Would an amendment to the law on currency and credit in Algeria together with the introduction of unconventional funding impact the economy with inflationary risks and opportunities reduction?

A draft amending the law on money and credit, allowing the Bank of Algeria to “directly” lend to the Treasury, was recently adopted by the Council of Ministers. Moreover, the Government notes that the recovery of the budgetary balances is dictated by the constraints imposed on public finances and the use of exceptional and transitional (for a period of five years) methods to allow non-conventional finance, including direct funding of the Treasury via the Bank of Algeria.

The purpose of this modest contribution is to, whilst taking into account the reality of the Algerian economy, pose the problem of risks and opportunities that could be brought by this change in the money supply legislation.

Basis of the Law on currency and credit

It should be noted that the current law was introduced on April 14, 1990, before being slightly modified in August 26, 2003 and in August 26, 2010.

This law has introduced, universal banking orthodoxy rules granting greater autonomy to the banking and financial system and total independence of the Bank of Algeria under the high authority of the president of the Republic, responsible for monetary policy, as separate from the Department of Finance under the Government, in charge of fiscal policy. In addition to its issuing of currency operations, the Bank of Algeria provides the conditions for an orderly development of the national economy by ensuring the stability of the currency and the functioning of banking in the prudential rules in line with international standards.

The Currency and Credit Act instituted the National Council of Money and Credit (CNMC), a banking commission and the Association of Banks and Financial Institutions (ABEF). This law marks a break with the old system of financing insofar as it substituted funding by the Treasury with that of financing by the banking system, establishing a separation between the real and monetary spheres.

Indeed, by devoting a certain degree of autonomy to the Central Bank, the Currency and Credit Act (CML) puts an end to the relationship between the Government (represented by the Treasury Board) and the Bank of Algeria responsible for setting all monetary objectives and policy instruments and this allowed Algeria to avoid one or two digit inflation.

Thus, under this Act, the Bank of Algeria has a mission of creating the most favourable conditions for the development of the national economy through monetary policies and Exchange, and to ensure internal and external currency stability in order to create a business climate conducive to savings and investment.

Foundation of the non-conventional funding as adopted by the Government?

Western Central banks have used these unconventional measures which may take the form of easing of certain standards of conventional monetary policy and massive injections of liquidity into the financial system in circumstances that justify their adoption, especially during the appearance of a risk of deflation, a stock market crash or bond, bankruptcy of a large credit institution and crisis of confidence in the financial sector.

Thus, the Bank of England launched in July 2012 the Funding for Lending Scheme (FLS) to encourage banks and building societies to lend more to households and non-financial private corporations. This has helped credit institutions to refinance loans in the long term by providing a wider range of collateral advantages in return.

This program has also inspired the Targeted longer-term refinancing operations (TLTROs) as one of the European Central Bank’s non-standard monetary policy tools. Specifically, the non-conventional measures are temporary monetary policy measures whose goal is the restoration of the transmission of the monetary policy and ultimately channels to bank credit and liquidity support on the money market. The non-conventional measures fall into three categories.

First, quantitative easing, (QE) are measures by which the Central Bank offers an unlimited amount of money to commercial banks. The saturation of demand for money of these must lead to what they spend surplus balances, that they grant again loans to households and businesses.

Second, measures of orientation of the future rate expectations are for the Central Bank to engage in the future path of rates contributing to lower interest rates in the medium and long term and to bring them closer to the main rate of the Central Bank. They take the form of explicit commitments to maintaining a very low level or zero rate for a significant period of time.

Third, credit easing measures that tend to bypass the blocking of credit caused by channel either by the phenomenon of ‘liquidity trap’, or tensions on some key segments of the financial markets.  The Central Bank then acts as a ‘last resort’ by directly funding the economy. A de-facto relaxation of the eligibility criteria will lead banks to less hesitation in their risk-taking, and so to grant more loans to small and medium enterprises.

Unconventional financing has been used but in a structured market economies with potential for possible added value creation as in the case of growing and / or restructuring businesses or enterprises, and when traditional financing would not enable an enterprise to fully develop, or when funding is simply not available.

As a matter of fact, when an enterprise has assets and / or generates a cash flow, non-conventional financing options are also open to it, in addition to the traditional financing.

As far as Algeria is concerned, this type of funding must be closely supervised because of its having certain structural rigidities. If this funding is for any of the competitive productive sectors in terms of cost/quality, the eventual tensions in the short-term would be amortized by the positive effects in the medium-term due to the creation of added value.

In the case of the absence of a productive sector, of payments of wages without productive counterparties and the appearance of new speculative annuities by printing money, with the assumption of a $50/55 a barrel, we would have the following consequences,:

  1. A two-digit inflation and distrust on behalf of the public whom might take refuge in purchases and storage of gold, currencies, real estate, durable goods, etc. and expanding the informal sphere.
  2. A recovery required of banks interest rates to avoid bankruptcy.
  3. With two-digit interest rates that would block any productive investment.
  4. An equivalent drop in the employees and public service functionaries incomes whom might end up being halved in terms of purchasing power parity with possibly a further reduction of the middle class earnings all of which could lead to increased inflation with the risk of being caught in the non-ending spiral of social demand – rising wages – inflation – rising wages and inflation, and so on,
  5. An accelerated lowering of the value of the Dinar (DZD) in hard currency that is officially approaching the DZD200 a Euro on the “free” parallel market that is a deviation of 50% with the rising cost of all goods imported inflationary process.

Apart from all of the above, the question that arises is why did the current Government set a five-year period, for the transitional phase of the implementation of this policy whereas this Government’s life is most certainly 20 months, as a run off time to the presidential elections in 2019?