Algeria - Economic Rehabilitation Loan (ERL)

Report No. PIC486 Project Name Algeria-Economic Rehabilitation Loan (ERL) Region Middle East and North Africa Sector Structural Adjustment Lending Project ID DZPA35704 Principal Responsible Agency National Planning Council Date PID Prepared August 1994 Projected Appraisal Date September 1994 Projected Board Date November 1994 I. THE ADJUSTMENT PROGRAM 1. In the first quarter of 1994, the further weakening of world oil prices, the drying up of external financing, growing macroeconomic imbalances, rising inflationary pressures and a build-up of external debt arrears convinced the authorities to accelerate the implementation of economic policy reforms, for which they have requested the financial assistance of the Bretton Woods institutions and other creditors. 2. The key development issue facing Algeria is how to foster a resumption of sustainable economic growth while coping with the immediate economic and social problems of high unemployment, a severe housing crisis, and shortages of basic necessities. The authorities have developed a three-pronged strategy to meet this challenge: (i) implement a stabilization program to correct macroeconomic imbalances and distortions with the technical and financial support of the IMF; (ii) approach the key creditors for a rescheduling of the country's official bilateral external debt (Paris Club), as well as a restructuring of its commercial debt (London Club), in order to finance an increase in the severely compressed level of imports; and (iii) accelerate the transition to a market economy by reinvigorating the structural reform program with the support of the Bank. The Stabilization Program 3. On May 27, 1994, the IMF Board approved a one-year stand-by arrangement (in four quarterly tranches) and a request for a purchase under the compensatory and contingency financing facility, for a total of SDR 731.52 million. The program period is from April 1, 1994 to March 31, 1995. The key elements of the stand-by program are: adjustment of the exchange rate and reform of the exchange regime, trade liberalization, domestic price liberalization, deficit reduction, monetary restraint and higher interest rates. The program also provides for an explicit increase in budgetary allocations for the social safety net to alleviate the impact of stabilization on the most vulnerable groups of the population. External Debt Rescheduling 4. Although the total stock of external debt of Algeria of around US$ billion in 1993 is not large relative to many other middle-income countries, its average maturity has steadily decreased, and was only  about three years prior to the recent Paris Club rescheduling. In early 1994, the drop in world oil prices and difficulties in mobilizing external financing prompted the authorities to reconsider the option of formal debt rescheduling. Following approval of the stand-by arrangement, the Government reached agreement with the Paris Club for a rescheduling based on favorable terms: 15 years, including 4 years of grace, with a cut-off date of September 30, 1993 and rescheduling of interest payments on official debt through October 1994. The authorities have also approached commercial creditors for a restructuring of London Club debt on equivalent terms. Structural Reform Program 5. The basic objective of the structural reform program is to ensure a sustainable supply response to macroeconomic stabilization by enhancing the role of market forces. To accomplish this, the reforms must eliminate structural rigidities, correct distorted incentives, and promote domestic and external competition. At the microeconomic level, developing the private sector and restructuring the PE sector are crucial priorities. In parallel, the emerging agricultural supply response must be strengthened and consolidated by restructuring off-farm services to encourage competition. Moreover, nascent structural reforms in financial and labor markets need to be deepened to promote factor redeployment and more efficient allocation of new resources in response to changes in relative prices. Medium-term Policy Framework and Outlook 6. Accompanied by a deepening of structural reform, the stabilization program will provide a solid basis for a medium-term macroeconomic framework geared to supporting adjustment and setting the economy on a permanent high growth path. Sustained growth is important to maintaining the momentum of the structural reform program and the transition to a market economy. A key objective is a steady reduction in the debt service ratio which would trigger a sustained boost in import capacity. While the amount of growth that higher import capacity can generate over the medium term will depend on the costs of adjustment, notably PE restructuring, the objective is to create jobs at a rate at least equal to the 4% growth rate of the labor force. This would lower the unemployment rate and ease social tensions. Restored growth would also support faster structural adjustment, which, in turn, would accelerate the transition to markets and generate a more rapid improvement in economic efficiency. The resulting increase in market forces and productivity would help to sustain growth, and provide for a more flexible response to adverse external shocks. As the reforms take hold, sustained growth and greater efficiency would support further increases in per capita consumption. Of course, it is possible that growth could falter over the medium term because of higher-than-expected adjustment costs. This highlights the need for continuous efforts to convince the population of the necessity and credibility of the adjustment program in order to sustain popular support. II. THE PROPOSED LOAN Rationale -2-  7. Two main reasons justify the proposed operation: (i) it will help the authorities define and implement measures to accelerate the transition to a market economy; and (ii) it will contribute to, and help catalyze, the international community's efforts to mobilize the substantial external financing package needed to support restored growth and bolder economic reform. The proposed loan is a continuation of the Bank's efforts to help Algeria in implementing critically important reforms needed to assure sustained growth, particularly in the areas of enterprise and financial sector restructuring, private sector development and privatization. 8. As explained earlier, restarting the engine of growth requires a loosening of the external resource constraint. The international community has launched a concerted effort to reduce Algeria's debt service burden and provide additional resources. The objective is to increase imports from their critically low level of 1993. The multilateral institutions, including the Bank, are foreseen to play an important financing role, and the IMF program includes this source of financing. The proposed SAL would contribute to the external financing plan. Taken together, disbursements from adjustment (and adjustment- like) Bank loans during 1994 could amount to as much as US$600 million. Loan Features 9. The proposed SAL is designed to support the next phase of structural reforms in the context of the macroeconomic stabilization program. It would cover the following areas: - Development of the Private Sector - Reform and Restructuring of the Public Enterprise Sector - Public Expenditure Reform - Financial Sector Reform - Strengthening of the Social Safety Net Development of the Private Sector 10. The proposed SAL would build on the existing basis for private sector development in three areas: (i) promoting private investment, (ii) stimulating competition, and (iii) promoting the development of the strategically important SME sector which offers the brightest prospects for job creation during the transition period. Reform and Restructuring of the Public Enterprise Sector 11. The proposed SAL would support the development and initiation of a privatization program. It would also support the establishment of a market-oriented framework for implementing the medium-term restructuring plans for the core group of 23 non-autonomous PEs covered under the Enterprise and Financial Sector Adjustment Loan (EFSAL), approved in 1991. Public Expenditure Reform 12. Fiscal adjustment and more efficient public expenditures are key objectives of the stabilization and reform program. The proposed SAL -3 -  would support fiscal adjustment through: (i) a further withdrawal of the Treasury from the financing of PE investments, and (ii) explicit limits on future Treasury expenditures on the financial restructuring of PEs. Financial Sector Reform 13. The proposed SAL would support a deepening of the financial sector reforms through: (i) extension of the prudential regulations to cover a broader range of market activities; (ii) measures to strengthen banking supervision; (iii) a market-oriented framework for the institutional development of the existing public banks; (iv) clear rules for applying the new ceiling on bank margins, and a review of its impact; and (v) studies of measures to encourage the creation of private banking institutions, and of the modalities for privatizing the existing banks. Strengthening the Social Safety Net 14. The proposed SAL would support the implementation of two measures to strengthen the social protection system: (i) the introduction of a system to protect redundant workers, including a national unemployment insurance scheme; and (ii) a reform of the social safety net introduced in 1992 to compensate for price increases in subsidized food staples. Risks 15. There are essentially two types of risks related to the implementation of the reform program to be supported by the proposed SAL: internal problems related to the political situation in the country, and risks related to negative external shocks. With regard to external shocks, the two main relevant factors for Algeria are the world oil prices and the value of the US dollar. Contact Point: Public Information Center The World Bank 1818 H Street, N.W. Washington, D.C. 20433 Telephone: (202)458-5454 Fax No.: (202)522-1500 Note: This is information based on an evolving project. Certain components may not necessarily be included in the final project. - 4 -