Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. P-6855-AL

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

TO THE

E CUTIVE DIRECTORS

ON A

PROPOSED STRUCTURAL ADJUSTMENT LOAN

IN AN AMOUNT EQUIVALENT TO US$300 MILLION

TO THE

DEMOCRATIC AND POPULAR REPUBLIC OF ALGERIA

APRIL 4, 1996

This document has a restricted distribution and may be used by recipients only in the perfornance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Unit of Currency = Algerian Dinar (DA)

1992 1993 1994 1995 JAN 1996

DA per US$, period average 21.84 23.34 35.06 47.66 53.00

DA per US$, end of period 22.78 24.12 42.89 52.17 53.77

FISCAL YEAR

January 1 - December 31

WEIGHTS AND MEASURES

Metric System

ACRONYMS AND ABBREVIATIONS

AFS Allocation Forfaitaire de Solidarite (public assistance payments to the elderlyand handicapped)

ASAL AgricuJture Sector Adjustment LoanBOP Balance of PaymentsCAS Country Assistance StrategyCNEP Caisse Nationale d'Epargne et de Prevoyance (National Housing Finance

Institution)CNPE Conseil Nationale de Participation de l'Etat (governing body for the state

holding companies)COSOB Commission d'Organisation et de Surveillance des Operations de Bourse

(Exchange Commission)EFF Extended Fund FacilityEPE Entreprise Publique Economique (Autonomous Public Enterprise)EPL Entreprise Publique Locale (Local Public Enterprise)EPS Entreprise Publique Socialiste (Non-autonomous Public Enterprise)ERL Economic Rehabilitation Support LoanEU European UnionFA Fonds d'assainissement (Restructuring Fund)ICOR Incremental Capital Output RatioIMF International Monetary FundLSMS Living Standards Measurement SurveyONS Office National des Statistiques (National Statistical Office)PAIG Programme d'Activites d'Interet General (self-targeted public assistance

program)PE Public EnterprisePER Public Expenditure ReviewPSA Private Sector AssessmentSAL Structural Adjustment LoanVAT Value Added Tax

FOR OFFICIAL USE ONLY

DEMOCRATIC AND POPULAR REPUBLIC OF ALGERIA

STRUCTURAI, ADJUSTMENT LOAN

TABLE OF CONTENTS

Page No.

Loan and Program Summary .................... i

PART I: Recent Developments and Prospects .1A. Background .1B. Performance under the Renewed Reform Program .2C. Medium-term Prospects and Financing Plan. 8

PART II: The Government's Adjustment Strategy .. 10A. Macroeconomic Program .IIB. Major Elements of the Adjustment Program .12

PART III: Algeria's Social Safety Net Strategy .18

PART IV: The Proposed Loan ........................................ 19A. Program to be Supported and Link to the Country

Assistance Strategy ................................... 19B. Poverty Impact .......... ........................... 20C. Negotiations, Effectiveness, and Proposed Tranche Conditionality ..... 20D. Procurement, Disbursement, Financial Management, and Auditing ..... 22E. Cofinancing . ....................................... 23F. Environmental Assessment .............................. 23G. Program Benefits and Risks ............................. 23

PART V: Recommendation ........... 24

ANNEXESA. Social Indicators of DevelopmentB. Key Economic Indicators, 1986-95C. Status of Bank Group OperationsD. Government Letter of Development Policy

Attachment 1 -- List of Monitorable IndicatorsAttachment 2-- Matrix of ActionsAttachment 3 -- Restructuring Fund

MAP: IBRD No. 21836

This document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disclosed without World Bank authorization.

Democratic and Popular Republic of Algeria

Structural Adjustment Loan

Summary of Proposed Loan and Program

Borrower: Democratic and Popular Republic of Algeria.

Amount: US$300 million equivalent.

Terms: Repayment in 17 years, including 5 years of grace, at the Bank'sstandard variable interest rate.

Loan Objectives: The proposed Structural Adjustment Loan (SAL) is the centralelement in the Bank's assistance strategy for Algeria. Thisstrategy aims to support the Algerian authorities in: (i)stimulating private-sector-led growth; (ii) protecting the poorduring the transition to a market-based economy; and (iii)enhancing the country's ability to mobilize external resources.The SAL builds on progress made under the recent EconomicRehabilitation Support Loan, under which the Algerianauthorities made tangible progress in adjustment and met manyof the agreed objectives, including the adoption of a privatizationlaw, sooner than anticipated.

Loan Description: The loan supports an adjustment program that is moving Algeriacloser to its goal of an open, market-based economy in thecontext of growth and increased employment. The keycomponents of the program include: (i) macroeconomicstabilization and rationalization of public expenditures; (ii)support for public enterprise reform and private sectordevelopment, including: large-scale privatization of small publicenterprises, where local demand exists; further reforms designedto limit the losses of large public enterprises and ready them forprivatization; increased private-sector participation insubcontracting and in the provision of municipal services; andfinancial sector reform designed to increase competition andcreate needed new financial instruments; and (iii) support for thealready successfully implemented new social protection system,including some measures to improve its performance. All of thespecific measures to be supported by the SAL are outlined in thegovernment's Letter of Development Policy and are listed in theattached policy matrix.

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Benefits: The key benefit would be to contribute, in conjunction with theIMF's ongoing EFF program, to the reversal of ten years ofeconomic decline in Algeria through a more efficient use ofeconomic resources. The actions to be supported by this loanwould clearly demonstrate the authorities' commitment to movequickly in establishing the necessary conditions for a market-based economy.

Risks: The risks are great, most notably the security-related risks. Thedifficult security situation complicates the process of structuraladjustment and reform. These risks cannot be totally offset.However, the fact that the authorities have taken most of themajor actions required under the loan before Board presentationminimizes, to the extent possible, the risk of policy reversal.Many of these actions, including privatization of small-scaleenterprises, will create a constituency for further reform and arelikely to keep Algeria on the path toward a market-basedeconomy.

Disbursements: The Structural Adjustment Loan will disburse in two tranches ofUS$150 million each. The first will be available upon loaneffectiveness. The release of the second tranche will beconditional on satisfactory macroeconomic performance (notablycompliance with EFF conditionality) and satisfactory progress onadjustment, including the fulfillment of a limited number ofspecific measures. The expected date for second tranche releaseis 12 months after loan effectiveness.

Poverty Category: Poverty focused; the loan acknowledges the efforts of theAlgerian authorities in successfully implementing their newsocial safety net programs, designed to minimize possiblenegative impacts of adjustment on the poor, notably as a resultof the removal of inefficient and costly generalized pricesubsidies. The two new programs, targeted payments to theelderly and handicapped without other income and a self-targetedlabor-based income transfer program for those able to work arein operation. The loan supports further improvements in thesocial safety net, including actions to improve the functioning ofthe above two programs.

REPORT AND RECOMMENDATION OF THE PRESIDENT OF THEINTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THEEXECUTIVE DIRECTORS ON A PROPOSED STRUCTURAL ADJUSTMENT LOAN

TO THE DEMOCRATIC AND POPULAR REPUBLIC OF ALGERIA

1. I submit for your approval the following report and recommendation on a proposedStructural Adjustment Loan (SAL) to the Government of the Democratic and Popular Republic of Algeriafor the equivalent of US$300 million in support of a program of structural reform and privatization. TheLoan would be at the Bank's standard variable interest rate, with a maturity of 17 years, including fiveyears of grace. The Bank's Country Assistance Strategy was presented to the Board on February 27,1996 (Report No. 15316-AL).

I. Recent Economic Developments and Prospects

A. Background

2. After independence in 1962, Algeria followed a central planning model of growthcharacterized by heavy industrialization and extensive social infrastructure development. Thedevelopment program relied heavily on hydrocarbon revenues. During this period, Algeria achievedimportant social progress. Illiteracy was reduced, life expectancy increased, and primary schoolenrollment reached close to 100 percent. By the end of the 1970s, however, there were clear signs thatthe model followed had resulted in an inefficient allocation of resources and presented poor growthprospects. Productivity was low in spite of investment/output ratios from 40 to more than 50 percent,on a par with the high-growth East Asian countries. Shortages were common and a flourishing informalsector had emerged.

3. The sharp fall in oil prices in 1986 triggered the crisis. Hydrocarbon exports fell fromUS$12.7 billion in 1985 to an average of US$7.7 billion in 1986-88. The authorities initially usedexternal borrowing to maintain consumption. In two years, the total stock of external debt rose fromUS$18 billion to more than US$24 billion; most of this new borrowing fell at the short end of thematurity spectrum. Realizing that the situation was unsustainable, the Algerian Government took initialsteps to liberalize the system, both on the political and the economic front. A wide number of policymeasures were undertaken, ranging from the dismantling of state farms to the removal of barriers toforeign investment, increasing the private sector's access to credit and foreign exchange, and the abolitionof state import monopolies. In addition, most public enterprises (PEs) became autonomous, collectivebargaining 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 twoadjustment operations, an Economic Reform Support Loan approved in 1989 and an Economic andFinancial Sector Adjustment Loan approved in 1991.

4. However, the institutional reforms failed to reverse the economic decline. The mainreasons for the lack of a supply response were: (i) little change in incentives for public sector managers;(ii) a financial sector not equipped to cope with the new demands placed on it; and (iii) a publicbureaucracy that maintained its orientation of control, rather than facilitation, of private sectordevelopment. For example, private sector access to foreign exchange improved but was limited anderratic, as demonstrated by the large gap, as much as 300 percent, between the official and parallelmarket rates from 1990 to 1993. Unemployment increased from 17 percent in 1986 to 21 percent in

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1991. An already serious housing shortage worsened to the point that the average occupancy rate perunit is now more than eight.

5. The period 1992-1993 was marked by increasing civil strife and some important reversalsof economic policy. Import controls were implemented in order to ration foreign exchange -- the privatesector was virtually excluded from access -- and to generate resources to cope with the service of theexternal debt; the debt service ratio reached 73 percent in 1993. However, arrears began to appeardespite these efforts and despite the government's attempt to restructure debt on a bilateral basis with keycreditors. Access to foreign credit became more and more difficult. Planned adjustment and structuralreform measures were delayed. Subsidies and wage expenditures soared, culminating in a fiscal deficitof 8.7 percent of GDP in 1993. In spite of these outlays, private consumption per capita fell by 4 percentand per capita output dropped 5 percent. The authorities faced an untenable economic situation.

B. Performance under the Renewed Reform Program

6. The initiation of the current reform process. In 1994, in response to the emergingnational consensus on the need for major structural reform, the authorities implemented an intensifiedstabilization and adjustment program. The program was based on 3 pillars: (i) stabilization of theeconomy; (ii) relaunching and deepening the postponed structural reform needed in order to acceleratethe transition to a market economy; while at the same time, (iii) taking actions to reverse the debilitatingdecline in living standards and to protect the poor during the transition. These actions included anincrease in the current account deficit to make room for imports necessary to stimulate growth. TheAlgerian Government needed and received the support of the international community. In March 1994,the IMF Executive Board approved a one year stand-by arrangement and a request for a purchase underthe Compensatory and Contingency Financing Facility totaling SDR731.5 million (about US$1 billion).This agreement was followed in early June by a rescheduling of Algeria's official bilateral debt at theParis Club. World Bank assistance for structural reform came in the form of an Economic RehabilitationSupport Loan (ERL) of US$150 million, approved on January 12, 1995.

7. The stabilization program for 1994/95 backed by the IMF and World Bank focused onreducing macroeconomic imbalances and, at the same time, establishing the basis for a sound and credibleprogram of transition to a market economy. Its main objectives were: moderation of the inflation rate;fiscal restraint; exchange rate realignment; and further domestic price liberalization. The policy packageincluded, among others measures: an important devaluation (80 percent and a further devaluation sincethen to 100 percent) of the exchange value of the dinar; elimination of most non-tariff trade and exchangerestrictions; the reduction of subsidies on energy and food products; freeing the prices on agriculturalinputs; imposing a ceiling on the central government wage bill; limits on bank credit to the non-autonomous PEs; and removal of the ceiling on bank lending rates. Special provisions in the programaimed at reducing the impact of the adjustment on the poorest segment of the population. Under theERL, reform measures agreed with the government included private sector development measures, a verysmall pilot privatization program, restructuring of the largest public enterprises, public expenditurereform, financial sector reform, and strengthening of the social protection system.

8. The Algerian authorities have clearly demonstrated that they are serious in the pursuit ofmeaningful adjustment. They met all the conditions of the Fund stand-by arrangement. They alsoundertook the measures foreseen under the ERL, in several cases ahead of schedule (notably the passageof a privatization law). When unexpected expenditure pressures arose at midyear, the authoritiesundertook corrective action to raise revenues (advancing cuts in subsidies) and to reduce expenditures

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(delaying wage increases) to keep the program on track. In spite of good policy performance, growthwas a disappointing -1.2 percent of GDP in 1994. Two key factors contributed to the poor outcome:a drought reduced agricultural output, and the expected increase in imports came too late in the year tocontribute to growth. The delay was in part the result of the difficulties faced by Algerian banks inmaintaining access to short-term credit after the Paris Club rescheduling.

9. Algeria's achievements through this first year of renewed adjustment were important (seecolumn 1 of Table 1). Prices are substantially free. The external trading system is open; for the firsttime, the private sector has access to foreign exchange on a market basis for trade transactions. The taxsystem has been reformed. Public enterprises face hard budget constraints -- no access to the Treasuryexcept for a handful of key enterprises on a very limited basis and access to the banking system on moreor less equal terms with the private sector. The commercial and investment codes have been modernizedand no longer favor the public sector. For example, investments no longer require government approvaland investment incentives apply equally to foreign and domestic investors, public or private. For the firsttime, the sale or dissolution of public enterprises is legally possible -- and has happened. The bankingand insurance sectors are open to private investment, in existing institutions or through the creation ofnew ones (one new private bank and a cooperative agricultural finance institution have opened). At leastas important, a vital and significant new social safety net has been put in place, comprising a self-targetedpublic works program for the able-bodied poor, a means-tested program for the elderly and handicapped,and a program of unemployment insurance for those laid off in the context of firm restructuring orclosure. To date, almost one million Algerians have benefitted directly from the three new programs;the number reaches approximately 4 million counting dependents.

10. The authorities realize that their ambition of achieving significant and sustainableeconomic growth depends on continued implementation of a strong stabilization and adjustment program.In that context, they sought the support of the IMF (and are seeking the support of the World Bank inthe form of the proposed SAL) for a medium-term reform program. On May 22, 1995 the IMF Boardapproved a three-year (April 1995-March 1998) SDR1.17 billion extended arrangement under theExtended Fund Facility (EFF). The program supported by the EFF, discussed below, targets fourobjectives: (i) ensuring high and sustainable growth; (ii) rapidly establishing a low level of inflation; (iii)strengthening the social safety net; and (iv) restoring balance of payments viability by 1998.

11. Performance under the EFF. The IMF has conducted its first review under the EFF.All the performance criteria for end-June 1995 were met, and all structural measures envisaged under theprogram have been implemented as scheduled, a few of them ahead of their target dates. Performancecriteria for end-September were met, except, however, for those relating to foreign exchange reservesand the Bank of Algeria's net domestic assets. The non-observation of these two criteria was due toexogenous factors which are temporary in nature, namely: (i) a large rise in grain prices: (ii) a shortfallof capital inflows; and (iii) a depreciation of the dollar relative to other major currencies (Algeria'sexternal debt and imports are heavily non-dollar denominated while petroleum exports are priced indollars.) In response to these shocks, the authorities have allowed the dinar to depreciate well beyondprogramn projections, maintained a tight fiscal stance, including an acceleration of the scheduled subsidyelimination, and allowed interest rates to increase. Given the policy actions taken by the authorities inresponse to these exogenous shocks, as well as their continued commitment to the macroeconomicobjectives of the three-year program, the Fund Executive Board granted a waiver for non-observance ofthe end-September 1995 performance criteria for the Bank of Algeria's net domestic assets and for foreignexchange reserves. The recent pressure on foreign exchange reserves is clear evidence of Algeria's needfor timely balance of payments support; the SAL will be a critical element of that support.

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Table 1: Algeria - Structural Reform Program

Policy Achievements prior to EFF Current Program Supported by the EFF Remaining Adjustment Agendaand Proposed Structural Adjustment I

Loan __

Trade and Exchange Reform

- Substantial exchange rate adjustment. - Establishment of an interbank foreign - Move to capital account convertibility.exchange market (end-1995, EFF) and

- Introduction of a managed float for the expansion of the interbank market to non- - Establish hedging mechanisms fordinar through fixing sessions. bank participants (1996, EFF). foreign exchange risk.

- Elimination of most exchange rate - Elimination of minimum maturity - Pursue negotiation of a Free Traderestrictions for trade transactions. requirement on external borrowing for Agreement with the European Union,

imports of capital goods, achieving full accompanied by parallel- Elimination of a broad range of convertibility for trade in goods nondiscriminatory reduction in tradeproducts from the list of products subject (completed, EFF). protection.to professional criteria requirements forimporters. - Progressive liberalization of invisible - Program of trade facilitation.

transactions, culminating in current- Elimination of negative lists for account convertibility (1997, EFF).imports.

- Elimination of export prohibitions and - Elimination of professional criteriathe adoption of a uniform export proceeds requirements for importers (completed,surrender requirement of 50 percent. EFF)

- Revise tariff rates progressivelydownward, based on the results of aneffective protection study now underwaywith Bank support (1996-1998; EFF).

Prce Liberalization

- Freeing of prices of goods accounting - Elimination of the global subsidy on (Price liberalization program is foreseenfor 80 percent of CPI basket, not energy products (domestic energy prices to be virtually complete at the end of theincluding further price liberalization noted now globally at or above world market EFF program.)below and in column 2. prices, completed. EFF).

- 98 percent increase in the weighted - Removal of subsidies on all productsaverage price of subsidized food and except wheat products and pasteurizedenergy products in the year ending in milk (completed, EFF).May 1995.

- Removal of last remaining global- Adoption of a competition law (ERL). subsidies -- wheat products (completed,

EFF) and pasteurized milk (end-1996,- Transfer of several products from the EFF).administered price category to thecontrolled profit margin category. - Elimination of profit margin controls on

sugar, all grains except wheat, edible oils- Quarterly revisions in the price of and school supplies (done, EFF).electricity and gas in line with inflationtrends. - Removal of last remaining profit margin

controls, those on medicines (1998, EFF).- Freeing of agriculture input prices.

- Freeing of construction prices for socialhousing.

Policy Achievements prior to EFF | Current Program Supported by the EFF Remaining Adjustment Agendaand Proposed Structural Adjustment

Loan

Government Budget

- Expansion of the VAT base and an - Further VAT reforms (ongoing through - Adoption of a fonmal mechanism toincrease in rates for several products. January 1997, EFF). institutionalize budget surpluses.

- Excise duty of 50 percent introduced for - Public expenditure program revisions in - Further reduction of marginal incomecars and increase in duties on luxury the context of a Public Expenditure tax rates.products and consumer appliances. Review (ongoing through 1997, SAL).

- Further reduction and rationalization of- Reduction in the maximum effective tax - Civil service reform designed to corporate income tax rates.rate for personal income from 79 percent gradually reduce overstaffing, whileto 65 percent. meeting priority needs more effectively - Continue civil service reform process

and generating savings on the wage bill started under EFF and SAL.- Increase in the tax rate on reinvested (1996-1998 in the context of the publicprofits from 5 to 33 percent as a step expenditure review, EFF/SAL). - Continued reform of budget formulationtoward a uniform corporate tax rate. and control processes started under the

- Achievement of significant budget EFF and SAL.- Elimination of tax exemptions for surplus (1998, EFF).interest earnings on treasury bonds.

- Ceiling on central government wage billand limitation of the minimum wageincrease to 12.5 percent.

- Withdrawal of the Treasury from thefinancing of new investments inautonomous public enterprises, withexceptions limited to the frameworkadopted under the ERL and establishmentof a timetable to phase out theRestructuring Fund (ERL).

Public Enterprise Reform and PrivateSector Development _________________

- Passage to financial autonomy of 5 of - Passage of a privatization law (drafted - Privatization of remaining public23 large non-autonomous public under ERL, passage -- SAL) enterprises in competitive sectors, exceptenterprises. (Almost 400 national public for a small number deemed strategic.enterprises are already autonomous.) - Implementation of a large-scale program

of privatization and private provision of - Reform, including possible- Creation of a Ministry charged with the municipal services. privatization, of public monopolies,development of a privatization program, including the national airline, railway,adoption of a privatization policy, - Adoption of a holding company and telecommunications companies.drafting of a privatization law. framework for autonomous public

enterprises, designed to isolate them from - Labor market reform; reduction in- Enactment of a revised commercial code political influence and prepare most for payroll tax rate,applying the same regulations to public privatization (SAL).and private enterprises. - Abolish public land developers; future

- Preparation of legal texts permitting the sales of public lands by auction.- Adoption of a new investment code that privatization of state agricultural landgives foreign investors rights equal to or (SAL). - Adoption of regulatory framework forsurpassing domestic investors. private pinmary, secondary, and higher

education.- Creation of a national investmentagency and a one-stop informationwindow to help cut through red tape.

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Policy Achievements prior to EFF Current Programn Supported by the EFF | Remaining Adjustment Agendaand Proposed Structural Adjustment

Loan

Pubhc Enterprise Reformn and PrivateSector Development (continued)

- Removal of the obligation to maintain - Program for the regularization of land - Development of institutions for a better-one price for a product throughout the titles or leases for commercial and functioning real estate market.country (pan-territorial pricing). industrial enterprises (SAL.

- Dissolution of 88 local publicenterpnses.

- Putting up for bids of five public hotels(one has been sold to date).

Financial Sector

- Introduction of a minimum reserve - Removal of the ceiling on bank interest - Privatization of remaining state-ownedrequirement of 3 percent on bank rate spreads (EFF). banks.deposits, remunerated at I I percent.

- Introduction of auctions for central bank - Development of a functioning stock- Elimination of the ceiling on bank credit to banks (EFF). market.lending rates and the introduction of a 5percent limit on spreads. - Achievement of positive real deposit - Further development of bond market.

interest rates (except on deposits related to- Issuance of government bonds carrying housing), in relation to underlying - Development of new privatean interest rate of 16.5 percent. inflation trend (EFF, end-1996). institutional savers and reform of existing

official institutional savers (pension- Auditing of state-owned banks and - Recapitalization of state-owned banks to funds, mutual funds, and insuranceagreement on a plan for their achieve capital adequacy ratios of 4 companies).recapitalization (ERL). percent and signing of management

contracts obliging managers to maintain - Development of an active and- Introduction of a management fee of 3.5 and increase capital adequacy ratios (to 8 competitive pnmary and secondarypercent on Bank of Algeria credit to the percent by end-1999 - SAL). mortgage market.government.

-Seek private sector participation in at - Development of financial institutions- Opening the bank and insurance least one state-owned bank (SAL). designed to service the demand for creditindustries to the private sector (latter-- from micro-enterprises.ERL). - Strengthening of prudential regulations

dealing with foreign exchange andgovernment bond transactions (SAL).

- Restructure the state housing bank (end-1996. SAL and housing loans).

- Creation of a functioning treasury billand bond market (1996; EFF and SAL).

Housing Sector

- Ongoing land registration program. - Adoption of a new housing strategy, - Shift housing fuiance from treasury-emphasizing the role of the private sector managed resources to household and

- A mechanism has been put in place for (SAL; the implementation of the strategy institutional savings, managed by aautomatic adjustment of rent on public would be supported by a Housing Sector private banking sector.rental housing. Adjustment Loan -- see CAS).

- Shift to transparent and targeted- Consolidation of some public sector housing subsidies.housing companies and liquidation ofothers. - Private sector land development in the

context of municipal plans.

Policy Achievements prior to EFF Current Program Supported by the EFF Remaining Adjustment Agendaand Proposed Structural Adjustment

Loan

Agriculture l

- Distribution of state lands held by - Preparation of laws establishing the - Carry out state agricultural landsocialist state farms to individuals and mechanisms for the privatization of state- privatization program, in the context ofcollective farms, with long-term usufruct owned agriculture land (SAL). an ASAL (see CAS).rights.

- Privatization of public agricultural - Elimination of state monopolies in- Elimination of input subsidies except for enterprises (SAL). cereal commerce, stocking, andseed potatoes and irrigation water. distribution.

- Resolve financial problems of privatizedcooperatives arising from debtsaccumulated before privatization.

- Development of modem, private sectorbased agricultural finance and riskmanagement systems.

Social Safety Net

- Elimination of system of poorly targeted - Strengthen the targeting and improve the - Carry out social protection programcash allowances for non-income-earning functioning of the PAIG, AFS, improvements, based on LSMS andfamilies. unemployment insurance schemes (SAL). poverty study results.

- Transfer of responsibility of family - Creation and implementation of a social - Overhaul of social security system.allowances from payroll taxes to the fund (1996-1998; proposed Social Safetygovernment budget. Net Loan). - Further public expenditure reform in

favor of expenditures targeted toward- Introduction of a self-targeted public - Program of public works designed to basic education and basic preventiveworks scheme (PAIG) designed to benefit unemployed workers (separate medicine.transfer income to the very poor. from the PAIG, which targets the very

poor -- 1996; proposed Social Safety Net- Introduction of a targeted transfer Loan.)scheme (AFS) for the elderly andhandicapped not benefitting from existing - Carry out LSMS to gain information forpension and benefit system. better targeting of social protection

programs (ongoing; ERL and SAL).- Introduction of an unemploymentinsurance scheme. - Revise social protection programs, based

on LSMS data and Poverty Assessment(1996; SAL).

- Reform of housing subsidy program,retargeted toward the poor (1996; housingloans).

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C. Medium-term Prospects and Financing Plan

12. Algeria's medium-term growth and balance of payments prospects are promising,provided that the authorities can maintain the momentum of adjustment (Table 2). Non-hydrocarbonoutput is projected to grow at a real rate of more than four percent between 1995 and 1998. The sourcesof non-hydrocarbon growth, as noted above, will be mainly in the construction, service, and agriculturesectors. Growth in these sectors will generate the jobs needed to blunt the growth in unemployment.Construction will benefit from the housing sector reforms, the availability of key imported inputs, theincreased use of private contractors for public works, and the privatization program. That program willput construction equipment in the hands of private operators. In addition, former public sectorconstruction workers are likely to start their own private businesses or find employment with emergingor expanding private firms. Expanded private sector activity will contribute enormously to meeting thecritical housing needs of the Algerian population. The agriculture sector will benefit from landprivatization and from the break-up of inefficient monopoly suppliers in the privatization process. Inorder to generate employment quickly, these reforms will be accompanied by labor-intensive public worksprograms aimed at unemployed youth. As explained in the Country Assistance Strategy (CAS) discussedat the Board on February 27, 1996, the public works program will be supported by the Bank.

13. While non-petroleum sectors will generate internal growth, Algeria will remain dependenton petroleum exports for a quick return to balance of payments viability, expected before the end of1998. Non-petroleum exports are projected to rise almost 300 percent between 1994 and 1998, but theirinitial level is low (US$280 million in 1994). Investments currently underway would double natural gasexports and reverse the decline in oil exports, resulting in an increase in hydrocarbon export revenuesof more than US$2 billion between 1995 and 1998 and a further sizeable increase thereafter. (Severalforeign petroleum companies, including BP, Total, REPSOL, and ARCO, have recently signed contractsto invest a total of almost US$6 billion in Algeria.) As noted in the CAS, the Bank strategy for Algeriaincludes support for policies that would further increase hydrocarbon exports.

14. The largest element in the medium-term financing plan is the rescheduling of officialbilateral debt through the Paris Club (Table 3). The rescheduling of private debt on the basis of anagreement reached with a consortium of banks and leasing companies will make a smaller but importantcontribution. These reschedulings, which provide a total of US$16 billion of debt service relief between1994 and 1998, would not have been possible without the support of the IMF, first through the 1994Stand-by and now under the EFF. The first Paris Club rescheduling, shortly after the approval of theStand-by, provided Algeria with favorable terms: a one-year consolidation period (the period in whichdebt service is reduced); a maturity of 15 years with three years of grace and a graduated principalrepayment period; a contract cut-off date of September 1993; and, importantly, rescheduling of interestbetween January and October 1994. The second Paris Club rescheduling took place shortly after theapproval of the EFF. It covered maturities falling due between June 1, 1995 and May 31, 1998; inaddition, to close the financing gap -- which widened, as noted above, between the negotiation of the EFFand the Paris Club meeting -- official creditors rescheduled US$750 million of interest payments fallingdue between June 1, 1995 and May 31, 1996. The repayment terms were the same as those for the firstParis Club rescheduling. The private debt rescheduling will cover US$3.3 billion of principal maturitiesfalling due between March 1, 1994 and December 31, 1997. Maturities vary between 10'h and 16 years(counting from March 1994), with creditors who had previously reprofiled their claims benefitting fromshorter maturities.

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Table 2: Selected Macroeconomic Indicators

1987-92 1993 1994 1995 1996 1997 1998

(In percent)

Real GDP Growth 0.4 -2.2 -1.2 3.5 5.8 4.2 3.5

-Hydrocarbons 2.4 -0.8 -2.5 1.0 13.6 4.0 0.1

-Non Hydrocarbons -0.6 -2.9 -0.5 4.0 3.4 4.4 4.6

(In percent of GDP)

Gross Investment 29.5 29.2 31.5 33.0 31.5 30.7 29.9

-Central Government 9.5 10.4 10.1 9.6 8.5 7.5 7.2& Public Enterp. 1/

- Other PE and Priv. 20.0 18.8 21.5 23.4 23.0 23.2 22.6

Budget Deficit (-) -2.8 -8.7 -4.4 -1.6 0.3 0.9 2.4

Current Account Deficit 0.7 1.6 -4.3 -7.2 4.4 -3.4 -2.8(-)

Imports 19.8 23.2 28.6 31.1 29.8 28.7 28.3

Exports 21.1 21.9 23.7 25.7 26.9 27.1 27.3

-Hydrocarbons 18.6 19.6 20.5 22.8 23.8 23.8 23.7

Foreign Debt 49.3 51.8 67.7 78.5 78.7 77.6 76.8

(In US$ billions)

Foreign Debt 26.7 25.8 28.4 32.3 34.9 36.5 38.2

(In percent of exports)

Foreign Debt Service 60.2 73.4 41.4 37.2 28.5 32.6 40.9

(In months of imports)

Foreign Rserves 1.2 1.5 2.5 1.8 2.1 2.4 2.4(excluding gold)

I lncludes only public enterpnse uiveslments fmanced through the budget or through thC Restructuring Fund (FA).

15. The World Bank will provide important direct and indirect contributions to the financingplan in 1996 and 1997. As outlined in the CAS, it is proposed that the World Bank increase adjustmentlending to three quarters of total lending in FYs 1996 and 1997, in order to provide quick-disbursingresources appropriate to Algeria's current circumstances and needs. Gross World Bank disbursementsare projected at US$410 million in 1996, of which about half would be direct balance of paymentssupport toward filling the financing gap (assuming one more adjustment loan before the end of calendaryear 1996 -- see the CAS). World Bank support through the SAL also provides comfort to other lenders,

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including potential SAL parallel financiers such as the EU (see "Cofinancing" below). These otherlenders are also key to filling the financing gap.

Table 3: Financing Plan(US$ billion)

1994 1995 1996 1997 1998

Extraordinary Financing 5.72 6.00 4.78 3.42 0.99Needs

Financing Sources: 5.72 6.00 4.78 3.42 0.99

Rescheduling 4.49 4.78 3.73 2.38 0.56

Paris Club 3.70 3.77 2.81 1.74 0.56

London Club 0.79 1.01 0.92 0.64 0.00

IMF 0.85 0.61 0.53 0.52 0.13

IBRD (BOP) 0.08 0.26 0.20 0.20 0.20

Other Multilateral (BOP) 0.30 0.35 0.32 0.33 0.10

U1. The Government's Adjustment Strategy

16. While the Algerian economy has made important progress since the introduction of theaccelerated reform program in early 1994, full macroeconomic stability has not been achieved and majorstructural impediments remain. Inflation remains high, and the economy remains dependent onhydrocarbon exports. Most notably, an inefficient and monopolistic public sector dominates in industryand finance and accounts for almost half of non-agriculture non-government employment. One in fourworkers in the formal sector is in government service. Property rights remain poorly defined for privatesector operators in agriculture and industry. To address these problems, the Algerian authorities arecommitted to a strong and sustained adjustment effort over several years. The goals of the programremain basically the same as in 1994: (i) achieving and maintaining a stable macroeconomy; (ii)deepening the structural reforms needed in order to accelerate and complete the transition to a marketeconomy; while at the same time, (iii) taking actions to reduce the unacceptably high level ofunemployment (see the CAS) and protect the poor during the transition. The stabilization and adjustmentprogramn supported by the EFF and to be supported by the proposed SAL is outlined above (see Column2 of Table 1). The EFF, the proposed SAL, and other proposed Bank adjustment lending supportcomplementary parts of a coherent program of adjustment. Discussions on the adjustment program haveproceeded in close collaboration with the IMF. (As always, the authorities cannot take on the wholeadjustment agenda under this program. Some measures must logically follow those currently under

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implementation; others may not yet have the necessary consensus for successful implementation. Column3 of Table 1 indicates key measures that should be tackled in the next phase of adjustment.)

A. Macroeconomic Program

17. The goals of Algeria's macroeconomic program are ambitious: the achievement of 5percent annual real growth in non-hydrocarbon output over the next three years; and a reduction ofinflation to the rate of its trading partners, achievement of a budget surplus equal to about 2½h percentof GDP (a sensible policy for a country dependent on non-renewable hydrocarbon resources for more thanhalf of budgetary expenditures), and a current account deficit of about 2½h percent of GDP by mid-1998.In addition to the adjustment program outlined below, a range of macroeconomic policies will be usedto achieve these goals. (Macroeconomic conditionality is listed in the policy matrix in Annex D.)

18. Exchange Rate Policy. The Algerian authorities plan to introduce current accountconvertibility of the dinar by end-1997. To this end, virtually all controls on foreign exchange purchasesfor merchandise imports have been lifted. Restrictions on payments for invisibles will be lifted graduallyduring the next two years. In addition, the dinar rate will be more heavily influenced by market forces.An interbank foreign exchange market was introduced at the end of 1995. The receipts of Sonatrach, thenational oil company, in excess of official needs will be sold through this market.

19. Trade Liberalization. Under the stand-by and ERL, imports were substantiallyliberalized. The removal of impediments to access to foreign exchange was the most important action.Algeria did not have an explicit quantitative trade restriction regime, relying instead on foreign exchangeallocation to achieve high rates of protection for domestic producers. Since the beginning of 1995,further trade liberalization measures include the removal of the minimum maturity requirement onextemal borrowing for imports of capital goods (a measure seen as important by the private sector) andthe elimination of professional criteria requirements for importers of medicines, milk, semolina, flour,and wheat. The maximum tariff rate is now 60 percent. Further tariff reductions are envisaged, inaccordance with the results of a study of effective protection now underway in collaboration with theBank. The phased reduction in tariff rates is necessary in the Algerian context in which domesticproducers currently face intense competition from imports as a result of the lifting of exchange controlsthat provided a much higher level of protection than that afforded by tariffs.

20. Price Liberalization. Price controls have been eliminated, except for a limited numberof energy products and pasteurized milk. The global subsidy on energy products has been completelyeliminated, although some cross-subsidization exists among products and among consumer classes.Controls on profit margins have been eliminated, except for medicines and powdered milk. The onlyremaining generalized subsidy (pasteurized milk) will be removed by the end of 1996. The authoritiesare aware of the potential negative impact on the poor of the price increases for basic commodities. Asa result, they plan to further strengthen the social safety net with measures targeting the poor.

21. Fiscal Policy. Much progress has already been achieved on the revenue side, but becauserates are high and because import tariffs will be reduced, further progress will depend on widening thetax base. To that end, some VAT exemptions have been removed this year, and interest income is nowtaxed. The authorities have agreed to review the possibility of reducing the number of VAT rates fromthree to two in consultation with the Fund. However, expenditure measures will be more important inachieving the targeted fiscal surplus. The key tool for expenditure decisions is the ongoing publicexpenditure review (PER). The authorities have used the PER as a guide in the process of expenditure

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reallocation, under the overall budget limits set in the context of the EFF. The government investmentprogram for 1996 is in compliance with the recommendations of that report, notably concerningexpenditures on basic health and education. In education, net recruitment will be zero (the educationsystem is overstaffed); and reallocation toward important non-wage expenditures was achieved.(Worldwide experience demonstrates the importance of these expenditures in education outcomes.) Inhealth, total expenditures as a share of GDP were not only protected but slightly increased, with areallocation toward preventive medicine. The authorities have agreed to a 130 percent increase inpreventive medicine expenditures, a 75 percent increase in pharmaceutical expenditures, and will launchpilot subcontracts with the private sector for food and cleaning services in government-run healthfacilities. In addition, adjustments have been made in transportation expenditures, including shelving theconstruction of the Algiers metro and a postponement of lower-priority infrastructure investments witha reallocation to housing. The PER also reviewed personnel expenditures; the recommendations of thereport were taken into account in the measures foreseen in the 1996 budget for reaching the agreedreduction of these expenditures as a share of GDP, in the context of the EFF. Specifically, recruitmentwill be stabilized. By 1998, personnel expenditures are to decline to 8.8 percent of GDP, from 10.5percent in 1993 and about 10 percent currently. The PER, which is an on-going exercise, will be thebasis for a review of the proposed 1997 investment and personnel budgets before release of the secondtranche of the SAL. In all, government expenditures are to fall from about 32 percent of GDP currentlyto about 28½/2 percent by 1998, all in recurrent expenditures. Government investment expenditures willremain roughly constant at about 7'½ percent of GDP.

22. Monetary and Interest Rate Policy. A strict monetary policy is an important componentof the Government's stabilization program, contributing to demand management and a reduction ininflation. At the same time, crowding out by the Government will be reduced, as it makes net paymentsto the banking system, allowing banks to increase non-government credit by 20 to 30 percent per year.Monetary growth is programmed at 13 percent in 1996. Interest rates have been freed. A five percentlimit on the margin between deposit and lending rates of banks was eliminated in December 1995. Mostlending rates are now in the 19-24 percent range.

B. Major Elements of the Adjustment Programn

23. The Algerian authorities' adjustment program supported by the ERL and to be supportedby the SAL has one key aim: to move as quickly as realistically possible to transform the Algerianeconomy into one that is market-based, efficient, and productive. The challenge is clear. The authoritiesrealize that they must use the window of opportunity presented by debt rescheduling to expand output andto reduce as much as is feasible the vulnerability of the economy to external shocks, notably oil priceshocks. By mid-1998, the economy must be ready to face the double impact of an end to reschedulingof debt service and the first principal payments on the US$16 billion of debt rescheduled during theprevious three years. The ICOR must be improved from the double-, and sometimes triple-, digit levelsof the last two decades. 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 are necessary if the latter is to be the engine of growth and employment creation.Experience across the world has shown the importance of an efficient and competitive financial sectorfor private sector growth. The Algerian authorities understand this and want to increase the number ofbanks and financial institutions, while strengthening supervision capabilities of the central bank. All ofthese measures will go in parallel with measures designed to improve the social safety net during thetransition (described in Section III below).

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24. Privatization. The proposed SAL will support privatization with the following strategy.Privatization will be implemented whenever and wherever possible, while, at the same time, moving thosepublic enterprises that would not yet be candidates for privatization, because of a problem of demandunder current circumstances, to a situation in which they are no longer a drain on the budget and a threatto the integrity of the financial system.

25. Privatization is the officially stated policy of the Algerian government for public sectoractivities in competitive sectors (see the ERL Letter of Development Policy) and probably the onlyeffective means of increasing the efficiency of the Algerian economy. However, in the present securitysituation, the private market for large public enterprises is likely to be limited. Foreign investors havebecome heavily involved in oil and gas development in Algeria in recent years, and this trend is likelyto continue. However, they are not likely to move into other sectors until the security situation improves.Few local private market participants have the resources to become strategic investors in these largeenterprises, and those that do tell us that they would seek foreign expertise; hence, they face the sameproblem as potential foreign buyers. The authorities' strategy in these circumstances for the large publicenterprises is the following: (i) impose hard budget constraints and impose a new management systemto prepare enterprises for eventual privatization (see Public Enterprise Reform below); (ii) identify smallerunits of these enterprises that can be sold off under current demand conditions -- or let the enterprisesthemselves do this as a way of raising funds; (iii) seek private management or minority equityparticipation for some units; and (iv) spin off service activities of the largest public enterprises toemployees.

26. At the same time, the SAL will support a large-scale program of privatization of smallenterprises and the private provision of local services, concentrating on activities and sectors where thereis likely to be effective demand for the resources to be privatized, notably small-scale industry,commerce, services, construction, and transport. As shown in the table below, the latter are importantin terms of employment, accounting for more than half of public enterprise employment and 20 percentof total non-agricultural employment (see Table 4). As noted in the CAS, these are also the sectors,besides agriculture, targeted for the strategy of labor-intensive employment creation. (Large, capital-intensive PEs, mostly in industry, will be shedding labor; however, public enterprise employment inindustry accounts for only 8 percent of total employment.)

27. The sources of demand for these privatized entities are three-fold. First, privatebusinessmen in Algeria reported in the context of the recent Private Sector Assessment (PSA) that theystand ready to bid for small-scale enterprises. (A group of visiting Algerian businessmen recentlyreconfirmed their interest in buying small-scale public enterprises.) Second, Algeria has had a thrivinginformal economy, profiting from shortages created by price and exchange controls and productionshortfalls by monopoly PEs. These economic agents have seen their profits shrink with adjustment andare looking for new investments, notably in the service sector. Third, the current management of someof these small PEs is another potential source of demand.

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Table 4: Algeria -- Value Added and Employment by Sector, 1991

Sectoral Value Of Which Total Of WhichAdded Public Sector Employment Public Sector

(percent) (percent) (thousands) (percent)

Total 100 63 4,231 52

Agriculture 10 * 1,040 4

Non-agricultural 90 70 3,191 67

of which:

Hydrocarbons 31 100 38 100

Industry 11 73 509 68

Construction 11 45 674 54

Commerce 14 19 400 19

Other Services 10 35 470 46

Public Admin. 13 100 1,100 100/ Less than one half of one percent.

28. The Algerian authorities have four legal vehicles for privatization and will present theBank with a privatization program using all four. The first is the privatization law passed recently,designed mainly for the large regional or national public enterprises. The authorities will develop a first-year privatization program under this law in consultation with the Bank. Under Articles 24 and 25 ofthe 1994 Complementary Finance Law, units of public enterprises can be sold outright, enterprises canbe offered for private management contract, or they can sell up to 49 percent of their equity to the privatesector. Using the commercial code, public enterprises can be dissolved and liquidated under thebankruptcy law. Lastly, under a 1990 law, public enterprises organized at the community level can besold by competitive bidding and local public services can be offered for operation by the private sectorunder concessions.

29. The most important part of the initial pre-Board privatization program falls under this lastlaw. Using that law, the Algerian authorities have brought 103 of these local enterprises (mainly intransportation, commerce, construction, and tourism) to the point of sale and have offered for concessionanother 35 activities. The first program under Articles 24 and 25 of the 1994 Complementary FinanceLaw touched 50 economic units (in agro-industry, industry, tourism, and commerce). These have beenoffered for sale, tendered for management contracts, or have opened their capital to private sectorparticipation. In addition, foreign investors have signed contracts to manage two public-sector hotels.As the last element in this initial program, the Algerian authorities have dissolved 88 local publicenterprises judged to be non-viable and have placed their assets in liquidation. To put this initial programinto perspective, it touches roughly 17,000 of the approximately one million public sector workers outsideof government. While its size was small, the virtually daily appearance of offers for sale in localnewspapers served as an effective signal that the process of privatization has been started in Algeria. It

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was designed to gain adherents for the privatization process and to lock in privatization as a prioritygovernment policy.

30. A second privatization program will be established and a portion of it, agreed jointlybetween the Algerian authorities and the Bank, will be brought to the point of sale before the release ofthe second tranche of the SAL. The Algerian authorities are committed to maintaining the momentumof privatization (see the attached Letter of Development Policy). In fact, the second-tranche program islikely to be significantly larger. It will have the same three components as the initial program, but, inaddition, it will include the first privatization program under the new privatization law. The privatizationinstitution was established in March 1996 and is in the process of preparing its first-year program. Inpreparing the second privatization program, the Algerian authorities will also be able to benefit from theirexperience with the initial pre-Board program and can orient sales towards sectors where demand hasbeen demonstrated to be strong.

31. Agricultural Land Tenure. The Algerian Government has announced its intention to selloff state-owned arable land. The land in question was converted from state farms to small collectivefarms or to small individual farms with usufruct rights at the beginning of the adjustment program in1987. However, some of the land went unexploited, partly because of a lack of complementaryresources; and collective operations did not work and were defacto divided into family farms. Still, landtenure is a sensitive political issue, and the process will take time. Contentious issues concerning priorproperty rights must be resolved. As a result, the authorities will work with the Bank on the preparationof legislation setting out the modalities of agricultural land privatization. (Privatization of state-ownedland is already permitted under Algerian law; the question that must be resolved is the process by whichthe land will be privatized.) This legislation will be approved by the Council of Government beforesecond tranche release. (Draft legislation, once approved by the Council of Government, is submittedto the legislative authority.) In the meantime, the Government has put into effect a law returning to theoriginal owners land voluntarily donated to the State during the period of collectivization.

32. Public Enterprise Reform. The strategy of the Algerian authorities is to limit PEs' accessto public resources, through the budget or through bad debts to the banking system made good throughbudget appropriations. Recent reforms in the banking system described below and supported under theERL effectively block access of loss-making enterprises to bank credit. As outlined in the ERL program,the last remaining 23 large non-autonomous public enterprises (EPS) were to be passed to autonomy,blocking routine access to Treasury financing and guarantees. Five were made autonomous before Boardpresentation of the ERL. Under this framework, at autonomy the authorities sign management contractswith the heads of these enterprises requiring them to implement restructuring plans that have received the"non-objection" of the authorities (approval could imply a moral obligation on the part of the governmentto provide finance.) All 23 are now autonomous. In addition, the authorities will abide by theiragreement in the ERL to close the Restructuring Fund, which was used to reduce the commercial bankdebts of PEs as the latter passed to autonomy. If this Fund were to remain operational, there would bea danger of future debt bailouts for PEs, effectively removing the hard budget constraint they wouldotherwise face and eliminating pressure to improve their financial performance.

33. The government has recently adopted a law setting up holding companies to manage PEs.Under this framework, the authorities have agreed that the holdings will: (i) set as their primaryobjective the achievement by these enterprises of positive rates of return; (ii) sanction those that do not,including requiring them to sell off assets; and (iii) prepare enterprises for eventual privatization whendemand conditions permit. In order to reduce the risk that the holdings will delay the privatization

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process, the authorities have put in place the following safeguards: (i) the government-level authoritythat oversees the holdings has essentially the same members as the government body that approves theprivatization program; (ii) this authority is represented on the boards of the holdings; and (iii) once anenterprise has been identified as a candidate for privatization, it immediately leaves the holding and falls,by law, under the control of the privatization institution.

34. One potential short-run escape from hard budget constraints for public enterprises is arun-up in inter-enterprise debt. Under the SAL, the authorities will monitor the inter-enterprise debtsof public enterprises.

35. Incentive Framework The Algerian authorities will support the private sector indirectly,through continued improvements in the overall framework for private sector growth, and directly, throughthe enhancement of opportunities for the private sector to carry out activities previously in the publicdomain. Other than improving the overall framework for private sector growth and providingopportunities for the private sector to compete for government concessions and public works, experiencein many countries shows that it is difficult to develop specific government interventions in favor of theprivate sector that actually work. This observation is especially relevant for small and mediumenterprises, which in Algeria describes virtually the entire private sector. However, drawing on the PSAcarried out during the last 12 months, the authorities have developed a program that tries to balancemeasures to improve the general framework for private sector activity with a few major specificinterventions.

36. An important general measure consists of putting the finishing touches on the new legaland regulatory framework for economic activity. This framework has emerged with the support of theWorld Bank, starting with the development of the first adjustment operation in 1989. It includes a newcommercial code and a new investment code. One final but important element remained. Before Boardpresentation, the authorities presented to the Bank the implementing regulations for the competition lawpassed in the context of the ERL. A well-functioning competition law is important during theprivatization process in order to avoid replacing public monopolies by private monopolies. (Poorlydesigned, these regulations could be used to reduce competition.) The Bank, through the Private SectorDevelopment Department, is providing technical assistance to the Algerian authorities to help themimplement the competition monitoring and enforcement system. Other actions seek to remove what theprivate sector reported through the PSA process as important remaining legal and bureaucratic barriersto private sector growth. The authorities are implementing measures to regularize titles to industrial andcommercial land and have legalized leasing and factoring as forms of investment finance.

37. The direct measures for private sector support are mainly related to government contracts.First, in the context of the privatization program discussed above, the authorities are committed to aprogram of private provision of municipal services. Second, the authorities have adopted a series ofreforms designed to increase the participation of the private sector in the construction of public housing,notably by reducing the size of individual contracts. It is projected that, in termns of value added, morethan half of the program of 80 thousand units of public housing planned for 1996 will be produced byprivate contractors. (The use of private contractors in road construction and maintenance is supportedunder the Highways VI project, under implementation.)

38. Reform of the Financial Sector. The strategy for the financial sector is consistent withthat developed with the Algerian authorities under the ERL. As foreseen in the ERL, the next phase offinancial sector reform must include measures to increase competition. A banking system dominated by

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five publicly-owned banks cannot generate the competition necessary to efficiently mobilize deposits orto provide the services needed by an expanding private sector. The interbank market for foreignexchange foreseen under the EFF and the bond market to be developed in collaboration with the Bankalso necessitate real competition to function well. In parallel, now is the time to start developing the basisfor new non-bank financial institutions, including a stock market.

39. Restructuring of existing banks will go on as planned under the ERL. The authoritieshave agreed with the Bank on the capital infusions necessary for the five banks in order for them to meetthe agreed interim capital-asset ratio of four percent. Recapitalization at the agreed level was a pre-Boardrequirement, as was signature and implementation of the agreed management contracts. Under themanagement contracts, the managers have the responsibility to respect the capital adequacy guidelines.As a result, they have no incentive to increase bank exposure to loss-making autonomous publicenterprises. Recapitalization was not a major drain on the government budget because the authorities hadalready cleaned up the balance sheets of these banks, using the Restructuring Fund to exchangegovernment bonds for the bad debts of PEs. More than 50 percent of the assets of the five governmentbanks consists of claims on the Algerian Treasury.

40. Increased competition in the banking sector will be encouraged under the SAL in thefollowing ways. First, the new management contracts will encourage some competition. Second, a studyis currently underway to identify the means to effectively privatize the management of one existing bank.Presentation of a draft plan to achieve this aim was a pre-Board condition. In informal contacts betweencommercial banks outside of Algeria and the IFC, many banking groups have expressed an interest inentering the Algerian market but are discouraged by the security situation. Private groups within Algeriahave explored the possibility of opening new banks but also have been discouraged by the securitysituation. They see the need to bring in foreign financial expertise, which will be difficult until thissituation improves. However, the IFC has given its assurance that it will continue to actively seek newentrants into the Algerian financial markets (see CAS). One new private bank has been approved (it plansto act mainly as an investment bank). Its entry into the Algerian market is a positive development.

41. Improvements in the supervision and regulation capabilities of the central bank willcontinue under the proposed SAL. Actions include the setting and enforcing of effective limits on bankoverdrafts and of accounting norms and regulations covering foreign exchange transactions andtransactions in governmnent securities.

42. Measures to introduce new markets concentrate in the first instance on the governmentsecurities market. The structure of new issues of government securities has been designed along the linessuggested in the Bank's study of Algerian capital markets. This design concentrates issues on a fewmaturity dates, allowing the creation of deeper secondary markets. The SAL will support the processof putting both the primary and secondary markets into operation, including the development of anauction system, the requirements for licensing of securities dealers, and the introduction of a clearingsystem. The SAL also supports the first steps toward the development of a stock market, including theadoption of key amendments to the stock market law, authorizing an over-the-counter secondary marketin Treasury securities, authorizing stock exchange members to trade other financial securities, andrelieving exchange members of the responsibility of accounting for the source of their clients' funds.Lastly, an Exchange Commission will be established and staffed.

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III. Algeria's Social Safety Net Strategy

43. The Algerian authorities realize that a workable social safety net is an importantaccompaniment to their adjustment program, to help the poor who might be adversely affected byadjustment and to engender popular support for the program. In late 1994, they replaced a cash paymentscheme that could not be well-targeted and had become too expensive by two new programs. (The cashpayment system itself was adopted to compensate the poor for the reduction of generalized food subsidiesas a part of past adjustment efforts.) The first program (AFS) provides assistance to the elderly andhandicapped and their dependents. It targets those who are missed by other social security programs:the elderly without pensions or other major sources of income and the handicapped who are not 100percent incapacitated (the severely handicapped already receive social assistance) but who are unable towork and have little or no savings. The second program (PAIG) provides employment, normally oflimited duration, on a self-targeted basis to those who are willing to work for half the minimum wage.

44. The other pressing social issue for the Algerian authorities is the 25 percent rate ofunemployment, mainly among youth. (While the problem must be addressed in the interest of socialcohesion, it must be noted that the link between unemployment and poverty is not clear; evidence fromother countries, including those with high unemployment rates, shows that most of those classed asunemployed come from families with incomes above the poverty line.) While the reforms underway aredesigned to generate a quick supply response, mainly in labor-intensive agriculture and construction, thereis a risk that unemployment could remain at or near its current level in the short run. To minimize thisrisk, the Algerian government, with Bank support, has put together a program of public works and isdesigning a social fund. (See the accompanying Social Safety Support Project.) In addition, the Algeriangovernment has introduced a scheme of protection for workers laid off for economic reasons.

45. The three recent programs -- the unemployment insurance scheme, the AFS, and thePAIG -- were brought to full operation in a very short period; the Algerian authorities are to becongratulated in this regard. The successful on-the-ground implementation of these social safety netprograms in a difficult security setting is -- along with (i) the public expenditure program and (ii) thepublic sector reform, privatization and private sector development components -- a key up-front policyaction justifying support under the proposed SAL. However, as with most safety net schemes, it couldbe improved. Under the SAL, the authorities will take measures to strengthen these programs. Theschemes are described below, along with potential measures to improve their effectiveness.

46. The program of aid to the elderly and handicapped (AFS) now covers 430,000 heads ofhouseholds, or about 900,000 people in all. Among the heads of benefitting households, 87 percent areelderly and 13 percent handicapped. Each beneficiary receives 600 dinars per month, plus 120 dinarsper month for each dependent up to a maximum of three. Based on a study of the program during itsinitial few months of operation, it could be improved and extended as follows. Under the SAL, theauthorities have agreed to: (i) make payments monthly, rather than quarterly; and (ii) integrate the AFSwith other existing social programs to reduce the risk of overlaps.

47. The program providing short-term emplovment (PAIG) has provided jobs of relativelyshort duration to 420,000 participants at more than 16,000 work sites. In a review undertaken by theBank, a number of areas for possible improvement were identified. The program's key feature is its self-targeting to the able-bodied poor: it is designed to benefit only those willing to work for half theminimum wage. However, some local authorities (the program is run at the local level) pay for a fullday when the participants work only half the day. As a result, the program loses its self-targeting feature

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and could attract participants from existing or potential new jobs in the private sector. Second, the worksites do not appear to have been selected on the basis of knowledge concerning the geographical locationof the poorest groups. Third, many of the activities appear to have an unnecessarily low rate of retum.While efficiency is not the major criterion for measuring the success of this program, it appears thatefficiency could be improved at little additional cost. In the context of the SAL, the authorities haveagreed to: (i) demand (and verify) a full day's work for a full day's pay; (ii) target work sites moreclosely to geographical areas identified as having a high concentration of poor people; and (iii) setefficiency norms for the local authorities to follow and verify their use.

48. The program of protection of workers laid off for economic reasons is contributory.Employers and employees pay a combined payroll tax of four percent into a fund. In addition,enterprises that lay off workers pay an "entry fee" for each laid off worker proportional to that worker'stenure with the firm. An enterprise that would like access to the fund must prepare a restructuring planthat specifies employment compression via retrenchment or early retirement. The benefit level andduration is based on salary history and employment duration, with an upper bound equal to three timesthe minimum wage. The benefit period is a minimum of one year and a maximum of three years, andthe benefits decline over time. About 48,000 workers, mainly in construction, are eligible for financialsupport (36,000) or have taken early retirement (12,000) under the program. While the program has beensuccessfully implemented, it can be improved by: (i) the close tracking of detailed accounts of revenuesand expenditures; and (ii) the establishment of guidelines for investing the funds that accumulate as areserve. It is possible that the cost of the scheme to both firms and contributing workers can be loweredover time, if the Fund begins to accumulate large reserves.

IV. The Proposed Loan

A. Program to be Supported and Link to the Country Assistance Strategy

49. This proposal has been prepared in response to a government request, going back to early1994, for support for its intensified adjustment efforts. The proposed SAL will be a continuation of thesupport provided under ERL, recognizing the successful policy performance of the Algerian authoritiesunder that loan and the vital program of medium-term structural adjustment, described above, that theyhave already launched. The proposed SAL and the already approved EFF are complementary; both havebeen prepared in close collaboration between the Bretton Woods institutions. With regard to themacroeconomic framework, the Bank will support improvements in the composition of publicexpenditures in the context of overall ceilings established with the Fund. Privatization and other measuresto improve enterprise and financial market efficiency, supported by the Bank, will benefit frommacroeconomic stability established in the context of the EFF. Improvements in the social safety netsupported by the Bank will underpin the cuts in government expenditures, notably generalized subsidies,necessary under the EFF for the reestablishment of monetary and balance of payments equilibrium.

50. The relationship between the proposed loan and the CAS is clear. The objectives of theSAL are the three key objectives enunciated in the attached CAS. Support under the SAL will help theauthorities: (i) stimulate private sector-led growth; (ii) protect the poor during the transition to a market-based economy; and (iii) enhance the country's ability to mobilize the external resources necessary tobridge the gap to balance of payments viability. As noted in the CAS, the SAL is a central element ofthe Bank's strategy of assistance for Algeria.

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51. The elements of Algeria's stabilization and adjustment program to be supported under theSAL are outlined in the policy matrix attached to the Letter of Development Policy (Annex D). Detailsof the specific elements to be supported under the SAL are presented above in the sections outlining theAlgerian macroeconomic, structural adjustment, and social safety net programs and are reiterated in thegovernment's Letter of Development Policy. Also annexed to the Letter of Development Policy is a setof monitorable indicators to be tracked during the life of the SAL.

B. Poverty Impact

52. While the exact impact on poverty of the Algerian program to be supported under theSAL in Algeria is difficult to quantify, its overall qualitative impact will be positive. The Algerianauthorities have already put in place a functioning social safety net designed to limit the impact ofadjustment on the poor (notably as a result of the elimination of generalized food subsidies). Theseprograms, the AFS and the PAIG, were described above. Under the SAL, the Algerian authorities willfurther improve the design and management of these programs, in consultation with the Bank. Inaddition, the program is designed to provide information to improve the targeting of future socialassistance. During the period of the SAL, the Bank will prepare, jointly with the Algerian authorities,the first Poverty Assessment for Algeria. The assessment will be based partly on data arising from aLiving Standards Measurement Survey, now underway, financed in part under a Bank technical assistanceloan. The Algerian authorities are also conscious of the need to assist those who are not poor but whomight suffer as a result of the adjustment effort, notably PE workers laid off for economic reasons. Theyhave put in place a program to provide financial assistance to these workers, described above in thediscussion of the social safety net.

53. In addition, SAL conditionality includes up-front measures to protect the level andimprove the efficiency of key social expenditures. As noted above, non-wage recurrent educationexpenditures were increased, as were expenditures on basic preventive health care.

C. Negotiations, Effectiveness, and Proposed Tranche Conditionality

54. The are no conditions of effectiveness separate from conditions for Board presentation.The program was designed, in the spirit of the CAS strategy, to require significant pre-Board actions fortwo reasons: (i) to demonstrate the authorities' commitment to the program; and (ii) to decrease to theextent possible the risk of policy reversal (see the section on risks below). Second tranche conditionsconcentrate only on major actions that require significant advance preparation.

55. The following were the key actions for Board presentation:

Macroeconomic and Public Finance Framework

o Submission to the Bank of a government investment program and plan for recurrent goverrnmentexpenditures in 1996 in the health, education, transportation, and housing sectors satisfactory tothe Bank and in accordance with the PER.

o Stabilization of recruitment for the civil service, in accordance with the EFF. (Note: the PERwas the basis for the agreement with the Fund in the context of the EFF.)

- 21 -

Support for Public Sector Reform and for Private Sector Development

o Promulgation of a privatization law.

o Implementation of an initial privatization program, including bringing 103 conmmunal-level publicenterprises to the point of sale, offering 35 communal activities for private sector operation byconcession, bringing to the point of sale (selling the units, opening of capital or operation by theprivate sector through management contract) 50 units of national public enterprises (EPEs),privatization of the management of two government-owned hotels, and dissolution of 84 localpublic enterprises (EPLs).

o Immediate passage to autonomy, redeployment, or dissolution of the 18 remaining large non-autonomous public enterprises (EPS) in conformity with the framework set out in the ERL.

o Adoption of a new housing strategy and financial plan and calendar for the 1996 public housingprogram, both satisfactory to the Bank.

o Publication of implementing regulations for the new Competition Law.

O Presentation of a draft proposal for the introduction of private share ownership and/or privatemanagement for at least one of the 5 existing public sector banks.

o Recapitalization of the 5 public sector banks (in accordance with agreements reached during pre-appraisal and appraisal discussions).

Social Safety Net

o Successful full implementation of the three new social safety net programs: the program for theelderly and handicapped; the self-targeted income transfer program; and the program for workerslaid off for economic reasons.

o Adoption of a program, acceptable to the Bank, of measures to improve the performance of thethree new elements of the social safety net.

56. Conditions for second tranche release are:

Macroeconomic and Public Finance Framework

o Maintenance of a satisfactory macroeconomic framework (in the context of the EFF).

o Presentation to the Bank of a government investment program and plan for recurrent governmentexpenditures for the 1997 budget including measures agreed jointly and satisfactory to bothparties, in the context of the PER.

o Presentation to the Bank of the program of personnel expenditures for the civil service proposedfor the 1997 budget, comprising the measures agreed jointly and satisfactory to both parties inthe context of the PER.

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o Progress toward the closure of the Restructuring Fund (used to pay off the bad debts of publicenterprises) in accordance with agreed timetable.

Support for Public Sector Reform and Private Sector Development

o Establish a second privatization program and bring to the point of sale (sale of the wholeenterprise, sale of units of enterprises, opening of capital), operation by the private sector throughconcession or management contracting arrangements, or dissolution a part, accepted by bothparties, of this program. (Note: as stated in the Letter of Development Policy, the privatizationprogram will continue, at a minimum, at the pace of the initial program.)

o Preparation and adoption by the Council of Government of a draft law establishing the modalitiesfor the privatization of agricultural land held by the State.

o Attainment of the established objective for the reduction of overdrafts granted by state-ownedcommercial banks.

Social Safety Net

o Development and adoption by the government of a program, based on the outcome of the PovertyAssessment and in consultation with the Bank, to improve the social protection system for thepoorest groups. (Note: the results of the recently-completed LSMS will be the key element inthe design of an improved social protection system.)

D. Procurement, Disbursement, Financial Management, and Auditing

57. The borrower will be the Government of the Democratic and Popular Republic of Algeria.Once the loan is approved by the Board, the borrower will be required to open and maintain five DepositAccounts, in U.S. dollars, pounds sterling, French francs, Japanese yen, and Deutch mark, in its centralbank. As each tranche is released, the borrower will submit a simplified withdrawal application, availablefrom the Loan Department, against which the Bank will disburse the loan proceeds for the borrower'suse into one or more of the Deposit Accounts denominated in the currency in which the withdrawal isrequested. (The borrower requested this flexibility in terms of the choice of currency of withdrawal, andthe Bank was able to respond positively.) If after deposit into the Deposit Accounts, the proceeds of theloan or any part thereof is used for ineligible expenditures, as defined in the loan agreement, the Bankrequires the borrower to either (a) return that amount to the Deposit Accounts for use for eligiblepurposes, or (b) refund the amount directly to the Bank, in which case the Bank will cancel an equivalentundisbursed amount of the loan. Although the Bank will not routinely require an audit of the DepositAccounts, it will reserve the right to do so. The loan will be made on a two-tranche basis. The firsttranche of US$150 million will be eligible for disbursement upon effectiveness. The second tranche ofUS$150 million will be conditional upon satisfactory macroeconomic performance (including compliancewith the EFF agreement), satisfactory progress in the implementation of its adjustment program, includinga limited number of specific measures, noted above. The projected date for second tranche release wouldbe 12 months after loan effectiveness.

- 23 -

E. Cofrnancing

58. As noted in the CAS, one of the strategic priorities is to aid the Algerian authorities inattracting new capital inflows. In that context, the Region plans to seek out parallel financing from theEU, and from bilateral sources. An EU staff member took part as an observer in the pre-appraisalmission.

F. Environmental Assessment

59. The project is consistent with the Bank's environmental policies and will follow acceptedBank procedures concerning the environment. The project has been given a C rating. In pastprivatization operations, the question of environmental liability for past pollution has been an issue.During the consultation process on the privatization law, the Bank has insisted on the importance ofestablishing, on the basis of environmental audits, a clear division of responsibility between the state andthe potential new owners for remedying damage caused by past pollution. During the privatizationprocess, the Bank will monitor Algeria's performance in this regard.

G. Program Benefits and Risks

60. The risks are great. This is not business as usual. This is a loan with a significantpossibility of failure. As noted in the CAS, these perils fall in three main categories: (i) a possibledeterioration in the security situation; (ii) risks associated with Algeria's high level of debt; and (iii) risksassociated with Algeria's dependence on hydrocarbon exports.

61. The greatest risk is the unstable security situation. Presidential elections were held onNovember 16, 1995. Turnout was unexpectedly high; the elections have increased the probability of apeaceful resolution of the security situation (see the CAS). While all four candidates endorsed the reformprogram, the winning candidate was the incumbent, Mr. Zeroual, whose government enacted the reforms.He named an new government in January 1996. That government restated its agreement with the thrustof the CAS before it was presented to the Board. Still, this government has not yet been able to reduceor eliminate the threat of violence. The best strategy for the Bank in dealing with this security-relatedrisk is to ensure that the adjustment program supported by the SAL is well-designed, provides anappropriate social safety net component, is moving forward in a timely fashion, and begins to show clearand tangible benefits.

62. Algeria's debt, at more than US$30 billion, is high and will grow rapidly during theprogram period. The risk is greatest after the rescheduling period ends in 1998. At that point Algeria'stotal debt will top US$38 billion. The strategy proposed to minimize this risk is the following. First,by pursuing the stabilization and adjustment program, Algeria will become a better credit risk as itseconomy grows faster than the growth in external debt. Second, the authorities would put in place aprogram, for which we will propose technical assistance through an IDF grant, to improve externalliability management. One component of the program would be the development of a debt managementstrategy for the late 1990s. Another element would be the analysis of the possibilities for debt buybacksand swaps, permitted under Algeria's draft commercial bank rescheduling agreement. Other countrieshave allowed creditors to exchange debt for equity in the context of privatization programs; anotherpossibility is to use privatization receipts directly for debt buybacks. Third, Algeria's program ofhydrocarbon investments provides an opportunity to generate roughly US$2 billion of new annual exportrevenue by 1998 that would contribute to debt service capacity. In addition, the CAS recommends a

- 24 -

strategy of Bank assistance to Algeria that would increase hydrocarbon exploration, development, andexports.

63. However, this dependence on hydrocarbon exports, as noted above, is the third majorrisk. Every dollar fall in the price of a barrel of oil reduces Algeria's exports by more thanUS$500 million. And between now and the end of the century, non-hydrocarbon exports are likely toprovide only a marginal contribution to foreign exchange earnings. During the EFF period, through mid-1998, the Fund will take the lead in assisting the Algerian authorities in coping with the impact of largegains or losses of oil revenues. In the context of the PER, Bank staff have proposed to the Algerianauthorities some form of explicit or implicit buffer fund to come into play at the end of the EFF program,in order to reduce the risks of debt service difficulties, to reduce the possibility of policy reversal ifhydrocarbon prices rise sharply, and to help smooth the shock if oil prices fall substantially.

64. In our assessment, the potential benefits of support to Algeria in the form of the proposedSAL clearly outweigh the high level of risk. The key benefit of the program will be a majorcontribution, along with the IMF EFF, to the creation of the conditions for sustainable development, afterten years of economic decline in Algeria. The achievement of sustainable growth is likely to be anecessary although not sufficient condition for an end to the social and political problems faced by thecountry. The current government is clearly committed to the creation of a market-based economy inAlgeria and sees the need for ongoing Bank assistance. The actions foreseen under the SAL, notablyprivatization and support for private sector growth, will create a clientele for further adjustment,especially if substantial job creation can be generated, through private sector growth buttressed in theshort run by the proposed program of public works outlined in the CAS.

V. Recommendation

65. 1 am satisfied that the proposed loan would comply with the Articles of Agreement of theBank, and I recommnend that the Executive Directors approve it.

James D. WolfensohnPresident

AttachmentsApril 4, 1996Washington, D.C.

Annex APage 1 of 2

AlgeriaMost Same region/income group Next

Latest single year recent Mid-East Lower- higherUnit of. estimate & North middle- income

Indicator measure 1970-75 1980-85 1988-93 Africa income group

Priority Poverty IndicatorsPOVERTYUpper poverty line local curr. .. ..

Headcount index % of pop. .. ..

Lower poverty line local curr. .. ..

Headcount index % of pop. .. ..

GNP per capita USS 950 2,490 1,780 1,980 1,590 4,350

SHORT TERM INCOME INDICATORSUnskilled urban wages local curr. .. .. ..

Unskilled rural wagesRural terms of trade " .. .. ..

Consumer price index 1987=100 31 83 270Lower income .. .. ..

Food.Urban " .. 79 207Rural

SOCLAL INDICATORSPublic expenditure on basic social services % of GDP .. .. 12.7Gross enrollment ratiosPrimary % school age pop. 93 92 99 97 104 105Male 109 102 105 103Female 75 82 92 90

NMortalityInfant mortality per thou. live births 132.0 88.0 52.8 52.3 39.0 35.8Under 5 mortality .. .. 68.0 69.9 61.5 42.6

IrnmunizationMeasles % age group .. 17.0 83.0 81.3 77.6 82.0DPT .. 33.0 89.0 84.0 82.2 74.2

Child malnutrition (under-5) .. .. 9.2Life expectancyTotal years 54 61 67 66 67 69Female advantage " 2.0 2.0 2.4 2.3 5.9 5.9

Total fertility rate births per woman 7.4 6.4 3.8 4.7 2.9 2.9Maternal mortality rate per 100,000 live births 129 ..

Supplementary Poverty IndicatorsExpenditures on social security % of total gov't exp. .. .. ..

Social security coverage % econ. active pop. .. .. 62.0Access to safe water: total % of pop. .. 69.0 .. 83.5 .. 86.7

Urban 84.0 85.0 .. 98.7 .. 93.9Rural .. 55.0 .. 69.0 .. 66.7

Access to health care .. .. .. 87.4

Population growth rate GNP per capita growth rate Development diamondb

(u vege. t) (annual average, percent) Life expectancy

4-, 5

GNP Gross24- *... -. -* ~~~~~~~0- per pnimary

capita enrollment

0 I -5

-2- -101970-75 1980-85 1988-93 1970-75 1980-85 1988-93 Access to safe water

z Algeria Algeria- Lower-middle-income - Lower-middle-income

a. See the technical notes, p.3 8 7 . b. The development diamond, based on four key indicators, shows the average level of development in the countrycompared with its income group. See the introduction.

Annex APage 2 of 2

AlgeriaMost Same region/income group Next

Latest single year recent Mid-East Lower- higherUnit of estimate & North middle- income

Indicator measure 1970-75 1980-85 1988-93 Africa income group

Resources and ExpendituresHMTIAN RESOURCESPopulation (mre_1993) thousands 16.018 21,887 26,722 261,650 1,096,665 500,507Age dependency ratio ratio 1.07 0.97 0.89 0.87 0.69 0.62Urban % of pop. 40.3 47.5 54.2 55.2 54.7 71.2Populationgrowth rate annual% 3.1 3.1 2.4 2.7 1.6 1.7Urban 3.5 4.9 3.9 3.7 2.9 1.8

Labor force (15-64) thousands 3.455 4,834 6,503 71,333 459,196 190,136Agriculture % of labor force 39 .. ..

Industry 24 ..

Female 7 9 10 16 31 29Females per 100 malesUrban number .. .. ..Rural

NATURAL RESOURCESArea thou. sq. km 2,381.74 2,381.74 2,381.74 11,021.26 40,682.67 21,848.14Density pop. per sq. km 6.73 9.19 10.96 23.10 26.52 22.51Agricultural land %of land area 18.37 16.40 16.19 32.10 39.61 41.26Change in agricultural land annual % -1.31 -1.41 -0.19 0.04 -0.13 0.08Agricultural land under irrigation % 0.56 0.87 1.12 30.59 12.66 8.84Forests and woodland thou. sq. km .. 0.04 0.04 0.45 5.95 8.04Deforestation (net) annual % .. .. 0.76

LSCOMEHousehold incomeShare of top 20% of households % of income .. .. 47Share of bottom 40% of households " .. .. 18Share of bottom 20% of households " .. .. 7

EXPENDITUREFood %ofGDP .. .. 19.9

Staples .. .. 6.2Meat, fish, milk, cheese, eggs .. .. 5.9

Cereal imports thou. metric tonnes 1.669 5,266 5.821 38.092 66,281 48,947Food aid in cereals 54 2 15 1,249 5,477 544Food production per capita 1987 =100 125 107 103 102 101 102Fertilizer consumption kgtha 2.8 7.2 2.5 89.9 48.0 67.8ShareofagricultureinGDP %ofGDP 9.9 8.2 10.8 13.3 15.7 8.0Housing % of GDP .. .. 5.7Average household size persons per household .. .. ..

UrbanFixed investmnent: housing % of GDP 2.2 .. 6.5Fuel and power %ofGDP .. .. 1.2Energy consumption per capita kg of oil equiv. 373 904 955 1.097 1,595 1,632Households with electricityLUrban % of households .. .. ..Rural

Transport and comnmunication % of GDP .. .. 3.2Fixed invesunent: transport equipment " 5.9 .. 2.3Total road length thou. km 78 78 75

LVESTMENT IN HUMAN CAPITALHealthPopulation per physician persons 8,095 2.343 2,322 .. 3,277Population per nurse .. 332 329Population per hospital bed 352 .. 399 633 604 395Oral rehydyration therapy (under-5) % of cases .. .. 27 56 .. 51EducationGross enrollment ratioSecondary % of school-age pop. 20 50 60 56 53 53Female " 14 42 53 50

Pupil-teacher ratio: primary pupils per teacher 41 28 27 26 .. 25Pupil-teacher ratio: secondary 27 22 17 21Pupils reaching grade 4 % of cohort 93 96 98 95Repeater rate: primary % of total enroll 13 8 7Illiteracy % of pop. (age 15+) 74 51 43 45 19 14Female %of fem. (age 15+) .. 65 55 57 .. 17

News p aper circulation per thou. Opp. 18 26 38 33 74 125V. orld Bank International Economics Department. Apnl 1995

Annex BPage 1 of 6

Algeria - Key Economic Indicators

Actual Estimate

Indicator 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

National accounts(as % GDP at currentmarket prices)

Gross domestic product 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0Agriculture' 8.8 10.1 11.1 12.2 11.0 9.1 10.9 10.8 9.5 9.8Industry' 37.6 35.2 33.5 32.9 34.9 35.7 34.8 34.7 34.6 30.0Services' 35.7 35.9 36.7 35.4 32.2 31.5 33.5 34.6 34.8 38.6

Total Consumption 70.6 68.1 73.0 70.7 73.4 62.6 67.7 72.2 73.3 72.5Gross domestic fixed 33.5 30.0 27.2 29.0 28.1 31.8 30.8 29.2 31.5 33.0investment

Government investment 14.6 11.4 11.9 9.2 8.2 8.3 8.0 10.4 10.1 9.6Private investment 18.9 18.6 15.3 19.8 20.0 23.5 22.8 18.8 21.5 23.4(includes increase instocks)

Exports(GNFS)b 13.1 14.7 14.4 18.6 24.3 29.1 25.4 21.9 23.7 25.7Imports (GNFS) 17.1 12.8 14.5 18.3 25.8 23.6 23.9 23.2 28.6 31.1

Gross domestic savings 29.4 31.9 27.0 29.3 26.6 37.4 32.3 27.8 26.7 27.5Gross national savingsc 33.6 36.9 32.1 37.4 31.3 37.7 32.4 28.5 26.7 25.7

Memorandum itemsGross domestic product 63065 64479 58788 54940 59902 45715 47866 49762 41941 40974(US$ million at currentprices)Gross national product per 2630.0 2880.0 2810.0 2610.0 2380.0 2030.0 1940.0 1780.0 1690.0 1534.5capita (current US$, Atlas method)

Real annual growth rates(%, base year 1994)

Gross domestic product at -0.2% -0.7% -1.9% 4.9% -1.3% -1.2% 1.6% -2.2% -1.2% 3.5%market pricesGross Domestic Income -21.5% 0.5% -5.2% 8.8% -7.2% 1.3% -2.5% -6.5% -2.0% 4.7%

Real annual per capitagrowth rates (%/o, base year 1994)

Gross domestic product at -3.0% -3.5% -4.5% 2.3% -3.8% -3.6% -0.9% -4.6% -4.0% 0.9%market pricesTotal consumption -7.6% -10.1% -6.4% 4.2% -6.9% -4.0% 3.1% -3.6% -1.8% 1.8%Private consumption -8.5% -11.1% -7.6% 4.8% -8.0% -5.6% 2.5% -3.8% -2.3% 2.7%

Annex B

Algeria - Key Economic Indicators Page 2 of 6(Continued)

Actual EstimateIndicator 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

Balance of Payments(USSm)

Exports (GNFS)b 7959 9290 8347 10147 13395 12819 12056 11005 9580 10556Merchandise FOB 7470 8737 7811 9569 12880 12387 11439 10410 8890 9745

Imports (GNFS)b 11163 9407 9767 11336 11481 9628 10336 9597 11080 12813Merchandise FOB 8720 7399 7592 9362 9659 7747 8541 7990 9150 10666

Resource balance -3204 -117 -1419 -1189 1914 3191 1720 1408 -1500 -2256Net current transfers 1798 1487 1527 2053 1528 1290 1458 1143 1400 1337(including official currenttransfers)Current account balance -3435 39 -1903 -1029 1352 2223 1020 802 -1821 -2980(after official capital grants)

Net private foreign direct -64 -109 -48 -25 -39 -34 3 -2 0 0investmentLong-term loans (net) 961 735 1216 412 -439 -984 -90 -335 2012 1755

Disbursementsb 4521 4455 6175 5569 6891 6632 7252 6560 4640 3915Repayments (scheduled) 3567 3814 4587 5112 6780 7221 7035 7034 7118 6940

Principle Rescheduling 0 0 0 0 0 0 0 0 3965 4325Interest Rescheduling 0 0 0 0 0 0 0 0 525 455

Net Other LT inflows 7 94 -372 -45 -550 -395 -307 139 0 0Other capital 1379 -617 -61 0 -959 -678 -866 -513 298 345

Change in reservesd 1159 -48 796 642 85 -527 -67 48 -489 879

Memorandum itemsResource balance (% of -5.1% -0.2% -2.4% -2.2% 3.2% 7.0% 3.6% 2.8% -3.6% -5.5%GDP at current marketprices)Real annual growth rates(1994 prices)

Merchandise exports -0.6% 5.3% 9.3% -1.3% 4.6% 0.1% 2.3% -2.5% -5.7% 3.2%(FOB)Primary 1.8% 5.9% -2.0% 8.4% 3.8% 2.0% 1.7% -0.5% -3.1% 2.5%Manufactures -92.9% 292.0% na -85.9%/o 4.0% -46.4% 9.5% -25.6% -49.1% 7.3%

Merchandise imports -20.4% -33.1% -3.7% 26.4% -4.0% -13.90/o -4.0% -11.4% 8.7% 10.6%(CIF)

Public finance(as % of GDP at currentmarket prices)'Current revenues 31.9 30.4 27.6 28.9 29.9 32.3 30.3 27.6 28.0 29.2Current expenditures 21.6 21.0 22.0 19.9 18.1 22.2 22.6 24.9 23.4 22.2

Annex B

Algeria - Key Economic Indicators Page 3 of 6(Continued)

Actual Estimate

Indicator 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

Current account surplus (+) 10.2 9.4 5.5 9.1 11.8 10.0 7.7 2.7 4.5 7.0or deficit (-)Capital expenditure 20.6 16.6 17.9 10.8 8.0 8.3 8.9 11.3 10.5 9.7Foreign financing 0.1 0.8 1.5 0.6 0.6 0.6 -0.3 0.1 9.4 12.8

Monetary indicatorsM2/GDP (at current market 76.5 82.5 84.3 73.7 63.9 49.3 49.4 53.8 49.2 41.8prices)Growth ofM2 (%) 1.4 13.6 13.6 5.2 11.3 21.3 24.0 21.2 15.8 12.9Private sector credit growth/ 8.6 14.3 32.1 -96.5 35.4 100.9 137.2 -237.9 645.3 140.0total credit growth (%/6)

Price indices (1994 = 100)Merchandiseexportprice 94.1 104.5 85.5 105.9 136.0 131.7 117.7 107.9 100.0 106.2indexMerchandise import price 64.0 74.5 81.3 79.7 86.7 78.1 88.7 94.9 100.0 105.7indexMerchandise terns of trade 147.1 140.3 105.2 132.8 156.9 168.5 132.6 113.7 100.0 100.5index

Real exchange rate indexr 31.1 35.3 43.7 49.8 55.1 88.5 87.0 77.5 100.0 88.7

Consumer price index 12.4% 7.4% 5.9% 9.3% 16.6% 22.8% 31.8% 20.5% 29.0% 29.6%(% growth rate)GDPdeflator 1.9% 6.2%/'o 13.3% 14.6% 30.1 % 59.3% 21.80/%O 13.60/%o 28.1 % 28.4%(% growth rate)

a. If GDP components are estimated at factor cost, a footnoote indicating this fact should be added.b. "GNFS" denotes "goods and nonfactor services."c. Includes net unrequited transfers excluding official capital grants.d. Includes use of IMF resources.e. Should indicate the level of the government to which the data refer.f. An increase denotes depreciation.

Annex BAlgeria - External Debt Stocks and Flows Page 4 of 6

(USS millions at current prices)

Actual' Estimate'1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

A. Gross disbursements

Public & publicly guaranteed 4521.0 4455.0 6175.0 5569.0 6891.0 6632.0 7252.0 6560.0 4640.0 3915.3

Official multilateral creditors, of whi 314.0 270.0 468.0 459.0 613.0 955.0 553.0 460.0 506.0 1208.5

IDA 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

IBRD 138.0 129.0 170.0 204.0 300.0 347.0 268.0 182.0 299.8 453.0

Oflicial bilateral creditors 326.0 249.0 301.0 679.0 1238.0 964.0 912.0 909.0 1227.0 1157.9

Private creditors, ofwhich 3881.0 3936.0 5406.0 4431.0 5040.0 4713.0 5787.0 5191.0 2907.0 1548.8

Bonds 93.0 50.0 447.0 232.0 0.0 1.0 0.0 0.0 116.0 0.0

Private creditors nonguaranteed 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Total LTb loan disbursements 4521.0 4455.0 6175.0 5569.0 6891.0 6632.0 7252.0 6560.0 4640.0 3915.3

Net ST" credit 0.0 0.0 0.0 0.0 0.0 0.0 0.0 -93.0 -50.0 360.0

Drawings from IMF 0.0 0.0 0.0 604.0 0.0 308.0 0.0 0.0 853.0 614.0

Total disbursements (LT+ST+IMF) 4521.0 4455.0 6175.0 6173.0 6891.0 6940.0 7252.0 6467.0 5443.0 4889.3

B. AmortizationsPublic & publicly guaranteed 3567.0 3814.0 4587.0 5112.0 6780.0 7221.0 7035.0 7034.0 3153.2 2615.4

Official multilateral creditors, of whi 104.0 184.0 208.0 213.0 314.0 392.0 338.0 355.0 539.0 522.3

IDA 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

IBRD 51.0 79.0 112.0 112.0 130.0 176.0 166.0 170.0 200.0 256.9

Official bilateral creditors 656.0 703.0 758.0 797.0 890.0 901.0 896.0 907.0 198.0 431.1

Private creditors, of which 2807.0 2927.0 3621.0 4102.0 5576.0 5928.0 5801.0 5772.0 2416.1 1661.9

Bonds 27.0 58.0 98.0 40.0 16.0 5.0 129.0 663.0 413.0 371.0

Private creditors nonguaranteed 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Total LT loan amortization 3567.0 3814.0 4587.0 5112.0 6780.0 7221.0 7035.0 7034.0 3153.2 2615.4

Repayments to IMF 0.0 0.0 0.0 0.0 0.0 0.0 166.0 329.0 195.0 170.0

Total amortization (LT+IMF) 3567.0 3814.0 4587.0 5112.0 6780.0 7221.0 7201.0 7363.0 3348.2 2785.4

C. Net disbursementsPublic & publicly guaranteed 954.0 641.0 1588.0 457.0 111.0 -589.0 217.0 -474.0 1486.8 1299.9

Official multilateral creditors, of whi 210.0 86.0 260.0 246.0 299.0 563.0 215.0 105.0 -33.0 686.2

IDA 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

IBRD 87.0 50.0 58.0 92.0 170.0 171.0 102.0 12.0 99.8 196.1

Official bilateral creditors -330.0 -454.0 -457.0 -118.0 348.0 63.0 16.0 2.0 1029.0 726.8

Private creditors, of which 1074.0 1009.0 1785.0 329.0 -536.0 -1215.0 -14.0 -581.0 490.9 -113.1Bonds 66.0 -8.0 349.0 192.0 -16.0 -4.0 -129.0 -663.0 -297.0 -371.0

a. Data through 1993 from Debt Reporting System (DRS); 1994-95 data estimated by country operations division staff.b. "LT" denotes "long-term," "ST" denotes "short-term."

Annex BAlgeria - External Debt Stocks and Flows Page 5 of 6

(USS millions at current prices)

Actual' Estimate'1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

Private creditors nonguaranteed 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Total LT" loan net disbursements 954.0 641.0 1588.0 457.0 111.0 -589.0 217.0 -474.0 1486.8 1299.9

Net ST" credit 0.0 0.0 0.0 0.0 0.0 0.0 0.0 -93.0 -50.0 360.0Net credit from IMF 0.0 0.0 0.0 604.0 0.0 308.0 -166.0 -329.0 658.0 444.0Total net disbursements (LT+ST+IMF) 954.0 641.0 1588.0 1061.0 111.0 -281.0 51.0 -896.0 2094.8 2103.9

D. Interest and charges

Public & publicly guaranteed 1549.0 1567.0 1682.0 1740.0 1783.0 1789.0 1833.0 1704.0 1223.4 1660.9Official multilateral creditors, of wh 69.0 88.0 93.0 97.0 116.0 153.0 200.0 212.0 238.0 295.1

IDA 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0IBRD 46.0 62.0 72.0 70.0 73.0 107.0 112.0 113.0 115.9 143.3

Official bilateral creditors 243.0 218.0 236.0 210.0 200.0 203.0 201.0 187.0 86.3 211.0Privatecreditors,ofwhich 1237.0 1261.0 1353.0 1433.0 1467.0 1433.0 1432.0 1305.0 899.1 1154.9

Bonds 58.0 60.0 63.0 91.0 105.0 98.0 90.0 68.0 52.0 13.9

Private creditors nonguaranteed 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Total interest on LTloans 1549.0 1567.0 1682.0 1740.0 1783.0 1789.0 1833.0 1704.0 1223.4 1660.9

Intereston ST credit 36.0 65.0 272.0 126.0 179.0 100.0 200.0 36.0 66.0 36.0Interest on IMF drawings 0.0 0.0 0.0 22.0 62.0 59.0 69.0 42.0 25.0 61.0Total interest (LT+ST+IMF) 1585.0 1632.0 1954.0 1888.0 2024.0 1948.0 2102.0 1782.0 1314.4 1757.9

E. Extemal debt (DOD)c

Public & publicly guaranteed 19498.0 23095.0 24421.0 24638.0 26397.0 25964.0 25226.0 24587.0 26598.8 29697.6Official multilateral creditors, of wh 925.0 1211.0 1391.0 1610.0 2039.0 2667.0 2768.0 2872.0 2839.0 3525.2

IDA 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0IBRD 693.0 924.0 895.0 960.0 1208.0 1413.0 1474.0 1512.0 1611.8 1807.9

Official bilateral creditors 3380.0 3473.0 3306.0 3120.0 3674.0 3798.0 3682.0 3683.0 4841.6 5700.2Private creditors, ofwhich 15193.0 18411.0 19724.0 19908.0 20684.0 19499.0 18776.0 18032.0 18918.2 20472.2

Bonds 777.0 823.0 1169.0 1347.0 1420.0 1436.0 1281.0 645.0 348.0 -23.0

Private creditors nonguaranteed 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Total LT DOD 19498.0 23095.0 24421.0 24638.0 26397.0 25964.0 25226.0 24587.0 26598.8 29697.6

ST debt 3152.0 1315.0 1621.0 1840.0 791.0 1239.0 793.0 700.0 650.0 1010.0Use oflMF credit 0.0 0.0 0.0 619.0 670.0 995.0 795.0 471.0 1129.0 1573.0

Total DOD (LT+ST+IMF), of which: 22650.0 24410.0 26042.0 27097.0 27858.0 28198.0 26814.0 25758.0 28377.8 32280.6Principal arrears 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Interest arrears 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

a. Data through 1993 from Debt Reporting System (DRS); 1994-95 data estimated by country operations division staff.b. "LT' denotes "long-term," "ST" denotes "short-term."c. "DOD" denotes "debt outsanding and disbursed"

Annex BAlgeria - External Debt Stocks and Flows Page 6 of 6

(USS millions at current prices)

Acal' Estimate 1986 1987 1988 1989 1990 1991 99Z 2 13 14 1995

F. Debt and debt burden indicators(based on data in parts A-E)

Total debt service(US$ millions) 5152.0 5446.0 6541.0 7000.0 8804.0 9169.0 9303.0 9145.0 4662.5 4543.3Interest (LT + ST + IMF)b 1585.0 1632.0 1954.0 1888.0 2024.0 1948.0 2102.0 1782.0 1314.4 1757.9Principal (LT+IMF) 3567.0 3814.0 4587.0 5112.0 6780.0 7221.0 7201.0 7363.0 3348.2 2785.4

Total DOD' and TDSdDOD/exports(XGS')ratio 238.1 220.9 263.0 229.9 185.5 198.2 195.1 206.8 252.0 264.4DOD/ GDP ratio 35.9 37.9 44.3 49.3 46.5 61.7 56.0 51.8 67.7 78.8TDS/exports(XGS)ratio 54.1 49.3 66.1 59.4 58.6 64.5 67.7 73.4 41.4 37.2

IBRD exposure indicators:IBRDDSr/publicloanDS 1.9 2.6 2.9 2.6 2.4 3.1 3.1 3.2 7.2 9.4Preferred creditor DS / public DS 3.4 5.1 4.8 4.8 5.7 6.7 8.5 10.3 21.7 23.3IBRD DS / exports (XGS) 1.0 1.3 1.9 1.5 1.4 2.0 2.0 2.3 2.8 3.3

Country share in IBRD portfolio 0.0 0.0 0.0 0.0 0.1 1.5 1.5 1.5 1.5 1.7

Memorandum itemsFactor payments / exports (XGS) ratios

Interest payments/ exports 16.7 14.8 19.7 16.0 13.5 13.7 15.3 14.3 16.3 18.1Total factorpayments/exports 23.1 14.9 21.0 17.0 14.4 16.4 16.5 15.3 16.3 18.1

a. Data through 1993 from Debt Reporting System (DRS); 1994-95 data estimated by country operations division staff.b. "LT" denotes 'long-term," "ST" denotes "short-term."c. "DOD" denotes "debt outsanding and disbursed"d. "TDS" denotes "total debt service."e. "XGS" denotes "exports of goods and services," which comprises exports of goods, nonfactor services, factor receipts, and workers' remittancesf. 'DS" denotes "debt service."

Annex CPage I of 3

DEMOCRATIC AND POPULAR REPUBLIC OF ALGERIASTRUCTURAL ADJUSTMENT LOAN

STATUS OF BANK GROUP OPERATIONS

1. World Bank Group involvement in Algeria has been intermittent. After a nine-yearmoratorium, Bank lending resumed in 1973. By 1980, 23 IBRD projects with commitments totalingover US$1.1 billion had been approved. Over time, increasing disagreement on project selection andimplementation criteria resulted in low disbursement rates. Several operations were canceled bymutual agreement in 1980, and another interruption in Bank lending followed. A new agreement led torenewed lending, and in 1984 and 1985, three projects totaling US$680 million were approved.Subsequent improvements in the dialogue led to a large increase in the lending program. Between1987 and 1992, 26 operations, with associated commitments of almost US$2.3 billion, were approved.These operation included two adjustment loans: the US$300 million ERSL and the US$350 millionEFSAL, approved in June 1991. The EFSAL was co-financed in the amount of US$300 million by theExport-Import Bank of Japan. Bank lending declined again in 1993, in large measure due to the slow-down of economic reform. However, higher lending resumed in 1994 with the approval of a US$110million Water Supply and Sewerage Rehabilitation project, and a US$51 million EmergencyReconstruction project for the Mascara region. In January, 1995, a sixth Highways project for US$130million was approved, as well as the Economic Rehabilitation Support Loan, a US$150 million one-tranche adjustment operation.

2. The IBRD's Algeria portfolio is one of the largest in the Middle East and North Africa region.As of February 29, 1996, cumulative commitments to Algeria stood at US$4,870 million (lesscancellations). Of this total, some US$1,774 million has been repaid and US$751 million wasundisbursed (see attached table). As of the same date, IFC commitments were US$10 million, almostcompletely disbursed. The Bank's share of Algeria's total debt (6 percent) and MLT debt service (9percent) are low compared to other Bank borrowers.

3. As noted in the CAS, and in close collaboration with the authorities, the Bank is engaged in abroad effort to improve the performance of the project portfolio. A full country portfolio review(CPPR) was carried out in July 1993, which resulted in action plans to address the key issues affectingthe Bank's portfolio, including closing several problem projects. Subsequent disruptions inimplementation, arising from the security situation and a lack of counterpart funds, led to furtherrestructuring in 1995, resulting in the closure of 4 loans. A thorough portfolio review in January 1996was followed by a February visit to Algeria, during which agreement was reached to restructure 8projects and cancel about US$80 million. Until the security situation improves, the Bank is workingwith known and experienced imnplementing agencies and is keeping project designs sirnple.

4. Other members of the World Bank Group are active in Algeria. The IFC's strategy for Algeriafocuses on the hydrocarbon sector, due to its strategic importance. The IFC approved its first projectin 1992 -- a US$10 million loan to Helios, a joint venture between SONATRACH and foreign investorsto produce helium gas for export. At present, IFC is preparing an oil recovery venture in conjunctionwith ARCO; the IFC has been requested to take part in a US$125 million syndicated loan. FIAScompleted a review of Algeria's investment climate in 1992, and Algeria signed the MIGA Conventionin April 1995, but has not yet completed its membership requirements.

Annex CPage 2of3

Algeria - Status of Bank Group OperationsIBRD Loans and IDA Credits in the Operations Portfolio

(as of February 29,1996)

Difference

Proiects Original amount between actual

in USS millions and expected

Project ID Fiscal Year Borrower Purpose IBRD IDA Cancellations Undisbursed disbursements a/

38 Loans closed 2486.46 10.46

DZ-PA-4903 87 Government Nat. Water Supply 11 250.00 60.35 60.35

DZ-PA-4904 88 SONELGAZ Power III 160.00 0.57 38.12 38.68DZ-PA-4907 95 Rep. of Algeria Highways VI 130.00 127.00 10.00DZ-PA-4914 88 Govt. of Algeria Voc. Training 54.00 16.51 15.81DZ-PA-4917 89 Rep. of Algeria Ports III 63.00 45.64 45.64DZ-PA-4923 90 Government Research & Extension 32.00 25.82 21.58

DZ-PA4925 90 Govt. Algeria/Enterprise Ind. Restructuring D 99.50 0.45 23.47 23.39DZ-PA-4929 89 Government Mitidja Irrigation 110.00 40.00 27.96 63.57DZ-PA-4934 91 Govt. of Algeria University Develop. 65.00 50.63 50.63DZ-PA-4938 92 Government Sahara Develop. 57.00 52.14 33.15

DZ-PA-4939 90 Government Technical Assistance 26.00 7.35 7.35DZ-PA-4944 92 Govt. ofAlgeria Foresty & Watershed 25.00 17.85 2.61DZ-PA-4952 92 SONATRACH First Petroleum 100.00 15.00 15.00DZ-PA-4954 93 Govt. of Algeria Basic & Secondary Educ. 40.00 33.73 4.23DZ-PA-4964 92 Rep. of Algeria Cadastre 33.00 17.91 (5.29)DZ-PA-4974 94 Govt. of Algeria Water Supply & Sewer 110.00 103.03 11.43DZ-PA-4976 93 Rep. of Algeria Housing Completion 200.00 6.94 (8.24)DZ-PA-34140 94 Govt. ofAlgeria Locust Control 30.00 24.84 24.84DZ-PA-38695 95 Govt. of Algeria Mascara Emerg. Reconst. 51.00 46.00 12.70

1,635.50 41.02 740.29 427.43

Total disbursed (IBRD and IDA) 3,510.67

Of which has been repaid 1,773.61

Total now held by IBRD and IDA 2,302.78Amount sold 36.37

Of which repaid 36.37

Total Undisbursed 750.75

Adiustment Lendine3 operations closed 798.79 0.00

a/ Actual disbursements to date less intended disbursements to date as projected at appraisal.

Annex CPage 3 of 3

Statement of IFC Investments

(as of February 29, 1996)

Amount in USS millionsFiscal Year Obligor Business Loan Equity Total

92 Helios S.P.A. Chemicals and 10.0 10.0Petrochemicals

Total Gross Commitments 10.0Less cancellations, terminations, 0.7

sales and exchange adjustmentsTotal Commitments now held by IFC 9.3Total undisbursed (including participant's portion) 0.0

Annex DPage I of 25

DEMOCRATIC AND POPULAR REPUBLIC OFALGERIA

LETTER OF DEVELOPMENT POLICY

April 3, 1996

Minister of Finance

To the President of the World Bank

Mr. President:

Please find attached a Letter of Development Policy concerning the StructuralAdjustment Loan which has been recently negotiated between the World Bank and theAlgerian authorities.

Please accept, Mr. President, the expression of my sincere consideration.

Ahmed Benbitour

Annex DPage 2 of 25

LETTER OF DEVELOPMENT POLICY

STRUCTURAL ADJUSTMENT LOAN

1- Introduction and Summary

1-1- The challenge:

The Algerian economy faces an important challenge if it wishes to enter theXXI Century in an environment that will enable its successful integration into the worldeconomy. Indeed, it must quickly restore sound and sustainable growth in order to correctpast imbalances, which have affected the productive sector as well as the social, monetary andbudgetary sectors. Equitable growth is a necessary condition to alleviate unemployment andenhance the standard of living of the population.

Demographic growth implies extensive social needs in education, public health,housing and economic infrastructure that necessitate large financial resources, as well asinstitutional reforms to improve the administration's efficiency and organization. Thechallenge facing the authorities arises in the context of resource scarcity. Therefore, it will benecessary to establish the conditions for optimal use of available resources, while ensuring thestability of the macroeconomic framework in particular. Some sectors will receive maximumpriority due to their essential role for growth: housing, taking into account the severe crisis inthis sector and its spillover effects and impact on employment; and agriculture, in relation tothe need to reduce food dependency and slow down rural migration.

The objective of equitable growth is ambitious, taking into account expected medium-term resource availability and the tight internal and external balances. With regard to externalbalances, long-term sustainability of the balance of payments must be ensured through thehydrocarbon sector and a larger contribution from export sectors, as well as throughestablishing an adequate external debt service profile. Management of internal balances willentail, for the Treasury, the maintenance of a budget surplus, which will be used both toconsolidate economic stabilization and to finance the expected growth by making resourcesavailable to finance investments.

1-2- The medium-term vision for the economy:

1-2-1- The new role of the State:

Starting with the implementation of the first development plans in the 1970s in thecontext of a centralized economy, the State attempted to undertake many functions that couldhave been assumed by other economic agents. Private savings outside the hydrocarbon sectorwere insufficient and the State became practically the sole investor. Through 1988, publicinvestments were mainly financed through temporary or permanent contributions from the

Annex DPage 3 of 25

Treasury. Since then, with the advent of the implementation of economic reforms, the Stateno longer intervenes directly in productive investment financing. Direct control of publicenterprises was replaced by monitoring of these enterprises through participation funds,fiduciary agents responsible for the management of State assets. Virtually all but 20 nationalpublic enterprises became autonomous, and are managed in accordance with private sectormanagement rules. Recently, the participation funds were dissolved. Ownership of publicenterprises will be transferred to holdings, thereby strengthening the reform process.

In this context, the State will pursue its disengagement from competitive sectors. Toensure the transition to a market economy, the State will require that holdings achieve theirgoal of developing and re-stabilizing their equity and stock portfolios. The State will thusgradually disengage from competitive activities, particularly from activities where the privatesector has the capacity to take over without creating significant market disruptions. Trade,services (except for basic public utilities) and small processing industries should no longerremain in its portfolio.

By gradually disengaging from the productive sphere as an economic agent, the Statewill be better positioned to play its regulatory role. As such it will ensure that economicagents function in a stable macroeconomic framework that fosters initiative and investment.The State will ensure the development and sustainability of market competition by enactingand enforcing relevant laws and regulations. The State will continue to play its role ofguarantor of the respect of the rules of the market, in goods and services, as well as thefinancial and labor markets.

1-2-2- Stimulating growth:

Economic performance has stagnated for several years, despite important latentproduction capacity in industry, construction and public works, and agricultural land. Usingmodem techniques, this capacity could be far more productive than it is today. Efforts will bemade to take better advantage of these opportunities by focusing on restructuring andenhancing the national productive capital stock. Macroeconomic constraints to market-relatedgrowth have been removed, but adjustment policies still need to be adopted to restoreenterprise performance through improved cost-effectiveness criteria. Therefore, improvementsin growth should first result from a better use of existing potential, and thereafter result fromnew investments that allow technological upgrading of productive capacities in order toachieve improved competitiveness. The hydrocarbon sector will still be expected to contributeto the growth objective, first because of its leading role for a sustainable external balance, butalso because of its capacity to generate residual savings to finance investments in otheractivities.

Growth will also depend on the expected dynamism of the private sector, both in areaswhere it is already predominant and in new activities in which it will invest using themechanisms of the new investment code. To alleviate and gradually reduce unemployment,

Annex DPage 4 of 25

productive investment will be fostered by a sound macroeconomic incentive framework inlabor-intensive sectors and in export-oriented activities.

In order for growth to be stable and sustainable, enterprises will have to obtain thenecessary resources to finance their investments and their current operations. The financialsector, through modernization and the development of capital markets, will have to play adynamic role in establishing active and sound financial intermediation based on prudentialregulation and competition rules. These adjustments will ensure better mobilization of savingsand will orient credit towards financing profitable productive activities.

1-2-3- The employment challenge:

One of the most important challenges facing the authorities is undoubtedly the issue ofunemployment. With a rate of approximately 25 percent of the labor force in 1995,unemployment will probably increase during a first phase of economic adjustment and publicenterprise restructuring. Indeed the viable solution to this severe problem lies in strong andsustainable growth. The sectors where a significant number of jobs are expected to be created-- construction and public works, agriculture and small and medium enterprises -- will have anessential role to play. However, it is possible that the effects of this growth, with respect toemployment, will only be felt in the medium term due to the lag between investment andoutput growth, even if new investments are labor intensive. It will thus be essential to plan fortransitional mechanisms capable of partially complementing the potential weakness of jobsupply during the next few years.

1-2-4- Maintaining a stable and sustainable macroeconomic framework and sustainable internaland external balances:

The success of growth recovery policies depends on the stability of the macroeconomicframework. This stability will be guaranteed by improving and maintaining externalcompetitiveness of the economy, establishing viable market economy rules and strictlymanaging public financial resources. Controlling inflation, which is at the base of thisstability, will remain a major concern for the authorities. This control depends on anincreased supply of goods and services entering the market, control of the wage bill and themaintenance of positive real interest rates, stimulating both household savings and enterpriseinvestment.

1-2-5- Protecting vulnerable groups of the population:

The authorities expect to implement the reform program at a cost that is equitablydistributed among all social groups of the population. It has been established that the mostvulnerable groups of the population, individuals with low income or no income, suffer mostfrom the impact of adjustment, through changes in relative prices or the temporary tighteningof the labor market. Hence, the authorities plan to maintain the newly-established socialassistance system, which would be improved and expanded in order to ensure that assistance

Annex DPage 5 of 25

reaches those most in need. In particular, a self-targeted income transfer program involvingwork on state infrastructure or social needs will be financed by the State so that a minimumincome can be guaranteed to each individual willing to work and unable to access the labormarket.

1-3- Summary of the principal measures supported by the SAL:

1-3-1- Budgetary measures:

The strict budgetary policy of the authorities has already resulted in a reduction of theTreasury deficit from 8.9 percent of GDP in 1993 to 4.6 percent in 1994 and 1.4 percent in1995. This stringency will be continued and accompanied by qualitative measures to increasethe effectiveness and efficiency of budgetary expenditures. For 1996, the following sectoralmeasures have been taken: (i) for education, the stabilization of the number of personnel and aparallel increase in expenditure on teacher training; (ii) for health, extra spending onpharmaceutical products and the strengthening of preventative medicine. The review of thebudget has also identified possibilities for reallocating resources, especially from economicactivities to the housing sector, in order to improve efficiency,.

The principles guiding this quest for efficiency and effectiveness will apply to thepreparation of the 1997 budget. These measures have been taken in order to maintainmacroeconomic stability, which is the foundation of sustainable growth.

1-3-2- Reform of public enterprises:

Public enterprise reform began in 1988 with the abolition of supervision by ministries,the granting of autonomy to public enterprises, and the introduction of fiduciary agents(Participation Funds) responsible for managing their equity portfolios.

An initiative relating to the 23 largest enterprises that remain non-autonomous wasintroduced in 1995 (plans for financing rehabilitation, restructuring, performance contracts,and redeployment and/or passage to autonomy); the implementation of this initiative will becompleted in the first quarter of 1996. To improve monitoring, the development of a systemfor tracking inter-enterprise debts in the public sector is planned. Public enterprise reform isbased on the introduction of holding companies, which manage the shares of the autonomouspublic enterprises.

These holding companies must increase the profitability of their portfolios. They aretherefore responsible for moving capital between affiliated commercial companies only whenthe interest of the companies requires it.

Annex DPage 6 of 25

1-3-3- Reform of the financial sector:

In the financial sector, a good understanding of the financial position of public banks isnecessary to undertake reform measures to bring this sector to the desired level ofperformance. Audits of the five public banks have been completed. On this basis, the bankshave been recapitalized. Management contracts requiring the respect of prudential regulationshave been put in place. At the same time, interest-rate ceilings on bank loans were replacedby maximum interest-rate margins; the margins themselves were then eliminated. Accountingrules and standards of evaluation for foreign-currency transactions have been adopted, alongwith the introduction of an interbank foreign-currency market. In the same manner,accounting rules and standards of evaluation for transferable securities will be adopted. Othermeasures necessary to make effective the banks' and the Treasury's interventions in the capitalmarket are listed in the matrix in Attachment 2.

A study on the opening up of the capital and/or the private management of at least oneof the five existing public banks has just been completed. It will serve as the basis for a planof action for implementing privatization. As for the capital market, the recent Treasury bondsauctions represent an notable important step. Rules and procedures for auctioning newsecurities and bonds have been adopted. The previously promulgated stock market law wasamended to permit the operation of a secondary market for the trading of Treasury bonds, toauthorize stock brokers to take part in other markets for transferable securities, and to liftcontrols on the origins of capital invested in the stock market. The commission for organizingthe monitoring of stock-market operations has been put in place and has defined its terms ofreference.

Finally, it is notable that the range of possible financial instruments was diversified bythe introduction of a legal framework permitting leasing and factoring, in order to allow moreappropriate financing of investment and more effective loan recovery.

1-3-4- Privatization:

The privatization law has been promulgated, along with its implementation texts, andthe relevant commissions have been created. Following a pilot operation in the hotel sector,the privatization process has already begun on the basis of existing legislation. A sizableprogram of privatization encompassing a significant number of enterprises (see Attachment 2)has begun and will be completed in the near future. The implementing system, which consistsof local and sectoral privatization committees and a monitoring committee, is already operatingto ensure the success of this initial phase of privatization under conditions of efficiency andtransparency. This initial program will be followed by a second one of comparable size,which will benefit from the experience gained during the initial phase and from more favorableinstitutional conditions.

Annex DPage 7 of 25

1-3-5- Housing:

Housing sector reform measures had already begun during 1994, notably including theadoption of a restructuring plan for the housing bank (CNEP), the liberalization ofconstruction prices for public housing, and a 20 percent increase in subsidized rents. Theundertaking and deepening of these reforms is being carried out in concertation with theauthorities' national housing strategy. A financing plan for the public housing program for thecurrent year has been adopted. As for 1995, the active participation of the private sector inpublic housing construction is expected.

1-3-6- Agriculture:

The organization of agricultural production has improved thanks to the reform of theagricultural sector through the dissolution, beginning in 1987, of socialist agricultural farmsand the distribution of their territories to collective and individual operations. The newbeneficiaries have usufruct rights over the land for an indefinite period, which they can passon to their descendants, as well as ownership rights over the farm buildings and equipment.Sector reform was strengthened by the promulgation of legislation permitting the restitution ofagricultural land to the owners who previously ceded their land to the State (amendment in1995 to Directive 95-25).

1-3-7- Social safety net:

A social safety net has been put in place to lessen the impact of adjustment on low-income households, especially following the reduction of food subsidies. The initial systemwas restructured to respond to the needs of the old and handicapped as well as those of theunemployed without income. The current system thus has two parts: (i) an income transfer topeople without income who are over 60 or handicapped, and (ii) a cash transfer to working-age people without a job or other source of income who participate in a public works scheme.Moreover, in order to reduce the negative impact of enterprise restructuring on employment,the authorities implemented a system of unemployment insurance, which is funded bycontributions from workers and firms and by entry fees paid by the firms concerned.

2- Macroeconomic framework in the context of the SAL

2-1- Objectives:

The successful implementation of the reform program requires the guarantee of a stablemacroeconomic framework. For this purpose, the authorities have developed a medium-termprogram covering monetary, budgetary, trade and pricing policy whose main objective is toreduce inflation to the level of Algeria's trading partners in the next three years. This is aprerequisite for economic recovery and its sustainability. The program must be maintained inorder to gain the confidence of foreign economic partners. It is expected that the frameworkto be put in place will be sufficient to attract non-resident investors; direct investment

Annex DPage 8 of 25

financing will replace debt financing of external debt.

This program will also enable the development of market competitiveness andencourage enterprises to develop quality products, facilitating access to foreign markets.(Implementation of the new competition law is important in this regard.) It becomes indeedimperative that hydrocarbon exports are no longer the only source of external income and thatexports of manufactured goods begin to play a role.

2-2- Monetary policy and interest rates:

Since April 1994 monetary policy has relied on a significant increase of interest ratesapplied to bank refinancing in the context of the liberalization of interbank money marketrates, accompanied by a substantial adjustment of the exchange rate. This strict managementof monetary policy resulted in a drop of 6 points in the liquidity ratio in 1994 compared to1993. The shift to indirect instruments of monetary policy, which was reinforced by theimplementation of public tender operations in May 1995, as well as the implementation at theend of 1995 of Treasury bill auctions, has consolidated the evolution of monetary policyinstruments.

With respect to interest rates, the flexibility of money market rates helped to minimizethe pressure on banking system liquidity. Monetary stabilization has been consolidated with aview to fully liberalize bank lending rates, and in this context, as of December 1995, theceiling on bank margins was removed.

Overall, the anticipated expanded role played by public auctioning of refinancingcredits will contribute to the development of a credit market as an anchor for sound bankportfolios. Similarly, the development of a government securities market, particularly inrelation to the management of public debt, will enable open market operations in 1996.Finally, the development of indirect monetary policy instruments is consistent with the goal ofreaching positive real interest rates.

2-3- Budgetary policy:

The fundamental principles guiding budgetary policy are the need to avoid higherinflation on the one hand, and to avoid denying private sector access to necessary investmentcapital on the other hand. For this purpose, the authorities will maintain the objective of aTreasury surplus, taking into account the level of public debt service, particularly after 1998when debt rescheduling will end. Economic growth, accompanied by greater efficiency ofbudget administration, should contribute both to a Treasury surplus and to a tightening of theState's current and capital expenditures. With respect to capital expenditures, it will benecessary to maintain the level of resources allocated to education and public health. At thesame time, the authorities will work to ensure efficient resource allocation of the investmentbudget between all sectors, and the efficient use of these resources. Priority will continue tobe given to water and agriculture. Rationalizing expenditures will depend on a stricter

Annex DPage 9 of 25

management of personnel together with modernizing the civil service. Finally, one of theGovernment's budget priorities will be to free up resources for social housing. As for theRestructuring Fund, the authorities will proceed with the closing of this fund in accordancewith the schedule established in 1994 (see Attachment 3).

24- Foreign exchange regime and external trade liberalization:

The liberalization of the external trade and foreign exchange regimes was initiated inApril 1994, in the context of the stabilization program. The 40 percent depreciation of thedinar that took place at that time was the anchor for the flexibility of the foreign exchangeregime, supported by the strict application of appropriate monetary and financial policies. Theintroduction of daily fixing sessions in September 1994 confirmed the shift from a fixedforeign exchange regime to a flexible exchange rate determined by auction.

Liberalization of imports was pursued starting in 1994, and was achieved in thebeginning of 1995 despite pressure on the foreign exchange market resulting from unfavorableexternal factors. Except for travel expenses abroad, current account convertibility is already areality. In January 1996, an interbank foreign exchange market was created.

Furthermore, the foreign exchange market has been gradually decentralized, operatingat the level of banks and licensed intermediaries. Revenues from exports other thanhydrocarbons and minerals are directly repatriated on the foreign exchange interbank market,and 50 percent of these receipts are traded on the market. In this initial phase, foreignexchange resources generated by these sales represent the main share of resources available tobanks and financial institutions. The expected increase in foreign exchange resources oflicensed intermediaries and the increase in the number of participants will contribute to anefficient allocation of resources on the foreign exchange interbank market. The developmentof this market will be supported by applying prudential monitoring standards for the foreignexchange positions of financial institutions.

2-5- Pricing policy and incentive framework:

Until recently, the system of relative prices contained major distortions due to the factthat they were not determined according to market rules but were centrally determined. Since1988, with the advent of reform, the State gradually liberalized the prices of goods andservices, the majority of which are now determined by market supply and demand. This is thecase for agricultural products, industrial consumption goods, and services provided to firmsand households. The quasi-totality of subsidies on staple foods and energy products has beeneliminated except for milk and butane gas, which continue to benefit temporarily from smallsubsidies. As for noncompetitive services, in particular public utilities, rate revisions willgradually lead to a closer covering of economic costs. It is expected that this policy togetherwith the development of competition through implementing the recently adopted legislationwill contribute to price stability. Enhancing the incentive framework will include a program torestructure and regularize land titles.

Annex DPage 10 of 25

3- Reform of public enterprises and sectoral policies

3-1- Reform of public enterprises:

In 1988, public enterprise reform was launched by granting them managementautonomy (Law 88-01), thus eliminating public control. The formerly non-autonomous publicenterprises (EPS) were transformed into autonomous public enterprises (EPE) governed bymarket rules. Participation funds were created to manage the equity of these companies. Thissystem resulted in a more precise measurement of the size of the capital stock of the State, aswell as a more efficient and transparent monitoring of the management of these enterprises.As a result, it is possible to understand better the internal and external causes of the financialdifficulties encountered by these enterprises. Financial restructuring measures have beentaken, accompanied by rehabilitation plans. Ownership of the shares of these enterprises willbe transferred to the recently-established holdings.

3-2- Privatization:

A privatization law was promulgated and the institutions envisioned by this law havebeen created, but these institutions are not yet operational. In the meantime, the privatizationprocess has been launched on the basis of previously existing legislation. A significantprivatization program comprising a considerable number of enterprises (see Attachment 2) hasbeen put in place and will be completed in the near future. To ensure the success of this firstprogram with the maximum possible efficiency and transparency, the mechanisms for itsimplementation are already operational, including the formation of local and sectoralprivatization committees and a monitoring committee. It will be followed by a secondprogram of comparable size, which will benefit from the experience acquired during the initialphase and will therefore proceed under more favorable institutional conditions.

Experience from the first program will be useful when the privatization mechanismenvisioned by the law is operational. By maintaining a pace of privatization taking intoaccount concrete market opportunities, the authorities intend to give the program the bestpossible chance of success.

In the context of implementing the privatization law, the State will gradually disengagefrom competitive sectors. The sectors concerned are: hotels, tourism, trade and distribution,textile and foodstuff industries, manufacturing in the areas of mechanical, electrical, andelectronic industries, wood and by-products, paper, chemical industries, plastics, hides andskins, passenger and freight road transport, insurance, port and airport service activities, allsmall and medium industries and small and medium local enterprises, as well as studies andoperations in construction and public works.

Annex DPage 1 1 of 25

3-3- Financial sector reform:

Financial liberalization in 1994-95 was an important component of the stabilizationprogram, aimed at developing financial intermediation. Adjustment of the capital stock ofbanks, notably through their recapitalization in 1995 based on audited 1993 financialstatements, followed a tightening of prudential regulations at the end of 1994. Liberalizationof the interbank market in 1994 constituted a pivotal element of banking reform. Managementcontracts signed by banks aim at strengthening their capital adequacy ratios and requireadherence to prudential regulations.

The development of a money market continued in 1995 with the creation of short-termpublic securities related to the auctioning of Treasury bills. The development of a publicsecurities market, along with active management of public debt, will stimulate the creation of atrue financial market. The development of financial intermediation will also be supported by aprogram to improve the payments system.

The elimination in December 1995 of the ceiling on bank margins will stimulate therole of the banks in mobilizing long-term financial savings. Similarly, strict application ofprudential regulations will enhance the functional efficiency of banks in allocating soundfinancing to the economy.

In addition to maintaining bank capital adequacy standards, bringing outstanding bankoverdrafts closer to the regulatory ceiling as well as monitoring inter-enterprise debts willmake the budgetary constraint on public enterprises more explicit, and will reduce therecurrence of non-performing bank loans. This will also improve the central bank's ability toconduct monetary policy through interventions in the flow of funds. In order to increase theefficiency of bank intermediation through private participation in the banking system, astructured approach for opening the capital and/or privatizing the management of one of theexisting public banks will be undertaken. This approach will lead to a pilot project that couldbe expanded to the entire public banking system in compliance with current legislation onprivatization.

Overall, the development of financial intermediation will be accompanied by anexternal financial liberalization inherent to the convertibility of the dinar. The intermediationof banks and financial institutions on the foreign market will contribute to the objective ofexternal competitiveness.

3-4- Housing sector:

Actions and policies related to housing have too often been addressed at a sectorallevel. Past policies suffered from a lack of coherence. Housing was exclusively seen as asocial need while it is first of all an economic asset. A change in policy is necessary to fullyintegrate the housing sector into the process of transition to a market economy. New policies

Annex DPage 12 of 25

are needed to better respond to the demand that will arise from lifting supply constraints. Thiswill foster access to ownership.

3-4-1- Fostering access to ownership:

To further this objective, incentives will be designed for housing sector operators,notably in the private sector, related to real estate promotion, construction by individualowners, up-front housing support to the most vulnerable groups, and up-front support forrenovating sub-standard housing.

These actions will be integrated into a global approach requiring the implementation ofmeasures related to: (i) adoption of land use planning instruments adapted to the new policy;(ii) enhancement and expansion of land registration; (iii) incentives for private owners to offerbuilding plots on the market; (iv) control of plot acquisitions through issuing ownership titles;(v) access to credit for land promotion; (vi) gradual integration of savings to finance housing,notably through improved collection; and (vii) technical support to the sector and developmentof technical monitoring of construction activities.

3-4-2- Promotion and organization of the rental market:

The limits reached by the current system of housing finance, distribution andmanagement justify the implementation of a new policy vis-a-vis the creation of a rentalmarket. This policy includes operational measures already adopted (rent increases) and otherinstitutional measures to be implemented in the short to medium term by: (i) reviewingconditions of access to public rental housing and the requirement of financial participation bybeneficiaries in the form of a deposit; (ii) gradually moving toward market rates accompaniedby a need-based program of rent assistance; (iii) promoting the privatization of public rentalhousing; (iv) gradually reorganizing the management of residual public rental housing bycreating the profession of property administrator and by fostering greater accountability byrenters for maintenance; (v) adopting incentive measures to encourage private investment inthe rental real estate sector (access to land, access to credit); and (vi) rebalancing the relationbetween owners and renters (through market determination of rent, and assurance that theproperty will be vacated at the end of a lease).

The objective for the sector is to create a true real estate market. The achievement ofthis objective implies major institutional reforms touching all participants in the housingmarket.

3-4-3- Public Housing:

Public housing reform will focus on the two major public housing developers. Theagency that builds housing for sale should be rapidly privatized in order to eliminatedifferences between public developers and those of the private sector with respect toadvantages conceded (including access to land and access to credit). The public developers

Annex DPage 13 of 25

that build rental housing will gradually be divested from managing and maintaining thehousing stock; specialized private agents, whose development will be fostered, will take overthese responsibilities.

3-4-4- Reform of the housing finance system:

Measures developed hereafter should be complemented by institutional reform ofhousing finance which focuses on the creation of a housing bank and of a financing fund forpublic rental housing. Furthermore. and in order to encourage participation of commercialbanks in housing finance, mortgage refinancing and mortgage guarantee companies will alsoneed to be created. The actions described above will aim at integrating the housing sector intothe process of transition towards a market economy; the State is renouncing its current role ofhousing producer and landlord.

3-5- Agriculture:

Reforms launched in the agricultural sector aim at increasing agricultural productionand as a result at improving food security. They are being implemented in accordance withthe requirements of building a market economy. These reforms address pricing policies,budgetary measures, organization of agricultural services, agricultural land status, organizationof the agricultural profession, adaptation of the administration and restructuring of publicenterprises. Recent reforms consisted of encouraging the development of a responsibleagricultural policy by divesting the State from its past management role and by fosteringinitiatives that contribute to improved efficiency in order to stimulate sound and sustainablegrowth.

It is in this context that State support for agricultural inputs was totally eliminated in1994. Guaranteed minimum prices have also been eliminated for most crops. Only wheatprices are still guaranteed, because of the vulnerable economic status of many wheatproducers. With regard to taxation, the approach has been to eliminate all VAT and customsduties exemptions on goods and services for the agricultural sector and by submittingproduction activities to the income tax system.

The budgetary adjustments that took place have also reversed past investment policies.Subsidies for productive investments are limited and are made in the context of a transparent,targeted incentive framework, ensuring maximum efficiency. Interest rate subsidies target inparticular priority activities through seasonal credits. Similarly the financing system, whichrepresents an important constraint to credit access, is being restructured through the creationof a mutual financial institution for agriculture.

The irrigation sector will undergo a reorientation to strengthen ongoing adjustmentsregarding water pricing. The aim is to improve the efficiency of existing investments andfoster maintenance and rehabilitation of existing infrastructure.

Annex DPage 14 of 25

With regard to agricultural services, the recent fundamental external trade reforms haveliberalized the supply activities that had been public enterprises monopolies. This has notablyfostered the emergence of private operators in the import and distribution of intermediaryconsumption products (fertilizers, phytosanitary products, veterinary products, seeds andanimal breeding).

Concerning land tenure, actions to dissolve socialist agricultural state farms havealready been dissolved are and actions of ongoing in order to protect farmers exploiting landbelonging to the State, on the one hand, and allow full restitution of nationalized land or landcontrolled by the State, on the other hand. It is with this in mind that the legislationconcerning land tenure was revised in 1995 and that the law governing state farms operation isbeing revised in order to establish the means for privatizing them and for developing a landmarket.

The adaptation of agricultural administration to the new economic environment is beingaddressed through a program aimed at improving its analysis and decision making capacities.

Finally, restructuring of public enterprises in the agricultural sector is startinggradually by fostering private initiative to promote a market for the production and distributionof goods and services. The implementation of the partial or total privatization program ofagricultural public enterprises is taking place in the context of the Government's privatizationprogram. The future role of ONAPSA, the major public enterprise operating in the area ofimport and distribution of seeds, fertilizers, phytosanitary and veterinary products, is currentlyunder review in this context. The gradual disengagement of the State, without marketdisruption, will first be envisaged through greater management responsibility for the enterpriseby representatives of the agricultural sector and thereafter through the transfer of equity toprofessional cooperative organizations that would privatize the enterprise.

4- Social Safety Net

4-1- Current system to protect the most vulnerable groups:

In 1992, the authorities reformed the pricing system by reducing budgetary subsidiesfor food staples. The system of support through prices proved to be very expensive because itwas not targeted. Three types of compensation schemes were adopted between February 1992and September 1994: (i) indemnity for a sole wage earner of 500 dinars paid to a marriedperson whose salary was less than 7000 dinars and whose spouse was without income; (ii)indemnity to groups without income, in the amount of 120 dinars per month and perdependent; and (iii) supplementary family allocation of 60 dinars per month and per child.

This system alleviated the impact of price increases but proved to be inefficient in itstargeting. In the third quarter of 1994 it was replaced by a new mechanism aimed atimproving the targeting to the truly needy. This new mechanism, currently in place, consistsof: (i) a lump-sum solidarity allowance (AFS) for the elderly (over 60 years) without revenue

Annex DPage 15 of 25

and for the handicapped who are not capable of working, in an amount of 600 dinars perdependent, up to three dependents; and (ii) a payment for public service activities (IAIG) of amaximum of 2100 dinars per month, paid to those who participate in these activities, pro ratedby the number of days worked.

In parallel to the mechanism to protect the most vulnerable groups of the population, anunemployment insurance system was established in July 1994 for workers who lose their jobsfor economic reasons. The beneficiaries of unemployment insurance receive a paymentthrough an unemployment insurance fund, financed by contributions from workers andemployers as well as entry fees paid by the enterprises concerned.

4-2- Improvements of the system:

Although the targeting of the most vulnerable groups has been improved thanks to itsnew configuration, the current system still has distortions that must be addressed. Concerningthe lump-sum solidarity allowance (AFS), the fact that the persons affected are truly poor andthus need to receive their payments on time to satisfy basic needs will need to be taken intoaccount. Quarterly payments are inappropriate, especially if the allocation is paid at the end ofthe quarter. A formula based on payments made at the beginning of the period could eliminatethis inefficiency as a less-costly alternative to more frequent payments. Furthermore,possibilities for reducing the payment frequency are under consideration.

To enhance the self targeting of the public service activities (IAIG), incentives thatencourage participation by the poor, and discourage participation of the non-poor will bereinforced through the following measures: (i) strengthening the enforcement of working timerequirements (in terms of a full eight-hour working day); (ii) a better selection of activities forIAIG, by introducing simple and transparent guidelines; (iii) analyzing the possiblemodification of the payment schedules (day rate or piece rate) based on the work site of IAIGactivities while taking into account their location and constraints; and (iv) focusing the locationof work sites in areas that are predominantly poor.

In order to complete the current system, a new program of public works is currentlyunder consideration which would be more cost-effective and would provide more consistentrevenue to its beneficiaries.

As in the case of the system to protect the most vulnerable groups, the system ofunemployment insurance will be evaluated, based on data such as the number of beneficiariesalready admitted, the level of benefits, the level of revenues (entry fees and monthly payrollcontributions), administrative costs and projected costs, etc., in order to take the measuresneeded to improve its efficiency and financial viability. These improvements will focus on therules of financing the system. In particular, control mechanisms will be implemented in orderto monitor regularly the fund revenues (payroll contributions and entry fees) and expenditures(benefit outlays and other uses of funds). The system must generate sufficient reserves to befinancially viable. In this context, an investment strategy for fund resources must ensure a

Annex DPage 16 of 25

maximum return on investment, as well as a reserve margin that ensures adequate resourcesand financial viability of the fund.

4-3- Knowledge of the current situation:

The design and implementation of a social safety net, essential to alleviate the impact ofadjustment measures on the most vulnerable groups of the population, requires a clearunderstanding of the economic and social characteristics of the population as well as a precisedefinition of poverty. A living standards survey of the population -- providing demographicdata, sanitary and housing conditions, access to public utilities, and information onemployment and income -- has just been completed in the field by the National StatisticalOffice. The preliminary results are already available and will serve as the basis of a povertystudy. This study, which will focus on revenues and living conditions of the pooresthouseholds, will be used to refine the targeting of households eligible to benefit from thesocial safety net. In order to improve the targeting of assistance programs, and based on theresults of the 1995 Living Standards Measurement Survey, a set of indicators on the socio-economic characteristics of the poor will be developed.

5- System of Indicators

To help assess progress of the reform program, the authorities have established a list ofquantitative indicators. The authorities will communicate to the Bank all necessaryinformation to compute these indicators before the evaluation missions of the StructuralAdjustment Loan, and will review together with the Bank the evolution of these indicatorsduring the course of these missions. The indicators are listed in Attachment 1.

6- Financing of the program

Algeria's program of economic reforms requires significant multilateral and bilateralsupport. A three year IMF EFF program covering program years 1994/95 to 1997/98 isongoing. Debt rescheduling agreements have been concluded with the Paris and LondonClubs. The program also receives support from the European Union. Furthermore, it benefitsfrom the support of the African Development Bank and the Arab Monetary Fund. Algeria'sbilateral partners have provided and continue to provide significant and sustained assistance tothe ongoing reform program.

The World Bank has a specific role to play in technical assistance and financing of thereforms. The Algerian authorities wish to see the Bank's support of the current reformprogram intensify and accelerate, particularly in the area of job creation and in thedevelopment of the housing and agriculture sectors. During this transition phase, the Algerianauthorities also expect the IFC to play a more dynamic and catalytic role in the development ofthe private sector.

Annex DPage 17 of 25

ATTACHMENT 1LETTER OF DEVELOPMENT POLICY

INDICATORS

Macro-economic framework

* GDP growth (annual)

* industrial production indices (quarterly)

* imports (six months)

* exports (six months)

* consumer price index (monthly)

* re-discount rate (monthly)

* interest rates and dinar amounts from credit auctioning sessions (monthly)

* average interbank market rates (monthly)

* foreign exchange reserves (monthly)

* foreign exchange rates (monthly)

* money supply (monthly)

* credit to the economy (quarterly):credit to public enterprises;credit to the 23 large, previously non-autonomous public enterprises;credit to the 10 food product import agencies.

Reform of public expenditures

* Treasury balance (quarterly)

* expenditures of the Restructuring Fund (quarterly)

Annex DPage 18 of 25

* capital and current expenditures, overall and by sector (those sectors covered by the PublicExpenditure Review) (quarterly)

Private sector development and public enterprise reform

* projected sectoral private value added (quarterly for industry, annually for the othersectors)

* number of enterprises newly created (six months)

* import-weighted average tariff rate (six months)

* nominal and effective protection rates (annual)

D information on privatized enterprises or units of enterprises (name of enterprise or unit,personnel figures, value added, type of activity) (six months)

* when the monitoring system is operational, information on inter-enterprise indebtedness ofpublic enterprises (in accordance with agreed mechanism), including overall amount ofinter-enterprise debt (quarterly)

Financial sector reform

* borrowing and lending rates charged by banks (quarterly)

* share of bank credit in the financing of the economy (quarterly)

* capital ratio to banks' liabilities (annual)

Strengthening of social safety net system

* number of beneficiaries of early retirement and unemployment insurance programs (sixmonths)

* number of beneficiaries of the social safety net: AFS and PAIG (six months)

ttachment 2 Algeria Structural Adjustment Program--Proposed Policy Matrix

Component Measures taken before May 1, Measures to be taken before Measures to be taken before the1995 presentation of the SAL to the relase of the Second Tranche

Board

Macroeconomic Framework - Maintenance of a macroeconomic Maintenance of a macroeconomicframework in accordance with the EFF. framework in accordance with the EFF.

Foreign Exchange and - Dinar convertibility achieved for most

Trade Regime trade-related transactions; elimination ofremaining professional criteria requirementsfor importers.

Budgetary Policy - Reduction of budget deficit from 8.9 - Submission to the Bank of a govemment * Submission to the Bank of a govemment

percent of GDP in 1993 to 4.4 percent in investment program and plan for recurrent investment program and a program of

1994. govemment expenditures for 1996 in the recurrent govemment expenditures in thehealth, education, transport, and housing context of the 1997 budget including the

sectors and in accordance with the Public measures agreed jointly and satisfying toExpenditure Review (PER). [Note: major both parties, in the framework of the PER.

measures taken include: zero net recruitmentin education; an increase of 150 percent in the - Adoption and implementation of

budget for teacher training and retraining; 75 institutional measures, satisfactory to bothpercent increase in pharmaceutical parties, designed to improve the functioning

expenditures; 130 percent increase in of the system of public finance, in the

preventative medicine expenditures; launching framework of the PER.of pilot operations for subcontracting withprivate sector for food and cleaning servicesin the health sector; shelving construction ofAlgiers metro; a reallocation of part ofplanned infrastructure investments tohousing.]

- Stabilization of recruitment for the civil * Presentation to the Bank of the program of

service, in accordance with the EFF. personnel expenditures for the civil serviceproposed for the 1997 budget, comprising the

measures agreed jointly and satisfying toboth parties in the context of the PER. UQ

Xi

Component Measures tsken before May 1, Measures to be taken before Measures to be taken before the1995 presentation of the SAL to the release of the Second Tranche

Board

Macroeconomic Framework(continued)

Budgetarv Policy - Agreement on the timetable for the closure - Progress toward the closure of the - Presentation to the Bank of a programn for

(continued) of the Restructuring Fund (Appendix B, Restructuring Fund in accordance with agreed the improvement of the efficiency of the civilAnncx 1, ERL Letter of Development timetable. [Note: three measures in the service and the implementation of a first setPolicy). matrix -- the above measure, the passage of of measures agreed jointly.

the remaining large public enterprises toautonomy (see Public Enterprise Reform), and * Progress toward the closure ofconstraints on banks to maintain prudential Restructuring Fund in accordance withratios (see Financial Sector) impose hard agreed timetable.budget constraints on public enterprises.]

Private Sector Support and Reformof Public Enterprises

Privatization - Drafting of privatization law, in - Promulgation of privatization law.consultation with the Bank (ERL).

- Promulgation the implementing texts, as - Joint review of the privatization processagreed and in consultation with the Bank; based on these implementing texts and theircreation of the institutions foreseen in the law improvement, if necessary.for the management of the privatizationprocess.

- Enactment of a pilot privatization program, - Implement an initial privatization program, - Completion of initial program ofsupported under the ERL, and liquidation of including bringing 103 communal-level public privatization (including concessions).88 local public enterprises. enterprises to the point of sale, offering 35

communal activities for private sector - Establishment of a second privatizationoperation by concession, bringing to the point program.of sale (selling the units, opening of capital oroperation by the private sector through * Bring to the point of sale (sale of themanagement contract) 50 units of national whole enterprise, sale of units of enterprises,public enterprises (EPEs), privatization of the opening of capital), operation by the privatemanagement of two govemment-owned sector through concession or managementhotels, and dissolution of 84 local public contracting arrangements, or dissolution a CD

enterprises (EPLs). part, accepted by both parties, of this second.__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ program .

LN')

Componet Measures tken before May 1, Measures to be taken before Measures to be taken before the1995 presentation of the SAL to tde release of the Second Tracbe

Board

Private Sector Support and Reformof Public Enterprises (continued)

Apriculture Sector - State lands under socialist state farms - Presentation to the Bank of the

Reform distributed to individual and collective farms Govemment's agriculture sector policy,with usufruct rights but without property notably conceming agricultural land and the

rights. privatization of public enterprises in thesector.

- Promulgation of the legislation authorizing * Adoption by the Council of Govemment ofthe restitution of agriculture land donated to a draft law defining the modes of

the State (Law no. 95-25). privatization of state-owned agricultural land.

Public Enterprise Reform - Passage to autonomy of 5 large previously -Rule definitively on the future (immediate

non-autonomous public enterprises. passage to autonomy, redeployment, ordissolution) of the remaining large non-autonomous public enterprises in conformitywith the framework set out in the ERL.

- The creation of the institutions necessary for - Management of the holding companies inthe implementation of the law creating conformity with the objectives given in the

holding companies to manage public Letter of Development Policy.enterprises, notably:

- promulgatation of the bylaws of theholdings;

- establishment of the technical support unitfor the CNPE;in conformity with the objectives set out inthe Letter of Development Policy.

- Design in consultation with the Bank a - Regular monitoring of the inter-enterprisesystem to monitor the inter-enterprise debts of debts of public enterprises.public enterprises.

CD

Incentive Framework - Promulgation of a competition law. - Drafting of the implementing regulations, inconsultation with the Bank, and publication of O b

all of these texts. e '

Componet Measue taken before May 1, Meaures to be tWen before Measures to be taken before the

1995 presentation of the SAL to the release of the Second TrancbeBoard

Private Sector Support and Reformof Public Enterriaes (continued)

Incentive Framework - Promulgation of the new investment code. - Carry out a general program to clarify and - Review of progress of program to clarify l

(continued) regularize property titles. and regularize property titles for industrial

- Installation of the Agency for the and commercial enterprises and the adoption,Promotion and Support of Investment - Enactment of legal texts permitting lease if needed, of measures jointly agreed to

financing of capital equipment. improve this program.- Opening of a one-stop information windowfor potential investors. - Promulgation of a decree permitting

factoring.

Housing Reform - Freeing of construction prices for social - Adoption by the Govemment andhousing. presentation to the Bank of a new national

housing strategy.- 10 percent increase in subsidized rents.

- Implementation of measures designed to - Evaluation of the private sector share in the

- Adoption of a plan to restructure CNEP, increase the participation of the private sector execution of the 1995 public housingthe national housing finance institution. in the execution of the 1995 public housing program and an increase in private sector

program. share of the 1996 program.

- Adoption by the Govemment and - Execution of the 1996 public housingpresentation to the Bank of a financial plan program following the financing plan andand a calendar for the 1996 public housing calendar agreed with the Bank.program.

- Presentation to the Bank of a financial planand a calendar for the 1997 public housingprogram.

Financial Sector - Replacement of interest rate ceilings on - Elimination of the ceiling on bank margins.bank loans by a maximum 5 percent margin.

- Determination of bank capital requirementsto meet minimum capital thresholds, on thebasis of end-1993 audits, in consultation withthe Bank. C

- Recapitalization of the five public banks and - Maintenance by the public banks ofpayment of the capital contributions as acceptable capital adequacy ratios.foreseen in the 1995 govemment budget.

Component Measures taken before May 1, Measures to be taken before Measures to be taken before the1995 presentation of the SAL to the relase of the Second Tra bhe

Board

Private Sector Support and Reformof Public Enterprises (continued)

Financial Sector - Adoption of a model management contract - Signature and implementation of(continued) between the Ministry of Finance and management contracts for the five public

managers of publicly-owned banks, holding banks.the managers responsible for respectingcapital adequacy requirements. - Completion of study and presentation to the - Adoption, in consultation with the Bank,

Bank of a draft proposal for private share and launching of jointly agreed program for- Redesign of the structure of new issues of ownership and/or private management of at the opening of the capital and/or the privategovernment securities, in conformity with least one of the five existing public banks. management of at least one of the fivethe principles agreed in the context of the existing private banks.Capital Market Study.

- Adoption and introduction of instructions - Adoption and introduction, in consultation- Adoptior and introduction of accounting concerning open foreign exchange positions with the Bank, of accounting regulations andand valuation standards for commercial bank of comrnercial banks and other financial evaluation norms for transactions in financialtransactions in foreign exchange. institutions. securities.

- Adoption, in consultation with the Bank, of - Establishment of an operational system for- Adoption of the regulations and procedures instructions concerning the issuance and the the auction of Treasury bills and bonds;for the auctioning of new Treasury bills and negotiation of the new Treasury securities establishment of the requirements forbonds. Treasury security dealers; to support the

development of a secondary market,establishment of payment mechanisms fortransactions in Treasury securities.

- Submission of a summary report on the - Introduction of the plan to improve theaction program to upgrade the bank check performance of the bank check clearing andclearing and fund transfer system, including fund transfer system, attainment of pre-the relevant data. established objectives.

- Establishment of quantitative targets for the * Attainment of the pre-established objectivereduction in commercial bank overdrafts for the reduction of overdrafts granted to thegranted to the economy. economy. m

O k

Component Measures take before May 1, Measures to be taken before Measures to be taken before the1995 presentatio of the SAL to the relase of the Second Trabce

Bo4rd

Private Sector Support and Reformof Public Enternprcs (contibued)

FaIsa Sector(contined) - Adoption of amendments to the Stock

Market Law: (I) authorizing an over-the-counter secondary market in Treasurysecurities; (2) authorizing stock exchangemembers to trade in other security markets;(3) relieving stock exchange members of theresponsibility to account for the origin of theirclient's funds.

- Putting into place of the COSOB (Exch. - Execution of the planned work program.Comm.) and establishment of its workprogram, notably staff training, allocation ofstaff functions, and drafting of regulations forpublic offerings, operations of investmentfunds, and licensing of stock brokers.

Soeial Safety Net - Launching of new social safety net - Implementation of new social safety netmeasures -job loss insurance, public works measures.program (PAIG), and cash assistance forthose not able to work (AFS). - Based on the results of joint studies with the * Implementation of measures designed to

Bank, adoption of measures necessary to strengthen the three programs.strengthen the three programs.

- Presentation to the Bank of a draft executive - Step-by-step implementation, indecree creating and establishing the bylaws of consultation with the Bank, of ana social development agency. autonomous social development agency.

- Launch LSMS, in collaboration with the - Agreement conceming the Bank's analytical * Based on the results of the LSMS and/orBank. use of the LSMS data, based on terns and the Poverty Assessment, and, in consultation

conditions established in advance with ONS, with the Bank, development and adoption ofthe national statistical office. a program to improve the social protection

system for the poorest groups

* Principal measures. 9 X

Annex DPage 25 of 25

ATTACHMENT 3LETTER OF DEVELOPMENT POLICY

RESTRUCTURING FUND(Closing schedule)

In accordance to the previously established approach concerning the Restructuring Fund, itsclosing schedule will be pursued. For the future, the following actions will be taken asinitially agreed in the context of the ERL:

(i) For the differential of commercial bank charges on external borrowing contractedfor the account of the State before April 1990: transfer from the RestructuringFund at the end of 1996; after that date, these expenditures will be treatedaccording to the same procedures as public debt.

(ii) For repayments of restructuring bonds (bons de rachat): transfer from theRestructuring Fund as of October 1, 1996; after that date, these obligations willbe treated according to the same procedures as public debt. Advance repaymentsto the banks by the Treasury will be halted after April 1, 1997. The amount ofthese advance repayments will not exceed two-thirds of the total amountallocated to repay the public debt.

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DECEMBER199%

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