On the surface, the Algerian economy appears to be in rude health.

According to the latest Article IV report, published by the Washington-headquartered IMF in February, GDP growth was an estimated 3.3 per cent in 2012 and 2.7 per cent in 2013, and is forecast to increase to 4.3 per cent in 2014. Such rates of growth are what most of the developed world can only dream of.

Over the past few years, the government has accumulated almost $200bn in foreign exchange reserves, as well an estimated $70bn in an oil stabilisation fund, the Fonds de Regulation des Recettes (FRR). It is also assured of a continued revenue stream: Algeria is the largest gas producer in Africa (the tenth-largest in the world) and the continent’s third-largest producer of oil.

Dig a little deeper, however, and it is apparent that Algeria’s economy has serious problems.

A growth rate that, according to the IMF, has averaged 2.8 per cent in the past five years by no means does justice to the wealth of natural resources at the country’s disposal and is too low to make inroads into Algeria’s structural problems.

The IMF predicts GDP growth will increase to an average of 4.3 per cent in the next five years, but this is still not enough and is dangerously dependent on oil and gas prices remaining high.

Structural challenges

Algeria’s structural challenges are stark. The official unemployment rate was 9.8 per cent in 2013, falling from 11 per cent the previous year, but independent analysts suggest this is an underestimate.

Joblessness among the under-30s is estimated to be as high as 25 per cent – and two-thirds of the population is aged under 34, according to the UN. The lot of many employed people is also improving only slowly. The minimum wage was increased to AD18,000 ($226) a month from AD15,000 a month in January 2012. Many rely on jobs in the parallel economy.

The government has made a great deal of its success in bringing unemployment down from 30 per cent in 2001, but the challenge ahead is just as tough.

Population growth over the past 20 years has been more than 2 per cent, meaning that the potential workforce is increasing by about 600,000 people every year and the population by about 800,000. At the current growth rate, the population will reach 50 million in the next 10 years, rise to 76.5 million by 2041 and exceed 100 million by 2052.

Hydrocarbons dependency

The economy is also dangerously reliant on oil and gas revenues. In 2013, the hydrocarbons sector accounted for 30 per cent of GDP and 98 per cent of exports earnings. These earnings are in decline.

Oil and gas exports have dropped since 2005, while domestic consumption has risen rapidly. Earnings from hydrocarbons exports are expected to fall from $71.7bn in 2011 to $63.5bn this year and to $56.9bn by 2018, according to the IMF.

“The economy is being held together by oil and gas, and the indications are that oil and gas reserves are running down fast,” says Michael Willis, a specialist in North Africa at St Antony’s College, University of Oxford in the UK.

Languishing upstream exploration and severe delays to oil and gas development projects mean that not much new production is expected to come on stream until 2017-18, and when it does much of it will be absorbed by domestic demand growth.

The giant Hassi Messaoud oil field and Hassi R’Mel gas field, both of which were discovered in 1956, are in decline. Production at Hassi Messaoud is being maintained at about 400,000 barrels a day, but oil recovery requires increasing volumes of injected gas. Output from Hassi R’Mel is already falling. At current production, Algeria’s oil reserves will last about 20 years, according to the latest statistical review of world energy, published in June by UK energy major BP.

Gas reserves

Gas reserves will last rather longer, with BP figures suggesting a reserves to production ratio of just over 57 years. But gas production will have to increase just to keep up with rising domestic demand. With the decline in oil output, it is also possible Algeria may also have overestimated its resource base.

“We have been very optimistic about the size of our conventional natural gas reserves,” says Nordine Ait-Laoussine, former Algerian energy minister and president of Nalcosa, an energy consulting firm based in Geneva.

Algeria’s shale gas reserves, estimated to be the third-largest in the world, could supplement conventional gas production in the long term. However, the cost of exploration – as well as the technical difficulties – may mean that this is not the panacea the government might hope.

Promises to take pressure off state finances by reducing the country’s imports bill have, meanwhile, come to nothing. Imports increased from $37.4bn in 2009 to $54.1bn in 2013, and will continue to rise, reaching $59.5bn in 2018, according to the IMF. There is little incentive among the elite to tinker with a system from which they benefit financially.

“Any import substitution programme is going to be stopped by the mafia responsible for imports,” says a UK-based energy consultant specialising in Algeria.

“The elite has access to licences that no one else has access to, particularly when it comes to imports,” says Azzedine Layachi, an Algeria specialist at St John’s University in the US. “There are monopolies for all sorts – sugar, pharmaceuticals… They’re not formal monopolies, but everyone knows about them.”

Trade imbalances

Persistently high imports are causing serious problems for government finances. The current account balance has dropped from a surplus of $19.8bn in 2011 to a forecast $700m this year. According to the IMF, this will collapse to a deficit of $6.1bn by 2018. The government is expected to run fiscal deficits of 2.1-2.6 per cent for the next five years.

These twin deficits will erode the government’s prized foreign currency reserves from a forecast peak of $196.8bn in 2014 to $184.5bn in 2018. There is no sign the trend will reverse.

The government has also failed to deliver on repeated promises to diversify the economy.

It has pledged to increase the contribution to the economy of the industrial sector from 5 per cent to 10 per cent, but there is no sign where this might come from. Industrial growth has average just 1 per cent a year in the past three years, according to the state data agency, Office National des Statistiques. Like import substitution, local private investment is hampered by a rentier economy, while inward investment is stymied by restrictive regulations. Foreign direct investment in 2013 was just $1.7bn.

Given the powerful interest groups involved, tackling these problems is extremely complex. The government has announced it plans to introduce changes to the country’s investment law, but there is little hope these will be any more than superficial. State officials are adamant that a regulation limiting foreign companies to a minority stake in local joint ventures will remain in place.

Reform inertia

There is often rhetoric about economic reform, but in 15 years of Bouteflika government little has come of it. In a regime dominated by a small elite that is unwilling to let go of the trappings of power, the sluggishness of economic reform is unsurprising.

“There’s a whole nexus around the Bouteflika presidency that wants the current system to go on indefinitely, but at some point time will be up,” says Hugh Roberts, a specialist in Algerian politics at Tufts University in the US.

The regime is conscious that it needs to change, but is divided over the best way forward. “There is a sense that whatever split exists within the heart of the regime manifests itself economically,” says Issandr el-Amrani, project director for North Africa at the International Crisis Group in Cairo.

“The economy is held hostage to this political split, whether it’s the choice between France, Russia and the US for its arms purchases or whether it’s the constant corruption scandals over contracts awarded by [state energy company] Sonatrach, which are essentially a form of political warfare.”

With oil and gas income on a downward trajectory and little immediate prospect of an alternative revenue stream, the strain on government finances is likely to increase rather than ease over time. Another of the economy’s structural issues exacerbates this: that of subsidies.

Subsidies elephant

“Subsidies are the big elephant in the room,” says Layachi. “The Algerian government doesn’t really acknowledge the full extent of subsidies in the economy. They come in so many different forms that it’s hard to pinpoint their total value. There are subsidies for housing, food, medicine, energy… It’s one of the biggest obstacles to Algerian membership of the WTO [World Trade Organisation].”

Again, the barriers to the removal of subsidies are largely political. Buying off the population is central to the government’s tactics for preventing popular exasperation with politics turning into widespread revolt.

“It seems to be the only thing they can do to prevent the contagion effect [of revolutions elsewhere in the region],” says Layachi. “Even if there was an intention to bring down subsidies, there is no political will. It would be suicidal [for the regime].”

“Oil prices have enabled the regime to buy social peace,” says Algerian politician Kamal Benkoussa. “They have spent billions of dollars to buy off a large part of the country. This isn’t sustainable. The state will have to reduce subsidies in the next 12 months. Algeria is close to falling apart.”

Algeria still has abundant resources and abundant foreign exchange reserves, but its economic problems are deepening rapidly. The government is running out of time to prevent much more serious problems in the future.