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Abstract
The macroeconomic policy mix in Yemen in the first half of the 1990s differed radically from that in the second. Unification of the YAR and the PDRY in 1990 joined two countries each of which already faced considerable macroeconomic policy challenges of its own in the late 1980s. The budget deficits of the YAR ranged from 15 to 20 percent of GDP in 1988 and 1989, about two-thirds of which were financed by the central bank, keeping inflation in double digits. In the centrally planned economy of the PDRY, the fiscal deficit exceeded 50 percent of GDP in both 1988 and 1989, of which 25 to 30 percent was domestically financed. (Price controls kept official inflation subdued, however.) Unification added new problems related to the merger of the two civil services and tax systems as well as the large number of publicly operated enterprises in the southern governorates. Since unification had resulted from negotiation between two sovereign governments, each of which received equal weight in the new joint government, many conflicts inherent in the different economic philosophies were resolved only after the 1994 civil war.29 The Gulf crisis of 1990 also added strains to both public and private financial balances in the early 1990s, with the return of workers from the Gulf countries and the drying up of most external financial assistance. Faced with financial crisis, after some early price liberalization efforts during 1990–91, the authorities centered the macroeconomic policy mix in the first half of the decade around attempts to manage financial imbalances through direct control of the economy, affecting in particular imports, the exchange rate, interest rates, and investment. The attempt to defend the nominal exchange rate led to a sharp appreciation in terms of the real effective exchange rate in the first half of the 1990s (Figure 3). As it became increasingly clear that multiple exchange rates and foreign exchange controls were intensifying the negative impacts of external shocks, in 1993—94 the authorities took some partial steps to achieve positive real interest rates and more realistic exchange rates.
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