Algeria: Staff Report for the 2017 Article IV Consultation
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International Monetary Fund. Middle East and Central Asia Dept.
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Publication Date:
01 Jun 2017
eISBN:
9781484302668
Language:
English
Keywords:
ISCR; CR; oil price shock; exchange rate; economy; labor market; forward market; stabilization fund; reducing price restriction; discount window
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2017 Article IV Consultation-Press Release; Staff Report;

Abstract

2017 Article IV Consultation-Press Release; Staff Report;

Introduction

1. The collapse of oil prices has exposed the shortcomings of Algeria’s growth model. Historically, the economy has relied on government redistribution of hydrocarbon revenues. When oil prices were high, this model allowed Algeria to build infrastructure, achieve social stability, make significant progress toward meeting the Millennium Development Goals, and repay most of its external debt to which the country is averse. Yet even when oil prices were high, this model was unsustainable considering that hydrocarbon reserves may be exhausted in one or two generations’ time.1 Over the past decade, a large share of new job creation has been either in the public sector, which is very large by international standards, or in the construction sector, which is driven largely by public investment. With durably lower oil prices, it has become even more apparent that the government no longer has sufficient resources to sustain high levels of spending and continue creating jobs for a young and fast-growing population.

2. While initially delayed, the adjustment to the oil price shock is now underway. After a slow start in 2014–15, the authorities have taken steps to address the challenges of living with lower oil prices. They have adopted an ambitious medium-term fiscal consolidation plan, implemented some structural reforms, and are working on a long-term vision for reshaping the country’s growth model. In response to changing liquidity conditions, the central bank has appropriately reintroduced refinancing instruments. The new reform momentum is welcome. However, staff believes the authorities’ policy mix is tighter than necessary, and that there is some fiscal space to conduct a more gradual fiscal consolidation, less costly in terms of growth and employment. The authorities should ensure that the burden of adjustment is borne equitably, even more so to foster wider ownership of the adjustment ahead.

Recent Developments, Outlook, and Risks

A. Recent Developments

3. Economic activity was resilient in 2016, but inflation increased. Real GDP growth slowed modestly to 3.5 percent in 2016 from 3.8 percent in 2015. Activity was supported by strong growth in the hydrocarbon sector, which benefited from new fields coming on stream and the return to full production of a major gas plant that was the target of a terrorist attack in 2013.2 By contrast, growth in the nonhydrocarbon sector—particularly the agriculture and services sectors—slowed, in part because of spending cuts, and reached its lowest level since 1999. Unemployment increased to 10.5 percent in September 2016 and remains particularly high among the youth (26.7 percent) and women (20.0 percent). Average inflation rose from 4.8 percent in 2015 to 6.4 percent in 2016, driven by higher prices for manufactured and imported goods, and stood at 6.9 percent year-on-year in March 2017. Inflation was particularly volatile in 2016 due to large fluctuations in food prices.

4. The fiscal adjustment in 2016 was sizeable. Overall spending was cut by 3.6 percent in nominal terms, a reduction equivalent to 5.8 percent of nonhydrocarbon GDP. While it was less than built into the budget, which targeted a 9 percent spending cut in nominal terms, this reduction, combined with an exceptional dividend from the Bank of Algeria (BA), helped lower the nonhydrocarbon budget deficit from 37.1 percent of nonhydrocarbon GDP in 2015 to 28.9 percent in 2016 (cash basis).3 The overall deficit of 14.0 percent of GDP was financed mainly by drawing down savings in the oil stabilization fund,4 which reached its statutory floor, and by borrowing in the domestic market. Payment delays increased, reflecting financing difficulties. Public debt increased from 8.8 percent of GDP in 2015 to 21.0 percent following government financial operations to support two state-owned enterprises.

5. The current account deficit remained substantial and far from its norm (Annex III). Following a deterioration in the terms of trade for the third year in a row, the trade deficit widened from US$18.1 billion in 2015 to US$20.4 billion in 2016. The wider trade deficit was offset by lower profit repatriation, leading to a slight improvement in the current account deficit in nominal dollar terms. As a percent of GDP, however, the current account deficit widened slightly to 16.9 percent of GDP. By comparison, staff estimates of the current account norm range from a surplus of 1.4 percent of GDP to a deficit of 3.7 percent, indicating an external balance significantly weaker than warranted by medium-term fundamentals and desirable policies. The nominal effective exchange rate (NEER) was broadly stable in 2016 while the real effective exchange rate (REER) appreciated by 5.6 percent because of higher inflation in Algeria than in its trading partners. The REER is significantly overvalued, hurting Algeria’s competitiveness.

6. Nevertheless, the net international investment position, though weakened, remains comfortable. International reserves fell by US$30 billion to US$113 billion (excluding SDRs) but remained substantial at 23 months of imports and 686 percent of the Fund’s unadjusted metric to assess reserve adequacy (ARA metric).5 External debt amounted to just 2.5 percent of GDP in 2016. Overall, the net international investment position stood at a comfortable 47 percent of GDP.

Figure 1.
Figure 1.

Algeria: Selected Macroeconomic Indicators

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Figure 2.
Figure 2.

Algeria: Fiscal Indicators

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Figure 3.
Figure 3.

Algeria: Monetary Indicators

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

7. Banks’ excess reserves with the central bank dried up. Lower oil prices contributed to a sharp reduction in excess liquidity. As a result, some banks returned to BA for financing, interbank lending picked up, and interest rates increased. In an environment of tighter bank liquidity, growth in credit to the economy slowed but nevertheless remained robust at 9.8 percent in 2016. This, combined with the government’s drawdown of the oil stabilization fund, helped offset the decline in net foreign assets such that broad money increased by 1.8 percent.

8. The banking system as a whole remained adequately capitalized and profitable, but credit quality deteriorated. Preliminary data at end-2016 suggest that the banking sector was adequately capitalized. The Tier I solvency ratio was up from 15.9 percent in 2015 to 16.4 percent in 2016, mainly due to the recapitalization of a public bank. The ratio of gross nonperforming loans to total loans increased from 9.8 percent to 11.4 percent, partly reflecting delayed payments from the government to its suppliers. However, the ratio of net nonperforming loans was only 5.1 percent thanks to a high level of provisioning (55.4 percent), and banks continued to post a high return on assets (1.9 percent on aggregate). At the system level, 27.5 percent of assets were liquid, roughly unchanged from 2015 and sufficient to cover more than two-thirds of banks’ short-term liabilities.

B. Outlook and Risks

9. The growth outlook is tied closely to the policy mix pursued to adjust to lower oil prices. The baseline scenario reflected in Tables 1–4 is based on the fiscal adjustment envisaged in the authorities’ 2017 and medium-term budget. It also assumes the continuation of current structural reforms efforts and a nearly stable real effective exchange rate over the medium term. This policy mix would help restore fiscal and external balances, but significant spending cuts would weigh heavily on growth. As detailed below, a more gradual consolidation combined with more ambitious structural reforms and further exchange rate depreciation would likely result in higher growth and would still be consistent with maintaining debt sustainability.

Table 1.

Algeria: Selected Economic and Financial Indicators, 2014–22 1/

article image
Sources: Algerian authorities; and IMF staff estimates and projections.

Including public enterprises.

In U.S. dollars terms.

Table 2.

Algeria: Balance of Payments, 2014–22

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

Weighted average of quarterly data.

Excluding SDR holdings.

ARA EM metric includes additional buffer for commodity intensive countries (projection period only).

Table 3.

Algeria: Summary of Central Government Operations, 2014–22 1/

(In billions of Algerian dinars)

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

On cash basis.

Including Sonatrach dividends.

Bank financing includes domestic debt issuance and a drawdown of the oil stabilization fund and other government deposits at the central bank.

Includes proceeds from sales of state-owned assets.

Table 4.

Algeria: Summary of Central Government Operations, 2014–22 1/

(In percent of GDP)

article image
Sources: Algerian authorities; and IMF staff estimates and projections.

On cash basis.

Including Sonatrach dividends.

Bank financing includes domestic debt issuance and a drawdown of the oil stabilization fund and other government deposits at the central bank.

Includes proceeds from sales of state-owned assets.

10. Risks are tilted to the downside (Box 1). Persistently lower oil prices would worsen economic imbalances and financial strains. Capital account restrictions insulate Algeria from direct contagion from world market turbulence, but higher global rates or risk aversion could complicate recourse to foreign savings. Fiscal adjustment could lead to social tensions, which have been isolated thus far. With memories of the 1990s’ civil war still fresh, the authorities are walking a fine line between too rapid an adjustment that could spark social unrest and insufficient action that ends in a sudden, disorderly adjustment. It will be important to garner a broad political and social consensus to ensure that future electoral cycles do not undermine support for reforms.

Risk Assessment Matrix1

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1 The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

Policy Discussions

11. Since the 2016 Article IV consultation, the Algerian authorities have taken actions to adjust to lower oil prices. The authorities achieved a sizeable reduction in the fiscal deficit in 2016 and have adopted an ambitious fiscal consolidation plan for 2017–19. They have made progress improving the business environment and are working on a long-term strategy to reshape the country’s growth model to foster greater private sector activity and economic diversification. The central bank has adapted its monetary policy instruments to a tighter liquidity environment.

12. The growing reform momentum is welcome, but the policy mix pursued by the authorities appears overly restrictive. Until 2015, adjustment to the oil price shock was borne essentially by exchange rate policy. The government’s current policy, which entails financing the deficit with domestic resources only, with no further exchange rate depreciation, runs the risk of excessively shifting the burden of adjustment toward fiscal policy. Staff considers that there is some fiscal space to conduct a more gradual fiscal consolidation, with less impact on growth, if fiscal consolidation were combined with: (i) further exchange rate depreciation, which not only would help address external imbalances and support private sector development, but would also raise oil revenue in local currency; (ii) a less restrictive financing strategy that includes external borrowing; and, (iii) more ambitious structural reforms to raise potential growth.

A. Balancing Fiscal Consolidation and Growth

13. The authorities’ fiscal policy plan goes in the right direction and uses levers broadly in line with staff’s recommendations (Box 2). After years of expansive fiscal policy (even in the early days of the fall in oil prices), the authorities are now firmly committed to consolidating their fiscal position. Fiscal consolidation is essential for restoring fiscal sustainability, ensuring intergenerational equity, and supporting external rebalancing. The authorities have adopted for the first time a medium-term budget framework (MTBF) with a clear medium-term anchor, which is a significant achievement. Staff welcomed the broad-based approach taken to reduce the deficit, which entails raising nonhydrocarbon revenues, reducing current expenditure (including wages) as a share of GDP, reforming the subsidy system, reducing investment spending while increasing its efficiency, and improving public financial management The key features of the authorities’ plan are as follows:

  • Cut current spending to pre-global financial crisis levels. Since 2009, current expenditures have averaged 26 percent of GDP. The MTBF aims to reduce current spending to 20 percent of GDP by 2020. The government intends to limit new hiring to strategic sectors and rein in other operating costs while preserving social transfers.

  • Substantially lower capital spending. Capital spending has averaged 15 percent of GDP since 2009—well above the average in other MENA oil exporters. The authorities aim to reduce it to 10 percent of GDP by 2020 (a return to 2002 levels) while increasing investment efficiency by improving the selection, implementation, and ex-post assessment of projects. Staff stressed the need to preserve investment in health, education, and well-targeted safety nets.

  • Continue subsidy reform. The government initiated subsidy reform in 2016 by increasing the prices of fuel, natural gas, and electricity for the first time since 2005. The 2017 budget law raised fuel prices further, and the government plans to deepen subsidy reform while introducing a targeted cash transfer system to protect the most vulnerable.6 Staff emphasized the need to explain the rationale and benefits of subsidy reform to the public.

  • Increase nonhydrocarbon tax revenues. The 2017 budget raised VAT rates by two points to 9 and 19 percent and increased taxes on tobacco and a range of luxury goods. Staff welcomed the authorities’ intention to further increase nonhydrocarbon revenues by focusing henceforth on rationalizing tax exemptions and strengthening tax administration, which will also help promote a more equitable tax system.

Authorities’ Response to Past IMF Recommendations

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uA01fig01

Expenditures – Baseline Scenario

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: Algerian authorities; and IMF staff calculations.

14. The degree of fiscal consolidation built into the MTBF is very ambitious and risks damaging growth. The authorities aim to bring the deficit close to zero by 2019. This is a steep (and possibly difficult to achieve) consolidation plan.7 If the authorities implement the MTBF, staff projects that nonhydrocarbon growth will slow to close to zero in 2018—a sharp deviation from the authorities’ own forecast8 Such a sharp deceleration in growth would likely worsen unemployment, dampen nonhydrocarbon revenues, increase financial stability risks, and heighten social tensions.

15. In staffs assessment, Algeria has some fiscal space. Fiscal savings have been nearly depleted, but public debt remains low, and external debt is nearly nonexistent. Public sector gross financing needs decline sharply under the MTBF and remain manageable even under more expansionary scenarios simulated by staff. Debt levels decline under the MTBF and remain well below benchmark levels for emerging markets in expansionary scenarios.

16. Using the fiscal space to cut spending more gradually than envisaged in the MTBF would help limit the slowdown in growth. The mission prepared an alternative scenario that illustrated policy tradeoffs and highlighted the existence of some fiscal space (Annex I). Compared to the baseline scenario, spending cuts in the alternative scenario are less severe and financing needs are larger, requiring more borrowing. The government is assumed to meet some of these needs through external borrowing. Fiscal policy is anchored by gradually stabilizing public debt at around 30 percent of GDP, a level higher than in the authorities’ plan, but moderate enough (by emerging market standards) to leave buffers should some fiscal risks related to the price of oil or contingent liabilities materialize.

Key Economic Indicators Under the Baseline and Alternative Scenarios

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Source: IMF staff calculations.

17. Tapping a broader range of financing options would allow for more gradual fiscal consolidation.9 Since 2009, the government has financed deficits mainly by drawing down fiscal savings and tapping the deposits of public entities held at the Treasury. Staff projects government debt to decline to 14.6 percent of GDP by 2022 under the MTBF. Given its low debt, Algeria can afford to borrow more. An increase in domestic debt issuance would also support the development of the country’s incipient financial markets. However, to avoid excessive crowding out effects in an environment of tighter liquidity, and to shore up reserves, the government could also borrow externally. Tapping international markets would require careful preparation and overcoming resistance to external debt. In addition, transparently opening the capital of selected state-owned enterprises, including public banks, could provide financing while helping to develop the stock market and improve corporate governance. In this context, staff encouraged the authorities to relax the 51-49 rule requiring majority Algerian ownership in foreign investments.

uA01fig02

Sources of Financing, 2009–16

(Percent of total)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: Algerian authorities; and IMF staff calculations.

18. Further public finance management reforms would support fiscal adjustment and improve governance. Staff encouraged the authorities to prepare sectoral medium-term expenditure frameworks (MTEFs) consistent with an overall MTEF. Staff supported the authorities’ intention to adopt a new organic budget law that would provide a legal basis for the multiyear budgeting process and ensure that debt is used only to finance investment spending. The authorities should improve their capacity to monitor budget execution and, if necessary, make adjustments upstream in the expenditure chain, rather than downstream, to minimize the risk of payment arrears. The authorities also need to improve forecasting and cash management to properly anticipate and cover future liquidity requirements. To enhance the effectiveness of monetary policy, the Ministry of Finance should regularly communicate its treasury cash flow projections to the BA. Finally, to better assess the sustainability of the broader public sector, the authorities should develop consolidated public sector flow and stock statistics that include the debt of state-owned enterprises and government guarantees.

19. Some fiscal risks could materialize during the adjustment (Box 3). The authorities reduced an important source of fiscal risk by closing several special treasury accounts that led to spending overruns in the past. However, other sources of fiscal risk have materialized recently and are still present. They include government guarantees of loans to state-owned enterprises, the potential need to recapitalize public banks, implicit commitments given to state-owned enterprises, and the financial difficulties of the state-run pension system. The fiscal consolidation process, although necessary, increases the probability that some fiscal risks could materialize. Staff recommended that the authorities monitor fiscal risks more closely, including by tracking the debt of the consolidated public sector.

Fiscal Risks1

Fiscal risks in Algeria are multiple and interrelated, and their potential impact on the budget deficit and public debt is considerable. The state plays a dominant role in economic activity through government programs as well as through commercial activities carried out by public institutions and state-owned enterprises. The government frequently recapitalizes public banks, buys back guaranteed debt, and provides financial support to state-owned enterprises to cover the differential between market prices and regulated prices. Other sources of fiscal risk include volatile hydrocarbon revenues, natural disasters, and the financial situation of social safety net programs.

Some of these risks have materialized in the past. Between 1991 and 2012, Treasury operations to support public banks amounted to 14.8 percent of 2012 GDP. In 2016, the materialization of fiscal risks cost an estimated 8.9 percent of GDP, mainly reflecting two operations: the government’s purchase of debt owed by a public utility company to a public bank, and the issuance of bonds to the state-owned oil company to compensate for losses incurred from selling imported refined fuel in the domestic market at subsidized prices.

1 See accompanying Selected Issues Paper: “Fiscal Risks in Algeria.”

20. Authorities’ views. The authorities said they might reconsider the composition of spending over the medium term to ensure the adjustment is as growth-friendly as possible, but they do not intend to raise the overall spending caps in the MTBF. Rather than turn to external borrowing, they argued that significant fiscal consolidation was necessary to reduce financing needs and minimize crowding out effects. They do not plan to relax the 51-49 rule at this stage and noted that previous efforts to sell state-owned assets had not gone well. They were unconvinced that their fiscal consolidation plan would severely damage growth, pointing to large industrial projects in the pipeline that would support activity in the nonhydrocarbon sector. While recognizing the potential for acceleration of growth in the industrial sector, staff noted, however, that its contribution to GDP remains too small to make a significant difference in the short run. The authorities acknowledged the existence of fiscal risks and agreed that they needed to be monitored closely, but said that developing consolidated public sector statistics would take time.

B. Structural Reforms10

21. Structural impediments are multiple and intertwined. Algeria ranks behind regional peers and emerging market countries in almost all key structural reform areas in international surveys. Notable deficiencies include a restrictive business environment, difficult access to finance, weak governance and corruption controls, insufficient transparency and competition, high barriers to entry, a rigid labor market, jobs-skills mismatches, and excessive growth in wages with respect to productivity.11

uA01fig03

Key Structural Impediments

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: World Bank; World Economic Forum; PRS Group; and IMF staff calculations. Percentile rank includes all countries with data available.

22. Therefore, structural reforms should be a pillar of Algeria’s strategy for adjusting to lower oil prices. In addition to undertaking fiscal consolidation to restore macroeconomic balances, Algeria should implement an ambitious structural reform program to facilitate the emergence of a dynamic private sector. There are some indications that reform momentum is building. Last year the government adopted a broad strategy to reshape the country’s growth model. It is now fleshing it out with World Bank support. Staff welcomed the objectives of the new model, namely to reduce dependence on hydrocarbons through investments in high value-added sectors such as agribusiness, renewable energy, services, and industry, and to support private sector development. The authorities also took steps to enhance the business environment, which resulted in an improvement in the World Bank’s Doing Business ranking from 163 in 2016 to 156 in 2017, and enacted new laws to foster investment and the development of small and medium-sized enterprises (SMEs).12

uA01fig04

Ease of Doing Business, 2016

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: 2016 World Bank Doing Business Indicators; and IMF staff estimates.

23. Algeria’s challenges call for an ambitious reform agenda. Staff encouraged the authorities to:

  • Continue to reduce excessive bureaucracy and strengthen the institutional and legal frameworks. Opinion surveys indicate that excessive bureaucracy and corruption are major impediments to private investment. Other indicators point to gaps in the institutional and legal frameworks. Simplifying administrative procedures and accelerating the transition to a digital economy should be priorities. The institutional and legal frameworks should be strengthened to better protect property and contractual rights and ensure more rapid settlement of contract disputes and bankruptcy proceedings. International experience suggests that where the rule of law is lacking and corruption is a concern, resistance to reforms is likely to be stronger.

  • Strengthen competition in product markets. Strengthening competition in product markets requires reducing barriers to the entry of new firms and to the exit of obsolete ones. Privatizing some nonstrategic public enterprises that pose implicit barriers to entry, and further reducing price restrictions by expanding subsidy reform, would create incentives for private entrepreneurs to emerge. To ensure an adequate enforcement of competition rules, the powers of the competition authority should be strengthened.

  • Open the economy to more trade and foreign investment. Relaxing the 51-49 rule could help strengthen competition in the domestic market, lead to technology transfers, and make Algerian businesses more competitive. Staff stressed that import licenses, which the authorities have imposed on selected products to dampen imports, should be avoided because they add to inflationary pressures and introduce distortions and rent-seeking opportunities that are likely to drive more activity underground. Staff also encouraged the authorities to pursue WTO accession.

  • Ensure adequate access to financing for businesses. Difficult access to credit is a key factor hindering the development of the private sector. Lending to the private sector represents only 24 percent of GDP, one of the lowest ratios in the region. There are substantial collateral requirements for lending to SMEs, and bankruptcy settlement proceedings are lengthy. Moreover, Algerian capital markets are nascent, and market capitalization amounts to less than 1 percent of GDP. A number of factors thwart the development of financial markets, including lengthy administrative procedures and subsidized bank lending that makes market financing unattractive. Staff recommended promoting competition in the banking sector, protecting creditors’ rights, modernizing the bankruptcy framework, and improving procedures for resolving nonperforming loans. Reducing widespread interest rate subsidies for investment loans would increase the attractiveness of capital markets, promote better self-selection of investment projects, lessen budget spending, and strengthen the transmission mechanisms of monetary policy. As noted above, the authorities could also consider opening up the capital of certain large public enterprises and banks.

  • Improve the functioning of the labor market. The labor market is characterized by a lack of flexibility caused by costly hiring and firing regulations, high payroll taxes, mismatches between skills offered by job seekers and those sought by firms, strict eligibility requirements that limit access to the unemployment insurance system, and excessive wage hikes relative to productivity gains.13 These characteristics reduce the demand for labor and hamper labor mobility across sectors. They also exclude a large part of the population from the labor market, in particular women and youth, and contribute to a large informal sector. Staff welcomed the ongoing dialogue between trade unions, employers, and the government on the labor code, which is an opportunity to increase labor market flexibility while ensuring adequate protection for workers. Staff reiterated the need to thoroughly assess the effectiveness of active labor market policies, improve the unemployment benefit system, develop closer ties between the educational system and the private sector, and consider measures that would support greater labor market participation of women.

uA01fig05

Executive Opinion Survey, 2016

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Source: World Economic Forum Executive Opinion Survey,Note: From a list of 16 factors, respondents are asked to select the five most problematic and rank them from 1 (most problematic) to 5.
uA01fig06

Legal System and Property Rights

(Best = 10)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Source: Fraser Economic Freedom Index. Note: Latest data are 2014.
uA01fig07

World Governance Indicators, 2015

(2.5 = best, -2.5 = worst)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Source: World Bank World Governance Indicators.
uA01fig08

New Business Density, 2008–14

(New registrations per 1000 population ages 15–64, average)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Source: World Bank.
uA01fig09

Algeria: Financial Institutions Index

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: IMF Financial Development Index.
uA01fig10

Labor Market Regulations

(Best = 10)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Source: Fraser Economic Freedom Index. Note: Latest data are 2014.

24. Structural reforms should be carefully sequenced and started without delay. International experience suggests that a “big bang” approach, involving many reforms in a short period, would likely fail in Algeria because the institutional and legal frameworks are not sufficiently developed to overcome public resistance. On the other hand, an overly fragmented approach would also likely fail due to the interrelated nature of the multiple binding constraints to private sector development. Staff recommended that the authorities adopt an intermediate approach, gradually implementing reforms across many areas while paying close attention to sequencing. Where reform preconditions exist, certain reforms should precede others. For example, strengthening the legal and governance framework would facilitate privatization efforts. Where complementarities exist, reforms should be implemented together. For example, product market reforms and reforms to open the economy to more foreign direct investment (FDI) would reinforce each other. Most importantly, reforms should be started without delay and steadily implemented, as they will take time to bear fruit.

25. Structural reforms should be designed to ensure that the burden of adjustment is borne equitably. Reforms should be carefully designed bearing in mind their distributional impacts. Fiscal reforms, in particular, have a key role to play to ensure equity in sharing the potential costs of the adjustment. For example, energy subsidies, which are costly and highly regressive, should be gradually replaced with targeted monetary transfers. Eliminating tax exemptions and strengthening tax administration would help make the tax system more inclusive while increasing nonhydrocarbon revenues. Reforms to increase the flexibility of the labor market and jumpstart private sector growth should be preceded by a review of the current unemployment benefit system to increase its coverage. The authorities should also strengthen anti-corruption efforts, including by mobilizing the framework for anti-money laundering and combating the financing of terrorism (AML/CFT). More broadly, given the currently weak macroeconomic environment and the potential for reform resistance, macroeconomic policies should support reforms, including by using the available fiscal space to cushion transitory costs.

26. Authorities’ views. The authorities agreed that wide-ranging structural reforms were necessary to change the growth model, and that such reforms should proceed at a gradual but steady pace. They highlighted measures already taken or in train, such as the new investment code, a draft law on private-public partnerships, and a new custom code, which aims at streamlining procedures and reducing administrative delays. They agreed that the institutional and legal frameworks were not well adapted to a market-based economy and needed to be revamped. They recently expanded the system of import licenses to cover twenty new products that are manufactured domestically, and they intend to ensure that imports meet appropriate standards. They argued that access to credit was not a major problem for many SMEs but rather that entrepreneurs often lacked managerial skills, and students, for cultural reasons, tended to seek skills more suitable for the public sector. They expressed wariness about possible tradeoffs between improving the flexibility of the labor market and protecting employee rights, and noted that active labor market policies helped create many jobs and a burgeoning private sector dynamic.

C. Supportive Exchange Rate, Monetary, and Financial Policies

Exchange rate policy

27. Measures are needed to deepen the official foreign exchange market and curtail the parallel market. Diversifying the supply of foreign currencies on the interbank market, through a relaxation of surrender requirements relating to repatriation of export earnings and a reduction in the de facto high compulsory reserve ratio on foreign currency deposits, would support the development of the foreign exchange market. Measures are also needed to reduce the premium on the parallel foreign exchange market, which stands at about 60 percent. In particular, the indicative foreign exchange allocation ceilings for individuals should be raised.14

28. Further depreciation of the dinar also has a key role to play to support the fiscal and external adjustment. Various methodologies suggest that the REER remains significantly overvalued (Annex III). While most of the adjustment to correct the overvaluation should come from fiscal consolidation and structural reforms, further depreciation of the nominal exchange rate, combined with efforts to gradually eliminate the parallel market, should also play a role. A weaker currency would increase hydrocarbon revenues in dinars and reduce demand for imports, thus helping to restore fiscal sustainability and external balance while supporting the diversification of the economy in the medium term. Moreover, staff analysis suggests that a gradual nominal depreciation should not cause significant inflationary pressures in the short term.15

Monetary policy

29. The BA has appropriately adjusted to changing liquidity conditions by reintroducing refinancing instruments, with open market operations as the main tool. For more than a decade, monetary policy focused exclusively on mopping up structural excess liquidity. Lower oil prices have caused excess liquidity to dry up, which should allow the BA to regain control over liquidity conditions and short-term interest rates. The BA recently reintroduced its refinancing instruments, which consist of open market operations as the main instrument and a marginal lending facility. To support this approach, the BA needs to further strengthen its liquidity forecasting and management capabilities, in coordination with the Treasury, as well as its capacity for evaluating collateral. Access to the discount window, which allows banks to satisfy liquidity needs in amounts and maturities not under direct control of the central bank, should be discouraged, which would reinforce the monetary policy transmission mechanism. To that effect, the discount window rate should rapidly be set higher than the rate of the marginal lending facility.

30. With inflation rising, the BA should stand ready to increase its policy rate to anchor inflation expectations around its target of 4 percent. The introduction of open market operations allows the BA to establish a new policy rate that will serve as the benchmark rate in the interbank market. Because this transmission channel is new, the effectiveness of monetary policy remains untested. As inflation has been rising, credit growth remains robust, and recent and planned measures (VAT increases, subsidy reform) have inflationary effects, the BA should adopt a tightening bias, pending an assessment of whether the planned fiscal consolidation will sufficiently dampen inflationary pressures in the short term.

Financial sector policy

31. To date, the oil price shock has had only a moderate impact on the stability of the banking system, but financial stability risks are increasing (Table 5). The banking sector is dominated by public banks, which represent 87 percent of total banking assets. The sector as a whole remains adequately capitalized and profitable, but, as expected, the oil price shock has increased liquidity, interest rate, and credit risks.16 The recent increase in payment delays by the government could translate into a sudden rise in impaired loans. Moreover, an abrupt fiscal consolidation that leads to a significant slowdown in the nonhydrocarbon sector would also increase credit risks.

Table 5.

Algeria: Monetary Survey, 2014–22

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Sources: Bank of Algeria; and IMF staff estimates and projections.

Net credit to government excludes Treasury postal accounts (“dépôts CCP”) deposited at the BA.

32. The prudential framework needs to be strengthened (Annex IV). The BA should monitor the evolution of risks within each bank and within the banking system as a whole through more frequent liquidity and solvency stress tests. The stress test launched in 2015 needs to be completed as quickly as possible. Existing regulations should be amended to include more detailed governance requirements for state-owned banks. Creating a level playing field among all banks (public and private) would ensure that government interventions to stabilize the balance sheets of public banks does not amount to regulatory forbearance. Further efforts are needed to strengthen the macroprudential framework, particularly given higher liquidity risks. Staff recommended that the authorities develop a systemic risk analysis framework, improve data quality, and adopt a toolbox of macroprudential instruments to counter the rising trend in systemic risk.

33. Improving crisis preparedness and management is also needed. A crisis resolution framework that clearly defines the roles and responsibilities of the various entities involved is lacking. Currently, bank resolution options are limited to the liquidation of insolvent banks under the general bankruptcy regime. An explicit bank resolution framework should be put in place, and the general business insolvency regime should be strengthened.

34. Authorities’ views. The authorities agreed that the dinar was overvalued and that correcting the overvaluation should primarily come from fiscal consolidation and structural reforms, together with some nominal depreciation of the dinar. However, they expressed concerns about allowing further depreciation until a foreign exchange forward market is in place for importers to hedge their exchange rate risk (IMF staff has provided technical assistance in this area). They are open to raising indicative foreign exchange allocation ceilings but are concerned that the additional foreign exchange could end up feeding the parallel market. To help develop the interbank foreign exchange market, they have not excluded the possibility of relaxing surrender requirements. They agreed that inflation developments should be watched closely but stressed that inflation was driven mostly by structural supply factors. Staff agreed but emphasized that supply-driven inflation could feed into inflation expectations, which the central bank needs to anchor around its target. With the introduction of open market operations, they are planning to gradually phase out the discount window. They indicated that strengthening the macroprudential framework would be a priority in 2017.

Staff Appraisal

35. Nearly three years after the onset of the oil price shock, Algeria continues to face significant challenges. The fiscal and current account deficits remain large despite sizeable fiscal adjustment in 2016. Savings in the oil stabilization fund have been nearly depleted, financing conditions have become more difficult, and payment delays have increased. International reserves remain comfortable but continue to decline rapidly. Excess liquidity in the banking system has dried up, and inflation is well above the Bank of Algeria’s target of 4 percent. Overall growth has been resilient, but activity in the nonhydrocarbon has slowed. Unemployment has increased and remains particularly high among the youth and women.

36. Algeria must undertake ambitious and sustained fiscal consolidation to restore fiscal sustainability, ensure intergenerational equity, and support external rebalancing. After several years of expansive fiscal policy, the authorities are now committed to consolidating their fiscal position and have adopted for the first time a medium-term budget framework. They intend to pursue fiscal consolidation by controlling the wage bill, expanding subsidy reform while protecting the poor, mobilizing more nonhydrocarbon revenues, increasing the efficiency of investment, and reducing its cost. This approach is broadly in line with staff’s advice.

37. Nevertheless, there is some fiscal space to pursue a more gradual, growth friendly fiscal adjustment. The fiscal consolidation built into the medium-term budget framework is extremely ambitious. Given relatively low levels of debt, staff believes Algeria could cut spending more gradually, with less impact on growth and employment. More gradual spending cuts would be possible if Algeria considered tapping a broader range of financing options, including external borrowing and the sale of state assets, and allowed further exchange rate depreciation.

38. Wide-ranging structural reforms are needed to reduce the economy’s reliance on hydrocarbons and transform the private sector into an engine for growth. The authorities have made some progress improving the business environment and are working on a long-term strategy to reshape the country’s growth model. Measures are needed to reduce red tape, improve access to finance, strengthen governance and transparency, make the labor market more effective, ensure that skills produced by the education system and sought by students match the needs of employers, foster greater female participation in the labor market, and further open the economy to foreign investment. The overall strategy should be designed and sequenced so that reforms reinforce each other and the burden of economic adjustment is shared equitably. Action should be timely, as structural reforms take time to bear fruit.

39. The real effective exchange rate should gradually be brought closer to equilibrium, and efforts are needed to curb the parallel foreign exchange market. Although the net international investment position remains comfortable, the external balance is significantly weaker than warranted by medium-term fundamentals and desirable policy settings. Correcting the dinar’s overvaluation will require not only fiscal consolidation and structural reforms but also further nominal depreciation. A weaker dinar would help address external imbalances, support private sector development, and raise hydrocarbon revenues in local currency.

40. Monetary policy should guard against emerging inflationary pressures. Consistent with staff’s advice, the Bank of Algeria has appropriately transitioned to open market operations to manage liquidity. Financing via the discount window should be phased out to encourage banks to manage their liquidity more effectively. Considering growing inflationary pressures, the central bank should stand ready to increase its policy rate.

41. Financial sector policies should be further strengthened to address growing financial stability risks. Based on preliminary data, the banking sector as a whole remains adequately capitalized and profitable, but the oil price shock has increased liquidity, interest rate, and credit risks. It is therefore important to accelerate the transition to a risk-based supervisory framework, enhance the role of macroprudential policy, strengthen the governance of public banks, and develop a crisis resolution framework.

42. Staff recommends that the next Article IV consultation for Algeria be held on the standard 12-month cycle.

Table 6.

Algeria: Financial Soundness Indicators, 2009–16

(In percent)

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Source: Bank of Algeria

Annex I. Alternative Scenario

Staff discussed an alternative scenario consistent with its recommended policy mix. The scenario assumes the use of available fiscal space for a more gradual fiscal consolidation combined with further exchange rate depreciation and more ambitious structural reforms. The purpose of the scenario is to illustrate that a different policy mix could lead to better macroeconomic outcomes.

In the alternative scenario, fiscal policy is anchored by gradually stabilizing public debt at around 30 percent of GDP, a level higher than the authorities’ plan, but moderate enough (by emerging market standards) to leave enough buffers should fiscal risks related to the price of oil or contingent liabilities materialize. Specific key assumptions are as follows:

  • Both current and capital expenditures decline more slowly than in the baseline scenario. Current spending falls to 22.6 percent of GDP in 2022 (compared to 19.5 percent in the baseline scenario). Both wage and non-wage current spending decline gradually. Capital spending falls to 11.3 percent of GDP in 2022 (versus 9.7 percent in the baseline scenario).

  • Tax revenues rise to 19.5 percent of nonhydrocarbon GDP in 2022 (compared to 18.7 percent in the baseline scenario), reflecting deeper subsidy reform, a greater reduction in tax exemptions, and improved tax administration.

  • To finance larger deficits, the government borrows externally as well as domestically.

  • The REER is assumed to depreciate by 10 percent over the projection period, whereas it is nearly stable in the baseline scenario.

  • Deeper subsidy reform dampens domestic energy consumption, providing a boost to hydrocarbon exports.

  • Efforts to diversify and liberalize the economy gradually result in more nonhydrocarbon exports, FDI, and tourism receipts.

uA01fig11

Expenditures – Alternative Scenario

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: Algerian authorities; and IMF staff calculations.

Growth projections, both in the baseline and alternative scenarios, are based on fiscal multipliers estimated using Algeria-specific data:

Fiscal Multipliers Used in Staff’s Scenarios

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Source: IMF staff calculations

The charts on the following pages compare the main outcomes of the alternative scenario versus the baseline scenario.

Alternative and Baseline Scenarios

Overall growth

Baseline: Growth slows sharply under the effects of the authorities’ medium-term fiscal consolidation plan.

Alternative: Growth declines more slowly mainly owing to more gradual fiscal consolidation, supported by greater exchange rate depreciation. More ambitious reforms allow for some productivity gains that gradually help increase potential growth toward the end of the projection period.

uA01fig12

Real GDP Growth

(Percent)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: Algerian authorities; and IMF staff calculations.

Fiscal balance

Baseline: Under the authorities’ medium-term fiscal consolidation plan, the deficit reaches equilibrium by 2020.

Alternative: The fiscal deficit declines more gradually over the medium term, approaching equilibrium by 2022.

uA01fig13

Fiscal Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: Algerian authorities; and IMF staff calculations.

Fiscal breakeven price

Baseline: The fiscal breakeven price declines below the WEO oil price forecast in 2022.

Alternative: The fiscal breakeven price declines more gradually over time, approaching the WEO oil price forecast in 2022.

uA01fig14

Fiscal breakeven price

(US$ per barrel)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: Algerian authorities; and IMF staff calculations.

Net savings and debt

Baseline: Net savings decline initially as fiscal savings are depleted, but start to increase in 2020 as debt falls. Debt declines to 14.6 percent of GDP by 2022.

Alternative: Net savings decline throughout most of the projection period, but stabilize by 2022. Debt stabilizes at around 30 percent of GDP, reflecting larger budget deficits and more debt financing.

uA01fig15

Net savings and debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: Algerian authorities; and IMF staff calculations.

Current account balance

Baseline: The current account deficit declines over the medium term as a result of the government’s medium-term fiscal consolidation plan.

Alternative: The current account deficit initially declines more slowly than in the baseline reflecting more gradual fiscal consolidation. However, toward the end of the projection period, the deficit narrows further than in the baseline scenario thanks to greater exchange rate depreciation and more ambitious structural reforms to diversify the economy.

uA01fig16

Current account balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: Algerian authorities; and IMF staff calculations.

International reserves

Baseline: Reserves decline to 8 months of imports by 2022.

Alternative: Reserves also decline but remain above 11 months of imports by 2022.

uA01fig17

International reserves

(US$ billion)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: Algerian authorities; and IMF staff calculations.

Algeria: Selected Economic and Financial Indicators, 2014–22 (Alternative Scenario)

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

Including public enterprises.

In U.S. dollars terms.

Annex II. Public Debt Sustainability Analysis

During the oil price boom, Algeria repaid most of its debt and accumulated large fiscal savings. Since the onset of the oil price shock, fiscal savings have been nearly depleted to finance large fiscal deficits, allowing debt to remain low. The authorities initially took little fiscal policy action in response to the shock, but they are now planning to undertake substantial fiscal consolidation over the medium term. Under the authorities’ medium-term fiscal plan, debt levels are projected to remain low, and stress tests suggest that financing needs are not sensitive to shocks. However, international experience suggests that such a consolidation plan may be difficult to achieve. Moreover, fiscal risks are numerous and could lead to further increases in debt.

The oil price shock, together with an initially timid policy response, led to a rapid deterioration of the fiscal position. The policy response to the shock was initially limited to exchange rate depreciation, while spending remained high. Consequently, lower oil prices translated into large fiscal deficits that Algeria was able to finance by drawing on its fiscal savings. More than two years into the shock, fiscal savings are now almost depleted, having declined from a peak of 43.3 percent of GDP in 2009 to 4.6 percent in 2016. Nevertheless, despite little new borrowing, government debt increased from 8.8 percent of GDP in 2015 to 21.0 percent of GDP in 2016 following the purchase of debt owed by a utility company to a public bank and the issuance of bonds to the state-owned oil company to compensate for losses incurred from selling imported refined fuel in the domestic market at subsidized prices (Box 3).

Algeria’s domestic debt consists of Treasury securities and restructured debt purchased from public enterprises. At end-2016, Algeria’s domestic debt amounted to DZD 3,407 billion (equivalent to 19.9 percent of GDP). Of this amount, DZD 978 billion consisted of regularly-issued Treasury securities with maturities ranging from 13 weeks to 15 years. Most of this debt is held by banks and insurance companies. The National Bond for Economic Growth, a local-currency bond issued by the government in 2016, accounted for another DZD 569 billion. The remaining DZD 1,861 billion resulted from government operations to support public enterprises. Most of these operations took place between 2009 and 2016. Government-guaranteed domestic debt amounted to DZD 3,163 billion, equal to 18.5 percent of GDP.

External public debt is minimal and mostly owed to official bilateral creditors. At end-2016, Algeria’s external public debt was equal to just US$1.6 billion (1.0 percent of GDP). Most of this debt is owed to official bilateral creditors and is on concessional terms. Algeria repaid the last of its debt to the IMF in 2005 and prepaid its outstanding balance to the Paris Club group of creditors in 2006. Since 2006, external debt has remained less than US$3 billion. In 2016, the African Development Bank (AfDB) provided Algeria a €900 million budget support loan—the AfDB’s first loan to Algeria in 12 years.

Under the authorities’ fiscal consolidation plan, debt would decline over the medium term. In this scenario, gross financing needs decline sharply, averaging 2.3 percent of GDP over the period. The government is assumed to deplete its fiscal savings in 2017. Thereafter, financing needs are met by domestic debt issuance and by using the deposits of public entities. The ratio of debt (including guarantees) to GDP falls from 39.5 percent in 2016 to 27.6 percent in 2022.

Central Government Debt, end-2016

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The authorities’ fiscal consolidation plan is exceptionally ambitious. The degree of deficit reduction ranks in the top 1 percent of fiscal consolidations recorded between 1990 and 2010 among advanced and emerging economies with debt greater than 60 percent of GDP. The drastic nature of the authorities’ fiscal consolidation plan appears to be motivated in part by a reluctance to incur debt (particularly external debt) and allow further exchange rate depreciation.

Under alternative scenarios and stress tests, debt levels are resilient to shocks and gross financing needs remain limited. Assuming that the primary balance remains constant at its 2016 level (i.e., no fiscal adjustment), public debt would increase to 39.4 percent by 2022—much lower than the 70 percent benchmark for emerging market countries. Projected gross financing needs are not sensitive to shocks given the size of the consolidation assumed in the baseline scenario.1

uA01fig18

Algeria: Public Sector Debt Sustainability Analysis (DSA)—Baseline Scenario

(In percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Source: IMF staff.1/ Public sector is defined as central government and includes public guarantees, defined as Debt guarantees.2/ Based on available data.3/ Spreads are not available due to the lack of international bonds.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r – π(1+g) – g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = 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).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes changes in the stock of guarantees, asset changes, and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
uA01fig19

Algeria: Public DSA—Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Source: IMF staff.
uA01fig20

Algeria: Public DSA—Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Source: IMF Staff.1/ Plotted distribution includes all countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year.3/ Algeria has had a positive output gap for 3 consecutive years, 2014–2016. For Algeria, t corresponds to 2017; for the distribution, t corresponds to the first year of the crisis.4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.
uA01fig21

Algeria: Public DSA—Stress Tests

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Source: IMF staff.
uA01fig22

Algeria: Public DSA Risk Assessment

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ Long-term bond spread over German bonds, an average over the last 3 months, 09-Jan-16 through 08-Apr-16.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.

Annex III. External Sector Assessment

Algeria’s net international investment position, though significantly weakened by the oil price shock, remains comfortable. External debt is nearly nonexistent, and reserves are still well above adequacy ratios. The EBA-lite methodology points to a substantial current account gap, suggesting that the external balance is significantly weaker than warranted by medium-term fundamentals and desirable policy settings and that the dinar is significantly overvalued.

Following the collapse in oil prices, Algeria’s current account has swung from large surpluses to large deficits. Between 2000 and 2013, current account surpluses averaged 12.5 percent of GDP. In 2014, the current account recorded a deficit for the first time in nearly 15 years—a consequence of sharply lower oil prices and declining hydrocarbon production, both of which contributed to lower hydrocarbon exports. Since 2014, current account deficits have exceeded 16 percent of GDP. In the baseline scenario, the current account deficit is projected gradually narrow as oil prices rebound somewhat and fiscal consolidation dampens import demand.

Algeria’s external buffers remain sizeable. International reserves stood at about US$113 billion at end-2016 (excluding SDRs), equal to 23 months of imports and 686 percent of the IMF’s unadjusted ARA metric. But reserves have declined almost 41 percent from their peak in 2013 and are projected to decline further over the medium term. In the baseline scenario, reserves are projected to fall to 37.8 billion in 2022, equal to 8 months of imports and 105 percent of the ARA metric adjusted to include an additional buffer that captures the risk of lower oil prices. Total external debt stood at just 2.5 percent of GDP in 2016 but could increase if the government decided to rely more on external borrowing to finance future deficits.

uA01fig23

Decomposition of the IMF’s ARA Metric 1/

(US$ billion)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: Algerian authorities; and IMF staff calculations.1/ The IMF composite metric is a weighted sum of exports, shortter m debt at remaining maturity, other external liabilities, and broad money. Bars display the dollar equivalent of the ARA metric by each of its components. Reserve levels are considered to be adequate when they range between 100 and 150 percent of the ARA metric.
uA01fig24

Exchange Rate Developments

(Index, 2010=100)

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: Algerian authorities; and IMF staff calculations.

Since the oil price shock, the dinar has significantly depreciated on a nominal basis, but the REER is broadly unchanged owing to relatively high domestic inflation. Since mid-2014, the dinar has depreciated by 29 percent against the dollar, helping to cushion the impact of lower oil prices. Most of the depreciation occurred in the second half of 2014 through 2015. Against the euro, the dinar has depreciated by 8 percent On a REER basis, however, the dinar is little changed since the oil price shock. In recent months, the REER has been on an upward trend. The foreign exchange premium on the parallel exchange market reportedly stands at close to 60 percent1

EBA-lite methodologies point to large differences between the actual current account and its norm. Both the current account and the external sustainability approaches suggest that the current account balance remains well below the norm for 2016, suggesting a significant overvaluation of the REER.2

  • The current account approach indicates that the current account deficit is much weaker than the value consistent with medium-term fundamentals and desirable policies, resulting in a current account gap of -13.2 percent of GDP in 2016. Closing the current account gap requires pursuing fiscal consolidation, improving the effectiveness of monetary policy, and fostering export diversification through exchange rate depreciation and structural reforms.

  • The external sustainability approach also points to a large current account gap. Assuming the net international investment position (NIIP) remains stable at its initial level of 46.6 percent of GDP, the current account norm would be 1.4 percent of GDP, implying a gap of -7.6 percent over the medium term.3 If the NIIP was stabilized at -5.4 percent of GDP (the projected value in 2022), the current account norm would be zero percent of GDP, yielding a smaller gap of -6.2 percent of GDP.

EBA-Lite Estimates of CA Gap 1/

(In percent of GDP)

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Estimates based on staff’s recommended policy mix, as captured in the alternative scenario (Annex I).

Table 1.

Algeria: External Sustainability Assessment

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Table 2.

Algeria: External Debt Sustainability Framework, 2012–22

(In percent of GDP, unless otherwise indicated)

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Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times 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(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of 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.

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

Figure 1.
Figure 1.

Algeria: External Debt Sustainability: Bound Tests 1/ 2/

Citation: IMF Staff Country Reports 2017, 141; 10.5089/9781484302668.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent ¼ standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2010.

Annex IV. Implementation of FSAP Recommendations

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1

Algeria’s oil reserves are projected to be depleted in 21 years and its gas reserves in 54 years. See BP Statistical Review of World Energy 2016.

2

Algeria’s crude oil production remained below its OPEC quota in 2016.

3

The dividends from the BA paid in 2016 and expected in 2017 reflect a reduction in the level of provisioning following the introduction in the 2017 budget law of a ceiling on the BA’s provisions equivalent to three times its capital, as well as valuation gains on the sale of international reserves.

4

Fonds de Régulation des Recettes (FRR).

6

The World Bank is providing assistance in this area. Many existing subsidies are highly regressive. See “Subsidy Reform in Algeria,” IMF Country Report No. 16/128.

7

See Public Debt Sustainability Analysis, Annex II.

8

Staffs growth projections are based on fiscal multipliers estimated using Algeria-specific data. See Annex I.

9

See accompanying Selected Issues Paper: “Financing Fiscal Deficits.”

10

See accompanying Selected Issues Paper: “Structural Reforms: Strategies and Possible Payoffs.”

11

Caution is needed when comparing survey-based structural indicators across countries. Although these indicators are updated yearly and survey methodologies are revised frequently, they are partly constrained by the data that can realistically be collected.

12

Algeria’s improvement in the Doing Business ranking is largely explained by tax reforms, publishing electricity tariffs, and reducing the time needed to obtain a construction permit.

13

For more details on Algeria’s social protection system, see “Fostering Private Sector Job Creation in Algeria,” IMF Country Report No. 14/342.

14

Algeria’s indicative foreign exchange allocation ceilings are the lowest in the region. See IMF Country Report No. 1¾7.

15

See accompanying Selected Issues Paper: “Determinants of Inflation.”

16

See “The Financial Stability Implications of Lasting Low Oil Prices for Algeria,” IMF Country Report No. 16/128.

1

The heat map on page 43 indicates that gross financing needs are a risk in the baseline scenario and certain shock scenarios. In fact, gross financing needs exceed the benchmark of 15 percent of GDP only in 2016; over the projection period, they remain well below the benchmark. The government was able to meet its financing needs in 2016 mainly by drawing down savings in the FRR and by borrowing domestically.

1

The parallel market remains illegal, and foreign exchange regulations stipulate that foreign exchange is available for all current international transactions.

2

Staff estimates the overvaluation to be in the 54–115 percent range. These estimates are subject to significant uncertainty as the magnitude and persistence of the terms-of-trade shock make the results of standard methodologies unstable: minor changes in underlying assumptions (e.g., regarding trade elasticities, desirable policies, or target NIIP) lead to significant variations in the degree of estimated overvaluation. The existence of a parallel exchange market also complicates the interpretation of the model’s results. The EBA-REER method did not yield reliable results.

3

Algeria’s NIIP consists mostly of international reserves. External debt and FDI are negligible compared to the size of international reserves. Valuation changes are not taken into account in the estimation of the NIIP.

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Cover IMF Staff Country Reports
Algeria: 2017 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Algeria
Author:
International Monetary Fund. Middle East and Central Asia Dept.
Volume/Issue:
Volume 2017: Issue 141
Publisher:
International Monetary Fund
ISBN:
9781484302668
ISSN:
1934-7685
Pages:
65
DOI:
https://doi.org/10.5089/9781484302668.002
Figure 1.

Algeria: Selected Macroeconomic Indicators
Figure 2.

Algeria: Fiscal Indicators
Figure 3.

Algeria: Monetary Indicators

Expenditures – Baseline Scenario

(Percent of GDP)

Sources of Financing, 2009–16

(Percent of total)

Key Structural Impediments

Ease of Doing Business, 2016

Executive Opinion Survey, 2016

Legal System and Property Rights

(Best = 10)

World Governance Indicators, 2015

(2.5 = best, -2.5 = worst)

New Business Density, 2008–14

(New registrations per 1000 population ages 15–64, average)

Algeria: Financial Institutions Index

Labor Market Regulations

(Best = 10)

Expenditures – Alternative Scenario

(Percent of GDP)

Real GDP Growth

(Percent)

Fiscal Balance

(Percent of GDP)

Fiscal breakeven price

(US$ per barrel)

Net savings and debt

(Percent of GDP)

Current account balance

(Percent of GDP)

International reserves

(US$ billion)

Algeria: Public Sector Debt Sustainability Analysis (DSA)—Baseline Scenario

(In percent of GDP unless otherwise indicated)

Algeria: Public DSA—Composition of Public Debt and Alternative Scenarios

Algeria: Public DSA—Realism of Baseline Assumptions

Algeria: Public DSA—Stress Tests

Algeria: Public DSA Risk Assessment

Decomposition of the IMF’s ARA Metric 1/

(US$ billion)

Exchange Rate Developments

(Index, 2010=100)
Figure 1.

Algeria: External Debt Sustainability: Bound Tests 1/ 2/