed on their access to commercial bank credit, while medium-term plans were drawn to cut operating losses by imposing better inventory control and cost management procedures. In addition, to improve competitiveness, labor costs were reduced and production was reoriented toward more viable activities. By the end of 1996, all 23 enterprises had been granted autonomy in conjunction with the completing of their financial restructuring and the signing of performance contracts with their managers. Further-more, in September 1996, the commercial banks and the 11 holdings that now group all the large public enterprises established financial programs aimed at restoring the financial viability of the large public enterprises and closing the nonviable ones.

Progress was also achieved toward the restructuring of other public enterprises. In 1995, a program was launched to privatize, downsize, or liquidate all public construction companies. This entailed the dissolution of 19 enterprises and the layoff of more than 25 percent of the initial workforce. Retrenchment was facilitated by the introduction, in July 1994, of a new unemployment insurance system providing for lumpsum severance payments to dismissed workers (see Section VI). Over 1994–97, the government also undertook debt conversion operations to clean up the balance sheets of food-importing agencies, utility companies, and public real estate management companies. These public entities also received cash transfers from the Rehabilitation Fund, which was established by the 1991 budget law and liquidated at the end of 1996 to ensure the end of government bailouts (with all payments ending in March 1997).

The process of government disengagement from productive activities called for the adoption of a comprehensive legal framework to privatize public enterprises and foster private investment. The 1994 complementary budget law allowed for the first time the sale of public enterprises, the offer of public enterprises for private management contracts, and the private participation of up to 49 percent in the equity of public enterprises. The legal framework was further extended by the 1995 privatization law, which allowed 100 percent private ownership in most public enterprises. Furthermore, in 1994, the government approved a law removing the state’s monopoly in the insurance market and amended the 1994 Investment Code to allow foreign participation in the capital of commercial banks. In addition, a law promulgated in 1995 restored to original owners certain lands that had been nationalized after independence. Finally, to enhance the efficiency of agriculture, the government adopted in early 1997 a draft law to transform into full-fledged property rights the usufruct rights granted to farmers in 1988, at the time of the dismantling of socialist farms. Legislative approval of this measure—still pending in 1998—would facilitate farmers’ access to bank credit and hence investment in agriculture.

Within this framework, in April 1996, a first privatization program was launched with World Bank support, targeting about 200 small local public enterprises, mostly in the service sector. However, it was only in late 1996, after the creation of five regional holdings, that the dismantling and privatization process gained momentum. Indeed, as of April 1998, more than 800 local enterprises had been privatized or dissolved. Moreover, at the end of 1997, a second privatization program focusing on large public enterprises was adopted, covering about 250 enterprises to be sold over 1998–99. To facilitate the effective privatization of these enterprises and to address the problem posed by the relative scarcity of private domestic savings, the 1995 law was amended in April 1997 to introduce more flexibility in divestment procedures—opening the possibility of payment in installments, equity participation by employees, and voucher privatization.

Beyond these privatization initiatives, new institutions were established to promote private sector development. In particular, a national investment agency was set up in 1994 to act as a one-stop window to help private investors, domestic and foreign, cut through bureaucratic red tape and administer tax breaks and other investment incentives. In the construction sector, contracts have been increasingly awarded to the private sector by breaking up the size of contracts previously awarded to public construction companies.

Significant headway has been made since 1994 in the area of financial sector reform to improve the efficiency of financial intermediation and to safe-guard the soundness of the banking system. In addition to the emergence of real positive interest rates since the beginning of 1996, the financial viability of Algeria’s five state-owned banks was strengthened by their recapitalization and the swap of government bonds for nonperforming bank loans to public enterprises. On this basis, banks have begun to adopt more competitive behavior while being subject to strengthened prudential regulations (see Section V).

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