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Algeria risk: Macroeconomic risk(RiskWire Via Thomson Dialog NewsEdge)COUNTRY BRIEFING FROM THE ECONOMIST INTELLIGENCE UNIT RISK RATINGSCurrentCurrentPreviousPreviousRatingScoreRatingScoreOverall assessmentC56C56Macroeconomic riskA10A10Note: E=most risky; 100=most risky.SUMMARY The macroeconomic position is basically sound. The balance of payments outlook is extremely robust and management of the exchange rate is appropriate. Real growth prospects are good, though they are centred largely on the capital intensive, and geographically remote, hydrocarbons sector. Consequently, job-creation is largely a product of government spending and is therefore vulnerable to political pressures. Liquidity management is a concern, given unsophisticated monetary tools. SCENARIOS A sharp and sustained downturn in oil prices depresses GDP growth (Low Risk) Much of Algeria's economy remains dependent on hydrocarbons sales. An undersupplied market allied with security concerns stemming from violence in the Middle East kept oil prices high in 2005 and they will remain high in 2006. Only in 2007 will prices ease, but only slightly. Oil earnings will be bolstered by the In Salah gas project, which has now come on stream, and by the In Amenas gas project which will come on line in 2005. Consequently, we expect real GDP growth to remain extremely strong at over 6%. Nevertheless, as a hedge, foreign companies might consider diversification to neighbouring Tunisia, where demand is not subject to the vagaries of energy prices. Despite a small population (around 10m) Tunisias income per head is slightly higher than Algerias. Inflationary pressures increase sharply (Moderate Risk) The Economist Intelligence Unit remains concerned by the limited tools available for liquidity management in the context of a likely loosening of the government's fiscal stance. We have raised our consumer price inflation forecast, but this could go even higher than we expect depending on the exact level of extra public spending. Under conditions of high inflation, companies producing for the domestic market should exercise caution in planning investment and pricing decisions. BACKGROUND (Background material is updated twice yearly. Last update: May 5th, 2005) Economic Structure Main economic indicators, 2004Real GDP growth (%)5.2 (a)Consumer price inflation (av; %)4.58Current-account balance (US$ bn)11.9 (a)Exchange rate (av; US$)72.1Population (m)33.4 (a)External debt (US$ bn)22.2 (a)(a) Economist Intelligence Unit estimate.Sources: Office of National Statistics; Banque Central dAlgerie; IMF; Economist Intelligence Unit.Algeria is a low- to middle-income country with huge reserves of natural gas and other hydrocarbons. The hydrocarbons sector accounts for more than 96% of Algeria's export earnings and about 30% of its GDP. Algeria is the largest supplier of natural gas to the EU, and projects to increase oil and gas revenue over the coming decade should underpin strong levels of real GDP growth. Agriculture accounts for some 10-11% of GDP in an average year, and 9% of GDP in drought years. The sector also employs 15% of the labour force. It witnessed a real expansion of over 13% in 2001 following good rains. Despite shrinking slightly in real terms in 2002, further good rains contributed to an estimated 6.4% expansion in 2003. Real GDP growth is estimated to have been 5.2% in 2004. Comparative economic indicators, 2004Algeria (a)Tunisia (a)Libya (a)Morocco(a)Egypt (a)GDP (US$ bn)76.228.325.253.176.6 (b)GDP per head (US$)2,2802,8404,4501,7101,040GDP per head (US$ at PPP)5,2607,41010,4204,3803,810Consumer price inflation (av; %)4.6 (b)3.6 (b)2.91.711.2Current-account balance (US$ bn)11.9-0.410.80.73.9Current-account balance (% of GDP)15.7-1.542.91.34.6Exports of goods fob (US$ bn)33.69.7 (b)20.69.711.9Imports of goods fob (US$ bn)17.912.17.915.920.8External debt (US$ bn)22.215.64.117.234.4Debt-service ratio, paid (%)10.212.83.912.67.4(a) Economist Intelligence Unit estimates. (b) Actual.Source: Economist Intelligence Unit, CountryData.The most pressing economic challenge for the government is to stimulate investment in the non-hydrocarbons sector in order to address an unemployment rate which officially stands at around 24%, but is significantly higher among the under-30s. Economic Policy A slow process of liberalisation Algeria's economy after independence was marked by rigidity and inefficiency in both agriculture and industry. State-led development planning was a key feature of economic policy. In 1971 the oil industry was nationalised and agriculture placed under collective ownership. Financed by rapidly increasing oil revenue and foreign borrowing, the government pushed development of heavy industry. However, economic growth ground to a halt in the late 1970s and overspending on ill-thought-out projects and consumer products led to increased national debt. The government's 1980-84 economic plan was a continuation of earlier plans, but economic problems then forced the government to make some policy changes in the 1985-89 plan. The high cost of food imports during a period of collapsing oil prices prompted moves to bring the private sector back into agriculture. Manufacturing industries continued to receive subsidies, but much of this was to finance reform in the industrial sector, which was being broken down into smaller, more manageable units. Large international credits were needed to finance these changes, and Algeria's foreign debt burden ballooned as energy prices declined. The high external debt burden, combined with low international oil prices in the second half of the 1980s, forced Algeria to negotiate a stand-by agreement with the IMF in 1989. Algeria's third IMF stand-by loan was agreed in April 1994, followed by a US$1.8bn three-year extended fund facility (EFF) agreed in May 1995. The EFF came to an end in May 1998, having helped Algeria to achieve unexpected success at the macroeconomic level. Since then the government has not sought a new agreement, but it has maintained relatively tight monetary and fiscal stances. The government has stressed its determination to push on with IMF-style reforms. It says its reforms will strive to achieve real GDP growth of between 4% and 6% a year in order to combat unemployment. (The Conseil national economique et social, a government advisory body on social and economic affairs, has set a target of 350,000 new jobs a year; the IMF estimates that 260,000-300,000 new jobs a year will be needed just to stabilise unemployment.) This will involve: the gradual elimination of exchange controls and trade barriers; the removal of remaining price subsidies; an overhaul of the tax system; the restructuring of public-sector firms; and privatisation. The IMF released a Public Information Notice (PIN) about Algeria in late January 2005. The PIN paints a favourable picture of recent macroeconomic developments, noting that real GDP growth has recovered strongly since the slowdown of 2000. The Fund attributes much of the recovery in growth to the 2001-04 government spending initiative aimed at boosting capital investment, and hence job creation. Although flawed, the IMF believes that this plan has had a significant impact on employment: according to official figures, unemployment was around 29% in 2000, but had declined to 23.7% by end-2003. The Fund is also pleased to note that despite the spending plan, inflation has remained subdued (although it did increase quite sharply in the final quarter of 2004) and the countrys external position has strengthened significantly. Minimal progress in privatisation Successive Algerian administrations have talked boldly about the need for reform and the importance of privatisation. Indeed, specific targets for divestment have been drawn up. The government announced in February 2002 that it would privatise, either fully or partially, 100 state-owned firms during the course of the year. These mostly comprised small companies in areas ranging from hotels to food-processing, although they also included the shipping firm SNTM and three medium-sized cement plants. Yet by September 2004 nothing had been sold, bringing back memories of a previous privatisation effort in 1998, when the government failed to sell any of 89 state-owned companies that it had planned to privatise as a result of strong opposition by powerful trade unions and confusion about who was in charge of the process. In addition, any suggestion of labour market reform has been fiercely opposed by the unions, who have strong support within the military elite. Legal reform is another area that is much-needed (contract enforcement leaves much to be desired) but about which the government has done very little. Indeed, most observers agree that the president, Abdelaziz Bouteflika, used Algeria's judiciary to undermine his rivals in the 2004 presidential campaign. Despite the president's political strength, privatisation is unlikely to make much headway. Vested interests are deep-rooted and complex, and oil and gas revenue is healthy. As such, the political will is weak and the financial imperative is missing. In its 2001 Article IV report the IMF noted that the Algerian government had made good progress in some aspects of deregulation. The Fund admitted that most sectors of the economy were open to private activity, including mining and telecommunications; the deregulation of the power sector followed soon after the IMF report. However, in its Article IV report for 2004, the Fund said that there had been minimal progress since then. Only in two areas, trade liberalisation and Treasury market development, had concrete progress been made. Fiscal policy Fiscal policy under IMF tutelage remained tight in the latter half of the 1990s, enabling the government to weather the oil price downturn of 1998-99. However, the rebound in oil prices in the latter half of 1999, combined with the outbreak of mass demonstrations--principally, but not exclusively, in the Berber-dominated Kabylia region--in the spring of 2001, prompted the government to relax its fiscal stance, albeit gradually, in order to boost growth and employment. The government's fiscal accounts for the 1999-2003 period show that receipts more than doubled, thanks to the pick-up in global oil prices and increased hydrocarbons output. Spending did not rise commensurately, however, and the government recorded a fiscal surplus of AD400bn (US$5.5bn), equivalent to 9.7% of GDP in 2000. Only in 2002, as social unrest mounted, did the government begin to inject significant amounts of its hydrocarbons surplus into the local economy, with the surplus easing to AD53bn, or 0.2% of GDP in 2002 (according to Banque d'Algerie--the central bank--data, which differ slightly from IMF figures). Government finance(AD bn unless otherwise indicated)19992000200120022003Receipts9501,5781,5051,6031,929% change22.766.0-4.66.520.3Hydrocarbons5881,21310019421272% change38.1106.2-17.5-5.834.9Expenditure-962-1178-1,321-1,551-1,770% change9.822.512.117.414.2Balance-1240018553159Source: Banque d'Algerie.In 2003 a further surge in hydrocarbons revenue more than offset the increase in spending and the surplus widenend again, to AD159bn (3.2% of GDP). However, the overall increase in the surplus disguised a sharp pick-up in government spending in the second half of 2003, as a belated response to the devastating earthquake earlier in the year and as the April 2004 presidential election began to draw near. In 2004 pre-election spending pledges are expected to be fulfilled and expenditure is likely to expand by 10%. Although spending will outstrip revenue growth, the government is still expected to record a fiscal surplus of around 4.2% of GDP. Government revenue is, and will continue to be, dominated by hydrocarbons receipts, which accounted for over 65% of overall revenue in 2003, up from 62% in 1999. Taxes on goods and services were the next highest contributor, at 12.5%, still low by most measures and well down on the 17% in 1999. The Economist Intelligence Unit expects efforts to expand the tax base in line with IMF and World Bank recommendations to continue, but these are likely to be half-hearted in the context of strong hydrocarbons receipts. Analysts estimate that tax evasion deprives state coffers of about AD30bn per year. Despite Mr Bouteflika's comprehensive election victory, prospects for a major overhaul of fiscal policy are not good. While the president's re-election was secured largely because of his handling of the Islamist insurgency, an increase in government spending also played its part in mobilising support for the president in rural areas. This type of populism and associated spending pledges, rather than serious structural reform, is likely to colour fiscal policy going forward. Consequently, the government will use substantial oil and gas earnings to create public-sector jobs and improve infrastructure when it is politically expedient to do so. This is unlikely to impress the IMF. IMFs report, released in January 2005, states that it is concerned about the governments fiscal stance in 2004, although the Fund clearly does not regard it as critical. The Fund estimates that the primary non-hydrocarbons budget deficit increased from 29.5% of GDP in 2003 to 32% of GDP in 2004. Yet it acknowledges that higher oil prices are likely to have enabled an overall strengthening in the fiscal position (it estimates a surplus of 5.3% of GDP). The IMFs reference to the non-hydrocarbons budget appears designed to remind the authorities of Algerias dependence on oil and gas revenue and the associated vulnerability to any downturn in international prices. Monetary policy Monetary policy aims at stabilising prices in the economy. The law on money and credit, which was originally launched in 1990, laid the foundations for current monetary policy. The government began to develop indirect monetary policy instruments at the end of 1995 when it started to auction Treasury bills. In 2002 the Banque d'Algerie reduced its discount rate by 50 basis points to 5.5% and added greater flexibility to its monetary policy by creating greater transparency in the functioning of the interbank money market. The negative liquidity auction, introduced in April 2002 to mop up excess liquidity from the banks, is currently the main instrument used by the central bank. This in turn has led to more flexible money-market rates. However, as the IMF points out, monetary management is hampered by several factors: the strong dependence of the economy on hydrocarbons revenue and the resulting swings in bank liquidity; the weak development of the market in Treasury securities and the financial market in general, although the former problem is now being addressed; the lack of marketable government securities in the central bank's portfolio; the lack of interest rate competition between state-owned banks; the lack of sensitivity of non-financial public enterprises to interest rate variations; the absence of formal liquidity forecasts for the fiscal sector; and weaknesses of the statistics and payments systems.The government's expansionary fiscal stance is also a concern. In 2004 government expenditure is estimated to have risen sharply as a result of a budgeted 25% increase in the minimum wage, an allowance granted to civil servants in the education sector and an upsurge in current transfers to public services. A sharp accumulation of net foreign assets, which the government appears not to have sterilised, added further liquidity to the local market. So far, increased M2 growth has not translated into higher inflation, probably because of increased agricultural output and a reduction in trade barriers. Nevertheless, economic agents might not be willing to hold additional real money balances beyond a certain level. Nominal bank deposit rates are forecast to average 6.9% over the next five years, giving a not particularly attractive real average of 3.3%. In addition, no interest is paid on sight deposits, while interest on term deposits is subject to a 15% securities revenue tax. Meanwhile, the Algiers Stock Exchange remains undercapitalised, opaque and generally unattractive. Excess liquidity could therefore quickly be translated into higher M1 growth, which one study has found to be the main determinant of inflation in Algeria (along with agricultural performance). Economic Performance Energy prices are crucial togrowth Economic growth in Algeria depends heavily on the price of oil and the level of rainfall. With the steady expansion of the hydrocarbons sector, GDP growth was rapid for more than a decade from the mid-1970s. At its peak in 1980 GDP increased in real terms by 17%. The collapse of oil prices in late 1985 produced a slump in growth that lasted into the 1990s. Political and economic chaos took an additional toll on the industrial economy. The economy contracted in 1993 and 1994. However, with the rise in world oil prices in 1995, GDP grew by 3.8% in 1995 and 4.1% in 1996. The slump in oil prices in 1997 led to a further sharp downturn in economic growth, which registered 1.1% in that year. In 1999, despite growth in the hydrocarbons sector, economic expansion slowed to 3.2%, from 5.1% in 1998. The slowdown in 1999 can be attributed to a fall in non-hydrocarbons sector growth, particularly agricultural growth, which declined from 11.4% in 1998 to 2.7% in 1999. This pattern was repeated in 2000, with real GDP growth held at 2.4%: hydrocarbon production increased by almost 5%, but a severe drought saw a halving of wheat production and a 5% contraction in agriculture. Agriculture saw a sharp bounce-back in 2001, which more than offset the impact of a slump in manufacturing and only moderate growth in oil production. Consequently, GDP growth edged up to 2.6%. In 2002 a further slight increase in crude oil production and a more pronounced pick-up in liquefied natural gas (LNG) output, coupled with the impact on private consumption of the boost to 2001 agricultural incomes, pushed up real GDP growth to 4.1%. Gross domestic product(% real change)Annual average20042000-2004GDP5.24.1Sources: Ministry of Planning; Economist Intelligence Unit.Despite the solid growth performance in 2002, it is only in the 2003-04 period that an acceleration of hydrocarbons output began to push GDP growth up significantly. The Economist Intelligence Unit estimates that real GDP grew by 6.4% in 2003 and 5.2% in 2004. In its recent Public Information Notice (PIN), released in January 2005, the IMF said that Algerias economic performance in 2004 was favourable. It attributed the slowdown in 2004 from 2003 to a dip in the rate of hydrocarbons output (though this remained healthy) and in agriculture following the 2003 bumper crop. The industrial production index from the Office national des statistiques (ONS) shows that hydrocarbons output expanded by 2.5% year on year in the first nine months of 2004, compared with growth of 7.4% in 2003 as a whole. However, the ONS figure does not sit comfortably with the fact that Algerias crude oil output increased by 8.6% over the year and that there was a significant additional contribution from gas exports. The index, excluding hydrocarbons, rose by 2.6% in the same period, following a 3.5% decline in 2003 as a whole--although this is not particularly meaningful since hydrocarbons dominate the economy, accounting for at least 60% of GDP (and indirectly much more) and around 97% of export earnings. Gross domestic product(AD bn; current market prices)2000 (a)2001 (a)2002 (a)2003 (b)2004 (b)Private consumption1,714.21,847.71,970.602,108.82,235.3Government consumption560.10624.60683.20758.20836.34Gross fixed investment879.40965.501,102.201,218.701,412.76Stockbuilding65.60183.80253.00308. 2026.00Exports of goods & services1,734.801,550.901,587.701,988.702,466.82Imports of goods & services855.20930.701,142.601,258.601,487.75GDP4,098.804,241.804,454.805,124.005 ,489.50% real change2.402.604.106.40 (b)5.20(a) Actual. (b) Estimates.Source: IMF, International Financial Statistics.Exports are crucial to GDP Despite the strong showing of imports, the figures demonstrate the importance of exports to the Algerian economy. Exports account for 38% of nominal GDP, which is well above average for the North Africa region; in Egypt and Morocco they account for 22% and 26% respectively. Unfortunately, most of this activity is confined to the geographically remote and capital-intensive oil and gas industry. Consequently, few Algerians are employed in the country's most important industry and it is left to government spending (both capital and current) to disperse oil revenue throughout the country. The problem with this mechanism is that such spending is often wasteful and sometimes harmful (by creating extra layers of bureaucracy) and is subject to the vagaries of political expediency. Despite generating substantial hydrocarbons earnings from 2000 onwards, the government waited until serious social disturbances in 2001 before formalising a plan to increase capital spending. Even then, it was not until 2002-03 that significant spending began (and expenditure only accelerated to substantial levels as the presidential election began to loom). Nevertheless, this spending has had some impact. Construction and public works (the second-largest contributor to GDP) created 120,000 jobs over the 1998-2003 period. Although the number of unemployed has increased--to 2.4m from 2.3m in 1998--the unemployment rate has fallen (to 23.7% by September 2003 according to the authorities, though a rate of 25% might be optimistic). Meanwhile, the agricultural sector has lost ground, but remains important. Its share of GDP has fallen from 11.5% to 9.3% over the past five years, but it remains Algeria's third-largest employer and has been responsible for almost half of the new jobs created over the past five years. Inflation Despite the central banks absorption of much of the surge in foreign assets, the strong pick-up in M1 in 2004 does appear to have had an impact on consumer prices. Consumer prices increased by over 4% month on month in September, a month when M1 also surged by 2.2%. Prices continued to increase in October (by 0.5%) and in November (1.5%) before falling back by over 1% in December. Food shortages also appear to have played a role, with the food price index increasing by 5.6% in September, which may have been related to pre-Ramadan hoarding. The net effect of these trends was a fairly sharp 4.6% increase in average annual prices, in line with the Economist Intelligence Units expectations. Inflation was brought under control in the late 1990s. The government's efforts to cut subsidies in 1994 and 1995 helped push consumer price inflation up to around 30% in those years, but despite further subsidy cuts, pressure for wage rises and an upturn in the amount of credit allocated by banks to public enterprises, a prudent monetary stance saw inflation fall steadily from 20.3% in 1996 to 2.1% in 1999. Average consumer price inflation increased to 3.5% in 2001 from deflation of 0.6% in 2000. The main driver appears to have been the 49% increase in M2, which was driven by both a steep reduction in money-market interest rates and a sharp increase in foreign assets. Inflationary pressures cooled somewhat in 2002, easing to 2.3% before accelerating to 3.5% in 2003 as government spending picked up in the second half of the year (M2 grew by just under 44% for the year as a whole). The IMF notes two points about the consumer price index (CPI). First, its weights are derived from the estimated structure of private consumption in 1988 when many prices were administered, and is in need of an overhaul. Second, agricultural droughts do not tend to have a negative impact on the CPI since cereal prices are supported at the production level. Inflation(% change)Annual average20042000-2004Consumer prices4.62.6Source: Office national des statistiques.Wages and subsidies The national trade union, Union Generale des Travailleurs Algeriens (UGTA), remains fairly influential in economic policy formation. UGTA has around 3m members and although the wide-ranging benefits traditionally enjoyed by public-sector workers have been steadily removed, the pace has been slow as the authorities remain acutely aware of the potential for social unrest. The UGTA and its affiliated unions have so far advocated radical action while pulling back from outright conflict with the state. Although there has been industrial action, it has been limited to short, sharp bursts. For example, more than 100,000 workers in the metallurgy and mechanical industries went on strike in March 1998, to protest against the decline of wages in real terms, while March 2001 witnessed a stoppage among oil workers in protest against plans to open up the sector to foreign competition. In February 2003 a two-day general strike was called by UGTA, which was observed by around 95% of its membership. The strike brought all but the country's oil and gas sector--which was exempt from the strike--to near stand-still. It was called to protest against the government's privatisation plans, which strike leaders described as "opaque". It was also designed as a means to express the union's disapproval of the precarious state of Algeria's social security and pension schemes and the erosion of workers' incomes, which UGTA says are driving increasing numbers of families intopoverty. UGTA claims that it is not opposed to reforming the Algerian economy, which remains heavily state-controlled, but complains that the government's privatisation policy, aimed at creating a market economy, lacks transparency. However, the UGTA secretary-general, Abdelmadjid Sidi Said, struck a more confrontational note in February, following the strike, stating that the government's economic reforms will push Algeria "right over the edge", and demanding that they be scrapped. Although Mr Sidi Said insisted that privatisation could proceed as long as the government engaged in "dialogue" with the workers, "dialogue" saw the hydrocarbons reform bill heavily diluted and, ultimately, led to its abandonment. Mr Bouteflika heeded the warning and effectively gave up attempting to reinvigorate the privatisation process in the run-up to the presidential election of 2004. In turn, UGTA extended their support to Mr Bouteflika's re-election campaign. Living standards and unemployment According to the World Bank, average gross national income per head in 2002 was US$1,720. This represents a fairly sharp increase on the US$1,589 that the Bank recorded in 1999, and occurred despite a 3.1% nominal depreciation of the Algerian dinar against the US dollar. Nevertheless, the depreciation of the dinar in the mid-1990s (by 40% in 1994) catapulted many who previously considered themselves middle-class professionals into the ranks of the poor. As the country moves slowly towards a market economy, the authorities have been forced to boost social welfare schemes to balance the decline in real wages, which has been compounded by increases in the local price of gasoline and the removal of subsidies on basic goods, including bread. Algeria's divide between rich and poor has widened in the past decade as a result of worsening poverty levels. Labour force growth averaged 3.4% during the 1990s and resulted in an annual average of 250,000 new entrants in the job market. Following the oil price shock of 1996, Algeria saw unemployment soar from 19.8% in 1990 to 27.3% in 2001. The government's decision to expand public employment has seen unemployment ease, although this appears to have been exaggerated by official statistics. The Office national des statistiques put the unemployment rate at 23.7% in September 2003, suggesting an unrealistically steep fall of 3.6 percentage points since 2001. Unemployment mainly affects the young (80% of the unemployed are under 30), urban dwellers and females. Nevertheless, the problem of unemployment is ameliorated to some extent by the informal sector, which expanded rapidly during the 1990s and now accounts for around 35% of GDP, according to the World Bank. Employment, Sept 2003Total workforce (000)8,762Unemployment rate (%)23.7Source: Office national des statistiques.It is estimated that as much as 35% of the country's workforce are either unemployed or underemployed. The traditional escape route, migration, is now almost completely closed, as it is extremely difficult to obtain a visa to go to Europe or North America. To stem the rising numbers of unemployed, the government needs to develop labour-intensive non-hydrocarbons industries. |