1. My Algerian authorities thank staff for their well-focused report and informative Selected Issues paper. They appreciate the high-quality technical assistance and policy dialogue and helpful advice. They value highly the Board’s and staff views in support of their continued commitment to stabilization and reforms, leading to significant achievement over the past decade, including in attaining macroeconomic stability and considerably improving the institutional environment. At the same time, the authorities’ efforts have improved the security conditions and increased political stability, particularly following the April 2004 Presidential Elections. The authorities, however, are cognizant of the challenges ahead for attaining sustained high private sector-led growth that would allow a permanent reduction in unemployment and improve social welfare. As indicated in their medium-term economic program, they are determined to take advantage of the progress achieved thus far and the prevailing favorable conditions to press ahead with the remaining reform agenda.

2. Macroeconomic indicators continued to strengthen in 2004, leading to the achievement of 5.5 percent growth on average over the three-year period of the Economic Recovery Plan (ERP), which resulted in a per capita gain of over 3 percent per year. Though still high, unemployment has declined. Prudent monetary policy helped keep inflation at 4 percent, while the external position continued to strengthen with the current account recording a surplus of 15 percent of GDP; international reserves reached a record level. The external debt-to-GDP ratio continued to decline, partly on account of early debt repayments, reaching 24.7 percent from 34.9 percent at end-December 2003, and the debt-service ratio decreased further to 16.1 percent.

3. The supportive fiscal stance under the ERP has benefited capital expenditure, which had been constrained for years, including to address urgent rehabilitation and reconstruction of damaged infrastructures related to terrorism and natural disasters. At the same time, current spending declined by 2 percent in 2004 in nominal terms and dropped to below 20 percent of GDP from 23.3 percent in 2003. Total expenditures are expected to decline by 2.5 percentage points to 31.6 percent of GDP in 2004, allowing a sizeable fiscal surplus of over 5 percent of GDP. In these circumstances and given that inflation is under control, the authorities believe that the fiscal stance has been helpful in achieving the goals of the ERP.

4. Monetary policy remained geared towards containing inflation. The sizable increase in net foreign assets represented the major source of the monetary expansion. Nevertheless, broad money will be contained at 16 percent in 2004, allowing for a moderate growth in credit to the economy in the context of a further decline in net credit to the Government and sterilization of part of the hydrocarbon revenues. In its continued efforts to mop up excess liquidity, the central bank (BA) increased the amounts of deposit auctions significantly. In line with staff recommendations, BA has recently decided to mop up all excess liquidity. The substantial increase in reserve requirements at end-2002 also contributed to liquidity control. In addition, the regulatory framework of this instrument has been adjusted in 2004 to allow for increased flexibility. The authorities’ envisaged fiscal stance, and the continuation of the early external debt repayment policy should help to keep inflation at its low level. Nevertheless, BA stands ready to take additional measures, if necessary.

5. As the staff report underscores, the exchange rate policy has continued to serve the economy well. Following BA’s intervention in the second half of 2003 to offset the earlier depreciation, attention has focused on avoiding undue misalignment. The authorities remain committed to a flexible exchange rate policy and believe that the present spread between the official and parallel exchange rate is attributable to informal import activities and tax evasion. They will continue to integrate the informal sector and improve tax and customs administration as part of their ongoing efforts to further liberalize the economy and join the World Trade Organization (WTO). They have requested Fund technical assistance to improve the payments and exchange rate systems with adequate safeguards against undue capital outflows. The mission will also be requested to look into the causes of the spread and recommend further policy actions.

6. Negotiations for WTO accession are now at an advanced stage. Efforts to modernize the legislative framework in line with WTO regulations are continuing with the revision of the Code of Commerce, following earlier issuance of the new legislation on international trade, free trade zones, protection of intellectual property rights, and competition. To prepare and monitor effective implementation of the Association Agreement with the European Union, a high-level, multi-sectoral permanent committee has been established at end-December 2004 and will report monthly to the Government. Ratification of the Agreement is expected in the near future. Implementation of the comprehensive tariff reform is proceeding as scheduled; the customs tax has been eliminated and the temporary additional duty tax has been reduced further to 12 percent as of January 1, 2005, to be eliminated on January 1, 2006.

7. In the fiscal area, modernization of the tax administration has benefited from recent Fund technical assistance, and progress is being made in the operationalization of the Large Taxpayer Unit and the establishment of tax units for small- and medium-sized enterprises. Efforts are also underway to re-organize the Ministry of Finance with, inter-alia, the creation of a department for the design of fiscal policy. Work is also progressing, with World Bank assistance, in modernization of the budgetary process. Moreover, in line with the recommendations of the fiscal ROSC, a draft organic law governing public finances is in preparation with Fund technical assistance.

8. Privatization of public enterprises continued with the divestiture of 50 small- and medium-sized enterprises in 2004. In addition, the privatization of the large sugar processing enterprise has been finalized recently, and the remaining state-owned stake in the partially privatized detergent company has been divested to the foreign partner. Negotiations on privatization of other enterprises and discussions with potential investors are in progress. The Government has recently announced that all but a limited number of public enterprises, such as Sonatrach (the oil company) and Sonelgaz (the electricity company), are eligible for privatization.

9. Building on the FSAP recommendations for the banking sector, a comprehensive strategy is being articulated that will include privatization of a number of public banks. The Ministry of Finance has tightened its control on public banks through strengthened performance contracts. Modernization of the payment system and the information and accounting systems is in progress. The latter should significantly improve the quality and timeliness of data reporting and should further facilitate the conduct of banking supervision by BA, which continues to be strengthened with Fund technical assistance. Following the recent fraudulent bankruptcy of two private banks, resulting in large losses of public entities’ deposits, the Government has temporarily prohibited public units from dealing with private banks, while supervision is being strengthened. Comprehensive on-site inspections have been conducted to evaluate public banks’ loan portfolios in order to determine their provisioning needs. The inspection reports have been recently finalized and submitted to the Banking Commission. This explains the delay in providing staff with the requested information, which will be provided shortly. Efficiency of the public banks is to be enhanced by the recent measures taken to replace quasi-fiscal activities with direct budget support. In line with FSAP and fiscal ROSC recommendations and following preliminary measures taken in the 2004 Budget Law, the 2005 Budget provides for appropriations in this regard; work is being undertaken by the Ministry of Finance to assess additional needs in this area. Progress is also being made in AML/CFT issues with the recent Parliament approval of the related comprehensive law.

10. Maintaining macroeconomic stability is a centerpiece of the authorities’ medium-term strategy. Key in this regard is ensuring medium-term fiscal and debt sustainability. The fiscal program for 2005-2009, which envisages a progressive reduction in the ratio of the nonhydrocarbon primary deficit to nonhydrocarbon GDP, attests to the authorities’ strong commitment in this regard. Current and capital expenditures are slated to decline in terms of GDP through appropriate measures, including wage containment, civil service reform, and further rationalization of capital expenditure through careful project selection and monitoring. In this latter regard, the authorities would welcome World Bank assistance to conduct a Public Expenditure Review, with priority to be given to sectors where expenditure is highest, including water, public works, health, and education sectors. At the same time, social spending will be preserved and, as the staff report acknowledges, the safety net may need to be expanded as the pace of implementation of structural reforms is accelerated. The envisaged fiscal strategy should allow for sizeable fiscal surpluses, which are to be accumulated in the stabilization fund. In this connection, the staff paper on the fiscal management of hydrocarbon revenues provides useful guidelines to ensuring medium- and long-term fiscal sustainability. The paper underscores the importance of intergenerational equity issues in the use of exhaustible resources. While this concept is yet to be unambiguously defined, the authorities believe it should not be limited to financial savings alone as a wide range of social and infrastructure spending would also benefit future generations. Moreover, early debt repayment would reduce the fiscal burden for future generations.

11. The authorities are resolved to complete the process of implementation of the remaining structural and institutional reform agenda in the medium term. While work is advancing in clearly articulating their strategy in this regard, implementation is already underway in a number of areas, including in the fiscal area, public enterprises restructuring and privatization, the financial sector, and the judiciary system. Enhanced efforts are also directed to reforming the health and education sectors with the aim of enhancing efficiency. To ensure successful implementation, the authorities are building public support through enhanced communication and consultation.

12. In line with their active debt management policy, the authorities are considering proposals to proceed with further early debt repayments to bilateral and multilateral creditors.

13. The authorities reiterate their strong support for the enhanced HIPC Initiative, and are considering further support to HIPCs. While noting that a major portion of their outstanding debt to Algeria consists of arrears on debt in kind, they have expressed willingness to examine comprehensively the issue with the Fund.

14. Finally, the authorities look forward to the Board discussions, and, in line with their continued commitment to transparency, they consent to the publication of the staff report, the Selected Issues paper, and the fiscal ROSC paper.