Algeria: 2021 Article IV Consultation-Press Release; and Staff Report; and Statement by the Executive Director for Algeria
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International Monetary Fund. Middle East and Central Asia Dept.
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Publication Date:
02 Dec 2021
eISBN:
9781616357948
Language:
English
Keywords:
bank financing; stabilization fund; stability mandate; w Bank of Algeria; diversifying financing source; financing operation
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1. Algeria entered the Covid-19 pandemic with significant economic challenges. The oil price shock in 2014 led to a sharp decline in hydrocarbon revenue and severely tested the country’s growth model. The authorities initially relied on currency depreciation to adjust to this sizeable shock, before embarking on fiscal consolidation in 2016. Structural reforms were launched in parallel to help diversify the economy away from hydrocarbons and the Bank of Algeria (BA) modernized its monetary policy framework.

Abstract

1. Algeria entered the Covid-19 pandemic with significant economic challenges. The oil price shock in 2014 led to a sharp decline in hydrocarbon revenue and severely tested the country’s growth model. The authorities initially relied on currency depreciation to adjust to this sizeable shock, before embarking on fiscal consolidation in 2016. Structural reforms were launched in parallel to help diversify the economy away from hydrocarbons and the Bank of Algeria (BA) modernized its monetary policy framework.

Context

1. Algeria entered the Covid-19 pandemic with significant economic challenges. The oil price shock in 2014 led to a sharp decline in hydrocarbon revenue and severely tested the country’s growth model. The authorities initially relied on currency depreciation to adjust to this sizeable shock, before embarking on fiscal consolidation in 2016. Structural reforms were launched in parallel to help diversify the economy away from hydrocarbons and the Bank of Algeria (BA) modernized its monetary policy framework.

2. Efforts to adjust to lower oil prices stalled with domestic political developments in 2018–19. Fiscal consolidation was reversed in 2018 amid mounting social discontent as growth slowed and unemployment rose. In 2019, former President Bouteflika’s re-election bid for a fifth term was followed by widespread social unrest (the ‘Hirak’ movement), leading to his resignation. A protracted period of transition and policy paralysis ensued until the election of President Tebboune in December 2019. Following early legislative elections in June 2021, a new government was appointed in July. Overall, macroeconomic imbalances increased significantly between 2013 and 2019: the budget deficit widened from 0.9 to 9.6 percent of GDP, government debt rose more than six-fold, and reserves declined from 32 to 17.6 months of imports. Faced with rising financing needs, the government resorted to monetary financing between 2017 and 2019.

3. The pandemic further aggravated economic imbalances. Despite the authorities’ efforts to alleviate the health and social impact of the shock, the economy suffered a broad-based contraction in 2020. Official data shows that the number of job seekers rose by 673,000 while job offers declined by 130,000 (Agence Nationale de I’Emploi). The drop in oil prices widened the current account deficit, and international reserves continued to fall. Fiscal savings in the oil stabilization fund were spent.

4. The consultation focused on policies to mitigate the impact of the pandemic, address pre-existing economic vulnerabilities, and unlock Algeria’s growth potential. Discussions focused on a policy-mix to strengthen the post-Covid recovery by reducing macroeconomic imbalances while protecting the most vulnerable, and reinvigorating reforms to diversify the economy, improve economic governance, and revive growth.

Recent Developments

5. Like other countries, Algeria has been hit hard by the Covid-19 pandemic. To date, Algeria has had over 205,000 infections and over 5,800 deaths out of a population of 44 million. Timely implementation of sanitary measures and an acceleration of the vaccination campaign in July 2021 have helped bring a third wave of infections under control (Text Figure 1). By mid-October, close to 11 million people (25 percent of the population) had received at least one dose of the vaccine. Local production of the Sinovac vaccine since September is expected to boost Algeria’s vaccination drive.

Text Figure 1.
Text Figure 1.

Confirmed Coronavirus Infections and Deaths and Stringency Index

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.A001

Source: Our World in Data (https://ourworldindata.org/coronavirus/countrv/algeria), covid github dataNote: The Stringency Index, compiled by Oxford Coronavirus Government Response Tracker Projects a composite measure of nine response indicators including school closures, and travel restrictions. It measures the strictness of governments’ responses (100=strictest).

6. The authorities implemented a comprehensive set of measures to cushion the economy. In addition to containment and health measures, they eased fiscal policy through tax deferrals, increased health spending, allowances for the unemployed, and a one-off transfer to poor households (Table 1). The BA eased monetary policy by lowering the reserve requirement coefficient from 10 to 2 percent and the policy rate from 3.5 to 3 percent. It also relaxed prudential requirements. The dinar fell against the US dollar and the euro by about 13 and 16 percent respectively, between December 2019 and September 2021.

Table 1.

Algeria: Policy Response to COVID-19 in 2020–21

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Sources: Algerian Authorities, World Bank Economic Monitor for Algeria, and IMF staff estimates and calculations. Notes:

Listed tax measures were introduced under the 2020 supplementary budget law and the 2021 budget and supplementary budget laws. Their actual timeline is set by various decrees. Most temporary tax exemption measures will remain in place until the end of the pandemic. Most income tax deferral measures did not go beyond the end of the fiscal year; thus, staff expects their impact on the full-year tax collection in each of 2020 and 2021 to be somewhat small.

Measures above do not take into account any liabilites assumed by the government on account of guarantees on bank lending to state-owned enterprises or other corporates. Their cost is expressed in percent of the 2021 GDP.

7. A moderate recovery is underway, but inflation is rising. After contracting by 4.9 percent in 2020, real GDP grew by 2.3 percent (y-o-y) in 2021Q1, reflecting a gradual pick-up in domestic activity following the easing of containment measures and higher external demand. Hydrocarbon production expanded by 7½ percent (y-o-y) over the same period. Inflation accelerated to a 12-month average of 4.1 percent in June 2021 driven by cost-push factors, including a drought episode in 2021, and base effects. Non-food inflation also rose, partly due to exchange-rate depreciation.

8. The current account deficit improved, after widening significantly following the concomitant oil price shock and OPEC+ production quotas in 2020. It narrowed by 47.3 percent (y-o-y) in 2021H1, driven by higher hydrocarbons exports volumes and prices, the strong performance of nonhydrocarbon exports, and import compression policies. Higher net exports and the authorities’ use of the 2021 IMF SDR allocation of US$2.67 billion to shore up FX reserves helped slow their decline. FX reserves reached US$46.2 billion (11.8 months of imports) at end-August, from US$48.2 billion (12.5 months of imports) at end-2020.

9. The pandemic and oil shocks have caused further deterioration in public finances. Large capital expenditure cuts in 2020 more than offset additional spending of around 1 percent of GDP in response to the pandemic and revenue losses from the support measures (Table 1). Hence, the nonhydrocarbon primary deficit (NHPD) narrowed by 3.3 percent of nonhydrocarbon GDP (NHGDP) to 24.2 percent of NHGDP in 2020. However, the sharp fall in oil revenue widened the overall budget deficit to 11.7 percent of GDP in 2020 from 9.6 percent in the previous year. Despite a recovery in hydrocarbon revenue, the fiscal plans announced in the 2021 supplementary budget law are expected to keep the fiscal deficit broadly stable in 2021, reflecting an increase in capital spending to underpin the economic recovery and combat the pandemic, as well as a delayed hit to domestic tax intake.

10. Preliminary budget plans for 2022 envisage fiscal reforms and continued large deficits. The 2022 budget draft provides for the creation of a cash compensation mechanism in preparation for a reform of universal subsidies and includes plans to broaden the income tax base and phase out inefficient taxes. In parallel, it incorporates fiscal easing measures to boost the recovery and support household purchasing power, including income tax cuts, wage increases, broader access to unemployment benefits and measures to promote access to housing. The fiscal deficit is projected at 11.8 percent of GDP based on staffs estimate.

11. Meeting the treasury’s large financing needs has remained challenging. Financing needs in 2017 had prompted the revision of the banking law to authorize monetary financing for five years. The 2018 Article IV consultations advised against such measures, highlighting the risks to inflation, international reserves, and the BAs balance sheet (Annex I). In 2019, monetary financing—which had reached 32 percent of GDP— was halted. In 2020, the deficit was mostly financed by running down government and other public entities’ deposits. The BA financed the government in 2021, by investing part of its equity in three-year treasury obligations for a cumulative DZD 520 billion (2.3 percent of GDP), and by extending temporary advances to the treasury of DZD 335 billion (1.5 percent of GDP), which have already been repaid.1 In July 2021, the BA launched a DZD 2,100 billion (9.3 percent of GDP) special refinancing program (Plan special de refinancement, PSR) to extend fresh lending to the government and the rest of the economy under an operation involving the BA, state-owned banks (SOBs) and the treasury (Box 1).

12. Financial stability risks have increased. Non-performing loans, which increased sharply in 2019 amid domestic political strife, were exacerbated by the pandemic. While the BA’s measures during the pandemic reduced banks’ refinancing needs, some banks still face fragile liquidity situations and regularly need to access the interbank market. Despite high average solvency ratios (Table 7), the exposure of some SOBs to state-owned enterprises (SOEs) limits their ability to provide credit to the economy.2

The SOE Debt Buyback and PSR Operations

In June 2021, a financing operation involving the treasury, SOBs and the BA was set up to meet budget funding needs. The main motivation for this arrangement was to increase lending capacity at the SOBs. This arrangement involves three steps:

  • i. The treasury swaps long-term syndicated loans (with long grace periods) to SOEs against long-term treasuries (with 10- and 15-year maturities), issued well below market rates.1

  • ii. The BA refinances SOBs using these securities as collateral under the PSR. These treasuries are the only eligible collateral in the PSR. The PSR is implemented through monthly fixed-rate refinancing operations, conducted at the BA’s policy rate on a one-year maturity, for a maximum total volume set at DZD 2,100 billion (9.3 percent of GDP).2 PSR operations are renewable twice and include an early repayment option.

  • iii. By agreement with the Ministry of Finance (MOF), SOBs invest most of their PSR funds into long-term treasuries, again issued below market rates.3

This operation could:

  • i. pose significant risks for monetary stability: The B A’s recognition as PSR collateral of long-term treasuries issued below market yields exposes its balance sheet to significant financial risks. Based on prevailing market yields, those treasuries are worth 60 to 65 percent of their nominal value, while the BA accepts them at their nominal value with an insufficient haircut (15 percent). If such operations are repeated rather than implementing fiscal consolidation, the BA is at risk of further misuse of its instruments to address fiscal needs. A renewal of the PSR would jeopardize the BA’s monetary stability mandate, with adverse consequences for inflation and FX reserves.

  • ii. put public finances at risk: While it optically lowers borrowing costs through the issuance of significant volumes of long-term treasuries below market yields, it simultaneously transfers SOEs’ long-term loans to the government’s balance sheet. Thus, it causes a significant increase in public debt and raises fiscal risks should those loans become impaired.

  • iii. causemoral hazard and may compromise SOBs’ capacity to finance the economy: The operation burdens participating SOBs with overpriced long-term treasuries, which are likely to remain illiquid because they cannot be sold without generating losses. Consequently, they may become lastingly dependent on central-bank liquidity, causing risks to financial stability and monetary policy implementation.

1/ These treasuries are issued at their nominal value, with coupons of 2.75 percent on the 10-year maturity and 3 percent on the 15-year maturity, vs. market yields exceeding 7.5 percent on those maturities. 2/ At end-August 2021, the amount of refinancing under the PSR amounted to DZD 1,259 billion. 3/ These treasuries are issued at their nominal value, with coupons of 5.38 percent on the 10-year maturity and 5.71 percent on the 15-year maturity.
Table 2.

Algeria: Governance Assessment – Overview of the Main Areas for Improvement and Key Recommendations

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Source: IMF staff.
Table 3.

Algeria: Selected Economic and Financial Indicators, 2016–26

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

Including public enterprises.

In U.S. dollars.

Table 4.

Algeria: Balance of Payments, 2016–26

(in billions of US dollars)

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

Weighted average of quarterly data.

Gross official reserves include holdings of SDR assets and, for 2021, Algeria’s share of the general SDR allocation by the IMF in August 2021.

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

Table 5a.

Algeria: Summary of Central Government Operations, 2016–26 1/

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

On cash basis.

Including Sonatrach dividends.

Includes 500 billion dinars of transfers to pension fund in 2018

Bank financing includes domestic debt issuance and a drawdown of the oil stabilization fund and other government deposits at the central bank. In 2021, the repurchase of syndicated loans owed by SOEs for a total amount of DA 2,100 billion, under the financial operation including the PSR, is included in bank financing.

Includes proceeds from sales of state-owned assets.

Table 5b.

Algeria: Summary of Central Government Operations, 2016–26 1/

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Sources: Algerian authorities; and IMF staff estimates and projections

On cash basis.

Including Sonatrach dividends

Includes 500 billion dinars of transfers to pension fund in 2018

Bank financing includes domestic debt issuance and a drawdown of the oil stabilization fund and other government deposits at the central bank. In 2021, bank financing includes DZD 2,100 billion in bond issuance for the repurchase of syndicated loans owed by SOEs under the financial operation including the PSR.

Includes proceeds from sales of state-owned assets.

Table 6.

Algeria: Monetary Survey, 2016–26

(in billions of dinars, unless otherwise stated)

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

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

Table 7.

Algeria: Financial Soundness Indicators, 2010–20

(in percent)

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Source: Bank of Algeria

Outlook and Risks

13. Staff projects a moderate recovery in 2021, with growth at 3.2 percent. Growth will be driven by the rebound in hydrocarbon production and prices as well as ongoing vaccination efforts. The external position—assessed to be substantially weaker in 2020 than the level implied by economic fundamentals and desirable policy (Annex II)—is projected to improve sharply in 2021. The current account deficit is projected to narrow to 4.9 percent of GDP, reflecting a pickup in both hydrocarbon and nonhydrocarbon exports and a moderate increase in imports. Inflation is forecast to rise to 6.5 percent in 2021 on exogenous supply factors and accommodative monetary policy.

14. The medium-term outlook remains challenging despite the recent increase in hydrocarbon prices. Staff project that growth will taper off and output stagnate in the medium term. This reflects both a decline in hydrocarbon production because of capacity constraints and the global transition to greener energy. Oil prices are projected to normalize and stay below the average fiscal and external breakeven prices through the forecast period (Text Figure 2). Under the current macroeconomic policy mix, inflation is expected to continue to rise and international reserves to drop to low levels over the medium term. Fiscal space will shrink further, and government debt will rise, putting its sustainability at risk.

Text Figure 2.
Text Figure 2.

Projected Crude Oil and Breakeven Prices

(US$/barrel)

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.A001

Source: IMF staff projections and calculations.Note: The oil price projections are based on the October 2021 World Economic Outlook projections.Spot oil prices have risen since these projections were finalized.

15. Risks are tilted to the downside. Prospects for recovery are contingent on the evolution of oil prices, the pandemic and the social and geopolitical environment. The recent increase in hydrocarbon prices represents an upside. However, weaker SOE and bank balance sheets could pose fiscal risks, and the delicate social environment coupled with the recent increase in oil prices could delay needed adjustment (Annex III).

Authorities’ Views

16. The authorities assessed the outlook as favorable and foresee a sustained recovery. In their view, timely policy measures have helped restore confidence, preserve resilience, and prevent a deterioration of corporate and bank balance sheets. They indicated that the increase in inflation was cyclical, primarily reflecting exogenous cost-push factors and speculation. They disagreed with staffs 2020 external balance assessment, arguing that the results are highly uncertain, given the limitations of econometric approaches in the face of large shocks and volatility.

Policy Discussions

The authorities’ strategy aims to support the post-Covid recovery and reignite growth through accommodative macroeconomic poiicies and comprehensive reforms detailed in a new Government Action Pian (PAG). The pandemic and the ongoing structural shift towards renewable energy have underscored the need to accelerate the diversification of the economy away from hydrocarbons. Discussions focused on the delicate balance between preserving the recovery and reducing fiscal and external imbalances to foster medium-term growth in a context of rising economic hardship and reduced policy space. The role of enhanced economic governance and lower informality for inclusive growth was also discussed.

A. Authorities’ Strategy

17. The authorities’ strategy aims to revive growth and reduce the dependence on hydrocarbons in the medium term. This strategy is based on the development of new growth drivers, alternative sources of financing for the economy, and structural reforms to stimulate private investment, improve economic governance, and reduce vulnerabilities to corruption. The PAG includes a broad set of reform priorities to enhance governance, economic recovery and social cohesion (Text Table 1). Implementation is expected to start in 2022. Staff welcomed the authorities’ strategy, underscoring the need for adequate costing and an implementation timeline.3 Staff also highlighted the need to balance the benefits of some support measures against their costs. For instance, permanenttax incentives for specific sectors generate excessive costs for the budget and could distort competition and weaken the fairness of the tax system.

Text Table 1.

Key Economic Reforms and Policy Initiatives of the Government Action Plan

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Source: Government of Algeria “Plan d’Action du Gouvernement”, September 2021 (Chapters 1–3) and policy announcements about draft budget law for 2022.

18. Still, the underlying macroeconomic policy mix is risky. The authorities’ fiscal plans are expected to translate into substantial narrowing in the NHPD in the medium term. Despite savings on spending and revenue from reducing tax exemptions, the decline in hydrocarbon production and rising debt service will result in continued high overall deficits of around 12 percent of GDP through 2026, giving rise to very large financing needs. This would put pressure on banks’ balance sheets while raising risks of crowding out private-sector credit. Public debt would rise sharply, reaching close to 84 percent of GDP by 2026 (Annex IV). After improving in the coming years, the current account would widen again, causing FX reserves to fall to 3 months of imports by 2026.4

19. Moreover, prolonged import compression policies could have deleterious effects.

The authorities have introduced measures to contain imports (Text Table 2). These together with conjunctural factors have contributed to a sharp reduction in goods imports from almost US$60 billion in 2014 to US$45 billion in 2019 and US$35.5 billion in 2020. Based on information provided by the authorities, staff has currently assessed that these measures do not constitute an exchange restriction. However, staff cautioned that their prolonged use risks reducing competition in products markets, raising prices, and undermining growth.

Text Table 2.

Algeria: Selected Import Compression Measures since 2016

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Sources: World Bank Spring Economic Monitor (2021); Government of Algeria Budgets (various) Note:

The import bans are mostly temporary in nature. The dates in parenthesis indicate the year in which the measures were introduced.

Based on information provided by the authorities to staff, this measure has not been applied in practice to date.

Authorities’ Views

20. The authorities considered staff’s baseline projections pessimistic. They deemed that the growth dividends and cost-savings from fiscal reforms will considerably reduce fiscal financing needs over the medium term. They also considered staffs assessment of risks from the PSR to be overstated given its limited size. They did not anticipate any need to renew the PSR. They indicated that regulation measures had helped substantially reduce the import bill— including by deterring over-invoicing and fraud—without adverse effects on supply and prices.

B. Maintaining Macroeconomic Stability

21. There was agreement that mitigating the human and economic cost of the pandemic are immediate priorities. Higher health spending and targeted support to the most vulnerable and affected sectors would be warranted in the event of a resurgence of the pandemic. Fiscal space for such measures could be created by reprioritizing spending and reducing capital expenditures from their comparatively high current levels.

22. At the same time, a tighter policy mix is needed to maintain macroeconomic stability. This is particularly important, given the projected normalization of oil prices and longer-term implications of the global transition to renewable energy. Accordingly, staff presented an alternative scenario with the following policy mix: (i) a gradual but sustained fiscal consolidation; (ii) sufficient exchange-rate flexibility to facilitate adjustment and reduce the gap with the parallel market; and (iii) a recalibration of monetary policy (Annex V). The scenario also incorporates plans to support the recovery, while diversifying financing sources.

23. Staff emphasized the need to act simultaneously on all policy levers. Fiscal consolidation is needed to restore the sustainability of public and external finances and should not be further postponed as delays would amplify the magnitude and costs of adjustment. In parallel, greater nominal exchange rate flexibility would support fiscal consolidation, help reduce REER overvaluation, and maintain reserve buffers. Monetary tightening would help consolidate the gains from adjustment and contain inflationary pressures. Staff emphasized the need for proactive communication on the adjustment strategy to muster support for policy recalibration.

24. Fiscal effort starting in 2022 and over five years would stabilize debt and generate fiscal space while easing the impact of consolidation on the most vulnerable. Staff recommended a medium-term fiscal consolidation strategy supported by structural reforms together with revenue and spending measures sufficient to narrowthe NHPD by 10.5 percent of NHGDP over 2022–26, with sequencing that minimizes their social impact. The pace of fiscal consolidation should be adapted to the evolution of the pandemic and to domestic economic conditions. Consolidation efforts should rely on prioritizing capital expenditure while reforms to improve its efficiency would limit the fallout on growth. Savings on current spending could be achieved by reining in civil service hiring and following through on announced plans for subsidy reform (Box 2). The launch of a parametric reform in 2022 would help restore the sustainability of the pension system, although this will only yield savings in the long term (Box 3). Recouping tax arrears, phasing out unwarranted tax exemptions, and enhancing compliance and collection efficiency would boost nonhydrocarbon revenue. Enhancing progressivityof the tax system is also important for equity objectives. Windfall gains from a rise in hydrocarbon prices beyond the assumed trajectory should be used to rebuild fiscal buffers.

25. Diversifying financing sources would avert the need for abrupt fiscal consolidation and mitigate risks to macroeconomic stability. Measures to spur the development of the secondary debt market and promote financial deepening would support the government’s financing over time. In the meantime, recourse to foreign borrowing, for instance to finance priority investment projects, could ease pressures on the domestic banking system and leave room for credit to the private sector. Staff recommended prohibiting monetary financing ofthe budget deficit, including by discontinuing the PSRto protect the independence of the BA and the ability of monetary policy to control inflation.

Authorities’ Views

26. The authorities broadly agreed on the need to recalibrate the policy stance and protect the most vulnerable, though they had a different view regarding the timing and calibration. They considered that starting fiscal adjustment in 2022 would be premature, given the need to protect the nascent recovery. They projected that the fiscal deficit could be halved by 2023 through comprehensive reforms, including measures to recoup tax arrears, revisions to the tax code to encompass the informal sector in the tax base, better targeting of subsidies and spending efficiency gains from improvements in public financial management. The authorities also highlighted that the legislative framework for public-private partnerships (PPP) was currently under preparation and envisaged PPPs would minimize the on-budget cost of infrastructure investment.

27. The authorities highlighted the considerable depreciation ofthe dinar since 2013. The dinar has fallen by 45 percent against the dollar while the REER has depreciated by 15 percent. They did not consider the parallel-market rate as an appropriate benchmark given the volume and type of transactions on this market.

Towards Subsidy Reform in Algeria

Algeria’s subsidies entail large fiscal costs. Several on-budget social transfers aim to provide affordable housing and ensure broad access to education and to low-cost basic food products, electricity, natural gas and water, for a total of 4 percent of GDP in 2019. Off-budget implicit subsidies mainly include foregone revenue from setting energy prices at levels below international market value or cost-recovery, and losses incurred by SONATRACH when importing fuel, which have led to episodic support by the government (5 percent of GDP in 2016). The cost of these implicit energy subsidies is estimated at 8 percent of GDP (authorities’ calculation).

Universal price subsidies are regressive, create inefficient incentives and distortions, and crowd out more efficient spending. In Algeria, more affluent households consume significantly more subsidized products than low-income households and hence benefit relatively more from subsidies. There is over-consumption of subsidized products relative to peer countries—forinstance, Algeria is the world’s first per capita importer of powdered whole milk. Subsidies create an incentive to smuggle fuel products into neighboring countries with higher fuel prices. Finally, energy subsidies are harmful to the environment, contributing to higher pollution and global warming and discouraging investments in cleaner, renewable energy.

Staff supports the authorities’ intention, as announced in the PAG, to gradually shift away from universal subsidies to more targeted support for low-income households. Immediate priority should be given to the costlier, more distortionary subsidies and those which affect low-income households the least. Mitigation measures—which could be financed from part of the savings generated by the reform— should be implemented to protect more vulnerable households from its impact, especially when tackling food subsidies. Price increases associated with phasing out subsidies should be staggered overtime and, if needed, accompanied by an automatic pricing mechanism to hedge against political interference. A successful subsidy reform requires strong and committed leadership, and transparent communication on the reform strategy and compensation mechanisms. A review of the social safety net in Algeria would be useful to identify efficiency gains and targeting improvements.

International experience suggests that well-designed subsidy reform carries growth dividends, with limited effects on inflation. In the short run, the reform could have a negative growth impact and cause some inflation. However, experience in other MENA countries shows that these effects are transitory, especially when price increases are clearly planned and communicated in advance. In the long run, a well-designed subsidy reform could also have a positive effect on competitiveness and growth, thanks to the removal of price distortions, greater energy efficiency and expected boost in energy exports. By reallocating fiscal gains to the poor, the reform can also contribute to reducing inequality and poverty.

Algeria’s pension system is relatively generous, both in terms of eligibility and benefits. The system relies on two defined-benefit schemes—one for employees, one for the self-employed—whose payments are administered respectively by the Caissenationaledesretraites{CNR) and the Caisse na tionaledesecu rite socia led es non-salaries{CASNOS).Jhe system provides high gross replacement rates of almost 80 percent for full career workers, compared with a 50 percent global average. While coverage is only 54 percent of the labor force, reflecting the informal sector, about 80 percent of the population has access to benefits thanks to generous eligibility criteria for dependents and survivors.

Ensuring the Sustainability and Equity of Algeria’s Public Pension System

Absent reforms, the scheme’s already large deficit would further deteriorate, deepening sustainability concerns. CNR, the larger of the two schemes, is already insolvent, as it only finances 45 percent of its benefit expenses from contributions, requiring subsidies, transfers and loans from the treasury and various extrabudgetary entities, including the main social security fund (3.5 percent of GDP in 2018). Maintaining current coverage, eligibility and replacement rates would double pension spending and increase pension system deficits to 8.9 percent of GDP by 2050.

The main determinants of these challenges are structural. The relatively high accrual rate—the share of pensionable income earned as pension each year—is disconnected from the contribution rate and from life expectancy at retirement. Pensionsare based on short reference periods (5 years forCNR, 10 years for CASNOS), making benefits even more generous and aggravating distributional inequities. Therelaxed eligibility rules for survivorship pensions lack explicit financing mechanisms. Pension indexation and wage valorization mechanisms are discretionary, subjecting pensioners and the budget to uncertainty.

A gradual reform strategy would ensure sustainability and more efficient targeting. Contribution rates would need to double to bring the schemes to an equilibrium—a drastic, unrealistic increase. A more realistic reform scenario would imply a combination of gradual parametric adjustments, which would tackle both sustainability and equity considerations. These adjustments could reduce unfunded pension liabilities by more than half, and include retirement age increases, lower accrual rates, tightened eligibility for survivor pension, and rule-based wage valorization and benefit indexation.

C. Reforming the Policy Framework to Support Adjustment

28. Reforms to the fiscal policy framework would support and sustain adjustment by reducing the level and improving the composition of spending. These should include:

  • Enhancing monitoring and management of contingent iiabiiities from SOEs. Non-financial SOE debt is high (29 percent of GDP at end-2020 based on staffs estimate). Around two-thirds of this debt is publicly guaranteed and SOEs require periodic support from the government. The authorities should formulate and disclose an ownership strategy, and classify SOEs according to their viability, strategic importance, and nature of their activities, while strengthening governance. They also need to improve SOEs’ financial reporting and transparency, develop a consolidated report on their financial performance, and reinforce their monitoring to manage fiscal risks.

  • Enhancing the efficiency and management of public investment. The rationalization of investment expenditure should rely on a more attentive appraisal, selection and financial monitoring of public investment projects. Projects should be prioritized according to their feasibility, readiness, and economic impact. Staff warned against fiscal risks associated with PPPs and highlighted the importance of sound governance mechanisms, which include a clear, fair, and predictable legal framework, the ability for the MOF to stop PPP projects that are fiscally unaffordable and the transparent disclosure of all future budgetary costs and fiscal risks from PPPs.

  • Continuing to implement the organic budget iaw (OBL) to confirm the shift to modern public financial management practices. Continued efforts, in line with IMF advice, towards the introduction of program budgeting and full-fledged medium-term budget and expenditure frameworks, and the rollout of modern information systems for fiscal management will help improve resource allocation choices and public policy implementation.

  • Improving the transparency of policy operations across the public sector. Much budget information is outside of the public eye or published late. There is limited reporting of recent monetary financing, transfers from and between off-budget public entities, financial data and quasi-fiscal activities bySOEs. Staff highlighted the need to enhance budget integrity and comprehensiveness by regularly publishing information on budget outturns and off-budget operations.

Authorities’ Views

29. The authorities agreed with the reform priorities and noted that several measures have already been taken or feature in the PAG. They highlighted that reforms to boost nonhydrocarbon tax revenue were under consideration and that plans have been announced for opening partially the capital of some SOEs to private investors. They also emphasized the progress achieved towards the implementation of the OBL and the rollout of new IT solutions for fiscal management.

30. Monetary and financial sector policies can also help adjustment by enhancing monetary policy effectiveness and reducing macro-financial stability risks. This requires:

  • Reinforcing the independence of the BA. Communication on the use of the BA’s instruments to achieve its legal mandates should be reserved to the BA.

  • Strengthening liquidity management. Improved collateral and emergency liquidity-assistance (ELA) frameworks would help address liquidity shocks while maintaining sufficient reserve requirements (Annex VI). Moreover, a more active management of liquidity, based on an improved liquidity forecasting framework, would help transmit the key policy rate to the banking system and to the economy.

  • Reinforcing bank supervision and resolution frameworks. Further strengthening of the supervision function and an effective resolution regime should be priorities in the face of systemic risks. Bank-specific issues should be addressed, including through asset quality reviews (AQRs), funding and capital plans, performance criteria for SOBs, and sound lending policies.

  • Strengthening governance at SOBs to mitigate financial stability risks from lending to SOEs. SOBs should implement an effective business strategy and be run on a commercial basis. Ultimately, a controlled phasing-out of the government from their capital should be envisioned.

  • Developing the domestic debt market. Bolstering market transparency, strengthening the medium-term debt strategy and the legal framework for public debt management and reinforcing investor protection would support that objective.

  • Improving the foreign-exchange regulatory framework. The liberalization in 2021 of the surrender requirements for nonhydrocarbon and non-mineral exports is a step in the right direction. It should help foster the development of the interbank spot FX market. More generally, a simplification of FX regulations would help narrowthe parallel market premium (30 percent on average over 2020–21), reduce market distortions and improve the effectiveness of monetary policy.

Authorities’ Views

31. The authorities broadly agreed with the staff’s proposed financial sector reforms. They indicated that revisions to the banking law were under consideration, which will reinforce the BA’s independence. They highlighted steps to address supervision and systemic banking-liquidity issues identified in the 2020 Financial System Stability Assessment, drawing on IMF technical assistance. They emphasized that the BA had conducted AQRs and stress-testing and was working on improving short-term liquidity forecasting and the collateral framework and developing an ELA framework. They stressed their strong commitment to reform, confirmed by the BA’s close engagement with the IMF on technical assistance. The authorities also noted that the governance of SOBs has been strengthened by separating their supervisory and executive functions and that a comprehensive financial sector reform was under consideration.

D. Reforms to Unlock Algeria’s Growth Potential

32. Supporting the post-Covid recovery and developing Algeria’s vast growth potential will require sustained structural reforms. With the pandemic, change has become even more urgent. The PAG’s objectives of economic diversification and development of high value-added sectors, international trade and FDI need far-reaching reforms. Priorities include reforms to economic governance and policies to foster private sector-led growth.

33. Ongoing efforts to improve governance can be deepened further.5 While the anti-corruption framework is being strengthened, it would benefit from simplifying the institutional setting and more systematically applying sanctions against corruption. The legal framework regarding AML/CFT, as well as the effectiveness of existing AML/CFT measures, should be reinforced as pertains to domestic politically exposed persons, asset declaration regime and beneficial ownership transparency. While fiscal governance is improving with the modernization of fiscal management enabled by the OBL, there is room to increase transparency on fiscal operations, both on- and off-budget, modernize control mechanisms and IT systems, and strengthen MOF oversight on SOE finances and public investment projects. The legal framework provides for key elements of sound central bank governance —clear mandates, transparency obligations, oversight mechanism — but central bank independence needs to be strengthened. And despite recent efforts to reduce monopolies and obstacles to FDI, the regulatory climate could benefit from further easing in product market regulation, trade, foreign investment and FX transactions, and from improving private sector access to information.

34. Staff highlighted a set of priority reform areas to improve governance and reduce potential for corruption. These include (i) enhancing transparency across the public sector; (ii) reducing administrative complexity and burdensome procedures; (iii) mitigating risks of political interference by strengthening independence of bodies outside the executive; (iv) reinforcing government oversight and control capacities, especially on SOE finances, tax compliance and asset declaration; (v) anchoring good governance principles in the legal framework and improving its effective application; and (vi) reinforcing digitalization efforts to increase the efficiency of monitoring and control procedures.

35. Reducing barriers and disincentives to entry into the formal sector is an important prerequisite for the emergence of a dynamic private sector. Staff discussed findings of analytical work which suggest that heavy regulatory burdens and policy distortions play an important role in explaining informality in Algeria (Annex VII). Staff recommended measures to: (i) create an enabling environment for private-sector participation through labor and product markets, and financial sector reforms; (ii) minimize distortions from tax policy and strengthen tax collection; (iii) promote a culture of compliance with laws and regulations through governance reforms.

Authorities’ Views

36. The authorities agreed on the need to improve governance and to reduce informality, noting that both issues feature prominently in the PAG. The authorities broadly concurred with the mission’s diagnostic and the proposed priority reforms. After the recent introduction of a citizens’ budget, the full implementation of the OBL by 2023 and ongoing digitalization efforts will further contribute to improving budget transparency. Future reforms to enhance SOE oversight and to strengthen public investment management practices are under discussion. The authorities anticipate that comprehensive tax reforms and financial inclusion efforts will create new incentives to participate in the formal economy.

Staff Appraisal

37. Timely sanitary measures and stepped-up vaccination have helped contain the impact of Covid-19 pandemic in Algeria. A third wave of the pandemic in July 2021 was brought under control. Around 11 million people have received a first dose of vaccine and the local production of the Sinovac vaccine since late September should boostthe government’s immunization drive. A gradual recovery has started, supported by the increase in hydrocarbon prices and production.

38. The pandemic has nevertheless compounded economic woes, stemming from a succession of adverse shocks. The pandemic and concomitant oil shock in 2020 came on the heels of difficult years during which the economy’s attempts to adjust to the decline in oil prices since 2014 were disrupted by domestic political developments. The pandemic exacerbated the loss of international reserves and the increase in public debt. Real GDP growth fell for the sixth consecutive year, turning negative in 2020, and unemployment increased.

39. A gradual recovery is underway but long-standing macroeconomic imbalances have left policymakers with significantly reduced policy space. Continued large fiscal deficits have contributed to elevated external current account deficits, despite import compression policies, and given rise to large financing needs which were largely met through the central bank. The fiscal and external deficits widened further in 2020 and international reserves continued to fall.

40. While welcoming the authorities’ reform strategy, staff cautions against the underlying macroeconomic policy mix. The authorities need to strike a delicate balance between preserving the post-Covid recovery and reducing fiscal and external imbalances to foster medium-term growth. This requires continued support to the vulnerable and the health sector. At the same time, rising concerns about Algeria’s external and debt sustainability need to be addressed. Reforms announced in the PAG are welcome and support medium-term growth. However, in the absence of policy recalibration, persistently high fiscal deficits would give rise to very large financing needs, deplete FX reserves, and pose risks to inflation, financial stability and to the BAs balance sheet. The banking system’s capacity to lend to the rest of the economy would be severely hampered, with adverse consequences for growth.

41. A more prudent strategy would help achieve better economic outcomes in the medium term and strengthen the economy’s resilience. A policy mix including fiscal consolidation starting in 2022, greater exchange rate flexibility together with monetary tightening could help address fiscal and external imbalances. This adjustment should be adapted to the evolution of the pandemic and to domestic economic conditions, including through policies to mitigate its impact on vulnerable groups.

42. Monetary financing should be discontinued to stem inflation, contain the depletion of FX reserves, and avoid financial instability. Budget financing sources should be diversified, including through external borrowing for priority investment projects, for instance. The financial arrangement between the BA, SOBs and the Treasury results in a more rapid increase in public debt and generates moral hazard in SOEs and public banks. Syndicated loans now recorded as government assets are a source of fiscal risk that would materialize in case of partial or total write-off of these loans.

43. The strategy should be supported by strengthening policy frameworks to underpin adjustment while mitigating fiscal and financial stability risks. The authorities should sustain efforts to modernize budget management, monitor fiscal risks, especially from investment projects and SOEs, and enable public-sector efficiency gains. Strengthening liquidity management would help make monetary policy more effective. Reinforcing the independence of the BA would help protect its operations and its price stability mandate. Financial stability risks can be mitigated by reinforcing bank supervision and the crisis management framework. Efforts to strengthen governance at SOBs and reduce risks from lending to SOEs should be enhanced.

44. To support the transition to a more sustainable growth model, structural reforms should be intensified. This includes reforms to strengthen transparency, reduce burdensome procedures and reinforce digitalization efforts, mitigate risks of political interference, anchor good governance in the legal framework and reinforce oversight across the public sector; and reduce barriers to entry into the formal sector. The authorities’ efforts to scale back restrictions to FDI and plans to modernize the legal framework for investment and competition—which would help diversify the economy and foster private sector investment and job creation—are a step in the right direction. Tapering off import compression measures is advisable—their prolonged use risks reducing competition in product markets, raising prices, and undermining growth. Also welcome are recent announcements about plans to reduce administrative burdens and strengthen the anti-corruption institutional framework.

45. Staff recommends that the next Article IV consultation take place on the standard 12-month cycle.

Figure 1.
Figure 1.

Algeria: Selected Macroeconomic Indicators

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.A001

Source: Algerian Authorities and IMF staff estimates.
Figure 2.
Figure 2.

Algeria: External Sector Developments

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.A001

Source: Algerian Authorities and IMF staff estimates.
Figure 3.
Figure 3.

Algeria: Fiscal Indicators

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.A001

Source: Algerian Authorities and IMF staff estimates.
Figure 4.
Figure 4.

Algeria: Monetary and Financial Sector Indicators

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.A001

Source: Algerian Authorities.

Annex I. Authorities’ Response to Past IMF Recommendations

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Annex II. External Sector Assessment

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Proven hydrocarbon reserves atend-2020 were estimated at 12,200 million barrels for crude oil and 4,504 cubic meters for natural gas (OPEC, 2020). Staff projections assume that hydrocarbons production grows at a constant rate of 1 percent, peaking in 2039. From 2040 onwards, both production and consumption decline by 1 percent annually. Hydrocarbon prices are assumed to increase in line with the US GDP deflator by 2.1 percent. Future hydrocarbon revenue is discounted at a rate of 5 percent, which is the assumed rate of return on foreign assets, while population growth is 1.5 percent.

Bems, R. and I. de Carvalho Filho. 2009. “Exchange Rate Assessments: Methodologies for Oil-Exporting Countries”, IMF Working Paper 09/281.

Annex III. Risk Assessment Matrix1

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Annex IV. Public and External Debt Sustainability Analysis

Public debt is projected to rise under the authorities’ current policies to high ieveis in the medium term, raising risks to its sustainability. Domestic financing constraints limit the ability of the government to carry a heavy and rising debt burden while continued recourse to monetary financing from the central bank would raise risks to macroeconomic stability. Placing debt on a sustainable trajectory in the medium term requires significant progress on fiscal consolidation to arrest unfavorable debt dynamics driven by subdued growth and rising interest costs. Broad fiscal reforms are also required to tackle challenges to debt sustainability from large government guarantees and other sources of fiscal risks.

1. Central government debt has increased dramatically since 2016. Over 2008–15, central government debt, excluding guarantees on SOE debt, remained relatively low at around 8 percent of GDP, as a shift to gaping budget deficits from a long-standing surplus was offset first by drawing on savings of public entities and then, as oil prices fell, on the oil stabilization fund (Fonds de Stabilisation des Recettes, FRR). Government debt subsequently rose rapidly from 8.7 percent of GDP in 2015 to 50.7 percent of GDP in 2020, reflecting elevated primary deficits and subdued economic growth which was further weighed down bythe dual pandemic and oil price shocks. Around 70 percent of outstanding government debt at end-2020 were owed to the BA, reflecting substantial central-bank direct financing of the budget deficit between 2017 and 2019.

2. Recurrent materialization of budget risks has also contributed to the rise in government debt. In 2016, the government recognized liabilities of around 5 percent of GDP to SONATRACH on losses incurred on sales of fuel at subsidized prices. In 2017, the treasury also repurchased loans owed bythe national electricity and gas company Sonelgaz for an amount equivalent to 3 percent of GDP. It has also on-lent around 3 percent of GDP per year on average to the National Salaried Pension Fund (CNR) over 2018–20 to cover financing shortfalls. Meanwhile, SOE publicly guaranteed debt has more than doubled since 2014, reaching 18.8 percent of GDP in 2020.

3. Without credible fiscal consolidation, government debt sustainability may be at risk over the medium term. Under the current baseline projections, total government debt, excluding guarantees, would continue to rise over the forecast horizon to reach 84 percent of GDP by 2026, well above the 70 percent benchmark for emerging countries. Despite government plans for fiscal reforms, current projections point to the continuation of sizeable fiscal deficits because of declining hydrocarbon revenue, pressures on current spending and high capital outlays. The government’s decision to directly monetize the deficit between 2017 and 2019 has suppressed borrowing costs, but the authorities have committed to stop any additional direct financing of the budget by the central bank. Hence, interest costs are poised to rise, consuming around 19 percent of budget revenue in 2026 under staffs baseline scenario, an unprecedented level since 1989.

4. Persistently large fiscal financing needs and the modest absorption capacity of the domestic debt market will constrain the government’s ability to carry an increasing debt burden and pose risks to macroeconomic stability. Gross financing requirements are expected to stay very large at around 19 percent of GDP on average per year over 2020–26. The government is reluctant to tap external financing for budget financing purposes, although it has some space to ramp up external borrowing given the very low level of external and FX debt. Given the modest absorption capacity of the Algerian debt market, domestic financing of large budget needs will lead to severe crowding out of private sector borrowing, with negative repercussions on growth. Staffs baseline does not incorporate any direct monetary financing of the fiscal deficit, but meeting budget financing needs domestically will entail a substantial relaxation of money supply which risks of stoking inflation, putting pressure on the dinar and international reserves, and leading to disorderly adjustment through sharp devaluation or demand compression.

5. Stress tests highlight that the high level of debt and its steep upward trajectory under the baseline generate significant vulnerability to a broad range of shocks, as illustrated in the heat map. Shocks to real growth or moderate fiscal slippages would drive debt higher than 90 percent of GDP by 2026, while a combined macro-fiscal shock illustrating, for example, a fall in oil prices, would lead debt to rise to 119 percent of GDP in 2026. Debt levels as well as gross financing needs are particularly sensitive to a real interest rate shock which would push debt to 106 percent of GDP in 2026 and gross financing needs to an annual average of 24 percent of GDP over 2021–2026. Under unchanged fiscal policies with a constant primary deficit of 12 percent of GDP from 2021 onwards, government debt would increase to 97 percent of GDP in 2026. The evolution of predictive densities of debt (see below) illustrates the substantial risk of government debt breaching 100 percent of GDP under a wide range of scenarios. The large size of the fiscal adjustment assumed under the baseline scenario relative to historical standards (see Realism of assumptions tool) tilts risks surrounding the debt trajectory to the upside.

6. Contingent liability risks from SOE debt and the pension systems as well as other budget risks are also material. Total debt of non-financial SOEs is high, at 29 percent of GDP at end-2020 on staffs estimates. SOEs have recurrently required government support in recent years, partly reflecting their quasi-fiscal role. In 2021, the treasury is expected to repurchase syndicated loans extended by public banks to SOEs for a total amount of DZD 2,100 billion (9.3 percent of GDP) in the context of the financing operation incorporating the central bank’s PSR (Box 1). An unknown portion of the repurchased loans is explicitly publicly guaranteed. As such, the full amount of the repurchases is added the government’s debt burden, but at least part of the repurchased amount is expected to be deducted from the outstanding stock of SOE guaranteed debt. The budget has also accumulated obligations to SONATRACH for fuel subsidies between 2016 and 2020, currently estimated at DA 900–1000 bn (around 5 percent of 2020 GDP) but not yet included in the debt figures as the government is yet to conclude an arrangement with SONATRACH to recognize them. Also excluded are obligations arising from the use of savings in public entities, including the Algeria Post and the National Investment Fund, to finance the 2020 deficit. Pension Fund obligations to the Treasury are also not reflected.

7. Debt is mostly domestically held and denominated in dinars. After its last disbursement from the IMF in 1999, external debt has continued to decline and the government did not borrow externally until 2016, when the African Development Bank (AfDB) provided a €900 million budget support loan. At end-2020, public external debt represented only 1 percent of GDP. In addition to the AfDB loan, remaining sovereign external debt is mostly on concessional terms and owed to bilateral creditors.

8. Total external debt is projected to grow moderately between 2020 and 2026. Staff projections show that total external debt would increase from 2.4 percent of GDP to 5.4 percent of GDP in 2026, reflecting an assumption about external borrowing under the baseline scenario to maintain reserves at 3 months of imports in 2026. Bound stress tests show that the trajectory of external debt is nevertheless subject to several risks, notably an adverse current account shock (Table 1, Figure 6).

Figure 1.
Figure 1.

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

(in percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.A001

Source: IMF staff.1/ Public sector is defined as general government.2/ Based on available data.3/ Long-term bond spread over German 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 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.
Figure 2.
Figure 2.

Algeria Public DSA – Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.A001

Source: IMF staff.
Figure 3.
Figure 3.

Algeria: Public DSA – Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.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/ Not applicable for Algeria, as it meets neither the positive output gap criterion nor the private credit growth criterion.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.
Figure 4.
Figure 4.

Algeria: Public DSA – Stress Tests

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.A001

Source: IMF staff.
Figure 5.
Figure 5.

Algeria: Public DSA Risk Assessment

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.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 notbaseline, 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.
Table 1.

Algeria: External Debt Sustainability Framework, 2013–2026

(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

Figure 6.
Figure 6.

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

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.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 a re calculated over the ten -year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2022.

Annex V. Alternative Scenario

In addition to the baseline, staff discussed an alternative scenario consistent with the recommended policy mix. The adjustment scenario shows that fiscal consolidation of sufficient scale alongside enhanced exchange rate flexibility, monetary policy tightening and progress on structural reforms would go a long way towards protecting fiscal and external sustainability, rebuilding policy space and enhancing resilience to external shocks.

The alternative scenario assumes a three-pronged adjustment strategy starting in 2022 and relying on simultaneous action on all three policy levers through (i) gradual fiscal adjustment of around 10.5 percent of NHGDP staged over five years; (ii) sufficient exchange-rate flexibility to support adjustment and close the gap with the parallel market; and (iii) monetary policy tightening. Under this policy mix, government financing needs would be substantially reduced, and government debt would peak below 60 percent of GDP. External borrowing would alleviate pressures on the domestic banking system and help maintain international reserves at adequate levels through the projection horizon, supporting the ability of the economy to respond to potential adverse external developments. Policy space would be rebuilt, and growth would accelerate, reflecting a substantial reduction in distortions from the policy setting and progress on structural reforms. The recommended adjustment incorporates measures to minimize its impact on low-income households through targeted support measures.

Specific assumptions are as follows:

1. Fiscal revenue. Nonhydrocarbon tax revenue is supported in the outer years by improvements in collection capacity, for example through digitalization reforms, and widening of the tax base from a targeted phasing-out of inefficient tax exemptions (on VAT for example). Stronger tax collections, alongside efforts to recoup part of the current stock of overdue tax payments, would limit the projected decline in total revenue, mostly owing to lower imports and dividend transfers from the BA and the gradual decline in oil production. Enhanced exchange-rate flexibility will partially shield hydrocarbon income from oil price volatility.

2. Fiscal spending. The fiscal adjustment relies on reduction in both capital and primary spending, while health and social spending should be increased as needed to support the fight against the pandemic and the nascent economic recovery. At 16 percent of NHGDP on average per year over the last five years, Algeria’s capital outlays are particularly high; cuts of around 2 percent of NHGDP relative to their projected 2021 level would bring them closer to peers, while concurrent fiscal reforms to enhance the efficiency of public investment would increase the economic benefits drawn from infrastructure. The authorities’ announced plans to improve the targeting of subsidies should achieve savings on spending and boost hydrocarbon revenue. Reforms to rein in hiring in the civil service with a replacement rate of less than 1, in line with the published 2022 budget guidelines, would achieve savings on payroll spending. In parallel, parametric pension reform starts in 2022 although the ensuing budget savings are assumed to materialize only in the outer years. Reforms to the governance of SOEs and enhanced monitoring of their financial performance would help mitigate materialization of fiscal risks. Part of savings achieved on spending will be reinjected in the economy through targeted transfers to low-income households.

3. Exchange Rate and Monetary Policy. Allowing for sufficient exchange-rate flexibility would help forestall the continued appreciation of the REER projected under the baseline scenario and realign the dinar with macroeconomic fundamentals. The exchange rate is assumed to be adjusted to durable shifts in terms-of-trade, supporting the authorities’ efforts to diversify the economy and stimulate nonhydrocarbon exports. Import compression policies are relaxed. The combination of exchange rate flexibility and recommended fiscal adjustment would help tackle ongoing pressures on the balance of payment, protect international reserves and substantially reduce the premium on the parallel FX market. Monetary policy is tightened as needed starting in 2022, to contain any increase in inflation from exchange rate pass-though, supported by structural reforms to streamline the policy framework.

4. Fiscal Financing. The government avoids any direct and indirect monetary financing of its deficit to protect macroeconomic stability. The treasury diversifies its financing sources through a combination of domestic borrowing at market rates and external borrowing. A rise in interest cost will partly offset savings on primary spending.

5. Economic Growth and Structural Reforms. The tightening of the policy mix would weigh on domestic demand and precipitate a slowdown in nonhydrocarbon GDP growth in 2022–2024. However, growth will recover and substantially accelerate thereafter, supported by stronger public spending efficiency, enhanced credit supply to the private sector and improved macroeconomic stability. In parallel, lifting restrictions on current account transactions and advancing structural reforms would enhance the business climate and support the recovery. For instance, easing restrictions on foreign investment would help Algeria bridge the gap in terms of FDI inflows relative to regional peers. Reforms to strengthen the competition framework and scale back barriers to domestic and foreign entry would spur the expansion of the private sector and spawn new capacities in the nonhydrocarbon sector, supporting efforts to wean the economy off oil dependence. Greater efficiency and wider coverage of social protection would support human capital accumulation and productivity. Governance reforms would improve public spending efficiency.

6. Communication. Proactive communication of adjustment policies to the broad public would be crucial for successful implementation. Fiscal reforms typically face resistance, as they have a material impact on income redistribution and generate short-term economic costs while their benefits tend to materialize only gradually. Laying out a clear case for the adjustment strategy would facilitate broad-based understanding and muster support among members of the public. Dialogue with the civil society and involvement of private sector representatives in the design and implementation of economic and fiscal reforms would enable ownership of the adjustment policies. Reforms to streamline governance and enhance transparency, most notably on budget matters and SOE financial performance, would also help build trust.

7. Contingency plans. While the credibility of the commitment to fiscal consolidation plans is crucial, the pace of fiscal consolidation should be adapted to the evolution of the Covid-19 pandemic and to broad domestic economic conditions. At all times, health and social spending need to be prioritized and ramped up as needed to combat the pandemic and its economic fallout. Accelerated and larger cuts to capital spending could be warranted to create further space for this purpose. Higher external borrowing beyond the assumptions of the alternative scenario would also help create temporary fiscal space. Conversely, the windfall gains from any potential rise in hydrocarbon prices should be used to rebuild budget deposits and international reserves, while pressing ahead of the adjustment.

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Annex VI. Improving Liquidity Management in Algeria

1. Significant gaps in the liquidity management framework limit the BA’s ability to address shocks through its monetary policy. The transmission of the BA’s key policy rate to the banking system and to the economy is weak, leading the BA to (appropriately) use reserve requirements as primary instrument to address liquidity stress, as evidenced by the Covid-19 pandemic.1 While fully justified in those circumstances, a significant, persistent decrease in reserve requirements presents many drawbacks: (i) it affects all banks in the same manner, while participation in refinancing operations allows a differentiation in the effects of monetary policy across banks; (ii) it may be conducive to moral hazard if banks get used to persistently low reserve requirements; (iii) it reduces the effectiveness of the reserve requirements averaging mechanism in encouraging interbank market activity and development; (iv) it visibly reduces the central bank’s leeway to address further liquidity shocks (while unconventional monetary policy measures can still be effective when the key policy rate has reached its lower bound); and (v) it may reduce the relevance of the key policy rate as the primary tool to signal and transmit the central bank’s monetary policy stance, thereby confusing public perceptions on the central bank’s primary instrument.

2. Activating the liquidity management should give a greater operational relevance to the key policy rate in signaling and transmitting the BA’s monetary policy stance. This implies that using the key policy rate (used as fixed rate or as reference rate in variable rate auctions) would be the primary tool to address liquidity shocks. It requires that the BA’s liquidity management operations have a sufficient volume and frequency to meaningfully influence the banks’financing costs, and consequently the economy’s financing costs.

3. Reinforcing the financial system’s resilience to liquidity shocks will also support a better transmission of monetary policy. A three-fold strategy could help building ‘lines of defense’, which could absorb liquidity shocks and unencumber reserve requirements—de facto currently the primary tool to address liquidity stress in Algeria.

4. First, the authorities should foster the development of the secured interbank money market through appropriate infrastructure and incentives. The interbank money market should be the first line of defense when a liquidity shock occurs, by allowing the reallocation of excess reserves between banks. When a liquidity shock negatively affects confidence between banks, the unsecured money market may not be an effective backstop. By contrast, an effective secured money market2 can be more resilient as collateral facilitates the reallocation of excess reserves between banks even in a low-confidence environment, provided that there is legal certainty on the collateral and sufficient high-quality assets available to banks. An appropriate legal and technical infrastructure would strengthen the development of the interbank repo market in Algeria.

5. Second, strengthening the potential “firepower” of the BA’s system-wide liquidity injections requires a broader collateral framework. Currently government debt securities account for the bulk of the eligible collateral for the BA’s monetary policy operations. The framework for the acceptance of performing credit claims is not actively used, for operational reasons. Making that framework operational, while applying strict risk control measures, would help diversify and broaden the eligible collateral, increasing the BA’s capacity to inject liquidity and reducing the need for lowering reserve requirements in face of system-wide liquidity shocks.

6. Third, an effective Emergency Liquidity Assistance (ELA) framework would help address residual idiosyncratic issues, while fostering the necessary reforms by the weakest links in the banking system. An ELA should be provided on a conditional basis to solvent banks facing temporary liquidity issues to preserve financial stability. The provision of ELA should be accompanied by strict conditions that the beneficiary bank implement specific remedial measures, agreed and verified by the supervisor, so that the bank becomes more resilient to future liquidity shocks.

Figure 1.
Figure 1.

System-Wide Liquidity Shock in a Banking System with Complete Safety Nets

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.A001

Note: The systemic liquidity shock is partly absorbed through there allocation of excess reserves between banks (for banks A, B, C, D). The secured money market allows a further interbank reallocation of excess reserves, as collateral offers appropriate protection to the lenders and preserves some banks’ (D, E, F, G) market access, despite perceptions of higher credit risk. Residual liquidity needs are addressed (for banks E, F, G) by central bank’s system-wide measures. BankG runs out of eligible collateral for monetary policy and needs additional central bank financing: BankG receives it as Emergency Liquidity Assistance (Lender of Last Resort- LOLR), providing that it verifies all conditions (in particular, solvency). Without LOLR, the central bank’s system-wide liquidity measures would have been calibrated differently, and probably sub-optimally.

Annex VII. Informality in Algeria

1. As in most of the developing world, informality is a major policy challenge in Algeria. Informality can be detrimental to inclusive growth and social welfare as it excludes large swathes of the population from social safety nets. This can aggravate income inequality, particularly in times of economic hardship as the ongoing pandemic has shown (Delechat and Medina, 2021). In addition, informality contributes to perpetuating gender and generational inequality, as it disproportionately affects women and the youth (Jutting and Laiglesia 2009, Ohnsorge and Yu 2021). It also undermines tax collection and hence reduce fiscal policy space and the quality of public services.

2. Commonly used measures suggest that informality in Algeria is significant but similar to that of peer countries (Figure 1).

  • National estimates suggest that information employment accounted for 42 percent of total employment in 2019. The decline in informal employment from around 50 percent of total employment in 2009 mostly reflected increased hiring in the public sector (IMF, 2014). Informal employment is concentrated in agriculture as well as in commerce and construction, two sectors which were hit hard by the Covid-19 pandemic in 2020.

  • Single indicator-based measures also suggest that informality is pervasive in Algeria. ‘Excess’ demand for cash—as measured by the share of currency in circulation outside banks relative to broad money—is higher in Algeria than in other Middle East and North Africa (MENA) countries. It has also been rising since 2008. A parallel market for the Algerian dinar with an important the exchange rate premium may similarly reflect’excess’demand for foreign exchange. Excess demand for either cash or FX can arise for various reasons, including precautionary motives, tight regulations or lack of confidence in the banking sector, but tends to be associated with higher informality as it helps keep transactions unregistered and untraceable.

  • Informality in Algeria is, however, lower than the median level for peer countries. The share of self-employment in total employment, commonly used to compare informal employment across countries was 30.1 percent in Algeria in 2019 compared to a median of 47.3 percent in a sample of 153 countries. Model estimates of the shadow economy for 158 countries indicate that, over the period 1991–2017, informality in Algeria closely tracked that of the median country and remained mostly below it.1 A similar conclusion emerges when comparing Algeria with other MENA countries or with other hydrocarbon exporters.

Figure 1.
Figure 1.

Informality in Algeria

Citation: IMF Staff Country Reports 2021, 253; 10.5089/9781616357948.002.A001

3. Substantial efforts have been deployed by the authorities to encourage formalization in recent years. The government has encouraged voluntary compliance through tax incentives or investment in infrastructure, while extending support to job creation and SMEs, working on promoting financial inclusion, and strengthening enforcement (Table 1). Data on the implementation of these initiatives is scant, and reducing informality takes time, but available information indicates there is room for improvement. For instance, the voluntary tax compliance scheme and affiliation to social security scheme under the 2015 supplementary budget had low take-up rates (Charmes and Remaoun, 2016) and the use of cash remains pervasive despite measures to facilitate payments through banks.

Table 1.

Selected Recent Policy Measures to address Informality in Algeria

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Source: 2015 supplementary budget law, Algerian authorities, Charmes (2016) and various media reports.

4. Existing evidence suggests that policy distortions and structural factors are the key drivers of informality in Algeria (Table 2). An analysis of the informality gap in North African countries relative to advanced economies by the IMF (forthcoming) suggests that in addition to structural factors (like the greater importance of the agricultural sector and lower level of human capital), these gaps also reflect a number of policy distortions. In the case of Algeria, business and labor market regulation, the tax burden, and the quality of governance play a non-negligible role in informality.

Table 2.

Commonly Identified Determinants of Informality in the Literature

article image
Source:Jutting and Laiglesia (2009), Charmes and others(2018), Loayza (2018), Ohnsorge and Yu (2021)

5. The Government’s Action Plan (PAG) identifies an ambitious set of measures to advance formalization, which need be complemented by efforts to tackle policy distortions. The PAG lists a wide range of measures to tackle informality, including by extending further support to start-ups and SMEs, streamlining administrative and tax control processes, and leveraging digital solutions to promote financial inclusion. In parallel, reforms to address policy distortions need to be prioritized. The creation of an enabling business environment through product market, labor and financial reforms would be key to support the capacity of workers to obtain formal jobs, reduce barriers to entry, enhance benefits of participation for firms and individuals and discourage the use of cash. Reforms are also needed to minimize distortions from tax policy while improving compliance. Lastly, governance reforms to enhance accountability and reduce corruption and waste can help to promote a culture of compliance and increase tax morale.

References

  • Charmes, Jacques and Malika Remaoun. 2016. “L’economie informelle en Algerie: Estimations, Tendances et Politiques” (Mimeo)

  • Delechat, Corinne and Leandro Medina. 2021. The Global Informal Workforce: Priorities for Inclusive Growth. Washington: International Monetary Fund.

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  • IMF. 2014. Fostering Private Sector Job Creation in Algeria. Country Report No. 14/34. Washington: International Monetary Fund

  • IMF. Informality, Development and Business Cycles in North Africa, forthcoming.

  • Jutting, Johannes P. and Laiglesia, Juan R. 2009. Is Informal Normal? Towards More and Better Jobs in Developing Countries. Development Centre of the Organisation for Economic Co-Operation and Development

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    • Export Citation

  • Loayza, Norman. 2018. Informality: Why is it so Widespread and How Can it Be Reduced? World Bank Research and Policy Briefs No. 133110.

  • Ohnsorge, Franziska and Shu Yu. 2021. The Long Shadow of Informality: Policies and Challenges. Washington: World Bank

1

Under Article 46 of the Central Bank Law, the BA can provide temporary advances to the government for up to 240 days in a calendarday, and up to 10 percent of the government’s ordinary revenues observed in the previous fiscal year. The investment purchases (under Article 53 of the Central Bank Law) were conducted at significantly higher interest rates than the treasury bond purchases by the BA between 2017 and 2019.

2

Syndicated loans with maturity of up 25 years and grace periods of up to 10 years—provided at the request of the government to finance investment projects—weigh on these banks’ liquidity.

3

Staff’s baseline scenario incorporates some of these reforms and assumes that spending is limited by financing constraints over the medium term; estimates will be refined once details about cost and implementation calendar become available.

4

To maintain reserves at 3 months of imports,the baseline scenario assumes some external borrowing in 2026.

5

Staff diagnostics and recommendations (Table 2) focused on six key areas. These include the anti-corruption framework;financial sector oversight and anti-money laundering and combating the financing of terrorism (AML/CFT); budget management; SOE governance; central bank governance; and transparency in the hydrocarbons sector.

1

The Risk Assessment Matrix (RAM) shows events that could material lyalter 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. The conjunctural shocks and scenario highlight risks that may materialize over a shorter horizon (between 12 to 18 months) given the current baseline. Structural risks are those that are likely to remain salient over a longer horizon

1

Between November 2019 and February 2021, the BA decreased the reserve requirement ratio from 12 to 2 percent (through 5 consecutive cuts), releasing about DZD 700 billion in banking-system liquidity. Over the same period, the BA reduced its key policy rate from 3.50 to 3 percent. In addition,in September 2020 the BA introduced monthly-one month refinancing operations in complement to its regular weekly refinancing operations,attenuating banks’ rollover stress in a context of surging liquidity tensions.

2

This could be achieved through developing the necessary legal and operational architectures (master agreement for interbank repos, electronic trading platforms etc.) and ensuring that the market participants have sufficient incentives (financial, regulatory, reputationalj to transact preferably between themselves than with the central bank.

1

These estimates are based on structural equations MIMIC models which exploit the information across Multiple Indicator and Multiple Causes variables to estimate the size of the ‘shadow/economy (Medina and Schneider, 2018).

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Cover IMF Staff Country Reports
Algeria: 2021 Article IV Consultation-Press Release; and Staff Report; and Statement by the Executive Director for Algeria
Author:
International Monetary Fund. Middle East and Central Asia Dept.
Volume/Issue:
Volume 2021: Issue 253
Publisher:
International Monetary Fund
ISBN:
9781616357948
ISSN:
1934-7685
Pages:
86
DOI:
https://doi.org/10.5089/9781616357948.002
Text Figure 1.

Confirmed Coronavirus Infections and Deaths and Stringency Index
Text Figure 2.

Projected Crude Oil and Breakeven Prices

(US$/barrel)
Figure 1.

Algeria: Selected Macroeconomic Indicators
Figure 2.

Algeria: External Sector Developments
Figure 3.

Algeria: Fiscal Indicators
Figure 4.

Algeria: Monetary and Financial Sector Indicators
Figure 1.

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

(in percent of GDP unless otherwise indicated)
Figure 2.

Algeria Public DSA – Composition of Public Debt and Alternative Scenarios
Figure 3.

Algeria: Public DSA – Realism of Baseline Assumptions
Figure 4.

Algeria: Public DSA – Stress Tests
Figure 5.

Algeria: Public DSA Risk Assessment
Figure 6.

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

(External debt in percent of GDP)
Figure 1.

System-Wide Liquidity Shock in a Banking System with Complete Safety Nets
Figure 1.

Informality in Algeria