Directors emphasized that the expansionary fiscal stance of recent years needs to be contained over the medium term to protect Algeria’s capacity to withstand negative and prolonged hydrocarbon revenue shocks. They welcomed the authorities’ commitment to undertake fiscal consolidation, starting with the 2011 budget. Continued fiscal reform will be critical for increasing nonhydrocarbon revenues and containing public spending, including greater control of the public sector wage bill, better targeting of transfers and subsidies, and prioritizing public investment projects. Directors also welcomed the efforts being made to improve the quality and efficiency of public expenditure as well as pursue budget system reforms.

Directors commended the Bank of Algeria for successfully containing inflationary pressures through sterilizing excess liquidity associated with high oil revenues and large public spending. They encouraged the authorities to tighten the stance of monetary policy in case these pressures were to increase.

Directors noted that the current exchange rate regime has served Algeria well. They welcomed the authorities’ policy to maintain the real effective exchange rate close to equilibrium, consistent with external stability. Containing government spending would contribute to reducing pressures for real exchange appreciation and potential “Dutch disease” effects.

Directors stressed that a more forceful implementation of structural reforms will be crucial for diversification of the economy, improving the business climate and competitiveness, as well as boosting growth and employment. Welcoming the authorities’ efforts to enhance the infrastructure, they emphasized that stronger measures will be necessary to improve the investment climate. Directors considered that the new rules on foreign direct investment could discourage foreign investors and hamper growth. They encouraged the authorities to continue to seek a better integration of Algeria in the regional and global economy.

Directors emphasized the importance of accelerating financial sector reform. Effective implementation of the recommendations of the 2007 Financial Sector Assessment Program Update would strengthen financial supervision and monitoring. Noting the recent decline in Non-Performing Loans (NPLs), Directors stressed that efforts were also needed to further reduce the high level of NPLs in public banks. Improving the governance of public banks and further modernizing their operational framework would help enhance financial intermediation. Efforts should also be made to bring these banks to the highest international standards, including through partnerships with foreign institutions.

Background

Despite the effects of the international crisis, real nonhydrocarbon gross domestic product (NHGDP) growth in 2009 exceeded the average of 6 percent seen over the past decade. The overall inflation rate rose in 2009 due to a surge in fresh food prices, but nonfood inflation remained low. Unemployment continued to fall, reaching 10.2 percent at end-2009, although youth unemployment remained high. The prudent macroeconomic management of the last ten years also enabled large external reserves to be accumulated and sizable budgetary savings to be built up in the oil stabilization fund, while maintaining a very low level of debt.

Algeria weathered the international crisis relatively well. The strong growth in NHGDP of 9.3 percent in 2009 was driven by an excellent cereal harvest and good performance in the Public Investment Program (PIP)-led service and construction sectors. However, the substantial drop in hydrocarbon output (-6.0 percent) lowered overall growth to about 2½ percent. The stabilization of the hydrocarbon sector and the dynamic performance of the PIP-related sectors should lead to an overall growth of 3–3½ percent in 2010.

Algeria has continued to maintain its expansionary fiscal stance, helping to support the nonhydrocarbon sector. The budget will remain in deficit despite the rise in hydrocarbon revenues and the country is expected to post its second consecutive budget deficit of the decade in 2010, which could reach 4 percent of GDP. The positive impact of the increase in total revenues will be offset by an increase in total expenditures, following a rise in civil service salaries due to the leveling of pay scales. Capital expenditure is expected to remain at the high levels of 2008 and 2009 with the continuation of the 2005–09 PIP.

The current account surplus deteriorated in 2009 but improved significantly in 2010 due to higher hydrocarbon exports, leading to an increase in external reserves. During the first nine months of 2010, hydrocarbon export revenues increased by about 32 percent from the previous year. Official reserves have risen by about US$8 billion since end-2009 to US$157 billion as of end-September 2010.

Algeria’s economy has continued to perform well but the main challenge remains to ensure sustainable, diversified and private investment-led growth to reduce unemployment further, especially among the young, and to improve the standard of living of its population.