Selected Issues

Abstract

Selected Issues

Financing Fiscal Deficits1

A. Introduction

1. The sharp and sustained decline in oil prices since mid-2014 has led to large fiscal deficits and exacerbated an already weak fiscal position. Even prior to the collapse in oil prices, Algeria’s fiscal policy was on an unsustainable path, in particular given the exhaustibility of hydrocarbon resources at a relatively short horizon.2 Algeria recorded consecutive fiscal deficits from 2009 to 2013, as government spending surged following the global financial crisis and the Arab Spring. The fiscal deficit widened significantly in 2014, when oil prices began to drop, and reached 15.6 percent of GDP in 2015 as oil prices fell to new lows.

2. In response to the oil price shock, the government is planning ambitious fiscal consolidation over the medium term. Following a reduction in the fiscal deficit from 15.8 percent of GDP in 2015 to 14.0 percent in 2016, the government’s medium-term fiscal consolidation plan aims to bring the deficit close to zero by 2019, mainly through further spending cuts combined with higher taxes and continued subsidy reform.

A01ufig1

Overall Budget Deficit

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Source: Algerian authorities; and IMF staff calculations.

3. With savings in the oil stabilization fund nearly exhausted and tighter liquidity conditions in the banking system, the financing environment has become more challenging. Once-substantial savings in the oil stabilization fund (Fonds de Régulation des Recettes, FRR)—a key source of financing in recent years—have been nearly completely depleted.3 Meanwhile, because of the oil price shock, liquidity in the banking sector has declined dramatically. Tighter domestic liquidity conditions mean that the capacity for the domestic banking system to absorb new government debt is more limited than in the past.

4. Tapping a broad range of financing options would allow Algeria to undertake more gradual fiscal consolidation, with less negative consequences for growth. The authorities’ ambitious fiscal consolidation plan poses risks to economic activity. Indeed, staff projects that nonhydrocarbon growth will slow to almost zero in 2018 under the weight of the envisaged spending cuts. By contrast, a more gradual fiscal consolidation, made possible by more diversified financing, combined with further exchange rate depreciation and ambitious structural reforms, would have less impact on growth while still placing fiscal policy on a sustainable path.

5. This paper discusses options for financing future fiscal deficits. Section B reviews how deficits were financed in the past and assesses Algeria’s current debt situation. Section C examines ways to increase domestic borrowing, while Section D explores the possibility of borrowing externally. Section E discusses the option of selling state-owned assets. Section F lays out an alternative scenario in which the government undertakes more gradual fiscal consolidation. Section G concludes.

B. Background

6. Algeria suffered from intense violence and considerable sovereign debt problems during the 1990s—an experience that continues to influence policymaking today. The Algerian civil war resulted in over 100,000 deaths and came at a time when the government was struggling to address severe macroeconomic imbalances that had emerged following the fall in oil prices in 1986. By 1995, against a backdrop of civil strife, external debt had increased to 75 percent of GDP, inflation had reached 30 percent, the unemployment rate stood at 28 percent, and Algeria’s debt to the Paris Club had been restructured twice. Memories of the 1990s have led to an aversion to public debt, and in particular to external debt, which many associate with economic and social hardship and feelings of loss of sovereignty.

7. Since the turn of the century, Algeria has managed to achieve economic stability. Starting in 1999, Algeria experienced a long period of steady economic growth and accumulated substantial fiscal savings and international reserves, mainly thanks to booming oil prices. By 2006, the government had repaid nearly all its external debt, erasing a painful legacy from the past. In 2009, fiscal savings in the FRR reached 43 percent of GDP. Algeria weathered the global financial crisis and Arab Spring relatively smoothly, as the government ramped up spending on public sector wages, transfers, and social housing. Following the decline in oil prices in mid-2014, however, large fiscal and external imbalances emerged once again, and fiscal savings were rapidly depleted.

A01ufig2

Public Debt and Fiscal Savings

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Source: Algerian authorities; and IMF staff calculations.

8. During the oil boom years, liquidity in the banking system surged. Rising oil prices led to a sharp increase in hydrocarbon exports and large current account surpluses. The dollar proceeds of hydrocarbon exports were ceded by law to the Banque d’Algérie (BA), resulting in continuous injections of liquidity into the banking system. With banks no longer having any financing needs, the BA stopped using its discount window as a monetary policy instrument and instead focused on liquidity absorption. In addition to its marginal deposit facility, the BA used term deposit auctions and required reserves to contain liquidity growth. Transactions in the interbank market progressively dried up.

A01ufig3

Money Supply

(DZD billions)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Source: Algerian authorities.
A01ufig4

Liquidity Absorption

(DZD billions)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Source: Algerian authorities.

9. Despite abundant liquidity, fiscal deficits of the central government since 2009 have been financed mainly by borrowing from public entities and drawing down fiscal savings. From 2009 to 2016, Algeria recorded a cumulative fiscal deficit of 8,297 billion dinars (equivalent to US$75 billion). Of this amount, 46 percent was financed using the deposits of public entities—a practice tantamount to central government borrowing but not reflected in government debt statistics.4 Another 42 percent was financed by drawing down savings in the FRR. The deposits of public entities financed the bulk of deficits during 2009–13, whereas savings in the FRR have been the main source of financing in the last three years. Only 6 percent of the cumulative deficit was financed by net domestic debt issuance. Net foreign borrowing has been negligible.

A01ufig5

Sources of Financing, 2009-16

(Percent of total)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Sources: Algerian authorities; and IMF staff calculations.
A01ufig6

Deficit Financing, 2009-16

(DZD billions)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Sources: Algerian authorities; and IMF staff calculations.

10. Notwithstanding the near depletion of the FRR and the lack of a sovereign wealth fund, Algeria’s asset-liability position remains strong. Unlike many other commodity exporters, Algeria does not have a sovereign wealth fund. Moreover, once the FRR is completely depleted, Algeria will no longer have any liquid assets with which to finance future deficits. Nevertheless, Algeria’s asset liability-position remains strong thanks to a low level of debt. Indeed, with almost no external debt, and with domestic debt at 20 percent of GDP, Algeria is among the least indebted countries in the world.

A01ufig7

Government Gross Debt and Assets, 2016

(percent of GDP)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Sources: WEO; and IMF staff calculations.

Central Government Debt, end-2016

US$1=DZD 110.9

article image
Source: Algerian authorities; and IMF staff calculations.

11. 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 3407.3 billion (equivalent to 19.9 percent of GDP). Of this amount, DZD 977.5 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 569.1 billion. The remaining DZD 1,860.7 billion resulted from government operations to support public enterprises. Two such operations occurred in 2016, when the government purchased debt owed by a state-owned utility company and compensated the state-owned oil company for losses incurred from selling fuel in the domestic market at subsidized prices. These two operations increased public debt by 8.8 percent of GDP.

12. The domestic debt market is underdeveloped and illiquid. Despite a notable increase in regular Treasury debt issuance in recent years, the value of Treasury securities traded in the secondary market has grown only modestly. For each of the three types of Treasury securities—bills (which have maturities of 13-26 weeks), Bons du Trésor Assimilable (BTAs, with maturities of 1–5 years), and Obligations Assimilables du Trésor (OATs, with maturities of 7–15 years)—the amount traded as a share of annual issuance has declined. OATs have experienced the sharpest decline in liquidity. In 2013, secondary trading in OATs represented 91 percent of OAT issuance. In 2015, secondary trading amounted to just 27 percent of issuance.

A01ufig8

Treasury Primary Market Issuance

(DZD billions)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Source: Algerian authorities.
A01ufig9

Treasury Secondary Market Transactions

(DZD billions; percent of primary market issuance shown inside cells)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Sources: Algerian authorities; IMF staff calculations.

13. External debt is minimal and is mostly owed to official bilateral creditors. At end-2016, government external debt was equal to just US$1.6 billion (1.0 percent of GDP). 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. The rest of Algeria’s external debt is owed to official bilateral creditors and is on concessional terms.

14. Algeria has space to borrow more without threatening debt sustainability. In staff’s baseline scenario, which reflects the authorities’ medium-term debt fiscal consolidation plan, government debt is projected to fall from 21.0 percent of GDP in 2016 to 14.6 percent in 2022. In the unlikely scenario that there is no further fiscal adjustment (i.e., the primary balance remains constant at its 2016 level), debt is projected to increase to 39.4 percent in 2022—higher than the baseline scenario, but still well below the 70 percent sustainability benchmark for emerging market countries. These projections suggest that Algeria has space to borrow more.

C. Domestic Borrowing

15. Domestic borrowing carries three main advantages. First, there is no exchange rate risk. Second, refinancing risk is low, owing to the fact that domestic investors have few other low-risk assets to invest in, as well as to factors that make Treasury securities desirable for banks to hold.5 Third, increased government debt issuance facilitates the development of domestic financial markets—a particularly important consideration given the government’s desire to diversify the economy and promote private sector-led growth. In particular, a well-functioning government securities market can establish a reliable yield curve that serves as a benchmark for private sector issuers. It can also support liquidity management operations of the central bank by providing more collateral to the banking system.

16. The main disadvantage of domestic borrowing by the government is that it risks crowding out credit to the private sector. Greater government borrowing could reduce the supply of loanable funds to the private sector, thus hurting private sector investment and growth. This risk of crowding out has increased with the rapid decline of liquidity in the banking system. In the six years prior to the oil price shock, banks collectively had, on average, DZD 2,400 billion in deposits at the BA (not including required reserves). This excess liquidity has evaporated in the wake of lower oil prices, implying that the capacity of banks to absorb new government debt without crowding out the private sector has become more constrained. Tighter liquidity conditions are also reflected in a significant increase in yields across the Treasury yield curve.

A01ufig10

Excess Liquidity and Oil Prices

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Sources: Algerian authorities; and IMF staff calculations.
A01ufig11

Treasury Yields at Issuance (Weighted Average)

(Percent)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Source: Algerian authorities.

17. Nevertheless, despite the decline in liquidity, the domestic banking sector should remain able to meet some of the government’s projected financing need. In staff’s baseline scenario, the government is projected to have a cumulative gross financing requirement of DZD 2,147 billion over the period 2017–19. At end-2016, claims of domestic banks on the government amounted to DZD 2,761 billion, or a third of total bank assets. Credit to public enterprises accounted for nearly half of total assets, whereas credit to the private sector represented just 4 percent. Assuming bank balance sheets grow in line with nominal nonhydrocarbon GDP, banks would be able to absorb an additional DZD 455 billion in government debt in the next three years without changing the composition of their assets. If public enterprises were to borrow externally to finance some of their investments, banks would be in a position to reallocate some credit to the government. In such a scenario, if banks were, for example, to reduce their claims on public enterprises by a third, they could absorb an additional DZD 1,492 billion in government debt. Two conclusions can be drawn from this analysis: (1) the financing of future budget deficits by the banking sector will likely involve some reallocation of credit toward the government, and (2) to avoid crowding out the private sector, the government will need to look beyond the domestic banking sector for financing.

A01ufig12

Composition of Banking Sector Assets, 2016

(Percent of total)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Source: autorités algériennes; et calculs des services du FMI.
A01ufig13

Composition of Banking Sector Assets 1/

(DZD billions)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Sources: Algerian authorities; and IMF staff calculations.1/ Assuming assets grow in line with projected nonhydrocarbon growth.

18. Algeria could consider issuing another national sovereign bond. The National Bond for Economic Growth raised DZD 569 billion in 2016, with the financing coming in large part from the banking sector, either directly or indirectly. To broaden the investor base, the authorities could consider issuing another such bond but should be careful not to overly fragment the debt market between regular Treasury issuance and ad-hoc bonds. Another national sovereign bond could be useful to the extent that it attracted interest from retail investors and captured savings in the informal sector. Nevertheless, international experience suggests that the authorities should proceed with caution. In other countries with large informal sectors—even those with more developed domestic debt markets—the share of government debt held by retail investors is typically small. The risk of issuing more ad-hoc national sovereign bonds in Algeria is that it distracts from efforts to develop the market for regular Treasury issuance while yielding relatively little financing from alternative sources.6

19. Reforms aimed at developing the domestic debt market would support higher financing at lower costs. A sound issuance policy is the starting point for developing a liquid domestic debt market. The Treasury should issue, at regular intervals, a balanced supply of debt securities at various maturities, so that all points on the yield curve have liquid references. The issuance policy should be guided by an overall public debt management strategy that takes into account the government’s risk preferences and market development priorities. It should be complemented by a communications strategy that clearly articulates the government’s macroeconomic objectives and debt program. Implementing these policies will require more resources and capacity building within the debt management office. Reforms to diversify the investor base, including policies to develop the insurance and mutual fund industries, would foster stronger and more stable demand for government debt. Upgrades to the clearing and settlement infrastructure would further support market development and strengthen investor confidence. Banks, for their part, could draw in more savings from the informal sector—which would increase their capacity to purchase government debt—by offering a broader range of services to their clients, such as debit and credit cards, e-payment services, and financial products consistent with specific religious preferences.

20. Borrowing reserves from the central bank to finance the budget deficit should be avoided. Borrowing reserves to finance the deficit would be equivalent to the creation of base money. Creating money that exceeded demand in turn would create excess cash balances and eventually drive up the overall price level and accelerate the fall in internal reserves. Without any limits on central bank financing, the government would have less incentive to rein in deficits and restore fiscal sustainability while the credibility and independence of the central bank, and therefore its ability to promote price stability, would be undermined.

D. External Borrowing

21. External borrowing has several advantages, particularly in the current global economic environment:7

  • Mitigates crowding out effects. By tapping foreign savings, the government would avoid crowding out credit to the private sector at a time when domestic liquidity has tightened significantly.

  • Favorable financing conditions. Interest rates on emerging market sovereign debt remain near historically low levels, as investors continue to search for yield in a global environment of low interest rates. At end-

  • Favorable financing conditions. Interest rates on emerging market sovereign debt remain near historically low levels, as investors continue to search for yield in a global environment of low interest rates. At end-February 2017, the yield on the EMBI stood at 5.7 percent, having fallen 103 basis point on net over the course of the previous 14 months.8 Yields on sovereign debt issued by GCC oil exporters fell to a lesser degree, reflecting worsening economic conditions and increased risks, but in absolute terms fell nonetheless.

    A01ufig14

    EMBI and GCC Sovereign Yields

    (Percent)

    Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

    Source: Bloomberg, L.P.1/ EMBI = J.P. Morgan Emerging Market Bond Index.

  • Strengthens international reserves. After peaking at US$194 billion in 2013, Algeria’s official reserves have declined rapidly and are projected to drop to US$93 billion in 2017. Borrowing externally would shore up reserves, with little risk to debt sustainability given Algeria’s low level of debt.

  • Broadens the investor base. As discussed earlier, the investor base for government debt is currently quite narrow, consisting almost entirely of domestic banks and insurance companies. Borrowing externally would broaden the investor base, allowing the government to tap savings outside of the country.

  • Sets a benchmark for the private sector. Sovereign debt issuance at regular intervals can establish a yield curve in foreign currency that can serve as a reference for the private sector or public companies looking to borrow externally.

  • Increases awareness about the Algerian economy. External borrowing via the issuance of international bonds would increase investors’ awareness about the Algerian economy. This, in turn, could ultimately facilitate external borrowing by nongovernment entities and could also generate more foreign direct investment.

  • Creates incentives to follow sound policies. By increasing investor scrutiny of Algeria’s economy, external borrowing can create pressure on the government to follow sound macroeconomic policies and enhance transparency.

22. The main disadvantages of external borrowing relate to rollover risk and foreign currency risk. International issuance exposes the borrowing country to sudden shifts in investor sentiment that would affect its ability to roll over maturity debt. A deterioration in international investor sentiment—which may not be directly related to circumstances in Algeria—would increase financing costs. In the event of a “sudden stop,” Algeria would be forced to look for alternative financing sources. In addition to rollover risk, external borrowing would expose Algeria to foreign exchange rate risk. This risk would need to be managed carefully considering that the dinar is significantly overvalued and Algeria currently lacks a forward market that would allow the government to hedge its position.

23. Algeria has scope to significantly increase external debt without threatening external sustainability. Algeria’s almost nonexistent external debt is unusual by international standards. At just 2.5 percent of GDP, total external debt (both government and nongovernment) is far below levels found in oil exporting countries, emerging markets, and advanced economies. Government external debt itself represents a mere 1.0 percent of GDP. Other indicators of external debt vulnerability, such as the ratio of external debt to exports and the ratio of short-term external debt to reserves, are extremely low. Nevertheless, to borrow externally, the government will first need to explain the merits of external debt and allay widespread concerns in the general public that indebtedness to foreign creditors poses a threat to Algeria’s sovereignty.

A01ufig15

External Debt Indicators

(Percent)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Sources: Algerian authorities; IMF staff calculations.

24. A sizeable portion of Algeria’s financing needs in the coming years could be met through sovereign debt issuance. Emerging market economies that are active in international capital markets commonly issue several billion dollars per year, sometimes raising more than 1 percent of GDP in a given year. Gulf Cooperation Council (GCC) countries were especially large borrowers in 2016: Qatar issued US$9.0 billion (5.7 percent of GDP), while Saudi Arabia issued US$17.5 billion (6.0 percent of GDP). With a nominal GDP of US$156 billion in 2016, and with minimal external debt and still large reserves, Algeria would appear to be in a position to issue around US$2 billion, or just over 1 percent of GDP, in Eurobonds per year.

International Issuance from Selected Emerging Market Countries, 2013–16

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Source: Bloomberg.

25. Tapping international capital markets would require time and preparation. Algeria has never issued an international sovereign bond and needs to develop its capacity to do so. Compared to domestic debt issuance, international issuance entails greater preparation time and investor outreach—a process that typically entails hiring legal advisors, conducting roadshows, and acquiring a sovereign credit rating from one or more credit rating agencies (Algeria does not have a credit rating). Given Algeria’s limited financial integration with the rest of the world, investor outreach will be especially important to raise awareness about the country’s economic prospects and the government’s policy agenda.

26. The interest rate at which Algeria could borrow depends on several factors. Research suggests that borrowing costs are lower for countries with strong external and fiscal positions, as well as robust economic growth and government effectiveness.9 Although yields on emerging market sovereign debt have declined over the past year, the supply of emerging market debt could increase significantly in coming years as other oil exporters seek to finance large deficits, putting upward pressure on yields. Algeria’s financing costs would also depend on whether its sovereign bonds met the criteria for inclusion in major bond indices.

27. Algeria could look to tap savings in the Islamic world by issuing Sukuk or similarly structured products.10 Global Sukuk issuance has increased significantly since 2006, albeit from a low base, reaching US$120 billion in 2013. Issuance has been concentrated in Malaysia and in the GCC countries and has been evenly split between sovereign and corporate issuance. Demand has generally outstripped supply, leading to an oversubscription on most issues and low yields where the fundamentals of the issuer are strong. Because of their risk-sharing property, Sukuk are particularly well-suited for financing infrastructure. Malaysia, for instance, has used Sukuk for airports, marine ports, and roads, and the GCC countries have followed suit.

A01ufig16

Sukuk Issuance, 2001–16

(US$ billions)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Source: Zaywa.

28. Syndicated lending is another option for external financing. Syndicated bank lending to emerging markets and low-income developing countries (LIDCs) has also grown significantly in the past decade. Although most syndicated lending has been directed to the private sector, governments have also benefited, particularly in LIDCs. Across both emerging markets and LIDCs, syndicated lending tends to finance infrastructure, energy projects, and extractive industry. In some cases, syndicated lending has provided access to external financing to countries unable to tap international bond markets because of low creditworthiness. Syndicated loans can contribute to a more diversified investor base and promote financial deepening, but they usually include covenants allowing for the discontinuation of financing at short notice and therefore carry some risk.

A01ufig17

Syndicated Bank Lending, Total Volumes, 1994-2015

(Billions of constant U.S. dollars)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Source: Dealogic Loan Analysis.
A01ufig18

Syndicated Bank Lending by Sector, 2007-15

(Percent)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Source: Dealogic Loan Analysis.

29. Algeria could consider borrowing from official creditors. Algeria borrowed from a range of multilateral and bilateral official creditors in the past and still has outstanding debt to Canada, France, Saudi Arabia, the United Arab Emirates, Japan, and Belgium. More recently, as mentioned above, the government borrowed €900 million from the AfDB.

E. Selling State-Owned Assets

30. Privatization of state-owned assets could yield substantial deficit financing, but attempts to date have been largely unsuccessful. There are at least 392 state-owned enterprises (SOEs) with 2015 revenues equal to 26 percent of GDP.11 The largest SOE is Sonatrach, the national oil and gas company, but SOEs are present in all sectors of the economy. In the banking sector, for example, public banks account for 87 percent of total banking assets. Regulations to facilitate privatization were first introduced in 2001. In 2004 the government launched the sell-off of more than 1,100 public companies, but only a third of those companies were actually fully or partly privatized. Plans to sell a majority stake in Crédit Populaire Algérie, the country’s third largest bank, failed in 2010. Last year, a public sector cement company canceled an initial public offering due to lack of interest, and a government scheme to list eight SOEs on the stock exchange has stalled.

31. Successful privatization will likely take time. The government will need to communicate the benefits of selling state-owned assets while putting in place mechanisms—such as expanded unemployment insurance—to provide compensation and retraining to those who may be negatively impacted by the potential restructuring of SOEs. Another obstacle to privatization may be the possible inefficient nature of some SOEs, many of which depend on subsidized loans, episodic bailouts, and other forms of state support. Many of these SOEs will need to be restructured first to attract investor interest and maximize value. In this way, privatization ultimately stands to improve not only public finances but also SOE governance and efficiency.

32. A more developed stock market would support privatization efforts. At end-2016, the Bourse d’Alger had just five listed equities with a total market capitalization of DZD 45.8 billion, equal to less than 1 percent of GDP compared to 46 percent for Morocco and 21 percent for Tunisia. The 2016 budget law allows for the sale of up to 66 percent of the share in an SOE and a complete sale after five years, subject to government approval. Creating a more dynamic stock market will require reforms on multiple levels, including relaxing the so-called “49/51 rule”, which limits foreign investors to a minority stake in Algerian companies, and eliminating the right of the state and SOEs to block the sale of shares by or to foreign investors.

A01ufig19

Market Capitalization, 2015

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 142; 10.5089/9781484302675.002.A001

Sources: World Development Indicators; Bourse d’Alger; Bourse de Tunis; and IMF staff calculations.

F. Simulating the Financing Strategy

33. Staff has developed an alternative scenario in which the government is assumed to create fiscal space to undertake a more gradual fiscal consolidation. In this scenario, the government is projected to have a cumulative gross financing requirement of DZD 9,713 billion over the period 2017-21 compared to DZD 2,819 billion in the baseline scenario. The larger gross financing requirement reflects higher current and capital spending, which more than offset higher revenues.12 Although spending declines over the medium term as a percent of GDP, it does so at a slower pace than in the baseline. As a result, the impact on economic growth is projected to be less severe.

34. Financing needs in the alternative scenario are assumed to be met by a combination of domestic and external borrowing. As in the baseline scenario, the FRR in the alternative scenario is depleted in 2017, and some financing needs are met by drawing on the deposits of public entities. The government borrows from official bilateral and multilateral sources in the amount of US$1.7 billion on average per year during 2017–20. Starting in 2018, the government is assumed to issue US$2 billion in Eurobonds per year at an interest rate of 5 percent and a maturity of 10 years. Remaining financing needs are met by domestic debt issuance. The alternative scenario does not assume any financing from the sale of state-owned assets.

35. Debt levels in the alternative scenario are higher than in the baseline, but remain moderate and stabilize at the end of the projection period. Total public debt peaks at 31.7 percent of GDP in 2021 before starting to decline. This is higher than the peak of 19.6 percent of GDP in the baseline scenario but nevertheless well below the level of debt in most other countries at a similar or more advanced stage of development. Domestic public debt is equal to 21.9 percent of GDP in 2022 while external public debt stands at 9.2 percent of GDP.

Alternative Scenario

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Source: IMF staff calculations.

G. Conclusions

36. Algeria needs to undertake sustained fiscal consolidation to restore fiscal sustainability. Even when oil prices were high, Algeria’s fiscal policy was unsustainable given its heavy reliance on hydrocarbon revenues and the relatively short time horizon for hydrocarbon resources. The collapse of oil prices has exacerbated an already weak fiscal position and made fiscal consolidation more urgent.

37. Nevertheless, an unnecessarily abrupt fiscal consolidation should be avoided. The authorities’ medium-term fiscal consolidation is extremely ambitious and risks damaging growth and employment. More gradual spending cuts, combined with further exchange rate depreciation and wide-ranging structural reforms, would have less impact on growth while still placing fiscal policy on a sustainable path.

38. Algeria can afford a more gradual fiscal consolidation. Although fiscal savings have been nearly depleted, government debt is low and external debt is nearly nonexistent. As one of the least indebted countries in the world, Algeria has fiscal space to borrow more without threatening debt sustainability.

39. The authorities should consider borrowing both domestically and externally to finance future fiscal deficits. Increased government debt issuance would facilitate the development of domestic financial markets by creating a reliable yield curve that serves as a benchmark for private sector issuers. However, relying on domestic borrowing alone could crowd out credit to the private sector, particularly in an environment of tighter domestic liquidity. The authorities should therefore consider external borrowing, which would not only mitigate crowding out effects but also strengthen international reserves, broaden the investor base, and raise awareness about Algeria’s economy. External borrowing could entail Eurobonds, Sukuk issuance, syndicated lending, and borrowing from official creditors.

40. Privatizing state-owned assets could complement debt financing. Transparently opening the capital of selected state-owned enterprises, including public banks, could provide deficit financing while helping to develop the stock market and improve corporate governance. Successful privatization will likely take time given the need to put in place mechanisms to compensate and retrain those who may be negatively impacted, as well as the need to restructure inefficient SOEs to attract investor interest

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1

Prepared by Andrew Jewell.

2

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.

3

International reserves, however, remain comfortable at US$113 billion, or nearly two years of imports, at end-2016.

4

Public entities include Algérie Poste, local governments, and other public institutions. The government has an obligation to replenish the deposits used to finance the budget deficit, although there is no set timeframe. See also accompanying Selected Issues Paper: “Fiscal Risks in Algeria.”

5

The Bank of Algeria requires banks to maintain a certain ratio of highly liquid assets, including Treasury securities, to meet short-term obligations. In addition, banks need collateral, including Treasury securities, to participate in central bank refinancing operations.

6

The government is contemplating issuing a non-interest-bearing, GDP-linked domestic bond aimed at attracting interest from retail investors who, for religious reasons, are unwilling to purchase regular Treasury debt.

7

External borrowing here refers to debt issued in foreign currency and purchased by non-residents.

8

The EMBI (Emerging Market Bond Index) is J.P. Morgan’s index of dollar-denominated sovereign bonds issued by a selection of emerging market countries. It is the most widely used and comprehensive emerging market sovereign debt benchmark.

10

Sukuk, the Islamic equivalent of bonds, are similar to asset-backed securities. Whereas a conventional bond is a promise to repay a loan, Sukuk constitutes partial ownership in receivables, a lease, a construction project, a deferred delivery of assets, a joint partnership, or investment. The principal amount is typically not guaranteed and the return is linked to the performance of the underlying assets. See Kammer et al. (2015).

11

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

12

The increase in revenues compared to the baseline scenario is a function of two assumptions: more exchange rate depreciation (which leads to greater hydrocarbon revenues) and improved tax administration.

Algeria: Selected Issues
Author: International Monetary Fund. Middle East and Central Asia Dept.