Compared with many nations, Algeria is breezing through the global financial crisis. Economic growth has not dropped below 2.4 per cent a year in the past five years.

Non-hydrocarbons growth has fluctuated around 5-10 per cent in the same period, and rising oil export revenues have enabled the country to accrue the second-highest foreign reserves in the Middle East and North Africa region after Saudi Arabia.

By almost every measure, Algeria’s economy is in rude health. In 2011, it generated a balance of trade surplus of $26.9bn and a balance of payment surplus of $19.9bn. By the end of the year, it had accumulated $182.2bn in foreign reserves, a figure that is expected to exceed $200bn by early 2013.

Oil economy

Budget surpluses over recent years have also enabled the government to save some $50bn in its Fonds de Regulation des Recettes, the oil stabilisation fund. They have also allowed Algiers to reduce international debt to negligible levels. Net external debt at the end of 2011 was just $4.4bn and short-term debt was only $1.1bn, down from $1.8bn a year earlier.

Algeria’s economic success has been almost entirely down to its hydrocarbons exports. Although the volume of oil and gas exports declined by 4.9 per cent in 2011, hydrocarbons earnings still grew 27.3 per cent year-on-year on the back of high crude prices.

Over the course of the year, Algeria earned an average of $112.8 a barrel for its Sahara Blend crude. In the first half of 2012, exports of oil and gas amounted to 57.2 million tonnes of oil equivalent, returning $37.7bn in earnings, according to the latest government figures.

“Algeria has done well, but the fragility of the oil economy could threaten the balance of the economy”

Martin Evans, University of Sussex

A recent history of current account surpluses, which recovered strongly since falling to 0.3 per cent of gross domestic product (GDP) in 2009 to reach an estimated 9.5 per cent of GDP in 2011, has enabled the government to maintain an ambitious infrastructure investment programme. The state committed $150bn to project development in 2005-09 and a further $286bn to its 2010-14 programme.

The current five-year plan includes $50bn for housing projects and a further $50bn in budgeted spending on the transport sector. On 11 July, the government announced that it would increase its planned spending on oil exploration, refining and petrochemicals infrastructure to $80bn over the next four years, from $62.2bn. Despite these strong fundamentals, Algeria still faces serious structural challenges. For all its non-oil growth, the country’s overwhelming reliance on hydrocarbons earnings makes it vulnerable to the fluctuations of oil prices on the international market. Oil and gas accounted for 98.6 per cent of export earnings in 2011, and this figure is unlikely to diminish in the medium term.

In the early years of his presidency, Abdelaziz Bouteflika attempted to introduce a liberal economic model to the country, based on attracting as much international business as possible. But in more recent times, he has reverted to a nationalist economic model that has dramatically slowed growth in inward investment. Foreign direct investment fell from 22.8 per cent of GDP in 2007 to 0.3 per cent in 2009, according to the Washington-headquartered IMF. Although it recovered to 7.5 per cent in 2010 and an estimated 9.5 per cent in 2011, it is expected to fall once more in 2012, to about 5.4 per cent of GDP.

Breakeven price

Algeria’s reliance on oil could have serious consequences. In recent weeks, the government has begun to express concern that a softening in international oil prices caused by weak demand in Europe, an increase in output from Saudi Arabia and the resumption of Libyan crude production could have a major impact on Algeria’s ability to balance its budget.

An IMF report published in January forecast a budget deficit of 6 per cent this year, based on an average international oil price of $100 a barrel. But the government is not convinced that the market will sustain this price over the course of the year.

“The bottom line is it’s clear that the government doesn’t have control of the economy any more”

Hakim Darbouche, Oxford Institute of Energy Studies

Brent crude, the European benchmark, was trading at about $106 a barrel at the end of July, having fallen to $90 a barrel in June. West Texas Intermediate, the US benchmark crude, recovered to $90 a barrel in July, having dropped below $80 a barrel the previous month. Few analysts expect much of an upturn in oil prices in the second half of the year.

Any drop in the price of crude below $100 a barrel will either put pressure on the government’s spending plans or force it to seek recourse to the capital accumulated in foreign exchange reserves or the oil stabilisation fund. Energy Minister Youcef Yousfi announced in early July that the fall in the price of oil could cost the government $20bn over the course of the year.

The minister also confirmed an earlier statement by the Banque d’Algerie, the central bank, that the breakeven point for the government’s spending plans is $112 a barrel. Yousfi said he was “worried” about the “drastic” drop in oil prices and the impact that it might have on the spending.

Rampant inflation

While the state has ample resources to manage a deficit in the short term, it is not a sustainable strategy. “Algeria has done well in the past few years, but the potential fragility of the oil economy could threaten the balance of the economy, as happened in the 1980s, when the collapse of the oil price translated into real economic hardship,” says Martin Evans, an expert in Algerian politics at the University of Sussex in the UK.

“As soon as the oil price falls below $100 a barrel, it sets alarm bells ringing,” says Hakim Darbouche, an Algeria specialist at the Oxford Institute of Energy Studies. “It looks like the 2013 budget will be very conservative when it comes to capital spending.”

The economy is also suffering from rampant inflation, due to a combination of rising import costs - particularly for basic foodstuffs - and an excess of liquidity. Broad money supply increased to 19.5 per cent in 2011 from 13.8 per cent the previous year, according to official figures. Still more concerning was the 13.6 per cent increase in the cost of imports, which reached $44.2bn in 2011, despite the government’s efforts to substitute local production for overseas goods.

In 2011, inflation averaged a moderate 4.5 per cent, but has exceeded that every month this year and the upward trend shows no sign of slowing. In March 2012, year-on-year inflation had reached 5.9 per cent; by May, it had reached 6.9 per cent; and in June, it increased again to 7.3 per cent ahead of Ramadan, which began in late July.

Rampant inflation contributed to a period of civil unrest in Algeria in early 2011 and the government will be wary that it could do so again as the cost of basic goods increasingly exceeds the reach of a population already suffering from widespread poverty and double-digit unemployment. Food prices increased by 11.3 per cent year on year in the first five months of 2012 alone.

The government has plenty of scope to soften the blow with capital disbursements. In early 2011, it responded by increasing state salaries and subsidising the cost of basic food items, and it could well do so again. But such measures only serve to further stoke inflation.

Monetary tools have also been tried. In May, the central bank increased the minimum reserve requirement for the country’s banks from 9 per cent to 11 per cent and raised the amount of liquidity it takes out of the banking system each year from AD1 trillion ($12.3bn) to AD1.25 trillion. The measures, while laudable, have had little effect. Economists predict that inflation may ease slightly after Ramadan, but will continue on an upward trajectory to the end of the year.

The issue of inflation highlights an uncomfortable truth for the Algerian government: while it has done excellent work in consolidating its external position, when it comes to the domestic economy it has relatively little control. Inflation is a largely imported problem, while fiscal and monetary mechanisms to help mitigate its impact are hamstrung by a poorly developed banking and finance system and a large parallel economy that the government can do little to influence.

“The bottom line is it’s clear that the government doesn’t have control of the economy any more,” says Darbouche. “It has lost what little control it had. Even the prime minister [Ahmed Ouyahia] has come out and said that the economy is run by a kind of mafia; in other words the informal economy, the black market. You can see it from the inflation figures and from the government’s inability to regulate any kind of economic activity.”

Living standards

Meanwhile, the state’s failure to deliver anything close to the level of infrastructure investment it has promised in its two most recent five-year plans, and its unwillingness or inability to address the huge gulf between the country’s rich and poor, mean there is little prospect of an increase in the standard of living for Algeria’s population in the medium term.

“It’s hard to say how much of the $286bn in the current programme was from investment that was supposed to be made in the previous five-year plan,” says Darbouche. “A lot of projects have been delayed and suffered budget overruns, and there’s no independent entity to scrutinise the figures.”

The failings of Algeria’s economic policy are driving an ever-greater wedge between the privileged few and the many who are struggling to make ends meet.

“It’s the big contradiction within Algerian society,” says Evans. “A large number of Algerians are aware of it and it is a source of huge resentment that someone is benefiting from all that money.”