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. If well managed, the current situation offers an opportunity to reshape Algeria’s growth model.

Executive Board Assessment

In concluding the 2016 Article IV Consultation with Algeria, Executive Directors endorsed staff’s appraisal as follows:

Algeria’s economy is facing a severe and likely long-lasting external shock, calling for a vigorous policy response built on fiscal consolidation and structural reforms. The collapse in oil prices has exposed longstanding vulnerabilities in a state-led economy that is overly dependent on hydrocarbons. Thus far, the impact of the oil price shock on growth has been limited, but fiscal and external balances have deteriorated significantly. Thanks to buffers accumulated in the past, Algeria has a window of opportunity to smooth the adjustment to the shock and reshape its growth model. Restoring macroeconomic balances will require sustained fiscal consolidation over the medium term combined with a critical mass of structural reforms to diversify the economy, while exchange rate, monetary, and financial policies should play a supporting role. Communication to build a consensus around the needed reforms will be important to ensure their timely implementation.

Fiscal consolidation will need to be sustained over the medium term to restore fiscal sustainability, ensure intergenerational equity, and support external stability. It will require controlling current spending, pursuing further subsidy reform while protecting the poor, mobilizing more nonhydrocarbon revenues, increasing the efficiency of investment, and strengthening the budget framework. Rapidly declining fiscal savings mean that Algeria will need to borrow more to finance future deficits. In addition to increasing domestic debt issuance, the authorities should consider borrowing externally and opening the capital of some state-owned enterprises, in a transparent way, to private participation.

Wide-ranging structural reforms are needed to help support economic activity during the fiscal consolidation and to diversify the economy. Key reforms include improving the business climate, opening up the economy to more trade and investment, improving access to finance and developing capital markets, and strengthening governance, competition, and transparency. Increasing the flexibility of labor markets while better matching the skills produced by the educational system to those needed by the private sector is also needed. Import restrictions, while perhaps providing a temporary relief, introduce distortions and cannot substitute for reforms aimed at boosting exports. As structural reforms take time to bear fruit, they should be started without delay.

Together with fiscal consolidation and structural reforms, greater exchange rate flexibility would support the adjustment to the oil price shock. Despite some depreciation in 2015, the REER remains significantly overvalued. Fiscal consolidation and structural reforms, together with greater exchange rate flexibility, would help bring the REER in line with its equilibrium value and contribute to the rebalancing of the economy.

Monetary policy must adjust to a changing liquidity environment while guarding against potential inflationary pressures. The BA is appropriately adjusting to a changing liquidity environment by reactivating its lending instruments and strengthening its liquidity forecast and management capacity. Going forward, it should carefully calibrate monetary policy to guard against potential inflationary pressures.

Financial sector policies should be further strengthened to address growing financial stability risks. The banking sector as a whole is well capitalized and profitable, but protracted low oil prices increase financial stability risks. Moreover, the strong links between the financial, hydrocarbon, and public sectors increase the vulnerability of banks to systemic risks and call for preemptive actions. The authorities should continue their efforts to strengthen the prudential framework, including by enhancing the role of macroprudential policy, and improving crisis preparedness and management.