Algeria: Staff Report for the 2002 Article IV Consultation

The strong hydrocarbon export performance has allowed Algeria to strengthen its external position and record a budget surplus. Executive Directors commend the government for the broad improvement in macroeconomic indicators. The government has eased the fiscal stance, and this strategy has succeeded in boosting short-term growth. The surge in credit to the economy is a concern. Algeria should reinvigorate its structural and institutional reform efforts to put the economy on a sustainable path of higher growth, lower unemployment, improved social conditions, and reduced poverty.

Abstract

The strong hydrocarbon export performance has allowed Algeria to strengthen its external position and record a budget surplus. Executive Directors commend the government for the broad improvement in macroeconomic indicators. The government has eased the fiscal stance, and this strategy has succeeded in boosting short-term growth. The surge in credit to the economy is a concern. Algeria should reinvigorate its structural and institutional reform efforts to put the economy on a sustainable path of higher growth, lower unemployment, improved social conditions, and reduced poverty.

I. Background

1. Algeria restored macroeconomic stability in the context of Fund supported programs (1994-98), after several years of stop-and-go policies, political and social tensions, volatile oil markets, and balance of payments crises However, unemployment and poverty continued to rise.

2. After a few years of tight fiscal policies, increased political pressures in a context of buoyant oil revenues have led the authorities to follow since 2001 an expansionary fiscal stance aimed at boosting growth and employment. This policy has indeed succeeded in the short term and resulted in rising growth, as well as higher agricultural and residential housing investment, without affecting macroeconomic stability based on favorable oil prices.

3. The transition from a centrally planned to a market economy undertaken in the 1980s has not yet been completed. Despite early structural reform successes in the 1990s (trade and exchange reforms, price liberalization), the business environment is still not conducive to strong, private sector-driven growth, because of a lengthy judicial procedure, infrastructure bottlenecks, ill-defined land and real estate property rights, and an inefficient payments system.1,2 Weak governance and security concerns are also weighing on investors’ decisions. Public banks’ financing of large loss-making public enterprises is hampering the financial system’s capacity to mobilize and allocate resources efficiently. As a result of these weaknesses, unemployment remains high and the informal sector large.3

II. Recent Economic Developments and Prospects for 2003

A. Activity and Inflation

4. Economic activity improved in 2002–03 Underpinned by a large fiscal stimulus, high oil prices, and a sharp rise in oil output, real growth rebounded in 2002 and 2003 (Chart I and Table 1). Despite adverse weather conditions, output growth exceeded 4 percent in 2002. In 2003, a bumper crop has also boosted growth. As a result, the high unemployment rate (estimated at 25.9 percent of the labor force in 2002) is expected to have dropped somewhat.

Chart 1.
Chart 1.

Real GDP Growth

(in percent)

Citation: IMF Staff Country Reports 2004, 033; 10.5089/9781451811438.002.A001

Table 1.

Algeria: Selected Economic and Financial Indicators, 1999–2004

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

In U.S. dollars terms.

Annual average changes in the total trade-weighted INS index. A decrease in the index implies a depreciation.

Including the impact of financial restructuring package involving the swap of government bonds for public enterprises’ commercial debt.

Including dividends on current profits paid by Sonatrach.

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

5. Inflation receded in 2002 and is likely to remain low in 2003 (Chart 2) Food prices and the gradual reduction in the external tariff have kept inflation low despite abundant liquidity and booming credit.

Chart 2.
Chart 2.

Inflation Rate

(in percent)

Citation: IMF Staff Country Reports 2004, 033; 10.5089/9781451811438.002.A001

B. Fiscal Policy

6. In spite of a continued surge in expenditures, the overall fiscal balance is expected to reach a sizable surplus in 2003, up from a near balance in 2002. This is mainly the result of high hydrocarbon revenues, which are projected to increase by almost 4 percentage points of GDP compared to 2002, Expenditure growth—already strong in the 2003 initial budget—has been reinvigorated by reconstruction needs arising from the May 2003 earthquake.4 Capital expenditures, in particular, are projected to further increase to 18 percent of nonhydrocarbon GDP (NHGDP) in 2003 (Chart 3), Therefore, the already substantial nonhydrocarbon primary budget deficit—the main fiscal stance indicator—will increase sharply (Charts 4 and 5, and Table 2).

Chart 3.
Chart 3.

Capital Expenditure

Citation: IMF Staff Country Reports 2004, 033; 10.5089/9781451811438.002.A001

Source: World Economic Outlook database and IMF staff estimates.
Chart 4.
Chart 4.

Fiscal Impulse

Citation: IMF Staff Country Reports 2004, 033; 10.5089/9781451811438.002.A001

Chart 5.
Chart 5.

Algeria: Fiscal Sector

Citation: IMF Staff Country Reports 2004, 033; 10.5089/9781451811438.002.A001

Sources: Algerian authorities and IMF staff estimates.
Table 2.

Algeria: Summary of Central Government Operations, 1999–2004

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Sources: Data provided by the authorities; and Fund staff estimates and projections.

Including dividends on current profits paid by Sonatrach.

Starting in 2002, includes CNEP.

Including privatization receipts.

C. Monetary and Financial Sector Developments

7. Since 2002, monetary policy has been accommodating and credit to the economy booming. Despite a 2 percentage point increase in reserve requirements and a rise in the amounts of central bank deposit auctions, money supply M2 is expected to increase substantially in 2003. This increase reflects in part the largely unsterilized surge in net foreign assets.5 Furthermore, credit to the economy accelerated in 2002 and 2003 (Chart 6 and Table 3).6 New credit has been concentrated in the private sector, including agriculture and housing.

Chart 6.
Chart 6.

Bank Liquidity

Citation: IMF Staff Country Reports 2004, 033; 10.5089/9781451811438.002.A001

Table 3.

Algeria: Monetary Survey, 1999–2004

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Sources: Bank of Algeria, and Fund staff estimates and projections.

Projections are based on banks balance sheets excluding the two liquidated banks.

This includes the impact of bank restructuring packages. The conversion of bank claims on public enterprises in bank claims on the government results, other things being equal, in a decrease of credit to the economy and an equal increase in credit to the government. The flow of new credits in 2003 exceeds the stock difference between 2002 and 2003, because of the liquidation of two private banks.

This includes the debt-rescheduling proceeds blocked in special accounts at the Bank of Algeria.

8. Two major developments took place in the banking sector. The two largest private banks (although small, with less than 6 percent of bank deposits) went bankrupt in 2003 because of fraudulent practices and violations of prudential regulations. Staff estimates that their liquidation will result in a one-off cost to the treasury as high as 2 percent of GDP (bailing out public entities which lost deposits). A new ordinance on money and credit addressing a variety of institutional issues highlighted by the private banks’ failure was issued in August 2003.

D. External Developments

9. Throughout 2002 and the first half of 2003, the external position has continued to strengthen (Chart 7 and Table 4). Boosted by both higher prices and volumes, hydrocarbon exports surged in 2003, leading to a sharp rise in the current account surplus and official reserves, which, at $30.4 billion (22 months of imports) at end-October, exceed gross external debt.

Chart 7.
Chart 7.

External Accounts

(In billions of dollars)

Citation: IMF Staff Country Reports 2004, 033; 10.5089/9781451811438.002.A001

Table 4.

Algeria: Balance of Payments, 1999–2004

(In billions of U.S. dollars; unless otherwise indicated)

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Sources: Bank of Algeria (through 2000 data); and Fund staff estimates and projections.

According to the information provided by the Bank of Algeria all official reserves are liquid.

According to the Bank of Algeria, its actual data inlcude short-term debt, use of Fund resources and debt to Russia.

10.Following a depreciation in the first half of 2003, the real effective exchange rate (REER) of the dinar has appreciated since July 2003 (Chart 8). The depreciation reflected the low inflation rate prevailing in Algeria together with the broad stability of the dinar relative to the dollar at a time when the euro appreciated. In the second half of 2003, upon evidence that the appreciation of the euro was more than a transitory event, BA intervened to correct the initial depreciation of the REER. By end November, the REER index was estimated to be in the vicinity of its end-2002 level.

Chart 8.
Chart 8.

Real and Nominal Exchange Rates, January 1994–September 2003 1990=100

Citation: IMF Staff Country Reports 2004, 033; 10.5089/9781451811438.002.A001

E. Structural Reforms

11. Despite a marked slowdown in the overall pace of reforms since 2001, progress has been achieved in two specific areas: trade liberalization and development of treasury securities markets. Regarding trade liberalization, the progressive elimination of the temporary surtax (which replaced the minimum dutiable values in 2001) continued in accordance with the pre-announced timetable. Furthermore, the legislative framework has been modernized to ensure consistency with World Trade Organization (WTO) rules, while negotiations towards Algeria’s WTO accession are pursued actively.7 As for the development of securities markets, a systematic effort has been made to issue regularly tradable treasury securities covering a large spectrum of maturities to generate a reference yield curve. The Treasury has also initiated a program aimed at substituting standardized marketable securities in exchange for some of the bonds issued in the context of past bank restructurings.

12. Furthermore, a pragmatic attitude towards privatization is being developed though there have been few tangible results so far. Full or partial sales of state-owned enterprises to private investors, and transfers of assets to joint ventures with private investors are being prepared with a view to completing a few transactions by early 2004. Nevertheless, attempts to privatize three cement factories, open up the capital of one state-owned bank, and transfer the management of Algiers’ airport to the private sector did not come to fruition.8

III. Outlook and Risks

A. 2004 Outlook

13. Overall, the outlook for 2004 seems favorable, although a return to normal weather conditions will result in lower growth in agriculture and thus in the overall economy, notwithstanding the continued fiscal expansion. Inflation is expected to increase slightly to about 4 percent, mainly owing to the impact of wage increases, the persistence of abundant bank liquidity, and a further expansion of credit to the economy. Despite the slight drop in hydrocarbon export prices, the current account balance is still projected to record a surplus, as nongovernment saving remains sufficient to offset the emerging fiscal deficit (see below). The external position will continue to strengthen. Nevertheless, fiscal expansion and pervasive quasi-fiscal expenditures keep building up medium-term vulnerabilities.

14. The 2004 budget retains the current expansionary fiscal stance, with the primary nonhydrocarbon deficit projected to stabilize near its 2003 level.9 Current expenditures will rise as a result of a 25 percent increase in the minimum wage (SNMG), an allowance granted to civil servants in the education sector, and the upsurge in current transfers to public services. The budget includes DA 80 billion (1.5 percent of GDP) for reconstruction and also DA 77 billion for local development programs announced ahead of the elections. Hydrocarbon revenues are projected to decline markedly, resulting in lower overall revenues and a projected overall budget deficit.10

B. Medium-Term Policies

15. The baseline medium-term scenario assumes an overall continuation of current economic policies and is based on the WEO oil price projections (Table 5) The fiscal stance remains broadly expansionary, although the gradual fall in oil prices triggers a modest consolidation. The scenario also involves a relatively strong growth of credit to the economy in the context of increasing bank liquidity, while the REER is assumed to remain constant at its estimated end-November 2003 level. It assumes that the pace of structural reforms remains tepid.

Table 5.

Algeria: Illustrative Medium-Term Scenarios, 2002–08

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

Illustrative scenario aimed at showing the effects of lower oil prices under unchanged policies. In particular, no additional eternal borrowing is assumed.

Including special accounts and net lending.

16. The scenario’s results are mixed. While Algeria’s external position continues to strengthen, the fiscal position weakens significantly, forcing the treasury to issue more securities and draw down its BA deposit. This monetary financing, coupled with an accumulation of net foreign assets, results in sustained liquidity expansion and a modest rise in inflation, while fiscal consolidation weighs somewhat on growth performance.

17. The scenario also highlights the risks of the current policy stance, which could, overtime, endanger Algeria’s internal balance:

  • First, the slow pace of reforms implies that the projected rate of growth is not sufficient to rapidly reduce the high unemployment rate and the resulting social tensions.

  • Second, the monetary creation induced by the fiscal deficit and by credit expansion constitutes a potential threat to macroeconomic stability and the banking sector. The increase in liquidity carries a significant inflationary risk. High liquidity may also encourage banks to follow a more aggressive credit policy, which, in turn, could generate additional nonperforming loans.

  • Third, the risk of oil price (and to some extent hydrocarbon output) fluctuations makes the treasury’s financial position vulnerable. The increase in the fiscal deficit in the case of a sharp and sustained drop in oil prices could generate a fiscal sustainability problem and require corrective measures that would have adverse consequences on growth.11 Similarly, the public debt sustainability analysis indicates that a very large and sustained (but unlikely) adverse shock to GDP growth would result in high and growing debt levels (Table 6, line B2). However, a smaller GDP shock, such as a one-year drop in oil output resulting in a decline in overall GDP by one standard deviation, leads to higher but sustainable public debt ratios (Table 6, line A2).

Table 6.

Algeria: Public Sector Debt Sustainability Framework, 1998–2008

(In percent of GDP, unless otherwise indicated)

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Central government gross debt.

Derived as [(r - p(l +g) - g + ae(1+r)]/(l+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt, and e = nominal exchange rate depreciation (measured by increase in local currency value of U S dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as–g.

The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1 + r).

For projections, this line includes exchange rate changes.

Defined ad public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

Derived us nominal interest expenditure divided by previous period debt stock.

The key variables include real GDP grow ill, real interest rate; and primary balance in percent of GDP The episodes of budget surpluses and negative real interest rates or dm past explain the unrealistically positive outcome of this stress test.

Assumes that key variables (real GDP growth, real interest rate, and primary balance) remain at the level in percent of GDP/growth rate of the last projection year.

Assumes permanent growth shock and elasticity of revenues of 1.

Real depreciation is defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

18 All in all, barring large and sustained shocks, Algeria’s external position will remain strong over the medium term (Table 7). The standardized stress tests for external debt sustainability reveal that even large and low-probability shocks would not bring the debt ratio above the 1998 level (63 percent of GDP). Furthermore, the ratio would decline, after an initial increase, again suggesting that the external debt is sustainable.

Table 7.

Algeria: External Debt Sustainability Framework, 1998–2008

(In percent of GDP. unless otherwise indicated)

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Derived as [r - g - r(l+g) + ea(1 +r)]/(l+g+r+gr) limes previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(l+g) + ea(l+r)]/(J+g+r+gr) times previous period debt stuck, r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth, nominal interest rate; dollar deflator growth, and both non-interest current account and non-debt inflows in percent of GDP.

The drop in growth is assumed to originate in the hydrocarbon sector and affects directly hydrocarbon exports and government revenue.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and both non-interest current account and nun-debt inflows in perent of GDP) remain at their levels of the last projection year