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Reform Needed For Algeria To Ride Out Low Oil Prices

Reform Needed For Algeria To Ride Out Low Oil Prices

The sharp decline in oil prices over the last two years has generated a heavy economic shock on oil-exporting nations, especially those whose GDP and exports are dominated by oil. Algeria, as the IMF reports, is no exception. The country is reeling from the fossil fuel price drop, as its sluggish economy remains heavily dependent on hydrocarbons.

Analysts have already underscored how the declining price of oil demands reform in Algeria’s oil industry. However, with public finances significantly deteriorating, Algerian officials must also quickly undertake broad financial and structural reforms to avoid widespread fiscal and social crisis.

Oil dependency in Algeria

The Algerian economy is heavily dependent on oil-related revenues. Energy earnings make up 97 percent of the country’s exports, 60 percent of the State budget, and represent more than 30 percent of its GDP. Moreover, the country’s break-even point (the required oil price for a balanced budget) is at around $93 a barrel, according to IMF forecasts for 2016. Therefore, Algeria’s reliance on hydrocarbons leaves it vulnerable to price swings—as it is now with oil hovering at around $40 a barrel.

Related: OPEC Report Suggests Massive Oil Price Rebound

Source: IMF

Algerian export revenues plunged by almost half in one year following not only declining oil prices, but the depreciation of the dinar. In turn, the fiscal deficit has grown significantly since 2014, and nearly doubled to 16 percent of the GDP in 2015

Related: Traders Should Not Dismiss Momentum In The Oil Market

With crude oil now trading well below the national break-even, the government has low flexibility. So far, it has tapped into its Revenue Stabilization Fund, financed by export earnings, to plug its budget deficits.

Debt financing underway

Taking these two trends together, it is unsurprising that fund reserves are depleting: $50 billion at their peak in 2013, $42 billion at the end of 2014, and now only $27 billion left at the end of 2015. If the slide is to continue, the balance of the fund could be reduced to zero by the end of 2016, leaving the government to search for new means to finance its 2016 expenditures.

In response, Prime Minister Abdelmalek Sellal recently announced the issue of a 5-year bond on the national market with an attractive interest rate of 5 percent. According to Minister of Finance Abderrahmane Benkhalfa, this financial opportunity will be open for 6 months in order to finance Algerian economic projects.

Algerian officials are thus relying on the dinar equivalent of several billion USD to balance the budget of 2016. Yet, this solution is temporary and prone to risk, as the government will have to run a new debt issuance next year. Furthermore, this future debt issue will be of a much larger amount in the face of an increasingly depleted Revenue Stabilization Fund.

A failing system

These problems are largely self-inflicted. Algerian officials have repeatedly ensured the valuation of the oil sector over other possible opportunities to diversify away from hydrocarbons, ensuring the country remained at the mercy of volatile international oil markets.

With the focus on fossil fuels, the country is dependent on imports, a dynamic that the depreciation of the dinar is making increasingly difficult. The government is now struggling to cover its import bill and to support consumption.

Related: Will China's Slowing Economy Stall The Silk Road Project?

The prevailing circumstances have caused a sizable external shock to the Algerian economy. The country has recorded its first trade deficit since the nineties, and its unemployment rate has risen to 30 percent among young people. In turn, the nation’s rentier model government — and social stability — are now increasingly in question.

Urgent reforms needed

In short, the opportunity to remodel Algeria’s economic structure and strategy must be taken now, before more destabilizing consequences cannot be escaped.

The situation is even more critical given that oil revenues were primarily spent to buy social peace by financing basic commodities, housing, and salary increases paid to officers and employees of public enterprises. The wide range of subsidies, representing 13 percent of the GDP, has helped the government ease social tensions and protests in the past—but are now looking difficult to continue.

Reforms are therefore necessary to avoid a fiscal and a social crisis. The announcement of a “new economic policy” later this month by Prime Minister Sellal is keenly awaited, and will warrant careful scrutiny regarding the future of Algeria.

By Arthur Brunel de Moze via Globalriskinsights.com

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