VIII Achievements and Future Challenges

Nicole Laframboise; Patricia Alonso-Gamo; Alain Feler; Stefania Bazzoni; Karim A. Nashashibi; Sebastian Paris Horvitz

Author: Ms. Nicole Laframboise, Ms. Patricia Alonso-Gamo, Mr. Alain Feler, Mrs. Stefania Bazzoni, Mr. Karim A. Nashashibi, and Sebastian Paris Horvitz¹

¹ 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

Language:: English

Keywords:: OP; government; reform program; public enterprise; Algeria's achievement; market economy; government food; public enterprise reform; price system; Privatization; Public enterprises; Structural reforms; Housing

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Abstract

For about twenty-five years following its independence in 1962, Algeria made significant progress toward developing its human and physical infrastructure, as well as a vigorous and diversified hydrocarbon sector. Income and gender inequalities were reduced, and a large degree of social cohesion was attained. The yearly flow of the petroleum rent and trade protection, however, shielded the Algerian economy from the inefficiencies inherent in its central planning of resources and in the one-party political system. Large investments in industrial development did little to create a diversified and competitive industrial base, while neglecting pressing housing needs, which reached crisis proportion.

The hydrocarbon shield was shattered with the reverse oil shock in 1986 and again in 1988, which coincided with the first political demonstrations that hit Algeria’s cities. It then became clear to policymakers that Algeria could no longer sustain an inward-oriented command economy, which subsidized its public enterprises and remained fully dependent on oil revenues. A gradual process of liberalization and reform was launched, reorienting the institutional framework toward one more compatible with a market economy. In particular, agricultural production and land tenure were increasingly liberalized, and greater autonomy was given to public enterprises.

This process gathered some momentum with IMF- and Bank-supported reform programs in both 1989 and 1991. Nevertheless, throughout this period, reform lacked a comprehensive vision and was mostly reactive to pressure points. As a result, liberalization in some areas coincided with a tightening of restrictions in other areas, exacerbating distortions and generating shortages of both imports and domestic goods and services. Above all, these reforms lacked the political will to make a decisive break with past reliance on government as the major provider of employment, housing, food subsidies, and financing for public enterprises. They neither had the demand management underpinnings nor a broad measure of support by labor unions and managers in both the private and public sectors. Attempts at easing shortages with short-term external financing of imports only bloated external debt and precipitated a payments crisis at the end of 1993. Rising unemployment, an acute housing shortage, and growing civil strife added further gloom to Algeria’s economic prospects.

The reform program launched in April 1994, in a difficult social and political environment, marked a new beginning as well as a new consensual approach. Indeed, after the failure in attempting to develop market mechanisms while maintaining a massive presence of the state in the economy, policymakers came to acknowledge that a change of strategy was needed. There was a fundamental recognition that for Algeria to be able to address its acute social and political problems, it had to reinvigorate its economy and ensure high and sustained growth, but that this objective could only be achieved by abandoning central planning and establishing an outward-oriented and efficient market economy, conducive to private sector activity and integrated with the rest of the world. This recognition provided a unifying approach to the transition and reform process, which was well sequenced and comprehensive. The initial emphasis was to set the exchange rate at a more realistic level, realign relative prices, eliminate distortions through liberalization, and stabilize domestic demand. At the same time, the following structural reforms, to be implemented over two to three years, were set in motion: public enterprise reform and privatization, banking system restructuring, social safety net provisions, and the establishment of market mechanisms such as the use of indirect instruments of monetary policy and the creation of interbank markets for foreign exchange and bank refinancing.

Within three years, by the end of 1997, this reform program had achieved remarkable success in restoring financial stability and establishing the building blocks for a market economy. While Algeria has been a latecomer in the reform process relative to other countries in the region, it has adjusted faster (see Box 13 and Figure 16).

Inflation declined to 6 percent, and after a decade of declining per capita income, there were three consecutive years of positive growth in 1995, 1996, and 1997.
A market-oriented price system was established, eliminating price restrictions and generalized subsidies.
A surplus was achieved in the fiscal and external accounts (even when allowance is made for the increase in oil prices), with a substantial buildup of external reserves to seven months of imports by the end of 1997, and a reduction in the external debt service ratio from 83 percent in 1993 to 30 percent in 1997.
The government’s disengagement from production and trading activities was accompanied by the establishment of a market-oriented banking system that imposed a tight budget constraint on its clients, including public enterprises (see Box 14).

Box 13.

Catching Up with Reformers

A number of countries in the MENA region, Morocco, Tunisia, Jordan, and Egypt, have successfully undertaken macroeconomic stabilization and wide-ranging structural reforms under IMF-supported programs. Morocco and Tunisia started comparatively early and have gone furthest: Morocco’s adjustment efforts since 1980 were supported by nine IMF arrangements, with an arrangement in effect at least part of every year during 1980–93, while Tunisia entered in 1986 a Stand-By Arrangement, followed subsequently by a four-year Extended Fund Facility. Both countries have by now successfully graduated from IMF programs. Jordan and Egypt were threatened by growing financial imbalances in the late 1980s, but Jordan’s initial adjustment efforts were hindered by the crisis in 1990–91, and comprehensive reforms were launched in earnest with a Stand-By Arrangement in 1992. Jordan then entered into Extended Fund Facility programs in 1994 and 1996, the latter ending in February 1999. Egypt initiated a stabilization program in 1991, whereas structural reforms accelerated in the mid-1990s, particularly in the context of the current two-year precautionary Stand-By Arrangement, which runs until October 1998.

While the experience of each of these countries is necessarily unique, a common thread runs through all of them. In the face of external shocks, they all attempted to maintain high absorption levels, giving rise to large budget deficits—generally monetized—widening current account deficits, overvalued exchange rates, growing external debt, and eventually debt-servicing difficulties that precipitated adjustment. The stabilization and structural reforms adopted to redress the situation received substantial financial support from the IMF and the international community, including through debt reschedulings and, in some cases, relief. In the event, all these countries have proved successful in sharply reducing budget and current account deficits, bringing down inflation to single-digit levels, going a long way toward restoring sustained economic growth, and achieving external viability, with comfortable levels of foreign exchange reserves, declining external debt burdens, and a resumption of capital inflows. Major progress has also been registered on the structural front, with price, trade, and exchange liberalization; tax, financial sector, and legal reforms; and the restructuring and privatization of large and inefficient public enterprises.

Algeria’s successful experience resembles in many ways that of the other MENA reformers, but a number of features set it apart. First, whereas Algeria embarked on its program comparatively later, in mid-1994, it has adjusted faster (Figure 16). By the end of 1996, Algeria’s macroeconomic performance equaled or even surpassed that of the early starters: real growth was 4 percent; inflation was declining to single-digits, both the budget and the current account posted surpluses; foreign reserves were at five months of imports; and external debt indicators had improved markedly. Second, oil plays a more predominant role: while the reverse oil shocks contributed to trigger the crisis, since then, Algeria has succeeded in diversifying its hydrocarbon sector and expanding gas exports, boosted by new discoveries, but oil prices remain crucial. Third, the legacy of central planning was heavier than in the other countries, and hence more radical structural changes are needed to allow market forces to play. Finally, reforms have faced the additional hurdle of having to be carried out against a background of civil strife.

Looking ahead, all these countries face largely similar challenges, though to a varying degree: to consolidate macroeconomic stabilization, to step up and deepen structural reforms, and to promote further integration with the world economy, so as to foster competitiveness and growth, while protecting the most vulnerable. Algeria’s task is nonetheless complicated by its own particular set of fragilities: high unemployment and a rapidly growing labor force that could only be absorbed through high growth rates in the nonhydro-carbon sector (see Figure 17); the vulnerability to fluctuations in international oil prices and dependence on food imports; its still heavy external debt burden; a fledgling private sector; and the need for institutional reforms and a political environment that would be conducive to private domestic and foreign investment.

In addition to the above-mentioned strong political will, several elements account for the successful implementation of the program.

The savings realized from the elimination of generalized food subsidies allowed the funding of a more efficient social safety net with a job-creation program, unemployment insurance, and cash transfers to the most disadvantaged groups. Budgetary appropriations for public housing were raised. The social components of the program were essential in gaining workers’ union support.
Both demand management and structural reforms were steadfastly implemented. Despite the succession of three prime ministers during this period, persistent civil strife, declining real wages, and large layoffs stemming from public enterprise restructuring, there was no weakening in public policy or wavering in the public commitment to reform. Continuity was maintained by an independent central bank, and follow up was exercised by a standing ministerial committee chaired by the Prime Minister with the sole responsibility of implementing the reform program. This whole process was supported by a dedicated civil service that ensured smooth policy coordination among the central bank, the ministry of finance, and other ministries and government agencies. Consequently, when slippages in credit policy occurred in the summer of 1995, corrective action was quickly taken.
A flexible exchange rate policy was pursued, which in Algeria’s case also played an important demand management role because of the large oil revenues that accrue to the budget. While the reduction in inflation may have taken longer, price competitiveness was preserved. Authorities successfully reduced inflation through strict demand management policies. As these policies firmly took hold in the budget and in wage negotiations, the exchange rate depreciation of the first two years gave way to a substantial degree of price stability in 1996 and 1997.
When oil prices increased sharply in 1996 and 1997, most of the oil windfall was saved. This reserve has helped cushion the recent oil price decline and will considerably ease repayment of rescheduled external debt beginning in 2000.
Comprehensive structural reforms with excellent coordination between the IMF, the World Bank, and the Algerian authorities took place. While the IMF concentrated its assistance on macroeconomic stabilization, liberalization of prices and trade and the social safety net, the World Bank assisted in the restructuring of public enterprises, the audit and financial restructuring of banks, housing, and privatization. Without public enterprise and bank reform, neither macrostabilization nor liberalization could be sustained. All these aspects must be tackled simultaneously.
A broad consensus for reform through periodic negotiations among the government, management (of both public and private enterprises), and labor unions was established. Commitments under World Bank and IMF programs were made public and widely debated in the press, establishing Algeria’s full ownership of the reform program.
An appropriate sequencing of measures took account of the public’s concerns. While some prices were quickly liberalized, food and energy subsidies were phased out gradually over three years through gradual price increases. Private sector importers were phased in into sensitive areas, such as Pharmaceuticals and essential food staples, hitherto monopolized by the public sector.
Algeria benefited from large financial assistance from foreign donors and international institutions. About $22 billion was provided over a three-year period ($17 billion in debt rescheduling and $5 billion in new lending from international and regional institutions) to support external trade and payment liberalization, eliminate import shortages, and sustain per capita consumption. This infusion of external support eased the burden of adjustment considerably and restored the sustainability to Algeria’s external debt profile.

Box 14.

Reducing the Size of the Public Sector in the Economy

Background

Reducing the share of the public sector in the economy constitutes a major pillar of the government’s strategy to allow the emergence of a dynamic private sector. Much has been accomplished in the last few years. In 1991, more than one-half of the labor force worked for the public sector (about 70 percent of industry, more than one-half of construction, and 30 percent of services, while agriculture was dominated by small private farms). Most public companies were operating with obsolete technologies and antiquated management under central planning, resulting in lack of competition, which, coupled with a high degree of protection, distorted resource allocation. Moreover, these fragilities were exacerbated by the liberalization process, which led rapidly to mounting losses and created an unsustainable burden on the financial system.
In the early stages of the transition to the market, the authorities favored a comprehensive restructuring of public enterprises, with a view to ensuring financial viability of public enterprises before moving toward privatization. During 1991–96, legal and financial autonomy was progressively granted to all public enterprises, accompanied by a program of financial rehabilitation, mainly through debt forgiveness from the treasury and swaps of government bonds for nonper-forming debts to commercial banks and the housing bank. Debt conversion operations amounted to DA 357 billion in 1991–96 (4 percent of 1991–96 GDP), with DA 187 billion (6.8 percent of GDP) devoted in 1997 to cleaning up the balance sheet of food importing agencies, SNTF and Sonelgaz. In addition, public enterprises received DA 110 billion over 1991–96 (1.3 percent of GDP) in cash transfers through the Rehabilitation Fund established in 1991. The Rehabilitation Fund was terminated in December 1996.

Progress to Date

A first privatization program was launched with the support of the World Bank in April 1996; it included the enactment of a privatization law. The program focused mainly on the 1,300 local public enterprises (EPL). Of the 274 EPL covered, 117 had been privatized or liquidated by the end of 1996. After a relatively slow start, privatization gained momentum with the creation of five regional holdings in charge of implementing the divestment operation. By April 1998, 827 EPLs had already been liquidated and 50 more are currently being sold. Most of these liquidations have resulted in important layoffs. However, 464 EPLs have been sold to their employees resulting in the creation of 608 new companies, protecting 12,141 jobs. The authorities have announced that by the end of 1998, the privatization process of the EPLs would be almost completed, culminating in the closure of most regional holdings.
Considerable progress has been reached regarding the “offices” or food-importing and distributing agencies. At the end of October 1996, seven of the 10 agencies launched restructuring plans, conditional on performance contracts, and the other three (ENIAL, ENAFLA, and ONAPSA) were dissolved. In 1997, ENAPAL, which was responsible for importing most foodstuff until 1994, was dissolved, spelling the end of the state involvement in those activities. Moreover, the 18 units of the three dairy agencies were converted into subsidiaries to facilitate their privatization. In addition, the three pharmaceutical companies were recapitalized, all without exceeding the ceiling of DA 143 billion earmarked for the buyback of the agencies’ debts. In early 1998, the large network of 1,139 pharmacies started to be sold.
As for the more than 400 large public companies (EPEs), massive financial resources were used in an attempt to keep public industry functioning. At the same time, financial autonomy was granted to most EPEs to create incentives to reduce losses and limit the burden on the budget. However, little was achieved in terms of tackling in depth the restructuring needs or privatizing these enterprises, with the exception of the construction sector, where increasing difficulties led to substantial labor shedding. Nonetheless, some acceleration in the restructuring process was registered in late 1996. After grouping EPEs in 11 sectoral holdings, a bank-enterprise mechanism that imposed hard budget constraints was set up. As a result, by December 1997, 76 EPEs had been dissolved and almost 160,000 workers had been dismissed (about 30 percent of the total number of employees at the end of 1996). At the same time, in December 1997, the government announced a list of 250 EPEs to be privatized (about 30 percent of the remaining EPEs in terms of labor and turnover). The authorities are confident that some major privatizations can take place by the end of 1998. As of now, the EPEs on the list of privatizable enterprises in the chemical and mechanical engineering sectors are being evaluated by international consultants to enhance transparency of the privatization process.

While Algeria made remarkable progress in macroeconomic stabilization and in establishing market mechanisms, other structural reforms proved more difficult to implement and, in some cases, more intractable.

The legacy of past government intervention in prices and external trade resulted in a string of quasi-fiscal deficits, which were financed by the banking system and could not be identified early on in the program. For instance, government food importing agencies could not service their external debt—which had more than doubled after the devaluation—from current operations, but had to rely on domestic or external bank financing. When such financing was sharply reduced in the context of stricter bank lending policies, these agencies defaulted and their bank loans were taken over by the treasury. A lesson for future IMF programs is to fully flesh out the external debt implications on the financial condition of banks and enterprises following a large devaluation.

The housing crisis proved difficult to address despite the best efforts of the authorities, the World Bank, and the IMF. This was partly due to the need to restructure the entire system of housing construction and financing, while ensuring a steady yearly delivery rate. The latter was essential to ease existing shortages and provide jobs. With the benefit of hindsight, greater progress would have required a high-level task force endowed with broad powers that superseded individual ministries to obtain and develop construction sites and to mobilize financing. The establishment of clear property rights in agriculture and in housing also proved elusive, which is understandable given 30 years of socialist legacy. The absence of such rights inhibits collateralization of bank financing, reduces incentives for investment, and limits bank intermediation. Indeed, the judicial system in Algeria is not yet geared to the norms of a market economy. It is slow and cumbersome in contractual disputes, and favors tenants over landlords.

Foreign direct investment outside the hydrocarbon sector, which is essential for modernizing the capital stock and for injecting best management practices, as well as domestic private sector investment have not been forthcoming to the extent anticipated. They have been inhibited by the civil strife which, in addition to the psychological impact, has exacted substantial costs. These costs include lost production, mostly in agriculture and industry; damage to infrastructure; costs associated with the provision of security services; higher transportation costs; cost of relocating plants to safer areas; and costs of uncollected taxes and rents in areas that lack security. It has also reduced labor mobility.

Future Challenges

It should be recalled that the major objectives of Algeria’s economic reform strategy were to secure high sustainable growth and reduce unemployment. Considering that the labor force has been growing at almost 4 percent a year (a rising female participation is expected to offset the impact of a declining birth rate) and that industrial restructuring will entail some labor shedding, Algeria needs a yearly growth rate of 6 percent to 7 percent in the nonhydrocarbon sector, together with a concentration of growth in labor-intensive activities. These two conditions are necessary for a significant reduction in the 28 percent unemployment prevailing today (see Figure 17).

On a macroeconomic level, the major antilabor bias, arising from an overvalued exchange rate, negative real interest rates, and a state industrial policy that favored capital intensive industrial complexes over agriculture or housing, has been corrected. The exchange rate is realistic, real interest rates have become positive, and the government has started to withdraw from production activities. Other conditions, however, are necessary to ensure high and sustained growth that would reduce unemployment, maintain a high quality of public expenditure in the context of tight demand management, and ensure a diversification of the production base away from hydrocarbons. A flexible exchange rate policy and wage increases tied to productivity growth will be critical in this respect. In addition, much needs to be done at the micro level and in terms of structural reforms.

The privatization of public enterprises is hindered by the small size of the private sector in Algeria and its lack of corporate structures and modern management practices. It is doubtful whether the private sector can absorb the large state-owned industries. Therefore, successful privatization would require a higher degree of public support for the program through a broadening of privatization mechanisms (e.g., vouchers, employee buy-outs, stock market listings, and so forth). The establishment of a stock market and adoption of standarized accounting practices with greater transparency would mobilize domestic savings and attract foreign partnerships and direct investment, which are essential to inject new technology and management.
Modernization of the banking system with the help of foreign partnerships or privatization will be necessary to support a growing private sector and deepen financial intermediation. In this transitional environment, the reluctance of banks to assume risk has slowed down the private sector’s efforts to take over some government activities and more generally to broaden their role in the economy. Consequently, there is a need to develop a banking culture and deepen financial markets, particularly for treasury bills and high quality commercial paper.
Clear property rights in agriculture, housing, and urban real estate need to be established. Steps are being taken in the agricultural sector. In particular, a law was presented to parliament in mid-1998 to clarify land ownership.
Housing delivery will have to be reoriented from the state to the private sector through the provision of financing and market incentives. This process has already been engaged and is being supplemented by the creation of a mortgage bank and other mechanisms, such as the creation of a secondary market in mortgages and a mortgage guarantee institution.
The judicial system should be reformed to ensure a quick settlement of contractual disputes and bankruptcy proceedings. Civil courts need to be established in major cities. The regulatory frame-work also needs to be simplified and become transparent and more accessible to the public.
Unemployment at 28 percent is high and a major cause of social instability. A concerted effort through labor market reforms, public investment in labor-intensive infrastructure, and the promotion of a competitive environment for private investment are essential to reduce unemployment and absorb new entrants to the labor force.
The education system needs to be restructured to meet the labor profile required by the private sector and Algeria’s economic integration in the Mediterranean basin.
Algeria’s integration into the world economy should be promoted by liberalizing further trade, services and capital flows, as well as fostering the absorption of new technologies, which will be essential to face the challenges posed by globalization.

Facing these challenges will not be easy, particularly if foreign investment continues to be deterred by security problems, but Algeria also holds great potential. Its dynamic hydrocarbon sector and considerable oil revenues provide both a large internal market and the government resources necessary to pursue the reforms outlined above. Its comparative advantage based on low labor costs and a capable human resource base as well as Algeria’s proximity to the European markets and other Maghreb countries should provide large gains from trade. The recent broadening of political participation in government following the June and October 1997 elections offers the promise of progress in the restoration of peace. This, together with continued determination in completing the structural reforms outlined above, should contribute to create an enabling environment for a full realization of Algeria’s potential.

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Future Challenges

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