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IMF gives thumbs-up to Algeria's economic performance

Challenges ahead include transition to market economy

Executive directors of the International Monetary Fund commended Algeria's strong macroeconomic performance in recent years, which has been marked by higher economic growth, low inflation, and rapidly growing international reserves. Unemployment has come down gradually, although it remains very high. Favorable world energy prices played a major role in achieving these results, but a fiscal stimulus also added impetus to economic growth. Furthermore, Algeria's economic outlook for 2005 and beyond remains favorable.

Directors called on the authorities to seize the opportunity provided by the current favorable economic climate and improved security situation to consolidate macroeconomic stability, sustain high economic growth, and significantly reduce unemployment.

The key challenges in achieving these objectives will be to accelerate the transition to a market economy, diversify the sources of economic growth, and establish a framework for sound management of the country's hydrocarbon wealth.

To meet these challenges successfully, the Algerian authorities will need to accelerate the implementation of structural reforms, with emphasis on strengthening the financial sector, creating a business environment conducive to private investment, and increasing the competitiveness and resilience of the economy.

Directors acknowledged that achieving the appropriate balance between using large hydrocarbon revenues for investment in physical and human capital to accelerate the transition to a more diversified market economy and saving the hydrocarbon wealth for future generations represents a key challenge for a natural resource-rich economy.

The authorities were commended for the prudent medium-term fiscal policy presented in the 2005 budget. Directors noted that the planned fiscal consolidation will put public finances on a path that is compatible with the sustainable spending of hydrocarbon resources. They regarded the containment of spending in 2005 as a first step toward reducing fiscal vulnerability. They acknowledged that priority capital and social spending should be protected, including programs for human capital development, and noted the sizeable capital budget planned for the medium term. However, they stressed that the investment process will need to be carefully managed to reduce waste, minimize the impact on current spending in the future, and enhance transparency.

Directors welcomed the authorities' continuing resolve to focus monetary policy on maintaining low inflation. They reiterated their concern about the potential impact of the high excess liquidity on macroeconomic stability and financial system soundness. Therefore, most directors encouraged the authorities to deal with the hydrocarbon company's deposits outside the money market and to mop-up the residual excess liquidity.

It was observed that the managed float of the exchange rate continues to serve the country well. They welcomed the Bank of Algeria's commitment to continue implementing the managed float in a flexible manner to bolster resilience to external shocks and export diversification prospects. Directors supported the authorities' request for IMF technical assistance to improve the exchange system and develop the foreign exchange market to help reduce the large spread between the official and parallel market exchange rates.

Directors urged the authorities to give priority to developing an efficient and sound banking system. They drew attention to the adverse impact on the banks' balance sheets stemming from lending to loss-making state-owned enterprises. Directors therefore welcomed the tighter control of public bank managers and the inclusion of subsidies in the 2005 budget to replace some loans to loss-making enterprises. They emphasized, however, that these subsidies should be temporary and set in the context of a public enterprise restructuring program. They urged the authorities to reverse the decree prohibiting public entities from dealing with private banks, to move ahead with the privatization of a number of public banks, and to significantly strengthen bank supervision.

The important progress achieved in trade liberalization was commended and the authorities' commitment to reform trade within a multilateral framework, ahead of joining the World Trade Organization. In particular, directors welcomed the continuing implementation of the comprehensive tariff reform since 2001 and look forward to early ratification of the EU

Association Agreement. They encouraged the authorities to improve customs administration in order to combat corruption and smuggling more effectively, and to strengthen regional cooperation.

Directors encouraged the authorities to reduce the state's direct involvement in the productive sectors through more rapid and extensive privatization of state-owned enterprises. They cautioned that making privatization conditional on the maintenance of jobs and activity could hinder the privatization program, and recommended replacing these conditions with social safety net measures. More generally, directors called for a clear articulation of Algeria's privatization strategy so as to provide unambiguous signals to private investors.

The authorities were encouraged to continue efforts to improve governance, which directors consider crucial to improving the investment climate and prospects for private sector-led growth. They welcomed the preparation of a draft organic public finance law to improve fiscal transparency, and urged the authorities to take further steps to improve transparency.

Beirut,02 14 2005
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