Low oil prices and economic diversification lead to a redirection of Algeria's fiscal policy

High international oil prices in the mid-2000s saw Algeria record large fiscal surpluses, peaking at 13.8% of GDP in 2006, according to IMF figures. This allowed the authorities to pay down the country’s debt and indeed to begin accumulating large fiscal savings in the years that followed, stored mainly in the oil savings fund, which is known as the Revenue Regulation Fund (Fonds de Régulation de Recettes, FRR). However, government expenditure also rose in the late 2000s and early 2010s, in particular following the Arab Spring in 2011, with outlays growing from 27.1% of GDP in 2005 to 43.5% in 2012, despite a substantial rise in GDP over the same period, according to the IMF.

As a result, the government had begun to record fiscal deficits even before the oil price crash of mid-2014; in fact, public finances have been in the red every year since 2009 (albeit only marginally in some years), financed by the surpluses from previous years that are stored in the FRR. The subsequent oil shock then saw the value of government hydrocarbons revenues fall sharply from AD3.39trn (€28bn) in 2014 to AD2.27trn (€18.8bn) in 2015, according to the figures from the Bank of Algeria. This pushed the fiscal deficit up dramatically to 8% of GDP in 2014 – the largest deficit recorded in the country’s history since at least 1990 – and 16.8% in 2015.

Debt Accumulation

The FRR allowed the government to continue to run deficits without recourse to borrowing until recently. Indeed, the government maintained net savings of around 3.3% of GDP at the end of 2015. However, the value of such savings has fallen sharply in recent years, from 17.7% of GDP in 2014 and a peak of 33.1% in 2009. In the October 2017 update of its World Economic Outlook database, the IMF expected the situation to move into one of net debt in 2016, worth around 8.9% of GDP, before nearly doubling to 17.1% in 2017 institution’s forecasts from the previous April, likely due in large part to a rise in the price of oil.

Subsidy Cuts

The government is taking a range of measures to bring down the deficit and contain rising levels of debt, including structural economic reforms such as the “New Economic Growth Model” announced in July 2016, which aims to generate additional tax revenues by increasing investment in high-value added sectors, and a new investment law passed the same month that is intended to increase investment in key sectors, including industry, which should also generate revenues.

In order to offset falling oil income, the government also cut public spending by 9% in the 2016 budget, with the aim of reducing the value of the deficit to 15% of GDP, Reuters reported in October 2016. A key element of the planned reductions in spending is cuts to subsidy spending, the total value of which was equivalent to around 13.6% of GDP in 2015, according to the IMF’s Article IV consultation for the country in May 2016. In January 2016 the government also made the first of a planned series of reductions to such spending by slightly reducing subsidies for petrol and other goods, having announced plans late in 2015 to gradually phase out subsidies for fuel electricity and gas entirely, as well as to decrease those for food.

The country is following the footsteps of a range of other Middle Eastern and North African governments that have cut spending on fuel subsidies in recent years. Mahdjoub Bedda, head of the country’s parliamentary finance committee, told Reuters in October 2016 that further subsidy cuts were being planned, and that in the future providing support for the poor would be more of a priority. He also said that support for basic food stuffs would not be reduced. The government is also planning measures to curb other forms of spending, including a freeze in public sector recruitment announced in 2015, according to the IMF. “The budget deficit widened from 18.5% of GDP in 2014 to 20% of GDP in 2015, following the sharp decline in oil earning,” Boubcar Traoré, Algeria’s resident representative of the African Development Bank (AfDB), told OBG.

2017 & Beyond

In October 2016 the cabinet approved the 2017 draft finance law, which sets the government budget, including further spending cuts of 14% aimed at bringing the deficit down to 8% of GDP. The proposed budget, which is based on an average oil price of $50 per barrel, was approved by parliament in November 2016. Local news site TSA reported in September 2016 that the authorities had aimed to reduce operational expenditure by 4.5% and investment spending by 38% in the budget. The authorities have also indicated that they intend to raise value-added tax by two percentage points in 2017 in order to boost non-oil revenues, among other planned tax rises reportedly aimed at boosting total government receipts by around 14.4%.

Looking to the longer term, the authorities are also reportedly planning to freeze spending in 2018 and 2019 at roughly the same level as 2017 and forecast receipts to rise substantially across both years. Traoré told OBG that moves to integrate the informal economy into the formal sector could help boost government revenues, citing Indonesia and Malaysia as recent examples of countries that had successfully managed to achieve this. He added that improving collection of some taxes in some areas such as property taxes could also make a difference. Reuters reported in May 2016 that measures to do so that are under way include a tax amnesty giving Algerians up until the end of 2016 to put undeclared income into bank accounts, subject to a 7% fee.

SHRINKING DEFICIT

Partly as a result of such measures, the fiscal deficit should fall in coming years. The IMF expects its value to shrink to 13.3% of GDP in 2016 and 9.3% the following year. As a result, while government debt will rise in coming years, the rate of its accumulation should progressively slow down, with the IMF expecting the value of government net debt to reach 34.5% of GDP by 2021. While unprecedented in Algeria over the last decade, such levels are low by the standards of both the country’s regional peers (for example, Moroccan net government debt was worth 63.8% of GDP in 2015). Furthermore, it is low even by many developed Western countries’ standards, and, indeed, in comparison to episodes in Algeria’s own modern history. The value of debt peaked at around 116% in 1995, at the height of the country’s so-called black decade.

Financing Options

Nevertheless, with the FRR depleted, Algeria is having to find ways to finance a growing debt burden. In April 2016 the government launched a domestic borrowing drive, selling local investors three- and five-years bonds worth AD50,000 (€4141) each, at respective interest rates of 5% and 5.75%. The authorities did not set a specific borrowing target, instead limiting the drive to a period of six months. By July 2016 the drive had raised funds of approximately AD600bn (€5bn), according to local daily El Watan. Under the six month timetable, the drive should have come to an end in October 2016. As of early November 2016 the government had not made any official announcements regarding the borrowing programme; however, Hadj Baba Ammi, minister of finance, told the Algerian Press Service that the bond had brought in AD568bn (€4.7bn). He added, “I am very satisfied with the results of this operation.”

In November 2016 the country also turned to external lenders for the first time in years, concluding a €900m loan from the AfDB, its first loan from the institution. The country is likely to seek further support from multilateral institutions, as well as concessionary loans from countries such as China, and may also make a return to international debt markets. However, Traoré told OBG that while the country was well-positioned in several respects do so, the government appears reluctant to tap markets unless necessary. He said, “External debt levels are very low, less than 2% of GDP, and foreign exchange reserves are still high, even if they are falling, so the country has the fundamentals in place to borrow. However, the authorities have made much of their ability to remain self-reliant in recent years and would prefer to first take measures such as the national loan, raising receipts and cutting subsidies before tapping international debt markets.”

Farid Bourennani, financial expert and private consultant, explained that the government was nevertheless likely to return to such international markets eventually, but that its lack of activity in them in recent years would raise the cost of borrowing. He told OBG, “Algeria should have continued to borrow small amounts in recent years in order to maintain its sovereign debt ratings and benchmarks, as without these in place, raising money in international markets will prove more expensive.”

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The Report: Algeria 2016

Economy chapter from The Report: Algeria 2016