Algeria
Selected Economic Issues

This paper examines institutional reforms in Algeria during the 1990s. A major step toward price liberalization was taken in April 1994, through the abolition of controls on profit margins for most commodities, except for edible oils, sugar, medicines, school supplies, coffee and tobacco, and five cereal products, which were transferred from the category of goods with administered prices to that of goods with controlled profit margins. The paper also reviews the performance of fiscal policy and future prospects for it.

Abstract

This paper examines institutional reforms in Algeria during the 1990s. A major step toward price liberalization was taken in April 1994, through the abolition of controls on profit margins for most commodities, except for edible oils, sugar, medicines, school supplies, coffee and tobacco, and five cereal products, which were transferred from the category of goods with administered prices to that of goods with controlled profit margins. The paper also reviews the performance of fiscal policy and future prospects for it.

I. Recent Institutional Reforms: Establishing Market Mechanisms

The program of macroeconomic stabilization and structural reforms implemented by Algeria with Fund support, first through a one-year stand-by arrangement, and subsequently under the Extended Financing Facility (EFF), has been predicated upon a far-reaching transformation of the institutional framework governing the allocation of resources in the economy. Until the beginning of 1994, resource allocation in Algeria had been mostly governed by a complex apparatus involving administrative decisions and direct state controls on prices, production, and credit. This apparatus has by now been mostly dismantled and replaced by market mechanisms in conjunction with a major liberalization of both the domestic price system and the external trade and payments regimes.

1. Domestic price system

The price law of 1989 divided products into three categories for purposes of price setting: (i) those for which prices were fixed administratively; 1/ (ii) those subject to controlled profit margins; 2/ and (iii) those for which prices were free but still needed to be declared to the authorities. Prices were also distorted by a number of generalized subsidies to: (i) final consumers of energy products and 15 major food staples; and (ii) producers of several agricultural products and inputs, such as wheat, potatoes, fertilizers, and seedlings for a variety of crops. Aside from the misallocation of resources which this system entailed, it was also inequitable since the richer half of the population were consuming more than 60 percent of the subsidized food items.

During the last two years, domestic prices have been almost entirely liberalized as controls on prices and profit margins were lifted for most products, and most subsidies eliminated.

a. Lifting controls on prices and profit margins

A major step toward price liberalization was taken in April 1994, through the abolition of controls on profit margins for most commodities, except for edible oils, sugar, medicines, school supplies, coffee and tobacco, and five cereal products (pulses, maize, rice, oats, and barley) which were transferred from the category of goods with administered prices to that of goods with controlled profit margins. The former category was thus reduced to the three subsidized essential food staples (flour, semolina, and milk), energy products, and public transportation fares. Later in 1994, prices of agricultural inputs and construction prices for social housing were liberalized, and all remaining controls on profit margins 1/ and prices were eliminated during 1995/96, except for medicines and subsidized food and energy products.

The reduction in the number of goods subject to controls on prices or profit margins was supported by the adoption in January 1995 of a Competition Law which institutionalized the principle of free price setting for all products while introducing safeguards against possible abuses by monopolistic suppliers, including through anti-trust regulations. The law prohibits noncompetitive practices, such as the imposition of limits on market access or collusion between enterprises to control a particular market. This regulatory framework is being enforced by a number of institutions, including a National Competition Council, the Commerce Department and the Justice Department. 2/ Since the adoption of the Competition Law, the requirement for producers to declare their prices to the Commerce Department has been replaced by an obligation for all suppliers to publish prices.

b. Eliminating generalized subsidies

The reform of the domestic price system also entailed major increases in the prices of subsidized products toward their opportunity costs. Prices of subsidized food and energy products were increased on average by about 100 percent in 1994/95 and 60 percent in 1995/96. As a result of these price adjustments, subsidies were eliminated on petroleum products (October 1994), powdered milk and semolina (June 1995), regular flour (October 1995), and bread flour (January 1996). These four food products have been transferred to the category of commodities with controlled profit margins for a one-year period, and are to be freed completely thereafter. With respect to energy products, the implicit subsidy was eliminated by setting the transfer price of crude oil from Sonatrach to the refineries at world price level. To make the elimination of the implicit subsidy durable, a system was introduced to adjust the transfer price every six months in line with export prices and exchange rate developments.

Thus, as of June 1996, subsidies have been eliminated for all food products, with the exception of pasteurized milk which will cease to be subsidized by the end of 1996. There also remains a global subsidy on gas and electricity products (equivalent to 0.4 percent of GDP in 1996), which the Government is committed to eliminate by end 1997. 1/

To cushion the impact of the elimination of generalized subsidies on the most vulnerable social groups, the authorities undertook a reform of the social safety net. A key aspect of this reform was the replacement of the previous system of low and poorly targeted income transfers by one of self-targeted public works programs. 2/

2. Reform of the enterprise sector

As a legacy of the central planning approach to economic development, Algeria’s manufacturing sector has been dominated by a large number of public enterprises which still account for more than two-thirds of both industrial value-added and employment, and, similarly, in the construction sector, where public enterprises contribute about half of value-added and employment. Overall, Algeria’s public enterprise sector includes about 400 large public enterprises and about 1,300 small and medium-scale public enterprises operating at the local or regional level. Most of these enterprises are characterized by low productivity stemming mostly from obsolete capital equipment, inefficient management, and over-staffing.

Several steps had been taken prior to 1994 to introduce more market-based pricing and management behavior on the part of public enterprises and promote the development of the private sector. In particular, most of the large public enterprises which appeared to be financially sustainable had been granted financial and management autonomy at the end of 1992. The acute financial difficulties and complex operational problems of the 23 largest loss-making public enterprises were addressed by a more specific restructuring strategy monitored in the context of the World Bank’s Enterprise and Financial Structural Adjustment Loan (EFSAL). In addition, the new Commercial Code adopted in 1992 established full equality of treatment between private and public enterprises, and the new Investment Code enacted in 1993 gave foreign investors equal rights to those of domestic investors.

The reform of the public sector has been deepened during the last two years, not only through further restructuring or liquidation of public enterprises, but also through an extension of the institutional framework allowing for the privatization of public enterprises and increased foreign participation in the Algerian economy.

a. Public enterprise restructuring

Public enterprise restructuring efforts during the last two years have focused mainly on the 23 largest loss-making enterprises that had remained under close government supervision since 1992. About two-thirds of these enterprises belong to the industrial sector (with about half in engineering and capital goods), while the rest are concentrated in the construction and transportation sectors. Altogether, they employ approximately 130,000 people and account for about 13 percent of value added in industry and construction.

This group of “23” has been subjected to a hardened budget constraint in the form of a ceiling on their access to commercial bank credit during both the stand-by supported program (1994/95) and the first year of the current EFF program (1995/96). Meanwhile, medium-term plans were drawn up for all of them on the basis of detailed diagnostic studies carried out in collaboration with the World Bank. These plans were designed to cut operating losses through better inventory control and cost management procedures, and to improve competitiveness through the shedding of redundant labor and a reorientation of production to a viable set of activities. Such plans have been translated into performance contracts signed between the State and the managers of these enterprises, which have all been granted financial and management autonomy by April 1996. While financial rehabilitation of these enterprises has taken place, it was left to enterprise managers to renew their capital equipment by raising resources through the sale of some assets, domestic or foreign participation, or privatization. Little progress in this respect has occurred so far but it is expected that the privatization law will provide an effective venue for such physical restructuring.

Progress was also achieved toward the restructuring of other public enterprises, including through the liquidation of 88 of the local public enterprises in 1994. The Treasury took the important decision to stop, as of end-March 1995, all on-lending to autonomous public enterprises. 1/ In addition, a restructuring program was launched in 1995 for all public construction enterprises. This program involved the dissolution of 13 enterprises and the lay off of 40,000 employees (25 percent of the sector’s work force), facilitated by the introduction, in July 1994, of a new unemployment insurance system providing for lump-sum severance payments to retrenched workers for a three-month period. 1/

The Government has recently adopted a law setting up holding companies to manage public enterprises. These holdings are expected to: (i) set as their primary objectives the achievement of positive rates of returns by public enterprises; (ii) sanction loss-making enterprises, through liquidation or requiring that they sell part of their assets; and (iii) prepare enterprises for privatization once demand conditions permit.

b. Privatization and private sector development

Prior to 1994, the two legal vehicles for privatization in Algeria were provided by: (i) a 1990 law allowing for the sale of local public enterprises by competitive bidding and the offer of local public services for operation by the private sector under concessions; and (ii) the bankruptcy law of the 1992 Commercial Code allowing for the liquidation of public enterprises. This legal apparatus has been recently significantly extended. First, under Articles 24 and 25 of the 1994 Complementary Finance Law, units of public enterprises can be sold outright, enterprises can be offered for private management contract, or can sell up to 49 percent of their equity to the private sector. Second, the Privatization Law, which was passed in July 1995, allows for 100 percent private equity participation in most public enterprises. In June 1994 the Government approved a law removing the State’s monopoly in the insurance market, and in July 1994, an amendment was introduced to the Investment Code allowing foreign participation in the capital of domestic commercial banks. In addition, a new law promulgated in July 1995 restored to original owners certain lands that had been nationalized or ceded to the State in the aftermath of independence.

Within this framework, the authorities recently adopted a privatization program supported by a World Bank Structural Adjustment Loan (SAL). As permitted under the 1990 law, 103 local public enterprises (in the transportation, commerce, construction, and tourism sectors) have been brought to the point of sale, and 35 activities have been offered for concession. On the basis of Articles 24 and 25 of the 1994 Complementary Finance Law, this initial privatization program has also offered for sale, tendered for management contracts, or opened up the capital of 50 public economic units in industry, agro-industry, tourism and commerce. In addition, foreign investors have signed contracts to manage two public sector hotels. In the context of their restructuring, a number of enterprises have carried some privatization by selling off some of their service activities (e.g., catering, transportation, housing) to their employees or the private sector, and by sub-contracting other activities. However, no actions have yet been taken on the basis of the 1995 privatization law which allows for full privatization of public enterprises. A privatization agency was, however, established in March 1996 to prepare a privatization program under this law.

Beyond these privatization initiatives, new institutions were put in place to promote private sector development. In particular, a national investment agency was established in 1994 to: (i) act as a “one-stop window,” to help private investors (domestic and foreign) cut through bureaucratic red tape; and (ii) 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.

3. Financial sector reform

Until the late 1980s, Algeria’s financial sector operated as a financing instrument for public sector investment with little linkage between risk assessment and the allocation of credit. Its modus operandi was radically modified in the period 1989-91, in the context of Algeria’s transition to market-oriented economic management. In 1989, a money market was instituted among commercial banks which were granted autonomy from the State. Another major step was taken in 1990 with the passing of the Law on Money and Credit which gave the Bank of Algeria autonomy from the Ministry of Finance and established the Council on Money and Credit to set credit, monetary, foreign exchange, and external debt policy. The law also established the principle of equal treatment for public and private enterprises in terms of access to credit, central bank refinancing and interest rates. Within this new institutional framework, a number of additional reforms were introduced in 1991 and 1992, including the imposition of a ceiling on the total access of commercial banks to central bank refinancing. Participation in the money market was broadened to institutional investors (e.g., insurance companies), while abolishing direct ceilings on commercial banks’ credit to the economy and sector-specific rediscount rates.

Notwithstanding these institutional changes, Algeria’s financial system was still saddled, in early 1994, by legacies of previous decades of administrative economic management. In particular, direct controls kept interest rates below market-clearing levels and limited the scope of indirect instruments of money and credit control. The banking system, including the housing bank (Caisse National d’Epargne et de Prévoyance (CNEP)), could not operate under market norms as long as many of their clients (public enterprises) were insolvent. Consequently, financial sector reform had to go hand in hand with public enterprise reforms. Substantial progress has been achieved on all these fronts since early 1994, when Algeria embarked on an ambitious Fund-supported program.

a. Interest rates deregulation

From May 1990 until early 1994, commercial banks’ lending interest rates remained subject to a 20 percent ceiling per annum. As a result, these rates became negative in real terms in 1993/94, since they were not allowed to reflect the increasing inflationary pressures arising from a substantial relaxation of demand management policies (Table A35). The ceiling on lending rates also constrained the flexibility of deposit rates which had been liberalized in May 1990.

An important measure of the adjustment program launched in 1994 was the abolition of the ceiling on money market interest rates and commercial banks’ lending rates to the public. It was accompanied by the imposition of a temporary cap of 5 percentage points on commercial banks’ interest rate spread, with a view to preventing an excessive increase of lending rates as a result of collusion among the five commercial banks. This cap on banks’ spreads was eliminated in December 1995. The deregulation of interest rates, together with the deceleration of inflation brought about by tighter demand management policies, has allowed the emergence of positive real interest rates since the beginning of 1996.

b. Indirect instruments of monetary management and budget financing

In early 1994, the Bank of Algeria controlled liquidity in the banking system by imposing bank-by-bank ceilings on the global amount of refinancing, through the rediscount facility or repurchase agreements on the interbank money market; however, these two instruments were still heavily geared to individual banks’ needs and were provided at the initiative of commercial banks.

To address these weaknesses, the Bank of Algeria first imposed a reserve requirement on commercial banks, starting in October 1994. The required reserves represent 3 percent of bank deposits (excluding foreign currency deposits) and are renumerated at 11.5 percent. The efficiency of indirect monetary control was further strengthened in May 1995, as the Bank of Algeria started repurchase-auctions to provide liquidity to commercial banks. The auctions were initially held every six weeks, but with their growing importance as a main refinancing instrument, they have been held every three weeks since the beginning of 1996. By the end of 1995, refinancing through repurchase agreements and auctions accounted for more than a third of total refinancing, compared to about a tenth at end-1994. Under the auction system, the Bank of Algeria announces a minimum interest rate prior to the auction; subsequently, banks bid in terms of rates and volumes. Initially, the Bank awarded refinancing at a single interest rate (standard auction) but in late 1995 moved to a type of Dutch auction awarding bids at the interest rates actually offered by banks.

In addition, the Government instituted in late-1995 a formal auction system (adjudication) to sell negotiable treasury bonds on the money market. Interest rates on these bonds reached 22.5 percent in early 1996. Participants in the auctions include banks as well as nonbank institutions such as insurance companies. The system is expected to facilitate the introduction of open market operations by the Central Bank in the course of 1996.

c. Commercial bank restructuring

The legacy of soft budget constraints for public enterprises, sectoral credit specialization, and inappropriate prudential regulations left Algeria’s commercial banks with major portfolio weaknesses and little experience in efficient financial intermediation. These problems started to be addressed in 1992 and 1993 through the taking over, by the Government, of DA 275 billion of nonperforming banks’ claims on public enterprises, in exchange for government bonds bearing annual interest rates of 5 percent and 6 percent. 1/ Subsequently, the authorities conducted a series of audits, in collaboration with the World Bank, to determine the banks’ recapitalization needs to meet a minimum capital/risk-weighted assets ratio of 4 percent in 1996.

Audits of balance sheets as at end-1994 have been completed for four of Algeria’s five commercial banks. They indicated that the Banque Nationale d’Algérie (BNA) did not need additional capital in the immediate future. Two other banks, the Banque Extérieure d’Algérie (BEA) and the Crédit Populaire d’Algérie (CPA), have been recapitalized in 1995 through budgetary contributions of DA 10 billion. Recapitalization was accompanied for each bank, along with its recertification by the Bank of Algeria, by the signing of performance contracts between the Government and bank managers. 2/ Performance contracts hold the bank managers directly and solely responsible for respecting the capital adequacy ratios established by the Bank of Algeria, which are expected to increase to the BIS norm of 8 percent by the end of 1999. The banks, in return, are being provided with increased autonomy with respect to operational decisions, notably the allocation of credit and more importantly the denial of credit to high risk enterprises. In addition, in early 1995 the Bank of Algeria started to implement new prudential regulations that limit risk concentration and establish clear rules for loan classification and provisioning. In particular, banks are now required: (i) to limit overdrafts to the equivalent of 15 days’ turnover (compared to 45 days previously); (ii) not to register overdue interest payments as revenues; and (iii) to establish provisions for off-balance sheet claims. This new framework is expected to tighten the budget constraint on banks and increase the incentives for bank managers to mobilize financial savings, improve the allocation of credit, and search for potential private partners.

Several measures were also taken to raise the level of competition in the banking sector. An amendment to the Investment Code was introduced in 1994 to allow foreign participation in the capital of domestic banks. A new private bank was chartered in September 1995 (Union Bank), along with the Caisse Nationale de Mutualité Agricole (CNMA), owned by private agricultural cooperatives.

4. External sector reform

In 1992, the inconsistency between expansionary domestic fiscal and monetary policies and a fixed exchange rate, coupled with an external debt strategy which sought to avoid a formal debt rescheduling, led the Algerian authorities to contain excess demand for foreign exchange through the introduction of an array of additional restrictions on international transactions. Since Algeria embarked on a Fund-supported adjustment program in 1994, major progress has been accomplished toward the liberalization of the trade and payments system, and the exchange regime has been transformed from a peg to a managed float.

a. Trade and payments liberalization

In early 1994, Algeria’s official foreign exchange resources were administratively allocated by a “Comité ad hoc” (CAH) to: (i) “priority imports” of strategic commodities 1/ and products necessary for the development of the hydrocarbon sector, for which authorization was granted on a case-by-case basis upon submission of a “cahier des charges” (CDC); and (ii) as second priority, imports of goods needed to promote production and investment. Other imports were either totally prohibited or, for a group of about 60 products, allowed only if they could be financed by an importer’s own foreign exchange resources. In addition, minimum maturity requirements, ranging from 18 to 36 months, were imposed for commercial credits financing such imports.

The dismantling of these restrictions began in April 1994 with the dissolution of the Comité ad hoc, and the abolition of the requirement for a cahier des charges. Concurrently, import prohibitions were organized through three lists: (i) a short list of goods whose imports are banned on a permanent basis for social and religious reasons; (ii) a negative list of temporary import suspensions which was eliminated at the end of 1994; and (iii) a list of ten basic commodities (mostly subsidized food staples) whose importation remained temporarily subject to observance of technical and professional criteria until its total abolition in May of 1995. 2/ The requirement that some imports be exclusively financed with the importers’ own foreign exchange remained in effect, on a temporary basis, for private cars until December 1994. Additional liberalization measures included: (i) the abolition of the minimum maturity requirement on import financing with the temporary exception of capital goods imports for which this requirement was maintained until October 1994 for imports of less than DA 500,000, and until May 1995 for imports beyond that amount; (ii) the elimination of all previous export prohibitions except for a limited number of items of historical and archeological significance; and (iii) the lowering of the maximum import tariff from 60 percent to 50 percent as of January 1996.

As of June 1996, Algeria’s trade system is free of quantitative restrictions. The payments system still contains some restrictions on the availability of foreign exchange for some current invisible payments and for remittances by nonresidents.

b. From a fixed exchange rate regime to a managed float

A major objective of the foreign exchange market reforms pursued by Algeria since early 1994 has been to make the exchange rate of the Algerian dinar more transparent and responsive to market forces. For this purpose, the exchange rate regime has been transformed from a peg to a managed float in three successive stages.

First, the Algerian authorities started by correcting the overvaluation accumulated by the dinar from 1991 to 1994, through two-step devaluations (7.3 percent in March 1994 and 40.1 percent in April 1994) while maintaining the dinar pegged to a basket of 16 currencies (Table A35). The second stage began in October 1994 with a move to daily fixing sessions, organized by the Bank of Algeria, in which the exchange rate of the Algerian dinar was determined in a marginal auction. 1/ Concurrently, foreign exchange surrendering requirements were unified at a rate of 50 percent, with the exception of earnings from exports of hydrocarbon and mining products. 2/ With the introduction of fixing sessions for the Algerian dinar in October 1994, exchange rate flexibility increased with the U.S. dollar/dinar rate depreciating from US$1 = DA 41.0 to US$1 = DA 52.2 by end-December 1995. This, as well as substantial broadening of the scope of transactions in the official exchange market, has reduced the premium on the parallel foreign exchange from more than 300 percent in early 1994 to about 20 percent at end 1995.

In a third stage, the fixing sessions have been superseded, since end-December 1995, by a full-fledged interbank foreign exchange market. Subject to prudential regulations which limit their open positions in foreign exchange, commercial banks are now no longer required to surrender to the Bank of Algeria the foreign exchange left at their disposal, and may trade these resources freely among themselves. In practice, as the Bank of Algeria purchases from the national oil company (Sonatrach) its hydrocarbon export proceeds, it retains a dominant role in the market for foreign exchange where its intervention policy has been guided by the objective of avoiding sharp fluctuations of the exchange rate while preventing the real exchange rate from appreciating significantly.

II. Fiscal Policy: Recent Performance and Future Prospects

1. Fiscal consolidation: 1993-95

After a major fiscal tightening in 1991, in conjunction with the implementation of a Fund-supported stabilization program, fiscal discipline was relaxed in 1992 and 1993, compounded by declining oil revenues. The large fiscal deficits were almost totally monetized and contributed to excessive money growth and inflation. Since 1994, a substantial fiscal consolidation was achieved through the implementation of a strong stabilization program, supported by a stand-by arrangement and subsequently by an EFF. As a result, the overall fiscal deficit was reduced from 8.7 percent of GDP in 1993 to 1.4 percent in 1995 (Chart 1). This achievement reflected both expenditure reductions and, to a lesser extent, revenue increases. Moreover, while the adjustment on the expenditure side resulted from the adoption of budgetary measures, the increase in revenue was mainly due to the exchange rate depreciation.

a. Revenue developments

Budgetary revenues in Algeria averaged more than 30 percent of GDP during 1990-95. While this ratio compares favorably with other middle income countries, more than one half of these revenues emanate from hydrocarbon receipts. After a substantial decline between 1991 and 1993, total revenues increased by 2.8 percentage points of GDP between 1993 and 1995, mainly due to the exchange rate depreciation which raised the domestic currency counterpart of hydrocarbon export receipts and boosted trade taxes. In addition, several measures were implemented to strengthen the tax system and to increase the domestic tax base (Table 1). Nevertheless, as budgetary revenues continue to depend excessively on hydrocarbon receipts and import taxes, they are particularly sensitive to exchange rate developments and fluctuations in world oil prices. For example, a 10 percent change in the exchange rate of the dinar against the U.S. dollar would result in a variation of about 2.3 percent of GDP in total revenue, with two thirds of it due to the effect on hydrocarbon revenues and one third to the response of import taxes. Similarly, a US$1 per barrel fluctuation in the oil price would result in a loss or gain in budgetary receipts on hydrocarbon exports equivalent to about 1.5 percent of GDP.

(1) Hydrocarbon revenue

After a substantial decline between 1991 and 1993, due to a fall in oil prices, hydrocarbon revenue increased from 15.9 percent of GDP in 1993 to 17.5 percent in 1994 and 18.2 percent in 1995. These increases explain about 30 percent of the fiscal consolidation of 1994-95 and were mostly due to exchange rate developments. In particular, the 39 percent increase in hydrocarbon revenues in 1994 reflected a 50 percent depreciation of the dinar that more than compensated the decline in export value due to a fall in the world market price of crude oil. At the same time, the administered prices for petroleum products sold in the domestic market were raised significantly, thus boosting domestic hydrocarbon revenue. Finally, under the stand-by supported program, Sonatrach ceased its implicit subsidization of crude oil to the refineries and aligned its domestic crude oil prices to world prices. This strengthened Sonatrach’s financial position and allowed the company to distribute higher dividends to the Government. Similarly, in 1995 a new increase in hydrocarbon revenues was mainly due to a further adjustment in the exchange rate, reinforced by a recovery in the world market oil price.

Chart 1
Chart 1

Algeria: Fiscal Developments, 1990–95

(In percent of GDP)

Citation: IMF Staff Country Reports 1996, 071; 10.5089/9781451811339.002.A001

Source: Algerian authorities.1/ Including net lending. special accounts, and operations of the Rehabilitation Fund.2/ Indirect taxes on petroleum products and dividends from oil companies are classified as hydrocarbon revenue.3/ Excluding hydrocarbon revenue.4/ Excluding compensation tax.5/ Excluding net lending, special accounts, and operations of the Rehabilitation fund.
Table 1.

Algeria: Central Government Revenue, 1990–95

(In percent of GDP)

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Source: Algerian authorities.

Includes receipts from hydrocarbon exports and sales of crude oil to domestic rafineries.

Earmarked tax on some imports and domestic sales imposed to raise resources for the Compensation Fund.

(2) Nonhydrocarbon revenue

During 1990-92, nonhydrocarbon revenue declined by about 3 percentage points of GDP, reflecting mainly the overall deterioration of the economy. In particular, the compression of imports, together with the fall in enterprise profitability, squeezed tax receipts, which were further reduced by the introduction of income tax exemptions. Since 1993, nonhydrocarbon revenue recovered by about 1.2 percentage points and by 1995 it accounted for 12.3 percent of GDP. This recovery was mainly due to an increase in tax revenue resulting from several factors. First, the depreciation of the exchange rate and the liberalization of imports boosted trade related taxes. Second, tax measures, such as the elimination of some tax exemptions, increased domestic taxes. Finally, the elimination of subsidies on domestically consumed petroleum products allowed for their effective taxation. 1/

Nontax revenues as a share of GDP have remained relatively unchanged during 1990-95, accounting only for about 4 percent of nonhydrocarbon revenue. Profits from the parastatal sector, except the petroleum sector, 2/ declined substantially in the 1990s, reflecting the contraction of profits of public enterprises. In 1994, the Bank of Algeria for the first time remitted dividends to the Government (0.4 percent of GDP), which fell to virtually nil in 1995.

• Direct taxes

Direct taxes declined from 4 percent of GDP in 1990 to 2.7 percent in 1995, reflecting the weaknesses of both individual and corporate income taxes.

Individual income taxes declined steadily from 2.5 percent of GDP in 1990 to 1.6 percent of GDP in 1995. However, different factors explain this trend before and after the stabilization program of 1994. During the period 1990-93, the decline resulted from numerous exemptions introduced in income tax legislation, 1/ whereas since 1994 it is mostly explained by a tight wage policy in the public sector. The budget law of 1995, aimed at increasing the tax base and the efficiency of tax collection, introduced some offsetting measures through the taxation of interest incomes and the elimination of the surcharge on the income tax applicable to the top income earners, which encouraged tax evasion.

Profit tax receipts (including corporate tax and the taxation of the self-employed) declined substantially during 1990-92, to 0.8 percent of GDP in 1992, but increased in the following years to reach 1.1 percent of GDP in 1995. The recovery, especially in 1994, reflects some improvement in enterprises’ financial situation due to wage moderation, the effect of price liberalization, and the increase of the tax rate on reinvested profits from 5 percent to 33 percent. However, corporate tax receipts remain low compared to similar countries, despite a relative high 38 percent tax rate, reflecting the poor profitability of public enterprises which still face quality and production line problems, especially in the context of heightened competition brought about by trade liberalization.

• Taxes on goods and services

Excluding, for comparison purpose, the receipts from the compensation tax, 2/ taxes on goods and services decreased relative to GDP from 1990 to 1992, but improved slightly afterwards. This improvement resulted mainly from the recovery in VAT and excises on imported goods, following the exchange rate adjustment and the increase in import volumes. Excises and VAT on domestic transactions declined from 1.8 percent of GDP in 1993 to 1.6 percent of GDP in 1995, mainly because of a reduction in the average VAT rate. This reflected both the elimination of the highest VAT rate of 40 percent in 1995 and the fact that the highest growth was concentrated in the agricultural sector where many exemptions persist and where the lowest VAT rate (7 percent) applies. Nevertheless, the authorities have tried to stem the decline in VAT receipts by expanding its coverage to certain agricultural products and financial transactions, and by increasing the share of the Central Government in VAT receipts from 83 percent to 85 percent. 1/

• Taxes on international trade

Receipts from custom duties increased significantly during 1990-95, with the increase after 1994 being the result of a more liberalized market and the elimination of tax distortions. The increase in 1991 was mainly induced by the depreciation of the dinar. While in 1992 and 1993 the reduction in import volumes with a broadly stable exchange rate had a contractionary effect on revenues, this was more than offset by the integration of part of the compensatory tax in the new tariff code of 1992. Customs duties rebounded since 1994 because of the exchange rate adjustment, the increase in import volumes following imports liberalization, the removal of exemptions on several products (e.g., pharmaceutical products), and a reduction in tariff dispersion. In 1995, customs duties accounted for 3.7 percent of GDP, or about 30 percent of nonhydrocarbon revenue.

b. Expenditure developments

From 1990 to 1993, government expenditures had increased from 26.6 percent of GDP to 33.6 percent (Table 2). The surge affected primarily current expenditures and was mainly due to substantial increases in wages, and an increase in the budgetary transfers to the Compensation Fund to meet the increasing cost of food subsidies following the exchange rate depreciation of 1991. At the same time, net treasury lending, which had been negative in 1990, rose to 1 percent of GDP in 1993, while disbursements of the Rehabilitation Fund for public enterprise restructuring reached 3 percent of GDP. A significant turnaround took place in government expenditures since the launching of the adjustment program in 1994. From 1993 to 1995, government expenditures declined by almost 4 percentage points of GDP, following cuts of both current and capital outlays. Moreover, reflecting the gradual disengagement of the Treasury from financing public enterprises and the partial completion of banking and enterprise restructuring, net lending declined to 0.1 percent of GDP in 1995 and expenditure of the Rehabilitation Fund to 1.9 percent.

Current expenditures decreased from 24.9 percent of GDP in 1993 to 22.5 percent in 1995 as a result of a tight cap on most spending items despite high inflation and exchange rate depreciation. Personnel expenditures, which account for the bulk of current expenditures (42 percent in 1995), declined from 10.5 percent of GDP in 1993 to 9.5 percent in 1995 as a result of a strict wage policy and a lower rate of recruitment. Salaries increases were limited to 17 percent in 1994 and 10 percent in 1995, implying a decline of about 10 percent in real wages for two consecutive years. The strict incomes policy also contributed to savings in public services appropriations and subsidies to hospitals, as these are used mainly to pay wages; thus public services expenditure declined from 3.4 percent of GDP in 1993 to 2.8 percent in 1995. Current transfers declined from 9.8 percent of GDP in 1993 to 7.6 percent in 1995, mainly as the result of the elimination of consumer subsidies on food products and the decline of producer subsidies in the agricultural sector. In addition, some savings were realized in social safety net expenditures through a reform which improved the targeting and the efficiency of the system. 1/ Debt service increased steadily from 2.3 percent of GDP in 1993 to 3.2 percent of GDP in 1995, mostly due to interest payments on the external debt. Interest payments on domestic debt remained low because until 1995 the Treasury had not been paying any remuneration on the Bank of Algeria’s advances, and the interest rate on treasury bonds issued in 1992 in the context of public sector restructuring was set below market levels.

Table 2.

Algeria: Central Government Expenditure, 1990–95

(In percent of GDP)

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Source: Algerian authorities

A positive number indicates a surplus

Excluding the compensation for commercial banks’ foreign exchange losses on principal payments of external debt contracted on behalf of the Treasury.

Including net lending, special accounts and operations of the Rehabilitation Fund.

Capital expenditures declined from 8.7 percent of GDP in 1993 to 7.3 percent in 1995, notwithstanding increases in allocations needed to repair infrastructure damaged by civil strife. The decline reflected mainly the withdrawal of the Government from direct investment in public enterprises, the scaling down of the number of projects, and the shifting of responsibility for certain investments to local governments.

2. Future Prospects

The key challenges in the fiscal area for Algeria over the medium term are to build upon the successes achieved so far, and: (i) to generate appropriate levels of government savings in the face of continuing expenditure pressures; (ii) to reduce dependency on hydrocarbon revenue and trade taxes; and (iii) to achieve a structure of expenditure that supports private sector driven growth and employment creation. This will require efforts to restrain certain categories of expenditures, along with a major restructuring of the tax system.

a. The need for a budget surplus

Algeria needs to achieve a fiscal surplus over the medium term for three main reasons. First, there is the need to cushion public finance against volatility in the world market price of oil. In particular, the achievement of budget surpluses would contribute to lowering the public debt-to-GDP ratio in the coming years, despite the major increase in public debt in 1996 to absorb past quasi-fiscal deficits of some public agencies (see below), thereby providing the Government with the flexibility to finance temporary revenue shocks.

Algeria–Central Government Debt 1989-98

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Source: Algeria authorities; and staff estimates and projections.

Excluding lending of the CNEP to the OPGI guaranteed by the government.

Second, the depletion of nonrenewable hydrocarbon resources would warrant converting part of the hydrocarbon revenue into alternative productive assets, mostly by encouraging private sector investment which would be the main engine of growth in the coming years. Third, given that the high level of external debt calls for a gradual reduction in the reliance on foreign savings, government savings must increase in order to channel adequate resources to the private sector for investments, without jeopardizing the inflation objective. This increase is even more necessary because private savings are expected to rise only moderately in the short term as private consumption recovers from its depressed recent levels.

b. New expenditure pressures

The achievement of budget surpluses is likely to be complicated by foreseeable pressures from four categories of expenditures. First, in order to absorb past quasi-fiscal deficits, the Government has decided to exchange in 1996 a sizable amount of nonperforming bank debt accumulated by public agencies for treasury bonds. This operation will result in a substantial increase in interest payments on domestic debt estimated at about 1 percentage point of GDP beginning in 1997.

Second, the Government may have to cushion the employment impact of the ongoing restructuring and expected privatization of public enterprises through higher budgetary support for the social safety net. For instance, with the assistance of the World Bank, the authorities intend to expand the public work programs, which employed about 500,000 people in 1995 (for a period of one or two months), through the creation of about 20,000 additional man-years of short-term employment in 1996/97. This may raise social safety net expenditures by 25 percent compared to their 1995 level. In addition, the Government may have to strengthen unemployment insurance funding in connection with further lay offs of public sector workers. Despite a more flexible unemployment insurance scheme introduced in 1994, the costs of labor shedding continue to be high and the Government may have to contribute to severance payments of public enterprises.

A third area where expenditure pressures are likely to appear is the housing sector. The Government is strongly committed to resolving the severe public housing shortage which is also a critical factor in strengthening labor mobility, generating employment, and sustaining public support for the economic reforms. The public housing sector has traditionally benefitted from substantial government support mainly in the form of: (i) privileged access to land; (ii) administered construction prices; (iii) preferential interest rates; and (iv) below-market housing rents. Even by the most conservative official estimates, the total amount of these implicit subsidies averaged about 2.5 percent of GDP in 1994 and 1995. In addition, the budget provided for up-front subsidies to individual housing construction and land servicing. Several measures planned for 1996/97 aim at eliminating implicit subsidies and promoting market mechanism in the sector, but they have budgetary implications for the medium term. In particular, the Government has decided to assume the implicit subsidy for social housing previously carried by the housing bank (CNEP), and to fund all public housing through the budget, thus allowing private savings mobilized by the CNEP to be mostly channelled to finance the housing needs of its clients. In addition, a system of explicit and well-targeted rent subsidies is likely to be necessary to provide support to low income tenants, following the planned increases of public housing rents to market levels by 1999. Lastly, the introduction of a system of up-front subsidies will encourage housing acquisition by low-income potential owners, while eliminating the system of implicit interest subsidies provided by the CNEP. The implementation of all these measures, together with the objective of maintaining the current pace of housing deliveries (about 80,000 units in 1995), is likely to require an increase in budgetary allocations to housing from 0.6 percent of GDP in 1995 to about 3.5 percent of GDP in 1997, and possibly to 5 percent of GDP in subsequent years.

Finally, to support private sector growth and Algeria’s integration in the world economy, major investments in infrastructure will be required.

c. Fiscal measures to achieve and maintain a budget surplus

Sustaining budgetary surpluses over the next few years and supporting private sector development, even while cushioning the adverse impact of reforms in the public enterprise sector, will require further revenue reforms and will also involve difficult trade-offs regarding the overall level of public expenditures and the composition of spending. The efforts to increase budgetary revenue should be mostly concentrated on tax reform as increases in nontax revenue, mostly on account of privatization proceeds, are expected to be small.

(1) Tax reform

On the revenue side, the key challenge will be to reduce dependency on volatile hydrocarbon revenue; in addition, the need to open the economy to international competition will require a reduction in tariff protection. In particular, the expected agreement with the European Union (EU) on a free trade area (FTA) will likely involve the phasing out of tariffs on imports from the EU over a period of at most 12 years. As imports from the EU account from about two thirds of Algeria’s total imports, an FTA with the EU would imply the gradual loss of trade taxes of about 2.5 percent of GDP, and up to 3.7 percent if tariff liberalization were to be generalized to imports from all trading partners, or if liberalization were to result in total trade diversion from non-EU sources. In addition, the restructuring of the public enterprise sector and the removal of protection may at least temporarily weaken part of the existing domestic tax base.

In terms of policy action, there is considerable room for enhancing the elasticity and efficiency of the tax system and reducing dependence on oil receipts and trade taxes. The fiscal reforms will have to aim at broadening the domestic tax base mainly through a strengthening of the tax administration and the inclusion of larger segments of the private sector in the tax net.

Currently, tax revenue excluding receipts from oil companies accounts for about 12 percent of GDP, well below ratios found in comparable countries (Table 3). Both direct and indirect tax ratios are low, partially due to the lack of incentives to mobilize resources outside the hydrocarbon sector.

Direct taxes. Within direct taxes, individual income tax, which accounted for only 1.6 percent of GDP in 1994, could at least double its contribution, approaching ratios prevailing in countries like Turkey (3-4 percent of GDP). Similarly, corporate income taxes, which currently yield half the level collected for instance in Morocco, could be doubled. Already, receipts from these taxes are expected to improve slowly following the restructuring of loss-making public enterprises and the consolidation of economic recovery. However, a strengthening of the tax administration will be necessary to ensure tax compliance of the growing private sector. Possible measures should include extension of the number of tax payers with a tax identification number; reform of the trade register; promotion of taxpayer self-assessment; adoption of procedures for minimizing the cost of compliance; implementation of systems for tax return processing and accounting that quickly detect noncompliance and trigger appropriate actions; and establishment of an effective audit plan to detect violations. In addition, with the objective of partially taxing the informal sector, the introduction of an additional flat tax of about 1-2 percent on private sector imports could be considered; this tax would be final for those importers not registered with the tax authorities. Alternatively, a minimum tax (1 or 2 percent turnover tax) could ensure that businesses do not evade income taxes.

Table 3.

Government Tax Revenue: Selected Countries, 1994 1/

(In percent of GDP)

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Source: Staff estimates

Social security taxes and direct taxes on oil companies are excluded;

Fiscal year 1993–94.

Includes property taxes.

Including VAT on imports.

Indirect taxes. In Algeria, domestic taxes on good and services yield about 5 percent of GDP, compared with 7 percent in Tunisia and more than 10 percent in Morocco. Increasing this ratio to at least 7-8 percent seems possible, and would go some way toward compensating losses in tariff revenue resulting from further trade liberalization. Reforms in the taxation of domestic petroleum consumption and the VAT seem the most promising.

Following the introduction of a new system of petroleum taxation in January 1996, the taxation of domestically consumed petroleum products consists of a VAT (the standard rate of 21 percent applies to gasoline, while the rate of 13 percent applies to almost all other petroleum products) and ad valorem excises varying currently between 10 and 246 percent. The new tax system introduced in 1996 raised the price of regular gasoline by about 16 percent compared to the December 1995 level. However, at about $0.28 per liter, gasoline prices in Algeria are still well below levels prevailing in other Middle Eastern countries such as Morocco and Tunisia ($0.80 per liter in Morocco and $0.53 in Tunisia in 1995, respectively).

The second area of potential reform concerns the VAT. Currently, three rates apply in Algeria: a standard rate of 21 percent, a reduced rate of 13 percent applying to building material, construction work, certain services and consumption goods, and a special rate of 7 percent applying to basic foodstuffs, activities related to housing construction, and traditional handicraft activities. Although the standard VAT rate is higher in Algeria than, say, in Morocco (20 percent) and Tunisia (17 percent), total revenue from the VAT was only 3.6 percent of GDP in Algeria in 1995, compared to 5.2 percent in Morocco. In line with the recommendations of a recent technical assistance mission from FAD, a reduction of the number of VAT rates from three to two will allow a simplification of the system and an increase in revenue. For example, a consolidated system of two rates (19 percent and 10 percent) is estimated to result in an increase of about 15 percent of VAT receipts (0.5 percentage points of GDP) when applied to the 1995 tax base. 1/ Reducing agricultural exemptions would result in further increases in revenues.

(2) Expenditure savings 1/

As Algeria has already carried out significant expenditure restructuring in recent years, the scope for additional savings is likely to be limited, especially in the short term.

Capital spending has been sharply reduced and further large cutbacks do not seem to be appropriate. However, additional savings can be generated by increasing competition through the involvement of the private sector in both the financing and the building of infrastructure, including through private concessions along the lines of ongoing experiments in neighboring countries. In addition, there is considerable scope for enhancing the efficiency of capital spending by reducing the burden of past unproductive investments, in particular in the transport sector which absorbed about 13 percent of total capital expenditures in 1995, 2/ and by giving priority to sectors and projects with high rates of social return, which likely will be projects that support and complement the ongoing transformation toward a more private and market-driven economy.

As regards current expenditure, steps can be taken to rationalize and further reduce outlays on current transfers, wages and salaries, and public services. First, the phasing out of food and energy subsidies is expected to reduce current transfers by about 1 percentage point of GDP by end-1997. Second, the public expenditure review carried out in collaboration with the World Bank in 1995 identified considerable scope for reducing the wage bill without affecting the quality of public services. While the share of GDP spent on public wages and salaries in Algeria (10.3 percent of GDP in 1994) is comparable with other Middle Eastern countries (10.2 percent of GDP in Morocco and 10.0 percent in Tunisia in 1994), it greatly exceeds those of some Southeast Asian states (6.8 percent of GDP in Malaysia in 1994). The reduction of the wage bill should come from a retrenchment in the size of the civil service, avoiding further declines in real wages because of their detrimental effect on performance incentives in the public sector. In the short term, the objective will be to enforce retirement rules, freeze net government employment and increase productivity in the public sector. In the longer term, reform of sectors such as health and education will allow government employment cutbacks as well as additional savings in public service expenditures.

Health. In Algeria, budgetary health expenditure accounted for 1.5 percent of GDP in 1994. Although this ratio is comparable to those observed in countries such as Tunisia or Thailand, Algeria’s health indicators, such as infant mortality and life expectancy, are less favorable. The main reasons seem to be the systemic bias toward curative care, an over-investment in major hospitals and physicians, poor maintenance, and weak links between staff performance and incentives. In the short term, better results can be accomplished by using more efficiently the ample resources already available. In the medium term, however, a major overhaul of the whole system will be needed to ensure that public health expenditures better serve public purposes. Resources currently going to “private” goods could be saved by instituting an appropriate system of pricing services provided in the public health system, while improving access to health care by the poor. In addition, certain areas of management and the provision of supporting services could be supplied by the private sector.

Education. Algeria devotes a large share of GDP to education (7.6 percent of GDP in 1994, compared with 5 percent in Morocco and 5.6 percent in Malaysia), and it has made impressive progress in broadening access to education since independence. However, the Algerian education system still suffers from a number of inefficiencies, such as administrative overstaffing and inadequate appropriations to nonwage expenditures. Furthermore, the absence of fees and charges encourages overconsumption of public education services. In the short term there is scope for increasing efficiency through measures such as increasing the number of students per teacher and retraining part of the administrative staff. A more fundamental reform of the system should aim at a reduction of costs, a closer match of the education profiles with those demanded by the market, and improving efficiency through greater competitiveness. Reduction of costs and increased quality could be obtained through a system of scholar fees for secondary and post-secondary education institutions. Encouraging private provision of education services would also greatly enhance competition in the sector, and help ensure that curricula would more closely match the skills demanded by the economy.

III. Housing Reform: Fostering a Market-Driven Supply Response

Housing needs have increased considerably in Algeria since independence in 1962, mainly as a result of rapid population growth and a high pace of urbanization. Housing supply, however, has lagged behind demand, as the housing sector remained overwhelmingly dominated by inefficient state-owned construction enterprises, public real estate management companies (OPGIs), and a state-owned savings and housing financial institution (CNEP). The inefficiency of the public housing sector has been reflected in long and costly delays for housing completion which became particularly acute in the early 1990s, when imports of construction inputs were curtailed as a result of foreign exchange rationing.

As a result, Algeria has a severe housing shortage that has largely contributed to social discontent in recent years. With a housing stock of less than 4 million units for a population of 28 million, it has one of the highest occupancy ratios in the world. Moreover, the housing stock is of low quality, as half of existing dwellings were built before independence and more than 10 percent do not meet basic standards of hygiene and safety.

Because of past centralized planning and rent controls, the supply of housing has come mostly from the public sector. More than 90 percent of the housing units delivered by the formal sector between 1980 and 1995 consisted of state-owned rental units. 1/ Housing supply has traditionally been heavily subsidized through a system of administered controls keeping construction prices, rents of public housing and mortgage rates below market clearing levels.

This system of implicit subsidization of housing has both stifled supply and resulted in mounting quasi-fiscal deficits. It is being gradually phased out and replaced by a system in which: (i) subsidies on construction inputs have been eliminated; (ii) most housing is supplied by the private sector at market prices; and (iii) government subsidies for housing are explicitly budgeted and redirected toward those who otherwise could not afford housing. This change in strategy, which is expected to foster a substantial market-driven increase in housing supply, requires the restructuring of the housing construction sector, a reform of the rental housing market, and the revamping of housing finance.

1. Restructuring the housing construction sector

Algeria has a large and inefficient public construction sector with some 90 state-owned enterprises operating at the national level and more than 500 smaller enterprises under the control of local governments. These public construction companies employed about 240,000 workers in 1994. National enterprises accounted for 65 percent of that workforce and 80 percent of value-added of the public construction sector.

The restructuring of the sector was initiated with World Bank support, first in 1992 in the context of the “Economic Financial and Structural Adjustment Loan” (EFSAL), and in 1993 through a “Housing Completion and Sector Development Loan.” It has been accelerated, first in 1994 with the liberalization of imports of construction materials and construction prices, and in 1995 through various measures aiming at both hardening the budget constraint faced by public enterprises and increasing the participation of the private sector in the supply of housing. Because public construction companies had large salaried workforces whether or not they were occupied in construction, the first measure in 1995 was to reduce the workforce of these enterprises to a small core of workers, and hire workers on a job-related contractual basis. In this context, 40,000 workers were laid off in 1995, or 25 percent of the current employment in public construction companies. With increased recourse by public enterprises to private subcontractors in the finishing stages of construction, labor regulations were also amended to increase the flexibility of both employment and remuneration of construction workers in the face of seasonal and structural developments in the market for housing. Finally, contracts for public housing projects were parcelled out into smaller components, more in line with the supply capacity of small-scale private contractors.

As a result of these actions, the participation of the private sector in the construction of public housing for rent has increased from 20 percent in 1994 to 55 percent in 1995. Concurrently, the number of formal construction projects for sale launched by the private sector is estimated to have increased from 11,300 units in 1994 to 17,100 units in 1995, while new construction projects for sale by the public sector fell from 36,100 units to 30,200 units. The increased involvement of small private construction firms has also contributed to a decline in the completion period from more than five years to one year for some projects, which, in turn, translated into a fall in construction costs which may have been as high as 50 percent, according to recent estimates by World Bank staff.

Overall, housing deliveries by the formal sector are estimated to have increased from 82,000 units in 1994 to 132,000 units in 1995 (Table 4). This increase mainly occurred in public housing, where the number of dwellings completed rose from 64,200 in 1994 to 105,200 in 1995, mostly as a result of the greater availability of domestic and imported construction inputs and the rising involvement of private subcontractors in secondary building operations. However, it should be noted that many of these deliveries stemmed from efforts at finishing constructed dwellings of the existing stock of projects. The stock of ongoing construction projects at end-1995 was estimated at about 300,000 units, including 160,000 units of public housing for rent. These units of public housing for rent could all be completed in about two years, assuming that the pace of housing deliveries is maintained at the level achieved in 1995.

Table 4:

Algeria: Data on Public Real Estate Management Agencies (OPGIs)

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Source: Algerian authorities

Including arrears

In addition, the authorities have decided to liquidate 13 local public construction enterprises, as well as one of the six national construction companies included in the group of 23 largest loss-making public enterprises. The remaining five of these six large construction companies were granted autonomy in April 1996 along with the signing of management contracts specifying performance targets and any budgetary support for their investment programs.

Over the next few years, this process of restructuring and liberalization would focus primarily on the liquidation of nonviable construction enterprises and the privatization of others. As shown by the recent experience of the transition economies of Eastern Europe, privatizing housing construction can quickly lead to significant productivity gains as this activity is particularly suited for small- to medium-scale enterprises. Many aspects of housing construction are relatively labor-intensive and can be easily subcontracted to small enterprises organized into specialized guilds. The possibility of privatization in the construction sector is therefore not as dependent on the availability of foreign direct investment as that of other more capital-intensive sectors of the Algerian economy.

2. Reforming the rental market for housing

The supply of rental housing in Algeria has been almost exclusively provided by the Government through the OPGIs at rents well below market clearing levels. At end-1995, rents for a publicly-owned, two-bedroom city apartment ranged from US$8 to US$12, while private sector rents for similar dwellings ranged from US$55 to US$85. In 1995, rents actually collected by the OPGIs were only about 40 percent of rents due and covered less than 70 percent of wages and maintenance costs (Table 5). Moreover, public rental housing was made accessible to a broad spectrum of middle income tenants, including a large segment of public sector employees.

As part of the action plan drawn up by the authorities in December 1995, several structural measures will be implemented in 1996/97 to remedy the structural causes of financial imbalances of the OPGIs. Specifically, a draft law will be adopted by the Government in June 1996 to amend the Civil Code and the Penal Code, with a view to: (i) placing the burden of proof of rental payments on tenants; and (ii) allowing the licensing of private property managers. It is even envisaged that all public sector employees benefitting from public housing would have their rents automatically deducted at source. In the context of this new legal framework, the authorities will then proceed to restructure the viable OPGIs and liquidate loss-making ones. The restructuring process will entail the privatization of the management of the existing stock of public housing for rent as well as the subcontracting of its maintenance to the private sector. As a result of the transfer of these functions to the private sector, remaining OPGIs will only retain a very limited staff to perform their role as contractors (“Maitres d’Ouvrages”) for public housing programs.

Table 5.

Algeria: Housing supply, 1990–95

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Source: Algerian Ministry of Housing

Concurrently, subsidized public rents will be gradually increased toward market levels within a period of three years, with two first increments of 10 percent and 20 percent in June 1996 and March 1997. Subsequent increases are expected to be much more significant as they will be associated with the introduction of a system of well targeted and fully budgetized direct subsidies to low income tenants. During the transition period, any loss made by the OPGI will be fully accounted for in the Central Government’s budget.

These measures should facilitate the purchase of state-owned apartments by their tenants, and contribute to the development of the private rental market for housing which has suffered from a judicial system favoring tenants over landlords as well as low rents for public housing. The Government is also envisaging a number of schemes whereby tenants of privately owned dwellings could benefit from a system of well-targeted rent subsidies to be put in place starting in 1997. Over time, such schemes would substantially reduce the need for new programs of public housing for rent.

3. Revamping housing finance

Housing finance in Algeria has de facto been monopolized by the state-owned housing fund (CNEP), although the five commercial banks are legally allowed to extend mortgage financing to households. The CNEP has a home purchase savings scheme whereby the interest earned by holders of savings deposit accounts may give them access to a mortgage at a preferential interest rate. However, the number of concessional mortgage loans tend to be limited and benefit only the better-off depositors who can meet the CNEP’s prescribed interest accumulation threshold. In addition, most of the savings of the CNEP’s depositors were channelled to the OPGIs to finance public housing for rent. The inability of the OPGIs to service their debt has caused severe liquidity problems for the CNEP since 1995.

This situation calls for a major overhaul of housing finance on the basis of the following principles: (i) there must be a clear separation of the subsidization of housing and mortgage financing; (ii) all banks should be in a position to participate, on a competitive basis, in the supply of mortgage loans; and (iii) mortgage loans must be supported by clearly defined property rights in order to ensure that they can actually be recovered.

In accordance with the first principle, starting in 1996, all public support to housing will be channelled exclusively through the Central Government’s budget. This will accompanied by a restructuring of the CNEP into a housing bank operating solely on a commercial basis. To this end, the Government will recapitalize the CNEP and take over all the OPGIs’ nonperforming debt in exchange for government bonds.

To facilitate the broadening of mortgage financing to all commercial banks, the authorities envisage the creation of a mortgage refinancing institution. This new institution would deal only with other financial institutions and would allow commercial banks to participate in the mortgage market while keeping the maturity structure of their assets in line with that of their liabilities.

Finally, regarding property rights, the authorities have embarked, since 1993, on a major operation to update and extend the coverage of the national land registry with World Bank assistance. This process, which was expected to be completed by 2008, may be accelerated by the authorities to strengthen the legal basis for property registration. In addition, the availability of land for construction purposes will be increased as a result of the land privatization law that the Government intends to approve before end-March 1997. Some of the collective and individual farms affected by this law have been reclassified as nonfarm land areas, suitable for urban construction.

IV. Recent Evolution of Employment and Medium-Term Prospects

1. Recent trends in the Algerian labor market 1/

Algeria’s population in 1994 is estimated at 27.4 million, of which more than half are under the age of 20. While population growth has been steadily slowing in the recent decade (Table 6), to an estimated 2.1 percent in 1995, the higher rates in the 1970s and 1980s explain the very young age structure of the population. Reflecting an ongoing exodus from rural areas into cities, the urban population has been growing much faster, at 4.8 percent on average during 1981-90, and only in most recent years did urban population growth fall below 4 percent. This rapid urbanization and the high proportion of youth severely strain the provision of basic social services. A key challenge for Algeria’s medium-term economic policies will be the provision of adequate education, health, infrastructure and housing services, and the creation of sufficient employment opportunities to absorb the new entrants and reduce existing unemployment.

Algeria’s total labor force stood at an estimated 7.1 million in 1995. Labor force growth has been much higher than population growth, averaging nearly 4 percent in 1981-95. As a percent of the total population, the labor force stood at 25 percent in 1995; both overall participation and women’s participation were below that of other countries in the region. However, historical evidence 2/ suggests that labor force participation has been rising in recent years. 3/ A considerable increase in the women’s participation rate, despite increased schooling which has led to declining participation rates for younger women, may indicate a response to falling real wages and rising family size.

The pace of employment creation in the past decade was insufficient to absorb the new entrants in the labor force, and unemployment rose from 10 percent in 1985 to 25 percent in 1995, when an estimated 5.3 million Algerians were employed, and 1.8 million unemployed. 1/ Thus, on average the earnings of one employed person need to support five people. Among the employed, self-employment is substantial, likely a reflection of a lack of salaried positions: in the absence of sufficient regular jobs, individuals become self-employed, rather than unemployed, effectively working in the informal sector.

Table 6.

Algeria: Recent Developments in the Labor Market

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Source: Data provided by the Algerian Authorities; World Bank; and staff estimates and projections.

In percent.

Data on the sectoral structure of employment indicate that about 1.0 million jobseekers entered the market during 1991-95 while the economy created only 0.4 million new jobs, virtually all in the public sector (0.1 million) and in commerce and services (0.3 million); employment in agriculture, industry, and construction broadly stagnated. Similar trends had been observed during 1985-91, and important differences in private and public sector hiring: annual growth rates of employment during 1985-89 in privately owned industrial and construction firms averaged 6 and 10 percent, respectively, albeit from a small base. These trends are likely to have accelerated since.

2. The structure of unemployment

Overall, in Algeria as in most north African countries, the unemployed are mainly under 25 years old, typically remain unemployed for more than one year, mostly live in urban areas, and tend to have at least a secondary education. Moreover, female unemployment is widespread, and in comparison to men it seems much harder for women to find a job. This points to labor market rigidities that need to be addressed in the context of an employment-creating growth strategy.

a. Rural and urban unemployment

The proportion of labor force participants that are self-employed has been rising steadily, accounting for a quarter of all employed in 1991. As the self-employed almost by definition cannot become unemployed, the aggregate unemp1oyment rate reflects pressures on labor markets only imperfectly. As self-employment and unpaid family employment are particularly large in agriculture, urban unemployment rates are likely even higher than the national average.

b. Youth unemployment

The unemployment rate among the young is nearly twice the global rate, in line with the situation in many Mediterranean countries. In 1991, about 41 percent of the labor force aged 20-25 were unemployed. The likelihood of being unemployed falls rapidly with age, and among the labor force aged 30 and older only 6 percent were unemployed. Given the large share of the young in the total labor force, this implies that the bulk of the unemployed are under 25 years old, raising major social and political concerns, in part because of the weakness of the social safety net.

c. Unemployment and education

Unemployment data broken down by educational background indicate that unemployment rates do not necessarily decline with the amount of education received. Indeed, the unemployment rate of individuals with a middle or secondary education is highest (26-30 percent in 1991). The unemployment rate is lowest among those with post-secondary education (6 percent) and those with no education (14 percent).

While one would expect job opportunities to rise with education, workers with secondary and primary school education are likely to search for different kinds of jobs, and the latter may be more successful in finding the jobs of their choice. Primary school degree holders are likely to work within the informal sector, as self- or home-employed, while those with a secondary school degree line up for the few formal sector jobs, notably the secure jobs in public administration. As recruitment in the public sector slowed down during the second half of the 1980s, graduates had to wait longer before being offered a job. Furthermore, a large share of graduates may have had degrees in the social sciences, and their job opportunities in the private sector were thus more limited (see below).

d. Unemployment duration

Data on the proportion of long-term unemployed--those without a job for more than one year--in total unemployment are not available. Based on labor surveys, the average length of unemployment spells was 23 months in 1991; by age, the average length of unemployment peaked for the age group 25-34 at 36 months, and was longer for men than for women. Anecdotal evidence also indicates that the long-term unemployed, on average, are likely to be much younger in Algeria than, say, in Europe.

3. Reasons for unemployment

The high unemployment in Algeria indicates that at the prevailing real wage labor demand falls short of the available supply. This reflects distortions embodied in certain features of the institutional structure of the Algerian labor market and labor regulations, which have also contributed to the existence of an informal sector. In particular, regulatory restrictions on hiring and firing may give employees some power to keep wages above market-clearing levels; in addition, mismatch between supply and demand may arise because of inefficient intermediation (e.g., by placement agencies) between supply and demand for labor; educational mismatch (the skills supplied do not match those demanded); and geographical mismatch (the labor supply not being available where it is needed).

a. Formal and informal labor market

The formal sector of the Algerian labor market groups all public sector establishments as well as private sector firms employing 10 employees or more, while the informal sector is made up of small firms as well as the self- and home-employed. Job protection legislation, minimum wage legislation, and sectoral or national wage agreements only cover the formal sector. In 1991, for example, only an estimated 27 percent of all private sector workers were salaried employees and covered by the Algerian minimum wage. Labor market legislation and official wage settlements are nonetheless likely to be important for the informal sector as well, if only because job market legislation and official wage bargaining will strongly influence the relative size of the formal and informal sectors.

A large informal sector typically entails losses in tax revenue as tax evasion is higher in the informal sector. In addition, most informal activities take place within sectors of relatively low productivity (e.g., services), typically at subsistence wages. Lastly, the availability of a few secure and well-paid jobs in the formal sector may raise unemployment by inducing workers to “line up” for them. For instance, university graduates could find insecure employment in the private or informal sector but may prefer to wait for a “lifetime” job in the public sector.

b. Job protection regulation

Before the reform of the labor code in 1990, dismissal of workers was only possible in severe disciplinary cases. The new law permits labor shedding for economic reasons, but only after a process of collective negotiations, arbitrated by labor inspectors, has failed to find an alternative solution, such as a reduction in working hours, part-time work, or early retirement. After shedding labor, employers are not allowed to take on new recruits at similar grades. Through 1994, dismissed workers were entitled to severance pay equivalent to one month’s pay for each year of service up to a maximum of 15 months. A major reform of the unemployment insurance system was implemented in mid-1994 (SM/95/108, page 31). Under the new system, retrenched workers receive a lump sum severance payment of three months and are not eligible for unemployment benefits for three months to encourage active job search. In addition, employers have to pay an “entry fee” to the Unemployment Insurance Fund based on years of service of the retrenched worker; and have to pay 2.5 percent of payroll to the fund. The duration of unemployment benefits is limited and benefits decline gradually during this period, strengthening incentives for active job search.

Despite these recent reforms, the current regulations still contribute to Algeria’s high unemployment through a number of channels: by creating incentives for insiders to ask for higher than market-clearing wages; by favoring the adoption of more capital intensive technologies in the formal sector through adding a fixed cost to the employment of labor; and by raising the cost of dismissal, thereby inducing employers to hire low risk workers with a work history, thus limiting the prospects for the young to find a job in the formal sector.

c. Trade unions, minimum wages, and wage bargaining

In Algeria, the legally binding minimum wage (Salaire minimum d’activité, SMA) is set by the Government in consultation with labor unions (in particular the Union Générale des Travailleurs Algériens which until 1990 had a statutory monopoly) and employers at the national level. Additional agreements (conventions collectives) are struck at the sectoral level, within the limits set out by the national settlements. Salaries in the civil service are determined according to a grid which, in the past, was also valid for public enterprises. Following the introduction of the new labor code in 1990, public enterprises have been granted more autonomy in the wage-setting process; however, civil service salaries still serve as a reference point in the determination of wages in public enterprises. Increases in the minimum wage are negotiated in the framework of the “tripartite” which gathers labor unions, enterprise managers, and the Government. In the past, both increases in the minimum wage and the average wage were negotiated for the public sector. For instance, in 1994, the 10 percent salary increase which was agreed upon, applied to all public enterprises, even those that were shedding labor under restructuring plans, and where workers had accepted to trade salary increases against job retention. This policy caused major financial problems for some enterprises, particularly in the textile sector, and in 1996 the policy was abandoned and only increases in the minimum wage were decided at the national level. Workers’ representatives committees, obligatory in enterprises with more than ten employees, monitor compliance with wage bargaining agreements and labor legislation.

d. The evolution of wages

The institutional set-up of the labor market is likely to have contributed to upward pressures on wages, although empirical evidence is not available. Data on minimum wages and public sector wages provide some indication of union pressures. The minimum wage rose in real terms by about 17 percent during 1989-97, while total labor productivity fell by 12 percent; the real minimum wage subsequently fell during 1994-95 while production remained broadly flat. Government wages also have been falling in real terms since 1993, by 10 percent during 1995 alone. While remaining well above the SMA, a more compressed wage distribution is emerging in the public sector; wage levels in the private sector are thought to be lower on average but more dispersed. The rapid rise in the real minimum wages may have encouraged labor migration into the informal sector and increased capital intensity in the formal sector. The much larger share of the wage bill in total output observed in the public sector, compared to the private sector, while not conclusive, is nonetheless suggestive of the fact that union pressures, in part supported by extensive job protection legislation, have raised the cost of employment in the formal sector. In addition, with the prevailing wage premium, the most talented job seekers will naturally prefer employment in the public sector; this further stifles the development of a productive formal private sector.

e. Mismatch

Some educational mismatch is suggested by the high unemployment rates among high school graduates. The reason for the divergence of the educational and economic systems may be that graduates were traditionally absorbed by the public sector, and schools developed their curricula accordingly. Another source of mismatch could be inefficient job intermediation. Only since 1990 are employers free to hire as they choose; all vacancies still need to be registered with the public employment agency (Agence Nationale de l’Emploi (ANEM)). The role of ANEM has declined in recent years, and firms have increasingly developed their own recruitment channels. The ratio of jobs offered to jobs demanded registered at ANEM has declined, consistent with the view that labor intermediation has become more efficient.

Matching problems in a broader sense may also reflect labor immobility. According to a survey from the early 1990s, a quarter of the unemployed still would not move to another province in order to get a job, although mobility as measured by the share of unemployed who would accept a job of lower qualification, or in another sector or region, has increased somewhat between 1989 and 1991. In addition, the housing shortage is likely to constitute a severe constraint on labor mobility.

4. Reforming labor markets

Structural reforms of the labor market are an essential component of any employment-generating growth strategy. Labor market reforms need in particular to promote employment in the formal sector because of its higher productivity and focus on the production of tradable goods.

A reform agenda aimed at lowering unemployment and fostering employment in the formal sector would include the following elements:

First, further reform of job protection legislation facilitating labor shedding, provided sufficient advance notice is given. The cost of labor shedding for employers should be reduced by lowering their contribution to severance pay and relying instead more on the recently introduced unemployment insurance scheme under which employers and workers would pool costs and risks. Compensation under this scheme should be limited to a shorter period of time to foster an intensive job search and avoid subsidizing long-term unemployment.

Second, the legal minimum wage should serve only to protect the weaker segments in the population and not as a benchmark for the wage structure. A prudent minimum wage policy is all the more important as payroll taxes in the formal sector are substantial; 1/ such taxes further exacerbate the shift of unskilled workers into the informal sector.

Third, a number of measures could be taken to reduce the high youth unemployment rate and foster employment of the young in the formal sector. The applicability of all job protection and minimum wage legislation could be limited to individuals older than 30 years. As a first step, the 1989 Finance Law introduced a series of exemptions to wage taxes applicable to the employment of youth up to age 30. This could be complemented by removing the minimum wage requirement for a period of apprenticeship.

Fourth, widespread unemployment among the educated points to the need for reforms in the educational system, so as to adjust the skill profile towards private sector needs. For example, to provide labor market entrants with more market-relevant, technical skills, formal apprenticeship schemes could be set up. 2/

5. Labor market prospects

With prospects for further migration to western Europe limited, the likely future evolution of labor supply in Algeria is mainly determined by two factors: (i) the evolution of the population aged 15 and over, and (ii) the likely evolution of the labor force participation rate. Regarding the latter, one would expect male labor force participation to accelerate, as the fraction of men aged 12 to 25 years and attending school is reduced; female labor force participation is also likely to continue to rise, as an increasing proportion of women will take advantage of their education to join the labor market. In the projection below (Tables 7 and 8), it is assumed that participation (as a percentage of the population) continues to rise through 2010 in line with recent trends, while population growth continues to slow. Consequently, on a net basis, about 300,000 people will be added to the Algerian labor market annually.

To establish a link between output growth and the demand for labor, assumptions need to be made regarding the elasticity of employment to growth. Past developments provide little guidance, as recruitment policies in the dominant public sector reflected political and social concerns rather than efficiency considerations. Thus, while real GDP remained virtually flat, total employment expanded by 31 percent between the 1985 and 1995, from 4.06 million to 5.32 million; of this, government employment rose from 900,000 to 1.25 million. Sectoral elasticities have also fluctuated widely for the period 1991-95. In agriculture, the most dynamic and most labor-intensive sector, the elasticity of employment to GDP growth was close to one. In the rest of the economy, the average elasticity during 1991-95 was very high, as public enterprises continued to recruit despite stagnating output.

To indicate a broad range of possible outcomes, two scenarios have been developed (Tables 7 and 8, and Chart 2). In the first scenario (“Low Growth”), annual growth of real GDP during 1997-2010 averages about 4.5 percent, with manufacturing growth averaging 5 percent. In the second scenario (“High Growth”), higher annual growth in manufacturing (7 percent on average) results in annual GDP growth of about 6 percent on average during the same period. In both scenarios government employment slows, as the authorities reduce net recruitment even while upgrading the qualification levels of the civil service. For each scenario, two sets of assumptions regarding the sectoral employment/output elasticities outside the government sector are examined. Under a “pessimistic” assumption, sectoral elasticities remain low at around 0.5, broadly in line with elasticities observed in other countries, while under an “optimistic” assumption, elasticities remain constant and equal to one. 1/

Table 7.

Algeria: Employment Prospects 1996–2001

(Low growth scenario)

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Source: Data provided by the Algerian Authorities; and staff estimates and projections.

In percent.

Table 8.

Algeria: Employment Prospects 1996–2001

(High growth scenario)

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Source: Data provided by the Algerian Authorities; and staff estimates and projections.

In percent.

Chart 2
Chart 2

Algeria: Unemployment Rates under Low and High Growth Scenarios, 1995-2010

Citation: IMF Staff Country Reports 1996, 071; 10.5089/9781451811339.002.A001

Source: Staff estimates and projections.

Under the low growth scenario, and assuming high elasticities of employment/output creation, unemployment would fall to 22 percent by 200l and 15 percent by 2010, with 4.4 million jobs created during 1997-2010. Making the pessimistic assumptions on elasticities, unemployment would rise rapidly to more than 30 percent by 2001 and 37 percent by 2010. Under the high growth scenario, and assuming high elasticities, about 1.5 million jobs would be created between 1997-2001 and another 4.6 million by 2010; unemployment would fall to 20 percent by 2001 and be virtually wiped out by 2010. Assuming low elasticities, high growth would be insufficient to reduce unemployment, which would gradually rise to 32 percent by 2010, even while a total number of 2.5 million jobs are created between 1997 and 2010. As discussed above, the high elasticity outcomes would become more likely with further reforms of the labor market and a continued restrained incomes policy to make economic growth more labor intensive. Strong growth in the construction sector to alleviate the housing shortage, in particular, could contribute substantially to further raising the labor-intensity of GDP. At the same time, strong and credible reform policies may help Algeria to achieve growth well above 6 percent, which even in the presence of relatively low elasticities would help generate faster employment gains.

V. The Hydrocarbon Sector and its Implications for Macroeconomic Policies

The presence of a large natural resource sector has been an important factor shaping the structure of the Algerian economy. For example, it has weakened--especially in the context of the fixed exchange rate regime and often expansionary demand management of the past--incentives to develop tradables production outside the hydrocarbon sector, and influenced the design of the tax structure by reducing the necessity to develop alternative revenue sources. In 1995, the hydrocarbon sector accounted for 26 percent of GDP, 95 percent of exports, and 63 percent of budgetary revenue, but only about 3 percent of total employment. Algeria’s nonhydrocarbon exports of goods amounted to about US$0.6 billion in 1995, as compared to US$5.5 billion in Morocco and US$4.6 billion in Tunisia.

Algeria’s dependence on hydrocarbon revenue as the major source of foreign exchange has also important macroeconomic implications, as the volatility of international oil prices has translated into the volatility of important macroeconomic aggregates. Through 1994, with the Algerian dinar pegged to a basket of partner currencies, movements in international energy prices generated corresponding variations in the value of exports, government revenues, and the availability of foreign exchange. There has been, for example, a strong correlation between changes in international oil prices and real GDP growth (Chart 3), which seems to have become even more pronounced in the 1990s.

Links between growth and other aggregates, on the one hand, and international oil prices, on the other, have operated through a number of channels. With respect to the impact on growth, oil price variations affected both demand and supply. In the face of adverse price (or output) developments in the hydrocarbon sector, negative wealth effects are likely to have reduced consumption demand, reinforced by a compression of government expenditure and lower investment outlays. In addition, the defense of the exchange rate peg has required--up until 1994--periodic intensification of rationing of foreign exchange or increased recourse to foreign borrowing. Formal or informal foreign exchange rationing affected supply, by reducing access to imported inputs, leading to a fall in capacity utilization and a deterioration of capital equipment due to shortages of spare parts. For instance, as Algeria’s access to external credit weakened in the late 1980s, formal payment restrictions were introduced to repress excess demand for foreign exchange, a development which may explain the more pronounced link between oil prices and growth in recent years.

Through the budget’s dependence on revenue from the oil sector, fluctuations in oil prices had important direct implications for public expenditure management. Favorable oil prices were often seen as signalling permanent increases in income, and triggered higher levels of public expenditure that were difficult to adjust downward once the boom had proven only temporary. For example, following the reverse oil shock of 1986, budgetary revenue fell sharply from 38 percent of GDP during 1981-85 to 28 percent during 1986-90. As public expenditure was cut only by about 5 percentage points of GDP--with capital expenditure bearing the brunt of the cuts--the fiscal deficit shifted from an average surplus of 3.5 percent in 1981-85 to a deficit of about 2.7 percent of GDP in 1986-90. As a result, public and publicly guaranteed external debt grew steadily, reaching 62 percent of GDP in 1993 and resulting in unsustainable levels of debt service due to the short-term structure of the debt profile.

Chart 3
Chart 3

Algeria: The Link Between Oil Prices and GDP, 1981-95

(percent change)

Citation: IMF Staff Country Reports 1996, 071; 10.5089/9781451811339.002.A001

Source: Algerian authorities.

The continued vulnerability to fluctuations in energy prices will have to be taken into account in the formulation of economic policy, with a view to minimize over the short- and medium-term the adverse impact of volatility in international energy markets, while implementing policies that help diversify the Algerian economy over the longer term.

Over the coming years, the relative importance of the hydrocarbon sector is unlikely to change very much. Nonhydrocarbon GDP is expected to grow somewhat faster than the hydrocarbon sector, reflecting the impact of liberalization and a growing private sector, notably in agriculture, industry, as well as construction to meet the strong demand for housing. The continued impact of the real exchange rate depreciation of 1994-95 is also likely to stimulate tradables production outside the hydrocarbon sector and, over time, reduce the relative importance of hydrocarbon exports. Under the baseline scenario (summarized in Table 9), hydrocarbon exports are nonetheless expected still to account for 74 percent of total exports in 2005. Employment creation will have to come almost exclusively from the nonhydrocarbon sector.

Under this outlook, Algeria’s vulnerability to fluctuations in international energy prices will decline only modestly over the next years. For example, a permanent fall in the world oil price by US$1 from 1997 onwards, relative to the path underlying the baseline scenario, would reduce exports by about 6 percent annually, taking into account the observed lagged pass-through to gas prices. Assuming a constant real exchange rate, unchanged imports, and the maintenance of reserves equivalent to three months of imports, GDP (in U.S. dollar terms) would be lowered by about 1 percent on average and the increase in the current account deficit, taking into account interest on any additional borrowing, would reach $0.9 billion by 2001, or 1.4 percent of GDP. Financing of the additional deficits would slow the decline of the external debt/GDP ratio to 46 percent of GDP by 2005 compared to 36 percent under the baseline scenario.

An even more pessimistic scenario would involve a permanent reduction in oil prices by US$3 per barrel. The external debt/GDP ratio would still decline during 1997-2001, although only marginally so, and current account deficits would be much larger, exceeding 5 percent of GDP through the year. Most likely, Algeria would find it difficult to mobilize the additional borrowing required under such a turn of events, as even under favorable assumptions on the terms of such borrowing, debt service would consume about two-thirds of exports during 1997-2001. Accordingly, Algeria would have to respond to such a shock with further adjustment measures, including a major fiscal tightening and appropriate exchange rate action to reduce imports and accelerate the development of exports outside the hydrocarbon sector.

Table 9.

Algeria: External Accounts Under Different Oil Price Scenarios

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

The baseline scenario corresponds to the medium-term scenario in the staff report (SM/96/90).

All scenarios assume nonhydrocarbon exports, imports, and the reserve path unchanged from the baseline scenario. The difference in exports thus affects only external borrowing, interest and amortization payments.

Hydrocarbon export unit price reduced from 1997 on by US$1 under scenario A and US$3 under scenario C. Scenario B assumes an increase of prices by US$1 from 1997 on.

By contrast, higher oil prices would raise different policy issues, and would under current circumstances warrant an asymmetric policy response. In particular, if the higher revenue from the hydrocarbon sector were to be used to reduce public debt rather than finance higher spending, and pressure toward a real exchange rate appreciation resisted, it would reduce Algeria’s vulnerability to future adverse price shocks, lower the future current account deficits, and further alleviate the debt burden. As an illustration (Scenario B in Table 9), if under otherwise unchanged assumptions the world oil price were to increase by US$1 from 1997 onward, the external debt/GDP ratio would rapidly decline to about 25 percent by 2005.

Such an asymmetric strategy--which could also involve a faster building of official reserves as a further cushion for future shocks--would also reinforce diversification of the economy and help prevent a “Dutch Disease”. Given Algeria’s endowment with human capital, fertile agricultural land, and favorable geographical location, optimal diversification would likely involve mainly investment in the domestic economy, which would call for increased public savings to channel greater resources to private sector investment, focusing public investments on areas complementary to private sector activity, and maintaining a real exchange rate conducive to the growth of an industrial sector.

In any case, the policy stance chosen has to take into account that the shift to a managed float of the exchange rate in 1994-95 has changed the nature of the mechanism transmitting changes in oil prices to macroeconomic aggregates. Most importantly, continued exchange rate flexibility would protect Algeria from some of the destabilizing effects of energy price volatility; the deepening of the domestic financial and foreign exchange markets and their integration into global financial markets would further increase such protection. For example, adverse oil shocks that are perceived by the market as temporary would cause less pressure on the exchange rate, and the temporary widening of the current account deficit would be more readily financed from abroad, thereby smoothing out the path of aggregate income and absorption. By contrast, market perception of a more permanent adverse oil shock would result in strong pressure on the exchange rate, signalling the need for a real depreciation to channel resources into the tradables sector and a tightening in demand management policies. Exchange rate flexibility would avoid the need for nominal wage and price deflation that may be difficult to implement in Algeria given the strength of labor in the socio-political landscape. Stabilizing output and relative prices in the face of shocks perceived by markets as temporary, while quickly adjusting to permanent shocks, will have the additional effect of supporting investment by reducing the risk premium that agents, faced with uncertainty about relative sectoral profitability, will attach to the required rate of return.