Algeria - Structural Adjustment Loan (SAL)

Report No. PIC3006 Project Name Algeria-Structural Adjustment Loan (SAL) Region Middle East and North Africa Sector Multi-Sector Project ID DZPA36076 Borrower Democratic and Popular Republic of Algeria Principal Responsible Agency National Planning Council (CNP) Contact: National Planning Council (CNP) Tel: 011.213.2.92.53.23 Fax: 011.213.2.79.94.72 Date PID Prepared December 1995 Project Appraisal Date January 1996 Projected Board Date March 1996 Country Background 1. After independence in 1962, Algeria followed a central planning model of growth characterized by heavy industrialization and extensive social infrastructure development. The development program relied heavily on hydrocarbon revenues. During this period, Algeria achieved important social progress. Illiteracy was reduced, life expectancy increased, and primary school enrolent reached close to 100 percent. By the end of the 1970s, however, there were clear signs that the model followed had resulted in an inefficient allocation of resources and presented poor growth prospects. Productivity was low in spite of investment/output ratios from 40 to more than 50 percent, on a par with high-growth East Asian countries. 2. The sharp fall in oil prices in 1986 triggered a crisis with hydrocarbon exports falling from US$12.7 billion in 1985 to an average of US$7.7 billion in 1986-88. Realizing that the situation was unsustainable, the Algerian Government took initial steps to liberalize the system, both on the political and the economic front. A wide number of policy measures were undertaken, ranging from the dismantling of state farms to the removal of barriers to foreign investment, increasing the private sector's access to credit and foreign exchange, and the abolishing of state import monopolies. In addition, most public enterprises (PEs) became autonomous, collective bargaining was decentralized, and the central bank was given much greater autonomy in monetary policy. The IMF and the World Bank actively supported these reforms. The Bank's support included two adjustment operations, an Economic Reform Support Loan approved in 1989 and an Economic and Financial Sector Adjustment Loan approved in 1991. 3. The period 1992-1993 was marked by increasing civil strife and some slowdown in economic adjustment. Import controls were implemented in order to ration foreign exchange and to generate resources to cope with  the service of the external debt; the debt service ratio reached 73 percent in 1993. However, arrears began to appear despite these efforts and despite the government's attempt to restructure debt on a bilateral basis with key creditors. Access to foreign credit became more and more difficult. Planned structural reform measures were delayed. Subsidies and wage expenditures soared, cuinating in a fiscal deficit of 8.7 percent of GDP in 1993. In spite of these outlays, private consumption per capita fell by 4 percent and per capita output dropped another 5 percent. Early in 1994, the authorities adopted a strong new adjustment program. It received the support of the IMF in the form of a Stand-by agreement, followed early in 1995 by an EFF. The World Bank's initial support of the renewed adjustment effort was provided under the January 1995 Economic Rehabilitation Support Loan (ERL). Major Elements of the Adjustment Program 4. The Algerian authorities' adjustment program to be supported by the SAL has one key aim: to move quickly to transform the Algerian economy into one that is market-based, efficient, and productive. Efficiency will be improved through public enterprise reform, including a large-scale program of privatization of small enterprises, and the strengthening of the existing private sector. These measures will go in parallel with measures designed to improve the social safety net during transition. 5. Privatization. Privatization is the officially stated policy of the Algerian government for public sector activities in competitive sectors and probably the only effective means of increasing the efficiency of the Algerian economy. However, in the present security situation, the private market for large public enterprises is likely to be limited. The authorities' strategy in these circumstances for the large public enterprises is the following: (i) impose hard budget constraints and impose a new management system to prepare enterprises for eventual privatization; (ii) identify smaller units of these enterprises that can be sold off under current demand conditions -- or let the enterprises themselves do this as a way of raising funds; (iii) seek private management or minority equity participation for some units; and (iv) spin off service activities of the largest public enterprises to employees. At the same time, the SAL would support a large-scale program of privatization of small-scale enterprises, concentrating on activities and sectors where there is likely to be effective demand for the resources to be privatized, notably small-scale industry, commerce, services, construction, and transport. 6. Agricultural Land Tenure. The Algerian Government has announced its intention to sell off state-owned arable land and has prepared legislation to this end. The land in question was converted from state farms to small collective farms or to small individual farms with usufruct rights at the beginning of the adjustment program in 1987. However, some of the land went unexploited, partly because of a lack of complementary resources; and collective operations did not work and were de facto divided into family farms. There is now consensus within the government that farmers must own their land. The implementation of this program could start relatively soon, but its fulfilent is likely to take time, because contentious issues concerning prior property rights must - 2-  be resolved and because land registration and the development of other land market institutions must take place. 7. Public Enterprise Reform. The strategy of the Algerian authorities is to limit PEs' access to public resources, through the budget or through bad debts to the banking system made good through budget appropriations. Recent reforms in the banking system described below and supported under the ERL effectively block access of loss-making enterprises to bank credit. As outlined in the ERL program, the last remaining eighteen large non-autonomous public enterprises would be passed to autonomy, blocking routine access to Treasury financing and guarantees. Five large enterprises have already been made autonomous and nine others would be made autonomous before presentation of the SAL to the Board. 8. Incentive Framework The Algerian authorities will support the private sector indirectly, through continued improvements in the overall framework for private sector activities, and directly, through the enhancement of opportunities for the private sector to carry out activities previously in the public domain. Other than improving the overall framework for private sector activity and providing opportunities for the private sector to compete for government concessions and public works, experience in many countries shows that it is difficult to develop specific government interventions in favor of the private sector that actually work. This observation is especially relevant for small and medium enterprises, which in Algeria describes the entire private sector. However, drawing on the Private Sector Assessment (PSA) carried out during the last 12 months, the authorities have developed a program that tries to balance measures to improve the general framework for private sector activity with a few major specific interventions. 9. Reform of the Financial Sector. The strategy for the financial sector is consistent with that developed with the Algerian authorities under the ERL. As foreseen in the ERL, the next phase of financial sector reform must include measures to increase competition. Restructuring of existing banks would go on as planned under the ERL. The authorities would make the capital infusions necessary for them to meet the agreed interim capital-asset ratio of four percent and implement management contracts with the five banks. Under the management contracts, the managers have the responsibility to respect the capital adequacy guidelines. Improvements in the supervision and regulation capabilities of the central bank would also continue under the proposed SAL. Lastly, measures to introduce new markets would be implemented, concentrating on the government securities market. The Proposed Loan Objectives and Description 10. The loan supports an adjustment program that is moving Algeria closer to its goal of an open, market-based economy in the context of growth and increased employment. This proposal has been prepared in response to a government request, going back to early 1994, for support for its intensified adjustment efforts. The proposed SAL would be a - 3 -  continuation of the support provided under the ERL, approved by the Board in January 1995, recognizing the successful policy performance of the Algerian authorities under that loan, and the vital program of medium-term structural adjustment that they have already launched. 11. The key components of the program to be supported by the SAL include the following: (i) macroeconomic stabilization and the rationalization of public expenditures. In the context of the IMF EFF and in line with the recommendations of the Bank's recent Public Expenditure Review, conducted jointly with a team from the Algerian Government, the authorities will reallocate public expenditures toward primary health care, recurrent non-wage expenditures in education, road transport, and housing and will strictly limit the growth of the public sector wage bill; (ii) support for public enterprise reform and private sector development. The program to be supported also includes a major start at the privatization of public enterprises, notably small and medium scale enterprises in transport, construction and retail trade; and (iii) support for the already successfully implemented new social protection system. This system includes targeted support for the elderly and disabled, self-targeted support for the able-bodied poor through a public works program, and an unemployment insurance scheme for those laid off from their current jobs for economic reasons. Under the SAL, the authorities would continue these programs and improve them, based on recommendations arising from a recent Bank-supported assessment. Project Cost and Financing 12. The proposed Bank loan is tentatively placed at US$300 million, with possible cofinancing from the European Union (EU), Japan, Italy and the African Development Bank. Project Implementation 13. The Borrower would be the Government of the Democratic and Popular Republic of Algeria, represented by the Ministry of Finance. The National Planning Council would be the lead Project Implementation Agency for the management of the Loan. An inter-ministerial working group would be in charge of coordinating the monitoring of the program. The Loan would be made available for disbursement in two tranches of US$150 million each, the first on effectiveness, and the second after the fulfilent of a limited number of policy conditions. It is expected that the second tranche would be available for disbursement 12 months after effectiveness. Program Objective Category -4-  14. While the exact impact on poverty of the Algerian program to be supported under the SAL in Algeria is difficult to quantify, its overall qualitative impact would be positive. The Algerian authorities have already put in place a functioning social safety net designed to limit the impact on the poor of adjustment (notably as a result of the elimination of food subsidies). Under the SAL, the Algerian authorities would further improve the design and management of this safety net, in consultation with the Bank. In addition, the program is designed to provide information to improve the targeting of future social assistance. Environmental Assessment 15. The project is consistent with the Bank's environmental policies and will follow accepted Bank procedures concerning the environment. The project has been given a C rating. Contact Point: Public Information Center The World Bank 1818 H Street N.W. Washington D.C. 20433 Telephone No.: (202)458-5454 Fax No.: (202)522-1500 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. - 5 -