Algeria to diversify, reshape economy as oil revenues decline

The International Monetary Fund headquarters' complex in Washington. (AP Photo/Cliff Owen)

*The International Monetary Fund headquarters’ complex in Washington. AP Photo/Cliff Owen.

22 May 2016, Sweetcrude, Washington D.C — Growth in Algeria remained stable in 2015 at 3.9 percent, but the country is facing important challenges given the large decline in oil prices, said the IMF in its latest assessment.

The government has started to undertake fiscal consolidation and initiated some reforms, but more needs to be done to adequately respond to the magnitude and persistence of the oil price shock and address long standing vulnerabilities. Speaking to IMF Survey, IMF Mission Chief for Algeria, Jean-François Dauphin, said that if well managed, the current situation offers an opportunity to reshape Algeria’s growth model.

What’s the outlook for Algeria? How do you see prospects for the country’s economy?

The outlook depends very much on the authorities’ policy response to the oil price shock. Thanks to savings accumulated in the past and very low debt, Algeria can afford to adjust to the shock and implement reforms gradually. But it cannot afford to let this moment pass without taking action.

In the near term, growth is projected to slow as the government undertakes necessary fiscal consolidation. Over the medium term, however, a critical mass of structural reforms could lead to a more dynamic and diversified economy, with stronger growth and more job creation. By contrast, insufficient reforms could ultimately result in economic hardship if an exhaustion of the country’s fiscal and external space were to lead to a sudden and more drastic adjustment.

Can you talk a little bit more about the impact of the oil price shock on Algeria? Has the government taken any steps to reduce the dependence on oil and diversify the economy?

Although the drop in oil prices has yet to translate into slower growth, it has significantly weakened Algeria’s fiscal and external balances. The fiscal position-already weakened by a ramp-up in spending in the wake of the Arab Spring has deteriorated further as oil revenues have plummeted. Fiscal savings have been nearly depleted to finance large budget deficits. Following several years of comfortable surpluses, the current account balance has swung sharply into deficit and official reserves, while still large, are diminishing. Public and external debt, however, remain low. The banking system as a whole appears healthy, but the fall in oil price increases financial stability risks.

The policy response in 2015 was insufficient, but the 2016 budget calls for a sharp reduction in spending, and the authorities have initiated some reforms, including a much -needed reform of the subsidy system and a strengthening of the financial sector prudential framework. The authorities will need to implement wide-ranging structural reforms to reduce Algeria’s dependence on oil and diversify the economy.

Unemployment increased this year and is particularly high for youth populations (about 30 percent). What can the authorities do to create more jobs and more inclusive growth?

Dauphin: To create more jobs and more inclusive growth, the authorities need to transform Algeria’s state-led, hydrocarbon-based growth model into one that is more diversified and led by the private sector. Such a transformation will require an ambitious structural reform agenda.

Key reforms include improving the business climate, for instance by streamlining regulations and administrative procedures and making it easier to start a business, as well as opening up the economy to more trade and investment, improving access to finance, developing capital markets, and strengthening governance, competition, and transparency.

The functioning of the labor market also needs to improve. In that respect, the ongoing revision of the labor code is a good opportunity to enhance the flexibility of the labor market while ensuring adequate protection for workers. Importantly, closer ties between the educational system and the private sector could help ensure a better match between the skills acquired by job seekers and those needed by employers.

You say that sustained fiscal consolidation will be needed. Is there a good way to implement it?

Dauphin: Fiscal consolidation is indeed a necessity to restore fiscal sustainability and help support the external adjustment while structural reforms can help mitigate its impact on growth. The consolidation needs to be conducted on several fronts. These include: mobilizing more non-hydrocarbon revenues, notably by reducing tax exemptions and strengthening tax enforcement; containing current spending; pursuing further subsidy reform while protecting the poor; curtailing public investment while significantly increasing its efficiency; and strengthening the budget framework.

Because fiscal savings have been declining rapidly, Algeria will need to rely more on other sources to finance future deficits. The low debt levels give space to increase borrowing while opening the capital of some state-owned enterprises to private investors, in a transparent way, would also help meet financing needs while improving their governance.

You also mentioned subsidy reform. What is the extent of subsidies in Algeria, and what needs to be done about them?

We estimate that subsidies cost about 14 percent of GDP in 2015. Their fiscal cost is not the only problem: subsidies are largely unfair, as they benefit the most affluent much more than the poor. For instance, the 20 percent richest households spend, on average, six times more on subsidized fuel products than the 20 percent poorest households. Furthermore, subsidies also encourage over consumption, and lead to economic and environmental distortions. Further reducing, gradually, generalized subsidies and replacing them with a well-targeted cash transfer system to protect the most vulnerable households would make the system fairer, while reducing its cost.

How exposed is Algeria’s economy to spillovers from regional conflicts?

Regional conflicts are a source of concern even if low trade and financial flows within the region have limited their direct impact on the Algerian economy. In that regional context, maintaining social stability is crucially important. The risk though is that, because of these concerns, difficulties in garnering consensus for the needed reforms complicate their implementation and, ultimately, lead to a more abrupt adjustment. To navigate this trade-off, an effective communication campaign can help raise awareness about the benefits of reforms in particular, higher growth and more sustainable sources of job creation, the cost of inaction, and how the burden of adjustment will be shared.

Algeria recently adopted a new constitution to foster greater transparency, better governance and a more market-based economy. What supporting role can the IMF play in helping the authorities achieve these objectives?

These are indeed key objectives and the signal sent by the new constitution is important. For our part, the IMF remains fully committed to helping Algeria achieve these goals and adjust to the oil price shock, through our close policy advice and technical assistance.

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