Algeria remains heavily dependent on the hydrocarbon sector and still maintains a sizable and inefficient state-owned enterprise sector. Against this background, the paper addresses two different issues with important implications for macroeconomic stability in Algeria. The paper proposes the replacement of directed credit to large loss-making public enterprises with temporary and explicit budget subsidies. It also shows that money, volume of imports, and weather conditions have a strong impact on price movements in the short term, whereas the exchange rate has none.
1. Algeria is still on the way to complete its transition to a diversified market economy driven by private sector-led growth. The country’s main challenges are to shift the economy to a higher sustainable growth path, to maintain macroeconomic stability in the context of a volatile market environment, and to reduce unemployment and poverty.
2. The country remains heavily dependent on the hydrocarbon sector and still maintains a sizable and inefficient state-owned enterprise sector. Neither of these sectors offers significant opportunities for future employment growth. Furthermore, both sectors can be sources of fiscal vulnerabilities and potential macroeconomic instability, albeit in different ways: The reliance on the hydrocarbon industry leads to volatile government revenues stocks as a result of large swings in oil prices and complicates liquidity management, while the continued financial support to large loss-making state-owned enterprises through public banks leads to the build-up of sizable quasi-fiscal deficits and has been a major factor of the fragility and underdevelopment of the Algerian banking system.
3. Against this background, the following chapters address two different issues with important implications for macroeconomic stability in Algeria: (a) the substitution of explicit budgetary support for directed credit to large loss-making public enterprises as a precondition for banking sector reform; and (b) the explanation of price movements in the context of the volatile behavior of money supply.
4. Chapter II proposes the replacement of directed credit to large loss-making public enterprises with temporary and explicit budget subsidies in the context of a well-defined restructuring program. Removing from public banks the burden of being the financier of last resort for large loss-making enterprises would facilitate banking reform, increase transparency of fiscal policy, improve governance, and provide an incentive for subsequent public enterprise restructuring.
5. Chapter III identifies both monetary and real factors as determinants of inflation in Algeria. It also sheds light on the recent phenomenon of continued price stability in the context of excess liquidity in the Algerian banking system and strong money growth fueled by high hydrocarbon revenues. The analysis stresses the need to conduct a prudent monetary policy on a sustained basis in order to avoid a future pickup in inflation, and recommends close monitoring of currency in circulation and M1 as the most important policy variables. It also points to the importance of returning to a less expansionary fiscal policy stance and the usefulness of policies improving total factor productivity as supporting measures to maintain price stability.