Public Information Notice No. 07/16

Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with Algeria

February 7, 2007

On January 10, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Algeria.¹

Background

Real GDP growth temporarily declined to about 3 percent in 2006, largely because of a drop in hydrocarbon output for technical reasons. Nonhydrocarbon GDP (NHGDP) growth would continue at 4½ percent, underpinned by sustained activity in the construction sector, resulting from the significant fiscal impulse, and agriculture. Inflation remained low through mid-year but is picking up, reflecting a rebound in food prices.

Favorable hydrocarbon prices on international markets further strengthened Algeria's external position. The current account surplus is projected to increase to 24½ percent of GDP from almost 21 percent in 2005. Gross external reserves reached $US70 billion at end-September 2006 (2 years of import cover). After early debt repayment, in particular to the Paris and London Clubs, the external debt-to-GDP ratio would decline from 17 percent in 2005 to below 4½ percent in 2006.

Buoyant hydrocarbon revenues have enabled a strong increase in public spending. The 2005-09 public investment program was increased considerably, and civil service wages were raised by about 15-16 percent on average. As a result, the nonhydrocarbon primary deficit is expected to widen from about 33½ percent of NHGDP in 2005 to almost 37½ percent in 2006, but the overall budget surplus would remain at about 12 percent of GDP in 2006.

Monetary policy remained prudent, in line with the authorities' objective of containing inflation. The Bank of Algeria continued to absorb most of the excess liquidity of the banking system through deposit auctions in 2006 and the expansion of credit to the economy slowed.

Some progress was made in structural reforms. The privatization of one public bank and the modernization of the payments system are underway. The governance of the remaining public banks is being strengthened and supervision has become more active, mainly through on-site inspections. However, nonperforming loans of public banks remained high. The corporate profit tax rate was reduced from 30 percent to 25 percent, and the taxation of small enterprises was streamlined by introducing a single presumptive tax. Privatization of public enterprises is proceeding and an anticorruption law was adopted in January 2006.

Executive Board Assessment

Executive Directors commended the authorities for their prudent macroeconomic policies and welcomed Algeria's encouraging economic performance in recent years, noting the decline in the unemployment rate, sustained economic growth, low inflation, and comfortable external and fiscal positions in the wake of high world energy prices.

Looking forward, Directors agreed that the country's increased political stability and favorable financial situation present an invaluable window of opportunity for achieving high growth and further reducing unemployment, while maintaining macroeconomic stability. They underscored the importance of ensuring sound management of hydrocarbon resources and pressing ahead vigorously with structural reforms to increase productivity and improve the business climate.

Directors welcomed the authorities' ongoing reassessment of projects included in the public investment program and the commitment to take into account the recommendations of the public expenditure review conducted in cooperation with the World Bank. They cautioned that, given the limited absorptive capacity, a slower pace of project implementation may be desirable to ensure a high quality of the public investment program and avoid undue strain on monetary policy. In addition, they encouraged the authorities to focus on the execution and monitoring of existing projects, accelerate budget modernization, and strengthen fiscal governance by implementing the recommendations of the 2004 fiscal Reports on the Observance of Standards and Codes.

Directors noted the authorities' intention to maintain fiscal sustainability over the medium term. In this context, they welcomed the new rules governing the hydrocarbon stabilization fund and recommended aiming at a higher investment return. They were also encouraged by the recently concluded National Economic and Social Pact, which

supports linking real wage increases to productivity growth and economic performance in the nonhydrocarbon sector, noting that it would help preserve Algeria's competitiveness as the economy opens up further.

Directors commended the authorities for the prudent conduct of monetary policy that has kept inflation under control. In light of the expected external inflows, the planned increase in public investment, and the wage increases, Directors welcomed the authorities' intention to pursue a tight monetary policy stance. In this respect, they supported the authorities' intentions to maintain the Bank of Algeria's policy interest rate positive in real terms and to continue managing the exchange rate in a flexible manner.

Directors were of the view that financial sector reform and a significant deepening of financial intermediation will be necessary to foster private sector activity. In this respect, they pointed to the need to push ahead decisively with the privatization of public banks, strengthen the governance of the remaining public banks, and promote competition in the banking sector, while avoiding bank lending to nonviable public enterprises. Directors also looked forward to the update of the 2003 Financial Sector Assessment Program.

Directors welcomed the authorities' pursuit of WTO accession and their intention to implement the action plan to reduce obstacles to regional trade following the 2005 conference on trade facilitation in the Maghreb. They welcomed the recent promulgation of the new exchange regulation that is aimed at removing the remaining ambiguities regarding the current convertibility of the dinar.

Directors urged the authorities to accelerate other structural reforms, in particular streamlining the tax system, completing the ongoing reform of the tax administration, and modernizing the customs administration. They also welcomed the authorities' intention to gradually increase the pass-through of world oil prices to domestic energy prices.

Directors praised the authorities' policy to prepay external debt and encouraged Algeria to participate as a creditor in the enhanced Heavily Indebted Poor Countries Initiative, and obtain a sovereign rating.

Directors encouraged the authorities to intensify their efforts to upgrade the production and dissemination of economic and financial statistics, including by benefiting from technical assistance under the General Data Dissemination System.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.