Fiscal vulnerabilities exposed in Algeria

11 July 2013

A drop in oil revenues earlier this year has alerted the government in Algiers that its public spending increases are unsustainable

For a country that has emerged relatively unscathed from the worst effects of the global financial crisis, and which has continued to use its oil revenues to accumulate vast reserves of foreign exchange, Algeria’s economy remains weak on a worryingly large number of fronts.

At a forum at the end of June, the government’s economic advisory body warned that Algeria’s external finances were “vulnerable” to external shocks due to the country’s failure to significantly reduce imports. The newly created Conseil National Economique Et Social (CNES) concluded that measures introduced in 2009 to cut imports had “not had an effect” in 2011-12, during which time imports had remained “significant”.

Balance of payments

The comments came hard on the heels of a warning by central bank governor Mohamed Laksaci that Algeria was facing a “shock” in its external balance of payments similar to that of 2009. The balance of payments fell to $846m at the end of March, compared with $4.1bn a year earlier, according to the latest bank’s quarterly report, published in June. The cause, said Laksaci, was a drop in oil revenues.

The drop in the price of oil signalled the need to adopt a more conservative approach to spending

Finance Minister Karim Djoudi

The Algerian government has been promising for years to reduce its exposure to the twin external threats of a downturn in oil prices and increased global food and products prices. It has had scant success. According to the Washington-based IMF’s Article IV report on Algeria’s economy published in February, import costs have been far from stable in recent years. In 2009, they eased by 1.6 per cent, before increasing by 4 per cent in 2010 and by 15.6 per cent in 2011. Costs were more or less static in 2012, but are likely to rise again this year and next.

Compared with food and product prices, the global oil market is much more volatile. Between 2002 and 2008, the price of Brent crude, the European benchmark, rose every year, almost quadrupling from $25 a barrel to $97.3 a barrel. In 2009, it collapsed to $61.7 a barrel, a drop of 37 per cent. The price then climbed dramatically for two years, reaching $79.5 a barrel in 2010 and $111.3 a barrel in 2011, before levelling out at $111.7 a barrel in 2012.

Despite the sobering experience of 2009, the government’s attempts to wean Algeria off its reliance on oil have been half-hearted and the results negligible. Non-oil exports in the first quarter of the year amounted to $319m, or just 1.8 per cent of total exports. The IMF predicts non-oil growth of 6-7 per cent for the next five years, but from such a low base this is not nearly enough to make an impression.

In the early months of 2013, the oil market delivered another reminder of how quickly fortunes can change for economies so reliant on one commodity. In the two-month period between February and April, the price for a barrel of Saharan Blend crude – the type that Algeria sells – fell from $117 a barrel to $103 a barrel, a drop of 12 per cent.

Twin shocks

In the first quarter of this year, Algeria suffered the twin shocks of a 5.7 per cent drop in oil prices and an 8.9 per cent fall in the volume of hydrocarbons exported. The combined effect was a slide in oil and gas receipts from $20.37bn in the first three months of 2012 to $17.53bn for the same period this year. This followed a year in which Algeria’s external surplus had already fallen significantly to $12bn in 2012, from $19.9bn the previous year.

The government’s attempts to wean Algeria off its reliance on oil have been half-hearted

The drop in Algeria’s oil income in the early part of this year can partly be accounted for by circumstantial factors. Refinery outages in Europe meant reduced demand for Algerian crude, while gas production from the In Amenas field, which was the target of a terrorist attack in January, is only gradually coming back on stream. But the government would be wise to learn from such warnings.

According to the IMF’s baseline scenario for the oil market up to 2017, Algeria would run a small deficit in its fiscal account, while maintaining a current account surplus of about 4-5 per cent of gross domestic product (GDP).  The IMF envisages oil prices remaining above $100 a barrel for the next two years before easing to just under $90 a barrel in 2017. If prices were to fall to less than about $80 a barrel, the current account would go into deficit. At $60 a barrel, that deficit would reach an estimated 4 per cent of GDP.

Exchange reserves

The accumulation of foreign exchange reserves in recent years has been so great that the economy is not in any immediate danger. Algeria has the second-largest reserves in the Middle East and North Africa region after Saudi Arabia. By the end of the first quarter, reserves (excluding gold) stood at $189.8bn. It also has the world’s 14th-largest oil stabilisation fund, with reserves of $77.2bn, according to a recent report by the US-based Sovereign Wealth Fund Institute.

In the longer term though, the government’s over-reliance on oil – a resource that according to BP’s latest Statistical Review of World Energy will only last another 20 years anyway – is a sizeable risk. This is particularly so because the government has become used to devoting huge sums to public spending programmes. Its infrastructure development programme between 2005 and 2009 involved headline investment of $150bn. The current programme, running from 2010 to 2014, targets spending of $286bn.

Spending on wage increases and social infrastructure has long been the fulcrum of the government’s strategy to buy off widespread discontent with a political system that is democratic only in name and in which the institutions of state are incredibly weak. Subsidies on basic foodstuffs and regular increases in government salaries are now taken as a given. Both were used to diffuse social unrest in early 2011, while the governments of Algeria’s neighbours were collapsing.

Such expansionary public spending policies are, however, reliant on a robust oil market. The breakeven oil price for Algeria’s budget has been rising and in 2012 was an estimated $112 a barrel. Algiers, which has long been wedded to the primacy of public spending as an economic driver is now beginning to realise that such policies are not sustainable in the long term.

In May, Finance Minister Karim Djoudi admitted that the drop in the price of oil signalled the need to adopt a more conservative approach to government spending in the future. The economy has reached a point where it needs to shift from public demand to “private demand, household businesses and exports”, said the minister.

In future, budgetary policy would be based on “greater prudence”, he said, adding the government’s attitude to salaries also needed to be “much more nuanced”.

Such a rhetorical shift is significant in itself. Throughout 2012, senior government officials could frequently be heard extolling the virtues of an economy founded on state spending programmes rather than private capital. But whether this new tone will filter through to policy actions is questionable.

Just a month after his May speech, Djoudi said that the new policy of prudence would not affect planned infrastructure development in 2010-14. There would be “no reduction in spending for the rest of the current programme”, he said.

Foreign investment

Whether the government has the capacity to grow private sector spending is also uncertain. Since 2009, it has introduced a slew of legislation to regulate the involvement of foreign companies in the economy. Most notably, it imposed a 49 per cent limit to the shareholding of a foreign company in a local joint venture.

The government has repeatedly ruled out rolling back this regulation despite some criticism that it is holding back private sector growth. Earlier this year, industry minister Cherif Rahmani announced that the share of Luxembourg-based steel manufacturer Arcelor Mittal in its El-Hadjar processing facility would be reduced from 70 per cent to 49 per cent to bring it into line with the regulation.

In late June, Prime Minister Abdelmalek Sellal allowed at least for the possibility of change in the future. The 51:49 rule he said “cannot be revised at least for the moment.”  Any change, though, would likely face stiff opposition from an influential Algerian elite, whose attitude to foreign involvement in the economy is moulded by the country’s struggle for independence from France.

The government has had a reminder of the dangers inherent in relying on oil revenues. It has responded by shifting its tone on the relationship between public and private investment. But with so much money in the bank, substantive policy changes are likely to be put off for another day.

Key fact

The breakeven oil price for Algeria’s budget in 2012 was an estimated $112 a barrel

Source: MEED

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