Republic of Yemen: Staff Report for the 2004 Article IV Consultation
Author: International Monetary Fund
Publication Date:
23 Mar 2005
eISBN:
9781451840803
Language:
English
Keywords:
ISCR; CR; exchange rate; government; GDP; U.S. dollar; private sector; core consumer price index; oil price; current account; public expenditure
Download PDF (768.9 KB)

This 2004 Article IV Consultation highlights that economic growth in Yemen slowed in 2004 owing to a sharp contraction in the oil sector. Oil production declined by 5.9 percent, reflecting diminishing recovery from aging large oil fields as well as the absence of significant new discoveries. Some progress has been made in structural reforms. The revised General Sales Tax law submitted to parliament in late 2004 included several improvements designed to protect the integrity and simplicity of this tax.

Abstract

This 2004 Article IV Consultation highlights that economic growth in Yemen slowed in 2004 owing to a sharp contraction in the oil sector. Oil production declined by 5.9 percent, reflecting diminishing recovery from aging large oil fields as well as the absence of significant new discoveries. Some progress has been made in structural reforms. The revised General Sales Tax law submitted to parliament in late 2004 included several improvements designed to protect the integrity and simplicity of this tax.

I. Introduction

1. Yemen’s strong adjustment efforts that began in the mid–1990s have stalled in recent years. Achievements under Fund-supported programs from 1996 to 2001 included macroeconomic stabilization, price liberalization, exchange rate unification, trade liberalization, and the reduction in external debt. Recently, the reform process has been held back by mounting opposition as the remainder of the reform agenda began to encroach on the interests of very powerful groups. The lack of broad-based political consensus for reform, fueled in part by a perception of rampant corruption, has not helped.

2. With oil depletion looming closer on the horizon, the government unveiled in October 2003 a reform package aimed at pushing the reform process forward and breaking the political deadlock. The package, which was designed to be adopted or rejected in its entirety, contained some popular measures, such as wage increases for civil servants and tariff reduction, in the hope of winning parliamentary support. However, in 2004, under political pressure, the government granted a public sector wage increase without any tangible progress in civil service reform; delayed the introduction of an amended GST Law by one year to July 2005; and postponed the adjustment in petroleum prices.

3. Strong commitment at the highest political level is needed to reignite and sustain reforms in the coming years. With the approaching presidential elections in 2006, it is critical that reforms be implemented soon. Otherwise, the adjustment process may be significantly delayed, putting at risk the achievements of the past.

II. Background

4. A steeper-than-expected decline in oil production in 2004 and a downward revision of the long-term production path raise serious concerns about sustainability. Oil production was estimated to have declined by 5.9 percent last year and is projected to decline by 4.7 percent in 2005 as the recovery from aging large fields diminishes. The prevailing opinion, within government and oil company circles, is that, while small discoveries are possible, they will not be sufficient to replace the loss from large oil fields. At current production levels, proven oil reserves could be depleted in five years. With more realistic lower production rates, the depletion horizon can be extended by 12–14 years (Box 1).

5. Recent developments point generally to a deterioration in macroeconomic indicators.

  • Real GDP growth was estimated to have declined to 2.7 percent in 2004, mainly because of the slowdown in oil production. Non-oil GDP growth is expected to have reached 4.1 percent, supported by stronger activity in the construction, transportation, and trade sectors, and fueled by domestic demand stemming from continued fiscal expansion and higher public sector wages. However, over the long term, non-oil growth is likely to taper off as oil production declines, and with it government spending, unless important reforms reverse the tide and boost private investment (Table 1).

Table 1.

Republic of Yemen: Selected Economic Indicators, 2000–05

article image
Sources: Yemeni authorities; staff estimates and projections.

Core CPI is defined as CPI excluding qat.

Oil price is different from the WEO price because Yemeni oil is traded at a discount.

Gross reserves minus commercial bank and pension fund foreign exchange deposits held with the central bank. Imports are for the current year and exclude oil and gas sector imports.

Public and publicly guaranteed debt including central bank foreign liabilities. Debt service ratio is measured as a percent of exports of goods and services.

The real effective exchange rate for 2004 is the average over eleven months through end-November.

Oil Sector: Recent Developments and Prospects

A sharp decline in production in two maturing large fields in 2004 is feared irrevocable. There are nine producing blocks in Yemen, the largest of which are Marib and Masila—together contributing about three-fourths of total production. Production in these two blocks is now expected to drop sharply in the next decade.

The authorities and oil companies feel that there is a possibility of discovering new small fields, but they do not believe that this will be sufficient to replace the loss from the existing large fields. They conjecture that, based on geological data, they are unlikely to find large new oil fields in the near future. However, there is a general optimism about discovering small fields with about 50 million barrels in reserves.

In the absence of major new discoveries, reserves would be depleted in about 12–14 years. According to the Production and Exploration Authority (PEPA) estimates, proven (and fully recoverable) oil reserves are at 750 million barrels. However, if we add the estimates of recoverable probable and possible reserves, the level of reserves could almost double to 1.4 billion barrels.

The reserves-to-production ratio—which indicates how long reserves would last if production were to continue at the current pace of 146 million barrels per year—is only 5 years for proven; and 10 years for proven, probable, and possible. Under more realistic declining production schedules, reserves could be extended, but not for long. The figure below shows the production paths under three different assumptions: (a) only proven reserves are considered (P); (b) proven, probable, and possible (3P); and (c) a more realistic assumption consistent with other countries’ experiences under which we assume that there is a 50 percent chance that the probable and possible reserves become proven (P+2P*Prob). Under the first and third scenarios, production will drop by more than 90 percent and under the second scenario, by about 60 percent by 2016. Under the third scenario, which is used in our projections, oil revenue and exports will be virtually depleted by 2018.

uA01fig01

Oil Production under Different Assumptions on Reserves

Citation: IMF Staff Country Reports 2005, 111; 10.5089/9781451840803.002.A001

uA01fig02

Non-Oil and Oil Real GDP Growth, 1998–2004

Citation: IMF Staff Country Reports 2005, 111; 10.5089/9781451840803.002.A001

  • The fiscal deficit was estimated at about 4.5 percent of GDP in 2004, about 1 percent higher than the original budget target due to higher development spending and the petroleum subsidy as authorized by the supplementary budget that was adopted late in the year (Table 2).

  • Broad money grew at a rapid pace during the better part of 2004 until it was reined in during November-December—ending the year with a growth rate of 15 percent. Money growth was driven largely by a buildup in net foreign assets (on account of high oil exports) and an expansion of credit to the private sector (33 percent) mainly to finance trade (Table 3).

  • Core inflation (excluding qat) picked up partly as a result of expansionary macroeconomic policies and partly because of the impact of adverse weather conditions on food prices. The end-year core CPI inflation rate reached 14.5 percent compared with 12.1 percent in 2003, while the headline inflation rate was at 10 percent.

  • The external current account deficit remained broadly unchanged in 2004. A pickup in the demand for imports mitigated most of the export gains resulting from higher oil prices (oil export volumes were actually lower than expected). International reserves increased to reach about $5.1 billion, or 16.4 months of imports, despite record sales of foreign exchange ($740 million) by the Central Bank of Yemen (CBY) to respond to increased demand for import financing (Table 4).

  • The nominal exchange rate remained fairly stable vis-à-vis the U.S. dollar in 2004 and depreciated against other currencies (by 9 percent against the euro). This depreciation was not sufficient to make up for inflation differentials with Yemen’s trading partners, leading to an appreciation of the real effective exchange rate by 3.5 percent over the 11 months through November 2004.

Table 2.

Republic of Yemen: Central Government Finance, 2003–09

article image
article image
article image
Sources: Ministry of finance; ministry of planning; and staff estimates.

In 2003–04 the increase reflects pending payments associated with project accounts.

Revenue excluding grants minus expenditures excluding interest obligations.

Overall balance (commitment including grants) excluding interest obligations and oil and gas revenue.

Domestic oil revenue net of cash petroleum subsidies.

External debt includes expected debt relief and projected stock-of-debt operations as well as expected future disbursements. Domestic debt includes net outstanding lending to government by the central bank and commercial banks, and treasury bills and repurchases held by the bank and nonbank sector.

Classification based on the ministry of finance bulletin (it may not include all expenditures in health or education).

Includes an acquisition of equity in Aden Container Facility of an amount of $200 million.

Table 3.

Republic of Yemen: Monetary Aggregates, 2000–05

article image
Sources: Central Bank of Yemen; and Fund staff estimates.

Includes valuation adjustment.

Table 4.

Republic of Yemen: Balance of Payments, 2003–09

(In million of U.S. dollars)

article image
Sources: Central Bank of Yemen, and Fund staff estimates and projections.

Oil sector includes oil companies share of exports less oil sector imports, expenses and repatriation.

Debt relief in 2004 from Bulgaria and Japan.

Includes central bank SDR holdings, foreign exchange held abroad, foreign securities, gold, silver and foreign currencies; excludes commercial bank required foreign exchange reserves with the central bank against their foreign currency deposits and pension fund reser

Imports are c.i.f. for current year and exclude oil sector imports. Include high grade oil imports for the refineries beginning 2005.

Public and publicly guaranteed debt including central bank foreign liabilities.