Diversifying the structure: Leveraging stability to push ahead

Oil and gas production continues to dominate the Algerian economy, accounting for almost all of exports, close to half of government revenue and over a third of GDP. In recent years non-hydrocarbons GDP has outstripped wider economic growth, though this is largely driven by public spending rather than private sector activity.

The government, flush with revenues from sustained high oil prices, is investing in infrastructure and undertaking initiatives to support business, particularly small and medium-sized enterprises (SMEs). Recent policy has focused to a large extent on limiting imports to boost domestic industry, albeit with mixed results.

GDP GROWTH & COMPOSITION: GDP growth stood at 2.6% in 2011, according to provisional figures from the Ministry of Finance, down from 3.3% in 2010. As of early November 2012, the IMF forecast GDP to grow by 2.6% in 2012 and 3.4% in 2013. Oil and gas production remains the mainstay of the economy. Hydrocarbons accounted for 34.7% of GDP in 2010, up on 2009 rates, but still lower than the figures of between 43% and 45% seen in the three preceding years. The decline is primarily attributed to a fall in oil prices. Provisional figures by the Ministry of Finance suggest that in 2011 the contribution of hydrocarbons rose to 37.6% of GDP.

Non-hydrocarbons GDP growth has outstripped that of hydrocarbons in recent years, standing at 5.9% in 2010 and a projected 4.9% in 2011, according to the IMF, though provisional Ministry of Finance figures place non-hydrocarbons GDP growth higher, at 5.4%, in 2011. Agriculture was 8.4% of GDP in 2010, compared to industry at 5%, services at 21.9%, and 10.4% for construction and public works. Provisional figures for 2011 suggest agriculture was 8.3% of GDP, industry 4.4%, services and construction 20.9%, and public works 9.2%.

INFLATION: Inflation stood at 4.5% at the end of 2011, according to the National Statistics Bureau, up from 3.9% in 2010. In response to rioting early in 2011 and in light of political and socioeconomic unrest throughout the region, the government took a number of measures, such as suspending value-added tax and Custom duties on some basic goods and increasing subsidies for basic foodstuffs, that helped stabilise prices.

At the time of writing, the IMF forecast inflation to increase to 8.44% in 2012 before falling back to 5% in 2013. This is in contrast to a draft copy of the 2013 budget, which forecast an inflation rate of 4% for 2012.

In January 2012 the IMF said that the rise in international food prices and recent public sector wage hikes were not being fully reflected in inflation due to subsidies as well as high demand for imports and the country’s prudent monetary policy. According to the IMF, in 2010 the government began raising civil service salaries by around 50% on average, over 2008 levels, including retroactive back payments for 2008 and 2009 wages, effectively amounting to an increase well above inflation. Employees of publicly owned companies are also receiving similar increases. In January 2012 the minimum wage was raised by 20%, having previously risen by 30% in December 2009, amounting to more than a 50% increase in two years, again well above inflation.

However, consumer prices from January to September 2012 were up by 8.85% on the same period in 2011, driven in part by food inflation. In September 2012 the governor of the Bank of Algeria (BoA), Mohamed Laksaci, blamed inflation in part on the structure of local markets as well as speculation. Bad weather also likely helped push the prices of local Algerian produce up substantially early in 2012, contributing to the rise.

LABOUR FORCE: Algeria’s population was 37.1m as of January 2012, and authorities predict a rise to 37.8m by the start of 2013. The labour force participation rate as of September 2011, according to a recent official survey, was 40% (65.3% men and 14.2% women).

Of these, 40% of employed Algerians work in the public sector, with 60% in the mixed and private sectors. Services made up 39% of employment, followed by construction (16.6%), industry (14.2%), agriculture (10.8%), and transport and communications (6.5%).

The unemployment rate stood at 9.9% in 2011, more or less stable on 2010’s figure. Underemployment was 17.9%, and 45% of unemployed Algerians had been seeking a job for over two years. Unemployment is highest among younger people; Algerians under 25 accounted for 41.1% of the unemployed while those aged 25-29 accounted for a further 30.4%. Of the under-20 workforce, 23.8% were unemployed, as were 22.1% of 20-24 year olds and 16% of those 25-29. By contrast, the unemployment rate did not exceed 10% in any age group over 30. Part of the reason, according to a recent IMF study, is a rigid labour market that “tends to favour insider versus outsider workers”; that is, it tends to protect those already in work while making it harder for those seeking employment to find jobs. Unemployment is also higher among the better educated, with 15.2% of those having completed university education being jobless, compared to 6.3% of those with just a primary school education, due to factors such as a lack of high-skilled jobs and mismatches between degree subjects and labour market needs.

Unemployment levels have declined enormously over the long term, down from nearly 30% in 2000, according to IMF figures. The fund claims this is a result of a slowdown in the rate of population growth in recent decades – from 3.1% annually in 1985 to 1.5% in 2007 – as well as falling participation rates. However, annual employment growth has also increased, from an average of 2.9% in the 1990s to 4.7% in the 2000s, thanks to factors like an improved economic situation with the end of the civil war and economic growth on the back of higher global oil prices. Nacer Eddine Hammouda, research director at the Centre for Research in Applied Economics for Development (Centre de Recherche en Economie Appliquée pour le Dé veloppement, CREAD), told OBG that a lot of recently created employment has been in construction and public works, where growth has been reliant on public spending. “The question is whether the current pace can be maintained. In the medium term works are likely to continue, but in the longer term there is a risk of a reversal.”

TRADE: According to BoA statistics, Algeria recorded a trade surplus of €21.9bn in 2011. The current account was €16.8bn in surplus, up from €10bn in 2010.

The value of imports stood at €37.1bn in 2011, up 15.8% from €32.1bn in 2010. Industrial equipment accounted for the largest share of purchases from abroad (€12.56bn, or 33.8% of the total), followed by semi-finished goods (€8.38bn, or 22.6%) and food (€7.81bn, or 21%). Exports stood at €59bn in 2011 – up strongly on €46.18bn in 2010, thanks to higher oil prices – of which €57.26bn (97% of the total) was made up by energy exports. However, non-hydrocarbons exports, of which around 74% were semi-finished goods, grew by 25.8%, to €975.4m. The trade balance for the first seven months of 2012 stood at €13.95bn, up from €11.15bn a year earlier, as imports fell by 5.5% to €22.75bn and exports rose by 4.6% to €35.47bn.

The largest single country buyer of Algerian exports in 2011 was the US, accounting for 20.8% of the total, followed by Italy (13.5%), Spain (9.8%), France (9%) and Canada (7%). The same countries were Algeria’s five largest buyers in the first quarter of 2012, in the same order. As for imports, the largest suppliers to Algeria in 2011 were France (15.1% of all imports), followed by China and Italy (both 10%), Spain (7.2%) and Germany (5.4%). France remained the country’s largest supplier in the first quarter of 2012; however, China reportedly overtook France for the first time as an exporter to Algeria in the first five months of the year, highlighting its increasing importance as a trade partner.

Algeria’s trade with North African neighbours remains limited. Economic exchange with other Arab Maghreb Union (AMU) members is just around 1.8% of total Algerian trade, although it grew by about 18% in 2011. Intra-Maghreb trade as a whole runs below 4% of the value of total foreign commerce in the region. Reasons for this include tense relations with neighbour Morocco (the land border between the countries remains closed) and repeated failed efforts to launch a regional free trade zone under the AMU, again in large part due to relations between Algeria and Morocco.

ON GUARD: Concerned with the large volume of manufactured goods coming into Algeria and the lack of a well-developed local industrial and manufacturing base, in 2009 authorities took several measures to stem imports. These included a ban on consumer credit and a requirement that importers use letters of credit (issued by an Algerian bank), increasing costs and obliging importers to place large deposits on the value of purchases. The measures did not seem to have had the desired effect, underlined by the rise in the import bill in 2010 and the growth of imports to record levels in 2011 (likely due in large part to significant wage increases), though, as noted above, imports subsequently fell back in the first seven months of 2012. In 2011 the authorities decided to relax requirements for companies importing raw materials by permitting them to use documentary collection and open account transactions up to a value of AD4m (€38,400) annually instead of letters of credit. Reports suggest that the ban on consumer credit may also soon be amended to allow for lending for the purchase of locally produced items.

OUTGOING: While working to limit imports, authorities have also taken measures to boost exports and ease regulations for Algerian exporters. In June 2012 the government announced the creation of a new training initiative for exporters in conjunction with the Algerian Chamber of Commerce and Industry and the Ecole Superieure Algérienne des Affaires (ESSA) business school. Additionally, Ali Bey Nasri, president of the National Association of Algerian Exporters, told OBG that 60 of 62 requests for regulatory changes put forward by the group were accepted in September 2011, though he added that implementation would take time. Changes included doubling the proportion of payments exporters are allowed to keep in foreign currency from 10% to 20% (for making payments abroad); reintroduction of a drawback system (allowing exporters to be reimbursed for VAT and duties previously paid on items to be exported); creation of a National Shipping Council; and formulation of a national export strategy. “The absence of such a strategy is the reason non-hydrocarbons exports have yet to take off,” Nasri told OBG. “Algeria has never really looked at exactly what it can export. Morocco has identified five key industries, but there has been no similar study here. Instead the focus has been on minor steps and the management of day-to-day issues,” he said. As in other sectors, like banking, exporters have called for an end to criminal liability for administrative errors.

Nasri told OBG that the most promising non-hydrocarbons export sector in Algeria is agriculture, particularly if reforms are made. “If a proper strategy is put in place to develop agricultural exports, Algeria could have a similar status as Morocco,” he said, arguing that as with Morocco, Algeria’s proximity to Europe is a major comparative advantage for the sector. “However, at the moment this isn’t really happening.”

GOVERNMENT FINANCE: Total government revenues stood at AD3.4trn (€32.64bn) in 2011, up from AD3.07trn (€29.5bn) in 2010. Hydrocarbons receipts stood at AD1.53trn (€14.7bn) in 2011, accounting for 44.9% of government income, a modest increase on 2010 levels, which stood at AD1.5trn (€14.4bn). However, thanks to resurgent oil prices early in 2012, the value of receipts as of June 2012 had almost matched those for all of 2011, at AD1.52trn (€14.4bn), accounting for 64% of government revenue for the period.

STRONG FUNDING: A proportion of oil receipts are paid into a stability fund, the Revenue Regulation Fund (Fonds de Regulation des Recettes, FRR). The value of the FRR has grown rapidly in recent years thanks to high oil prices, despite record withdrawals in 2011 and a slight decline in production of late. As of mid-2012, it contained approximately AD5.8trn (€55.7bn), well above its legal minimum level of AD740bn (€7.1bn).

Such ample financial reserves have allowed Algeria to provide the IMF with $5bn of financing in October 2012, ranking it amongst “intermediate” contributors to the fund. Finance Minister Karim Djoudi told local press that he hoped the contribution would help Algeria “occupy a more important place” in line with its economic strength and receive more attention in the fund.

Tax receipts stood at AD1.45trn (€13.9bn) in 2011, up from AD1.3trn (€12.5bn) in 2010 and AD1.15trn (€11.04bn) in 2009. Tax administration reforms aimed at boosting revenues and strong non-hydrocarbons GDP growth have led non-hydrocarbons government revenues to grow at an average rate of 15% a year over the last five years, according to the IMF. Still, the informal economy remains large, accounting for between 20% and 60% of GDP, according to some estimates.

INFORMALLY SPEAKING: All sectors of the economy have some aspect of informality; however, this is particularly acute in the retail sector, especially at the level of small neighbourhood shops and street markets. Reasons for the size of the informal economy include a rigid business environment, tax avoidance and a large cash-based economy that facilitates informal transactions. Plans to reduce informality by making the use of cheques or bank transfers compulsory for payments larger than AD500,000 (€4800) were dropped against the backdrop of strong opposition and the early 2011 unrest, though the authorities say they aim to introduce similar measures in the future.

In October 2012 Reuters reported that the government was cracking down on unlicensed street vendors and illegal markets, and late in the month Minister of Trade Mustapha Benbada said the authorities had shut down 600 such markets, out of over 1500 identified by the government, since the campaign began.

MORE TO SPEND: Government spending has risen in recent years, reaching AD5.73trn (€55bn) in 2011, up from AD4.47trn (€42.9bn) the year before. This was driven primarily by an increase in operating costs, which rose to AD3.8trn (€36.5bn) in 2011 from AD2.66trn (€25.5bn) the year before, thanks in part to civil service wage and pension hikes (including retrospective rises) approved in the 2011 supplementary finance law. These rises also saw operating expenses grow by approximately 34% in the 2012 budget to AD4.61trn (€44.25bn), and the 2012 supplementary finance law committed a further AD317bn (€3.04bn) of pension and wage increases. However, overall spending in the 2012 budget was reduced by around 10% compared to that under the 2011 supplementary finance law, mainly led by cuts to investment expenditure of 29%.

Such spending increases saw the 2011 fiscal deficit rise to AD2.26trn (€21.7bn), about 16% of GDP, a sharp increase on the AD1.5trn (€14.4bn) of 2010. Most of the deficit – AD1.76trn (€16.9bn), or 73.5% – was financed by drawdowns on the FRR, and withdrawals from the fund more than doubled from the prior year.

The IMF’s April 2012 “World Economic Outlook” forecast a budget deficit of 2.9% of GDP in 2012, though in practice the size of the deficit will largely depend on oil prices. Based on the 2012 budget, the government would require an average oil price of approximately $110 per barrel to break even. The deficit for the first six months of 2012 stood at AD1.3trn (€12.48bn). This was well below the projected deficit, though such undershoots have been a persistent feature of recent budgets, as the government has often used conservative oil price forecasts – for example, a reference price of $37 per barrel and a market price of $90 per barrel in 2012 and 2013 – as the basis of its calculations.

CHIPPING IN: Subsidies are a major component of government spending. The state subsidises key foodstuffs like cooking oil, flour, milk and sugar to keep prices down. For example, in 2011 a loaf of bread sold for AD8.5 (€0.08), well below production cost of AD25 (€0.24), with the government making up the difference. These subsidies cost AD271bn (€2.6bn) in 2011, or around 12% of that year’s budget deficit. Although there has been discussion of removing such subsidies due to concerns over their long-term sustainability, the 2013 budget maintains subsidies for basic foodstuffs.

Economic policy making tends to be heavily reactive to changes in the price of oil, and a fall in the second quarter of 2012 – the OPEC basket price fell from nearly $123 in March to $94 in June – made for significant jitters about the sustainability of public spending. Combined with the large increase in the public wage bill from measures taken in 2011, this prompted predictions that the government would impose an austerity programme and slash spending in the 2013 budget. In August 2012 Djoudi denied this, saying that the budget would be characterised by “prudence”, not austerity, and that reports of plans to freeze public hiring were false. Oil prices have partially recovered since June 2012, with the OPEC basket price rising to nearly $109.50 as of October 2012, somewhat assuaging concerns.

Nevertheless, the 2013 budget presented to parliament by Djoudi in late October 2012 reduced spending by 11.2% on 2012 levels. The budget forecasts a fiscal deficit of 18.9% of GDP, based on the same oil price forecasts used the previous year and GDP growth of 5%. The budget would need an average oil price of $105 per barrel to avoid posting a deficit. Government expenditure under the budget will stand at AD6.9trn (€662.bn), while government revenues are forecast at AD3.82trn ($), up 10% from those envisaged in the 2012 supplementary finance law. Of total expenditure, AD4.95trn (€47.5bn) was allocated to operational expenditure (including AD1.75trn, €16.8bn, on public sector wages), down 12% on the previous budget, AD1.82trn (€17.5bn) to investment and AD732bn (€7bn) to capital operations. The 2013 draft budget included plans to create 52,672 new civil service positions, most of them in the health and education sectors and the Interior and Finance Ministry. The key objectives of the budget, according to the government, are economic diversification, rationalising public expenditure and improving the national economic climate.

PUBLIC DEBT: Total government debt was 11.1% of GDP in 2010, according to IMF figures, and was projected to fall to 9.5% in 2011. Foreign debt levels have declined sharply over the last decade, from over 30% of GDP in 2003 to low single digits in recent years thanks to early repayments in the middle of the decade on the back of high oil revenues. Debt restructuring in the effort to wipe the debts of public enterprises accounted for around 55% of domestic debt. Total foreign debt stood at €3.5bn at the end of 2011, or around 2.2% of GDP, down from €4.55bn a year earlier. Bilateral debt accounted for 55% of the total, while short-term debt made up 25.9%; multilateral debt levels were negligible.

RESERVES & FOREIGN EXCHANGE: Total reserves stood at €228.7bn at year-end 2011. Foreign exchange reserves (excluding gold) were €145.5bn, up from €129.7bn in 2010, covering about three years of imports.

The dinar has remained fairly stable against the dollar in recent years. One dollar bought AD74.84 in December 2011, compared to AD74.39 a year earlier and AD73.36 in 2005 (though the currency went through a period of comparative strength in 2008). At the time of writing in November 2012, the dinar had weakened slightly to around AD79.95 to the dollar. A euro was worth AD102.27 at the end of 2011 and AD101.86 at the time of writing, without considerable change on December 2010, though the dinar has weakened slightly against the euro over the longer term, having stood at AD94.86 to the euro in 2008 and AD91.30 in 2005.

Access to foreign exchange is heavily restricted, and a parallel black market exists in which the dinar is considerably weaker against major foreign currencies than under the officially available exchange rate. Foreign investors are required to register capital contributions with the BoA and to seek approval for the remittance of dividends and some other payments, which has caused administrative problems for some firms in the past. “The rules are fairly simple, but if you make a mistake it can be difficult to rectify it,” said Youcef Mounir Meghlaoui, senior relationship manager of global banking and markets at HSBC Algeria. “For example, for a capital injection, you need a SWIFT code saying who’s investing, and the bank must also provide a certificate verifying all the details. Firms sometimes make basic mistakes, such as failing to obtain or losing SWIFT codes, and then trying to repatriate dividends.” Companies can face heavy penalties for breaching foreign exchange rules, even inadvertently. French bank BNP Paribas, for example, received fines amounting to €200m for exchange infractions. While some of these were reversed on appeal, courts confirmed fines of around €52m.

“The key question is why foreign exchange is still so strictly controlled given the country’s strong economic situation,” André Dieu, head of the operations division at the Algerian branch of French investment bank Natixis, told OBG, suggesting that the answer lies in still sharp memories of economic difficulties in the 1990s. There is little sign of a change; indeed, in August 2012 the authorities implemented the latest in a series of measures aimed at shoring up foreign exchange controls by creating a database of individuals and companies that have received warnings for infractions.

DEVELOPMENT & DIVERSIFICATION: Past efforts to develop an industrial base and diversify the economy away from hydrocarbons have largely failed, underlined by the fact that industry’s share of GDP has fallen over the past decade, from around 8.4% in 2002 to less than 5% in 2011. “The country is more dependent on hydrocarbons now than in the 1970s,” Hammouda told OBG. The government aims to reverse this decline, raising industry’s proportion of GDP to 10% by 2014 by encouraging the transfer of technology and know-how from foreign firms investing in the country.

Some observers blame past problems on the failure to properly leverage the country’s natural resources. “Diversification is possible based on hydrocarbons, which represent Algeria’s comparative advantage. However, the country remains reliant on imports of some refined products, never mind having yet to develop a petrochemicals industry,” said Abderrahmane Abedou, president of the CREAD Scientific Council. “For petrochemicals to take off there is a need for technology and expertise as well as large-scale investment, but the country lacks real private sector capacity for such investments and foreign direct investment is not really coming in either,” he told OBG. Egypt, which has the largest refining capacity in Africa and a developed petrochemicals sector in spite of its declining reserve-to-production ratio, provides a strong example.

STRATEGY NEEDS: A lack of integrated planning for industrialisation is an issue. “There is a tendency to think in terms of finished products, like car manufacturing, but no one thinks about intermediate products, such as the chemicals and plastics that go into making a car,” argued Abedou. “Industry remains heavily reliant on imported materials,” Hammouda said. “The focus also tends to be on the Algerian market, when there is a need to think more widely about the regional market and economic integration, especially since Algeria is not a major market in itself,” Abedou said.

GAINING GROUND: Another significant constraint on industry growth is access to land, with plots designated for industrial use generally hard to find and expensive. Even state-owned firms, such as Sonelgaz, have faced problems. The parastatal utilities firm was forced to delay its expansion and maintenance programme due to concerns over land usage with municipal authorities. Some observers say that the state tends to prefer designating land for residential use because of the country’s housing crisis, which is a source of popular discontent. To address the shortage, in May 2012 the National Investment Council charged the National Intermediation and Land Registration Agency (Agence Nationale d'Intermédiation et de Régulation Foncière, ANIREF) with the development of 42 industrial zones, with a combined area of 9572 ha, most of them located along the country’s new East-West Highway. This was followed by an agreement in September between ANIREF and the General Directorate of National Real Estate to allow ANIREF access to the sites.

In spite of such issues, some sectors are promising. “Classically, the most integrated sector is agro-industry,” said Abedou. “Private firms are well integrated in the sector, with both local and foreign companies active.” However, even here dependence on imports is high. “Agro-industry firms tend to be based around ports rather than agricultural zones, as much of their raw material is imported,” said Hammouda.

BUSINESS ENVIRONMENT: The government is moving to support local businesses. The September 2011 tripartite summit between the government, employers and trade unions agreed to measures to support businesses, particularly SMEs, including steps to improve access to credit and help firms struggling with bank debt. SMEs account for about 52% of non- hydrocarbons private sector output and roughly 35% of national value added, according to the French embassy’s economic service, citing the Ministry of Industry. Respondents to the World Economic Forum’s 2012-13 “Global Competitiveness Report” ranked access to financing as the second-biggest problem for doing business in Algeria, behind inefficient government bureaucracy, and gave the country a score of two out of seven in ease of access to loans, ranking it 128th out of 144 countries.

The summit also decided to restructure tax debts for firms facing financing difficulties, allowing for some debts (relating to tax incurred up until the end of 2011) to be deferred for one to two years and repaid over a period of another three, while cancelling previously incurred penalties for late payments. As of April 2012, roughly 10,000 firms had applied to benefit from the measures, representing around AD40.3bn (€386.9m) worth of rescheduled tax payments and a further AD34.5bn (€331.2m) of cancelled penalties.

There is scepticism over the government’s commitment to diversification, which observers say can wane when energy prices are high. “High oil prices make diversification less pressing; people tend to forget about it when it is not urgently needed,” said Hammouda.

PUBLIC WORKS: The government has committed to €228.7bn worth of infrastructure spending under a five-year plan from 2010 to 2014. The bulk of the investment will be in transport infrastructure, housing construction and utilities development. Of the funds, €124.7bn is to be spent on new projects, while €103.9bn will go towards completing existing ones. The plan’s projects include: construction of around 2m new housing units to address the country’s chronic shortages – a frequent cause of protests; completion of final segments of the 1300-km East-West Highway; the beginning of tram projects for 14 cities; and construction of nearly 5000 new schools, 172 hospitals and 35 dams.

The plan represents a significant increase in spending compared to prior versions, close to double the €119.9bn committed under the 2005-09 plan and much higher than the $7bn of the 2001-04 plan. It is also an opportunity for the country to solidify international partnerships. “The implementation of the large-scale 2010-14 five-year plan gives Algeria the opportunity to diversify its partnerships, allowing different countries to participate in the North African nation’s development programme,” Annele Voionmaa, Finland’s ambassador to Algeria, told OBG.

However, limited administrative capacity means that the government may not be able to spend the full amount in practice. Indeed, in the first nine months of 2011 only 34% of the year’s investment budget was spent. Observers also say that, given the legal and political difficulties of reducing operating expenses such as wages, investment plans are likely to be the main target of any cuts in the event of a fall in oil prices and fiscal difficulties. The 2013 budget as presented in parliament allocated AD555bn (€5.3bn) to re-evaluate major infrastructure projects under way.

The authorities estimate that the plan will create 700,000 jobs, and investment will likely help drive non-hydrocarbons growth. However, some argue that the country’s lack of an industrial base limits the knock-on effects of such spending. “Public works haven’t had the desired multiplier effect on the rest of the economy; the solution has always just been to import more,” said Hammouda. “Lots of public investment ends up going abroad, in the form of purchases of imports.”

OUTLOOK: Despite efforts to diversify the economy, it will remain dependent on the production and export of hydrocarbons for the foreseeable future. Long-term economic development will depend on international oil prices. Provided that prices remain relatively high, large-scale public works are likely to support healthy non-hydrocarbons growth and keep a lid on unemployment. Even if prices were to fall, the government has a large cushion in the form of reserves it has built up in the FRR, which it can rely on for the next decade or so. However, in the event of a sustained fall in prices, the country would eventually have to cut back on investment spending, threatening a rise in unemployment or risking deterioration in the health of public finances.