Algeria: Decline in hydrocarbon sector slowing the economic growth

Feb 13, 2014 12:00 AM

Economic performance last year was satisfactory. Inflation, which reached 8.9 percent last year, has decelerated significantly in 2013 thanks to fiscal consolidation and prudent monetary policy, according to the International Monetary Fund (IMF) Executive Board statement.

Real gross domestic product (GDP) growth is expected to slow to 2.7 percent from 3.3 percent in 2012, reflecting a continued decline in hydrocarbon sector output and lower public spending, somewhat offset by the strong growth of private demand and investment by state-owned enterprises.

However, Algeria’s external position, though still very strong, has started to weaken. The current account surplus is expected to narrow to 1.1 percent of GDP in 2013, as robust domestic hydrocarbon consumption, together with declining prices, weighs on hydrocarbon exports and import growth remains sizeable.

Risks are tilted to the downside: Algeria is vulnerable to a prolonged decline in oil prices, a worsening of the global environment, further pressure on the hydrocarbon rent, and an intensification of regional tensions. Outward spillovers are likely to be limited.

Algeria faces a number of challenges. Despite stabilization in 2013, new inflationary pressures may arise following the recent surge in credit and a new increase in public sector wages.

Fiscal and external vulnerabilities to developments in the hydrocarbon sector are worsening, as the domestic consumption drag on export volumes is compounding the longstanding risk related to lower oil prices.

In addition, notwithstanding the ongoing consolidation, fiscal policy is not on a sustainable path. It is de facto pro-cyclical, and the non-hydrocarbon primary deficit is well above its long-term sustainable level, implying negative net public savings in the long run.

Finally, shortcomings in competitiveness and productivity are weighing on economic growth, which remains below its potential and below the level required to significantly reduce unemployment, especially for youth and women. Although stable, the financial sector is underdeveloped, constraining access to financing, in particular for small- and medium-sized enterprises.

IMF Executive directors endorsed staff’s appraisal, as follows: Algeria’s economic performance, marked notably by the decline in inflation, unemployment and inequality, has been good. However, strong credit growth and another public sector wage increase call for continued caution over price stability. In addition, the economy’s vulnerability to developments in the hydrocarbon sector worsened, as declining hydrocarbon production and surging domestic consumption are squeezing export volumes, compounding the longstanding risk of lower oil prices. Finally, unemployment remained high among youth and women. Against this background, the authorities are encouraged to take measures to consolidate macroeconomic and financial stability, ensure long-term fiscal sustainability, and promote strong private sector-led non-hydrocarbon growth and robust job creation.

The decline in inflation brought about by monetary tightening and fiscal consolidation is welcome. However, the recent surge in credit to the economy, together with the planned increase in current spending in 2014, could revive inflationary pressures, and the Banque d’Algérie should stand ready to increase liquidity absorption and raise interest rates if needed. Avoiding new increases in current spending, and financing the budget deficit by issuing debt rather than by drawings from the oil fund, would also help.

The fiscal consolidation initiated in 2013 should continue in order to ensure fiscal sustainability. This implies containing the wage bill; gradually phasing out subsidies while establishing a targeted cash-transfer system to protect the poor; stabilizing transfers to public entities in real terms; and reducing tax exemptions. To protect economic growth, it will be important to preserve capital spending and enhance its efficiency and effectiveness.

Algeria should adopt a full-fledged fiscal rule to better manage hydrocarbon revenue volatility and attain fiscal sustainability. A fiscal rule using a backward-looking average oil price and setting a limit on the structural primary balance consistent with long-run fiscal sustainability would improve the management of hydrocarbon revenue. Further, the oil fund could be transformed into a sovereign wealth fund, and annual ceilings on drawings established to preserve financial savings. To improve public financial management, the transparency of hydrocarbon revenue collection should be increased and an integrated financial management information system developed.

Preserving fiscal and external sustainability would call for increasing hydrocarbon production and extending the time horizon of reserves. It will be important to improve the business environment, attract Foreign Direct Investment (FDI) in the hydrocarbon sector, and swiftly implement the national oil company’s investment plans. Phasing out implicit subsidies would help contain domestic energy consumption and support exports.

The authorities should continue targeting the equilibrium real effective exchange rate to protect the competitiveness of non-hydrocarbon exports. The premium in the illegal parallel exchange market is detrimental to growth and should be forcefully tackled. Furthermore, there is a case for increasing the indicative foreign exchange ceilings for travelers to more realistic levels.

The stability of the financial sector is welcome. To support its development, competition in the banking sector should be fostered, the development of credit bureaus sped up, the guarantee mechanisms revisited, collateral and insolvency regimes strengthened. The ban on consumer lending should be lifted, and more space provided for mortgage finance.

Issuing more sovereign debt and listing well-performing state-owned enterprises on the stock exchange, while removing disincentives to private sector debt and equity issuance, would support the development of capital markets. Finally, immediate steps need to be taken to address deficiencies in the Anti-Money Laundering/Combating the Financing of Terrorism framework.

To accelerate economic growth and job creation, wide-ranging structural reforms are needed. Improving the business environment, enhancing cost competitiveness, and relaxing the restrictive FDI regime are of particular importance, together with deeper trade integration through WTO accession, trade facilitation, and export promotion. Reforms are needed to increase labor market flexibility and ensure that job seekers are equipped with the right skills.

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