Algeria’s ‘system’ hangs tough

Algeria seems headed down a road already taken by other resource-rich authoritarian countries like Venezuela. Low oil and gas prices have made it harder to buy off the public with subsidies and benefits. Their latest expedient is to use the central bank to fund a government stimulus program, but that only delays the day of reckoning.

Said Bouteflika (C), the younger brother of Algerian President Abdelazziz Bouteflika
Said Bouteflika (2R), the younger brother of President Abdelaziz Bouteflika, is thought to be the key figure in Algeria’s political and economic power elite. © dpa

In a nutshell

  • Algeria’s oligarchy made a short-term political decision to delay austerity and reform
  • Fiscal stimulus aims to quell unrest and secure President Bouteflika another term
  • Budget financing is provided by the central bank, but that operation has its own risks

Algeria appears headed down a road already taken by other resource-rich, authoritarian countries like Venezuela. As pointed out in two earlier reports for GIS, for years, Algerian governments have imposed a closed, crony oligarchy (called “the system” by Algerians) with very little economic freedom and opportunity for the average citizen. In exchange, they have offered subsidies and “social” spending paid for by vast revenue from hydrocarbons. This arrangement worked until oil prices began to tumble in 2014.

Since then, budget revenue and foreign reserves have shrunk, even after the slight rebound in oil prices since the summer of 2017. Some observers were hopeful: with Algeria’s fiscal breakeven oil price at about $120 in 2015, dealing with oil prices at about half that level would force Algeria to open its economy and end the country’s “resource curse.” Austerity policies alone would not suffice. But while the government shunned foreign loans and support from the International Monetary Fund – which would have been conditioned on economic reforms – in late 2017 it pulled out a new weapon in its policy arsenal: the printing press. The central bank is now helping finance the state budget, allowing necessary reforms to be postponed.

While “the system” is not monolithic, with feuding clans and internal power struggles, most groups within the oligarchy have little interest in reforms that would grant significant political and economic freedom. The April 2019 elections seem to have triggered movement within the power structure, but the system seems destined to prevail, especially now that monetary intervention can ease the pain in an election year and head off a potential popular revolt. The question, of course, is for how long.

Reform resistant

A striking demonstration of the system’s resilience was the August 2017 dismissal of Prime Minister Abdelmadjid Tebboune, after only 80 days in office. Within the ruling camp, Mr. Tebboune was something of a reformer: his strategy aimed at weakening the business-politics nexus and reducing imports. In theory, the latter priority was probably unwise because it relied on a faulty import substitution strategy (“stimulating” local production without first reforming Algeria’s business climate would produce little but waste). But the aim was not just to expand local production and stop leakage of foreign currency; corrupt interest groups were also the target.

Powerful officials in Algeria’s import sector will not tolerate any disruption of their profits.

This was Mr. Tebboune’s undoing. Algeria’s lucrative import sector is controlled by a handful of powerful officials and companies; it was evident that these people, well connected to the system (the younger brother of President Abdelaziz Bouteflika, Said, is said to be a heavy hitter in business circles), would not tolerate any disruption of their profits. The then prime minister also publicly criticized local and foreign contractors for big infrastructure contracts, demanding that they speed up their work – something the vested interests would not appreciate. The result was that Mr. Tebboune was quickly replaced by Ahmed Ouyahia, a four-time premier and consummate regime insider.

‘Boutef’ again

Another sign of the system’s rigidity is talk of having President Bouteflika, 81 years old and clearly moribund, to stand for reelection in 2019. Appeals for “Boutef,” as Algerians call him, to run again have come from his own National Liberation Front, as well as from Prime Minister Ouyahia’s National Democratic Rally and the powerful General Union of Algerian Workers.

Certain preparatory steps seem to have been taken. Mr. Bouteflika canceled new, unpopular fees (notably for driving licenses and passports) that had been introduced by a supplementary finance law in May. He also presided over the transfer of 50,000 subsidized housing units to Algerian families as a gift to the nation on the Eid al-Fitr holiday.

President Bouteflika has held office since 1999, thanks to a constitutional reform in 2008 that lifted the two-term limit on the presidency. This curb was reintroduced by another constitutional amendment in 2016, but it specifically exempts the current president. There have been serious doubts about Mr. Bouteflika’s ability to perform his duties since he suffered a serious stroke in 2013. Over the past four years, he has made only a handful of public appearances in a wheelchair. Reportedly, he is unable to speak intelligibly.

Shadow play

For Algerians, however, the alternatives are unappetizing. One potential successor is the president’s 60-year-old brother, Said, who is already considered a major force and could keep the family clan in power. Prime Minister Ouhayia was also considered a potential contender, thanks to support from big business and senior military commanders, until he decided to back old “Boutef” instead. Most likely, he expects the endorsement will allow him to remain at the head of the government.

A spring cleaning of Algeria’s power structure has begun, with the usual mystery about who is pulling the strings.

Another likely candidate was General Abdelghani Hamel, the country’s top security and police official, until he was suddenly dismissed in June on President Bouteflika’s order. The commander of the Gendarmerie Nationale, Menad Nouba, was also removed a few days later. It almost seems as if a “spring cleaning” of the Algerian power chessboard has begun, with the usual dose of mystery about who is pulling the strings. None of this bodes well for transparency or democracy, nor do these events show any clear path toward political or economic reforms. Yet reform is what Algeria needs.

Leaky model

The country’s economy continues to run out of steam, according to the data. Official unemployment has risen to 12.3 percent at the end of 2017, from 10.3 percent a year earlier. Economic growth slumped to 1.6 percent, while the current account and foreign trade deficits remained substantial at $4.3 billion and $2.3 billion in the first quarter of 2018, according to the latest data from the Bank of Algeria, despite import restrictions and rebounding oil prices. In a country with low productivity, such deficits are a sign that something is wrong.

Indeed, the Heritage Foundation’s Index of Economic Freedom ranks Algeria 172nd (“repressed”) among 180 countries surveyed, while the World Bank’s Doing Business 2018 report puts the country in 166th place out of 190. No wonder that foreign direct investment inflows amount to only $1.2 billion a year. As a result, Algeria’s foreign exchange reserves – crucial in an undiversified economy that relies on imports – have continued to dwindle to $94.5 billion in March 2018, from more than $111 billion at the beginning of 2017. The obvious way out would be putting an end to the country’s corrupt, state-directed development model and start to diversify the Algerian economy by strengthening the private sector.

Monetary tricks

Instead of reforms, however, the government chose its lender of last resort – the central bank. In October 2017, parliament changed the banking law to allow the Bank of Algeria to directly lend to the Treasury. The strategy aims at financing the economy, but also the state budget, public agencies and state-owned enterprises – and would also pay wage arrears to public employees and civil servants. This is expected to drive this year’s general government deficit to 13 percent of gross domestic product. As of March 2018, 3.59 trillion dinars (or $30.4 billion) in new banknotes had been printed.

Many outside experts, including the IMF, have warned of the potential inflation risks.

Many experts, including the International Monetary Fund in its latest Article IV staff report from June 2018, have warned of the potential inflation risks, but Algerian officials say that the new monetary strategy has not generated price pressure. Officially, annual inflation is running at about 4 percent. Yet both the IMF and the World Bank forecast that consumer price growth will accelerate beyond 7 percent in 2018 and 2019. Some experts see it even higher, in the 10-15 percent bracket, since they believe Algeria’s official statistics are based on an obsolete consumer basket.

Spending spree

This monetary life belt, combined with recovering oil prices, gave Algerian politicians the confidence to drop their limited fiscal consolidation in 2016-2017 and embrace a stimulus program.

The result has been a real spending spree. The original 2018 budget law involved a 25 percent increase in public spending (roughly two-thirds of the extra funds were supposed to go for infrastructure projects). But the supplementary Finance Act of May-June 2018 added another 500 billion dinars ($4.5 billion) to that total, some coming from the National Fund of Investment. President Bouteflika insisted that this new money would be dedicated to once-frozen “social projects” and infrastructure – including railroads, highways and the modernization of port facilities in Annaba.

Prime Minister Abdelmadjid Tebboune’s short career shows reform is perilous in Algeria
Economic reformers face an uphill battle against Algeria’s crony system, as Abdelmadjid Tebboune’s brief 80-day stint as prime minister shows. © dpa

Much of the stimulus package is going to subsidies on basic consumer goods, especially fuel, which accounted for 23 percent of the government budget in 2017 and will increase by 8 percent in 2018. While subsidies help poor families, they are highly regressive, since richer households consume six times as much fuel. The IMF and the World Bank have consistently recommended that these blanket subsidies be replaced by targeted cash transfers to low-income households.

Yet the authorities clearly fear tampering with this key element of Algeria’s social contract. In early July, Finance Minister Abderrahmane Raouya said the idea of replacing some subsidies – especially on gasoline and electricity – with “more effective” aid to poor families was being considered for 2019. However, after criticism from the presidential party, his ministry quickly retreated, noting that “preliminary studies and dialogue” were necessary.

President Bouteflika announced that the stimulus strategy was a temporary response to difficult “circumstances.” In fact, it appears that after two years of modest fiscal tightening, the time has come to seek favor with the voters ahead of an election year in 2019. The government’s combination of fiscal stimulus and monetary easing is a nice illustration of the political-monetary cycle theory. However, this theory also holds that in the cycle, booms are inevitably followed by busts.

Stuck between

There are legitimate fears about runaway inflation. During an election year, the government is unlikely to tame price pressure by scaling back spending for fear of public unrest. This leaves curbing inflation and sterilizing excess liquidity up to the Bank of Algeria, which has already raised the mandatory reserve ratio for commercial banks from 4 to 8 percent in January, and then again to 10 percent in May. Even so, the liquidity of Algerian domestic banks jumped by 186 percent between September 2017 and March 2018.

Monetary illusion is a sweet drug, and it is unclear whether politicians have the willpower to give it up. Also worrying is the ratchet effect that the government’s stimulus strategy has created. Once people get used to public spending, it is always difficult to reduce it (say, by cutting subsidies or firing redundant public employees). These tough decisions will need to be made after the 2019 elections; otherwise, the crisis feared by international institutions could materialize, followed by the reemergence of social tensions. After next year, the risks of further delaying serious reforms to make Algeria’s political and economic institutions more inclusive will increase dramatically.

The optimism of Algerian officials is partly based on their faith in rebounding oil prices.

The optimism of Algerian politicians that they can handle this delicate transition is partly based on their faith in rebounding oil prices. Current tensions in supply and a possible renewed ban on Iranian oil exports could give prices an extra boost. However, with Russian and Saudi output set to increase and with Libyan crude becoming more available, it seems quite likely that the recovery in oil prices observed since 2017 (after OPEC’s decision in late 2016 to cut output) might slow down.

While Algeria’s “austerity” budgets of 2016-2017 brought the fiscal breakeven price of oil down to about $75, the renewed burst of spending may have pushed it back up to $100, according to some observers. Yet price forecasts by the U.S. Energy Information Administration, for example, predict an average oil price of $67 per barrel (West Texas Intermediate, or WTI) in the second half of this year.

How oil prices fare will largely determine how much the authorities will need to depend on the central bank for deficit financing. Either way, Algerians are on the spot – stuck between the resource curse and the printing press.

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