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.
1- At the outset, I would like to convey the Yemeni authorities’ appreciation to the staff and management for their continuing candid and constructive engagement in Yemen. They view the consultation process as well as the provision of technical assistance as being of great value to the country. The authorities are in broad agreement with the analysis and the thrust of the policy recommendations contained in the comprehensive staff report.
Background
2- Yemen undertook ambitious macroeconomic and structural reform efforts since the mid 1990s, bringing about major improvements in the economy. Accomplishments under Fund-supported programs, in the form of Stand-By and Extended Arrangements and subsequently the PRGF over the period 1996–2001, included macroeconomic stabilization, exchange rate unification, trade liberalization, and the reduction in external debt. Further significant advances in structural reforms included the fiscal area, the civil service, the banking sector, and public enterprise privatization. Yemen, still a developing democracy often confronted with precarious security situations, continues to muster strong public and political support to the wide-ranging reform program pursued. Looking ahead, the authorities are determined to maintain this consensus building approach to reform, which, sometimes, might have led to inevitable compromises, but which, they strongly believe, has served the country well.
Recent Developments
3- Following the favorable economic performance supported by the completion of the PRGF program in 2001, a number of weaknesses emerged, including a slowdown in economic growth and reemerging inflationary pressures. Unexpected adverse circumstances, namely a steeper than expected decline in oil production in 2004 accounted for the former, while the latter was largely due to the impact of adverse weather conditions on food prices. In spite of these factors, the overall fiscal deficit narrowed by 0.8 percent in 2004, although it was still 1 percent above its target. The external current account deficit remained broadly unchanged as increasing export revenues resulting from higher oil prices offset an increase in import demand. Higher oil exports boosted the central bank’s own gross foreign reserves to about U.S. dollars 5.1 billion (16.4 months of imports), despite a drop in oil production. Moreover, the non-oil GDP grew by 4.1 percent and is expected to further rise in the medium term. Given the internal circumstances and regional uncertainty, this is a commendable achievement.
4- The short-term outlook for the economy is broadly manageable. While the downward revision of Yemen’s long-term oil production path introduces new challenges, the prospect of natural gas exploitation could improve the economic outlook. To address these challenges, the authorities are already planning a comprehensive economic strategy supported by policies aimed at promoting growth and diversifying the economy’s production base. In a move to muster public support for these efforts, they have launched a public communication campaign aimed at explaining the benefits of these reforms in light of the long-term risks stemming from declining oil production. They are hopeful that they will mobilize the necessary effort to gradually implement the reform agenda.
Fiscal Policy and Reform
5- The authorities fully integrated an ambitious reform package in the 2005 budget, which was approved by parliament in early January, pending the adoption by the government of the following measures in order to ensure effective implementation: submitting to parliament a national wage strategy to be implemented fully by 2007, reducing customs duties to the level of neighboring countries, providing additional resources for social safety nets to reduce the impact of higher petroleum prices, fighting smuggling through better border control, and adopting policies that would encourage growth in non-oil sectors such as fisheries and tourism. I am pleased to report that the two major conditions related to the wage strategy and customs duties’ reduction are currently being finalized and on the way to be implemented. The government is hopeful that the remaining conditions will soon be fulfilled. In an effort to reverse the recent deterioration in the fiscal trend relative to end of year budget targets, the 2005 budget is targeting a 9 percent decline in the non-oil primary deficit, which will reduce the overall deficit to 3 percent of GDP.
6- The centerpiece of the reform effort consists in phasing out the petroleum product subsidy beginning in 2005. The price adjustment aims at bringing most domestic prices, especially gasoline, in line with international prices, while the price of diesel fuel would increase to 85 percent of the international price. In line with a proposal the government made last year, diesel prices would almost double to reach Yrls 33, and gasoline and liquefied petroleum gas prices would increase by 45 percent and 40 percent, respectively. Swift and full implementation of these measures would result in halving the fuel subsidy to about 3 percent of GDP, and improving the fiscal stance. In addition, the authorities are determined to eliminate fuel price subsidies totally, with a view to reducing their distortionary effect and their heavy burden on the budget. In view of the adverse impact the removal of the fuel subsidy is expected to have on the most vulnerable groups of society, the authorities recognize the need to strengthen existing social safety nets, including improving the targeting and coverage of the Social Welfare Fund and supporting the Social Development Fund, while enhancing capacity at the national level.
7- The Yemeni authorities are thankful for the staff’s elaborate medium and long-term fiscal scenario and the fiscal adjustment measures put forward. The adjustment will reduce the non-oil primary budget deficit by 12–15 percent of GDP over the next 12 years. While the authorities agree with the proposed measures, they note the difficulty of ensuring the timely implementation of some of them. In particular, they are concerned about the imposition of an excise tax on petroleum products as early as 2007, immediately after the elimination of the subsidy.
8- Major components of the fiscal adjustment effort, namely the GST and public expenditure management measures, have already received the government’s attention. The authorities are of the view that a broad-based and simple tax is key to improving revenue performance. In this respect, the government completed a revision of the draft GST law, which is now with parliament for approval. It is hoped that the draft law will be approved without amendments. Major improvements included in the draft comprise a streamlining of exemptions, the elimination of the tax on production and consumption, the unification of the GST registration threshold, and the development of special refund procedures. In addition, the authorities took note of further enhancing measures suggested by staff, such as the elimination of the few remaining exemptions, lowering higher GST rates while imposing an excise on specific goods, and shortening the time for processing refunds to one month. They intend to address those measures at a later stage.
9- The Yemeni authorities agreed with staff on the need to improve public expenditure management as a condition for achieving a sustainable fiscal adjustment over the long term. In this respect, the 2005 budget preparation process was significantly improved by the use of macroeconomic indicators and indicative ceilings. However, as the authorities recognize the importance of further strengthening internal expenditure control mechanisms, including by developing a commitment control system and strictly adhering to budgetary allocations, they discussed with staff the prioritization and sequencing of the remaining reform measures. Continuous technical assistance provided by the Fund and donors has been very helpful, particularly in streamlining the budget presentation and improving fiscal transparency. The authorities indicated their intention to gradually consolidate a number of extra-budgetary funds and other special accounts into the budget, in a move to create a Treasury Single Account.
Monetary and Exchange Rate Policies
10- The authorities are committed to a monetary targeting framework to achieve price stability. In light of the recent increase in inflation, they confirm their close monitoring of the situation and their intention to intervene when necessary. In this respect, they are open to increasing the benchmark deposit rate. However, they see no immediate need for such an action, given that they deem the recent pick-up in inflation mainly supply driven. Moreover, they are concerned over the effect of higher interest rates on investment and growth.
11- With regard to intervention in foreign exchange markets, the authorities remain of the view that such interventions should be limited to smoothing short-term fluctuations, especially that they concur with staff that a flexible exchange rate that reflects real market forces would serve the economy well as the non-oil export base expands.
Financial Sector and Other Structural reforms
12- The authorities recognize the importance of implementing the 2001 FSAP recommendations. While acknowledging that further steps should be adopted, the Central Bank of Yemen upgraded its accounting practice to the latest international standards and a new initiative to modernize commercial courts was launched recently.
13- The authorities are committed to supporting the necessary fiscal effort by adopting policies aimed at promoting economic growth and diversifying the production base. They have recently adopted a strategy for fisheries as they agree with staff on the serious employment opportunities provided in the sector. Transshipments activities and tourism are potentially other important sources of growth. In this context, the World Bank port cities project aims, at encouraging growth and creating jobs in the port cities of Aden, Honeidah and Mukalla. The development of non-oil sector activities remain, however, dependent on the improvement in the security situation and the business climate, which I will discuss below. The Yemeni authorities intend to adopt structural measures to accompany the fiscal adjustment and other pro-growth policies. These include preserving a core allocation of critical and poverty-related expenditures.
14- The authorities remain committed to removing impediments to private sector activity. Plans to reform the civil service are progressing steadily with the completion of the civil service database and the amnesty law resulting in a voluntary self declaration of multi-salary recipients. Moreover, Yemen remains committed to maintaining an open trade regime. It is expected to join the WTO in four to five years as negotiations on accession are steadily progressing. In a move to combat unemployment, the authorities are hopeful that the improved labor code, aimed at introducing flexibility in the market, would soon be adopted. They agreed with staff on the need to redesign the education curricula and enhance vocational training to better respond to market demand.
Conclusion
15- Yemen’s near-term outlook remains broadly manageable. However, the authorities recognize that there is no room for complacency in view of the medium- and long-term challenges posed by a rapid decline in oil production and the continuous need to undertake necessary reforms. I would like to reiterate the commitment of the Yemeni authorities to pursuing fiscal reforms and accompanying policies aimed at improving the supply response of the economy. They very much appreciate staff’s valuable advice and technical assistance, and look forward to continuous intensive support from the Fund in the period ahead.