Republic of Yemen
2007 Article IV Consultation: Staff Report; Staff Supplements; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Yemen
Author: International Monetary Fund
Publication Date:
28 Sep 2007
eISBN:
9781451840810
Language:
English
Keywords:
ISCR; CR; government; Yemen; debt; price; oil horizon; exchange rate regime; oil price; price statistics; nominal exchange rate; Inflation; Oil; gas and mining taxes; Global; benchmark deposit interest rate; hydrocarbon GDP
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This 2007 Article IV Consultation highlights that despite recent progress in poverty reduction, Yemen remains far from achieving the Millennium Development Goals. Oil production has been declining since 2000, and in the absence of major discoveries, proven oil reserves could be depleted in some 10 years' time. Economic performance in 2006 was generally favorable, but was accompanied by an increase in inflation. Overall real GDP growth reached 4 percent in 2006, with a 6 percent non-oil growth offsetting an 8 percent decline in oil production.

Abstract

This 2007 Article IV Consultation highlights that despite recent progress in poverty reduction, Yemen remains far from achieving the Millennium Development Goals. Oil production has been declining since 2000, and in the absence of major discoveries, proven oil reserves could be depleted in some 10 years' time. Economic performance in 2006 was generally favorable, but was accompanied by an increase in inflation. Overall real GDP growth reached 4 percent in 2006, with a 6 percent non-oil growth offsetting an 8 percent decline in oil production.

I. Introduction

1. Yemen remains one of the poorest countries in the Middle East. It is ranked 150th out of 177 countries in the 2006 United Nations Human Development Index. Strong oil revenues, especially in recent years, have permitted large increases in government spending. Together with sizable private transfers, this has contributed to a welcome decline in poverty, which has fallen from 40 percent in 1998 to 35 percent in 2006. Real per capita GDP, however, has been improving only slowly, reflecting Yemen’s high rate of population growth. Similarly, unemployment has been rising, from 12 percent in 1999 to 16½ percent in 2006, as labor force growth has been outpacing job creation. Yemen will face difficult challenges meeting the Millennium Development Goals.

A01ufig01

Real Per Capita GDP

(1998=100)

Citation: IMF Staff Country Reports 2007, 334; 10.5089/9781451840810.002.A001

Sources: WEO database; Yemeni authorities

2. High oil revenues have reduced the urgency to advance economic reforms. The pace of implementation of IMF recommendations has slowed down significantly since the end of the last Fund-supported program in 2001 (Box 1).

3. Relations with the international community have strengthened in recent years. External official assistance to Yemen has started to increase again, although aid has been relatively low in per capita terms. A Consultative Group (CG) meeting held November 2006 in London succeeded in generating almost $5 billion in pledges (23 percent of 2006 GDP, Text Table 1), underwriting a large part of Yemen’s Public Investment Program (PIP) for 2007-10.

Text Table 1.

Yemen: Consultative Group Pledges

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Source: Yemeni authorities.
A01ufig02

Per Capita Aid

(US Dollars)

Citation: IMF Staff Country Reports 2007, 334; 10.5089/9781451840810.002.A001

Source: World Bank’s World Development Indicators.

Implementation of Past IMF Recommendations

Fiscal policy: A General Sales Tax (GST) was introduced in 2007, after seven years of preparation, but with concessions regarding the valuation of imports to gain support from the business community. Full implementation is now envisaged only in early 2009. Customs tariffs were substantially reduced in 2006. Generous tax exemptions remain. The tax administration is moving towards a functional-based organizational structure and use of self assessment, but progress has been slow. A large tax payer unit was established. The authorities have not begun phasing out fuel subsidies, except for a one-time increase in domestic fuel prices in July 2005.

Monetary and exchange rate policy: Full liberalization of interest rates is yet to be implemented. Monetary policy remains geared more toward targeting the exchange rate than toward controlling inflation. Banking sector supervision needs to be strengthened and staff has repeatedly encouraged the authorities to request an update of the 2001 FSAP.

Structural reforms: Staff has called for reforms that boost private sector growth through improving the business climate and governance. New procurement legislation and implementation regulations have been prepared.

Macroeconomic data: Progress has been made in improving statistics, notably in monetary, balance of payments, and fiscal data, but further efforts are needed to improve the quality, timeliness and dissemination of Yemen’s statistics. Areas particularly in need of improvement include national accounts and price statistics.

Half of the pledges came from Gulf Cooperation Council (GCC) countries. The authorities are working to finalize the individual project agreements with each of the donors. Yemen was reinstated in the U.S.’s Millennium Challenge Corporation’s threshold program.

II. Recent Economic Developments

4. Economic performance was generally favorable in 2006, but inflation accelerated:

  • Output is estimated to have grown by about 4 percent, with almost 6 percent non-oil growth offsetting an 8 percent decline in oil production (Table 1 and Figure 1).

  • Core annual average inflation (excluding the volatile prices of the narcotic qat) rose to over 20 percent, after a decade of relatively stable inflation in the 10-12 percent range. This partly reflected exogenous supply factors, particularly a rise in world food prices. But buoyant domestic demand, driven by high government spending—including a large wage increase—and rapid money growth, also played a major role.

  • Government expenditures fueled domestic demand, as higher-than-budgeted oil revenues were largely spent (Tables 2 and 3, Figure 2). As in 2005, the additional oil revenues helped contain the overall deficit to less than 1 percent of GDP, but the non-oil primary deficit widened to over 38 percent of non-oil GDP. Since 2002, when the run up in oil prices started, additional oil revenues have been mostly used to finance (fuel) subsidies and development spending, and to a lesser extent for government wage increases and social spending (Text Table 2). Non-oil tax revenues fell to less than 7 percent of GDP in 2006, well below the regional average and falling short of covering either the wage bill or fuel subsidies.

  • Monetary policy was accommodative. With sizable government spending out of high oil revenues, the real exchange rate has continued to appreciate, by 10 percent. But with the Central Bank of Yemen (CBY) targeting a very slow, but steady depreciation of the exchange rate, similar to a de facto crawling peg—the rial depreciated a little less than 2 percent against the U.S. dollar during the year—the real appreciation has manifested itself through higher inflation. Money growth accelerated to 29 percent, twice the rate of the previous two years (Table 4). Despite the higher inflation, the benchmark deposit interest rate remained unchanged at 13 percent and domestic currency interest rates became negative in real terms.

  • The current account surplus remained broadly unchanged, at over 3 percent of GDP, with record-high oil receipts partially offset by imports related to sizable investment in the gas sector (Table 5). With the latter financed through foreign direct investment, the high oil revenues resulted in a large reserve accumulation by the CBY. Gross reserves increased by $1.5 billion to $6.8 billion by year end, the equivalent of about 11 months of imports.

Table 1

Republic of Yemen: Selected Economic Indicators (Adjustment scenario), 2003–12

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Sources: Yemeni authorities; and Fund 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.

Includes statistical discrepancy.

Gross reserves minus commercial bank and pension fund foreign exchange deposits held with the Central Bank.

Figure 1.
Figure 1.

Yemen: Recent Developments, 2001-07

Citation: IMF Staff Country Reports 2007, 334; 10.5089/9781451840810.002.A001

Sources: Yemeni authorities; and Fund staff estimates.
Table 2.

Republic of Yemen: General Government Finances (Adjustment Scenario), 2003–12

(In billions of Yemeni rials)

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Sources: Ministry of Finance; Ministry of Planning; and Fund staff estimates.

Includes statistical discrepancy (equivalent to below the line financing).

Consists of education, health, social assistance and transfers to social welfare fund; covers central and local government units only.

Refers to central and local governments.

Table 3.

Republic of Yemen: General Government Finances (Adjustment Scenario), 2003-12

(In percent of GDP)

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Sources: Ministry of Finance; Ministry of Planning; and Fund staff estimates

Includes statistical discrepancy (equivalent to below the line financing).

Consists of education, health, social assistance and transfers to social welfare fund; covers central and local government units only.

Refers to central and local governments.

Figure 2.
Figure 2.

Yemen: Fiscal Developments, 2001-12

Citation: IMF Staff Country Reports 2007, 334; 10.5089/9781451840810.002.A001

Sources: Ministry of Finance and Fund staff estimates.
Text Table 2.

Yemen: Use of Extra Oil Revenues 2003-06

(In percent of GDP)

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Each entry denotes the ratio of the cumulative nominal change in an indicator between 2002 and 2006 to the cumulative nominal GDP in 2003-06.
Table 4.

Republic of Yemen: Monetary Aggregates (Adjustment Scenario), 2000-07

article image
Sources: Central Bank of Yemen; and Fund staff estimates.
A01ufig03

Yemen: Interest Rates, 2000-2006

Citation: IMF Staff Country Reports 2007, 334; 10.5089/9781451840810.002.A001

Source: Yemeni authorities.
Table 5

Republic of Yemen: Balance of Payments (Adjustment scenario), 2003-12

(In millions of U.S. dollars)

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

Hydrocarbon sector includes oil and LNG exports less corresonding imports, expenses and repatriation.

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 reserves.

Imports are c.i.f. for next 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.

A01ufig04

Hydrocarbon exports and current account balance

Citation: IMF Staff Country Reports 2007, 334; 10.5089/9781451840810.002.A001

Sources: Yemeni authorities; and Fund staff estimates.
A01ufig05

CBYreserves

Citation: IMF Staff Country Reports 2007, 334; 10.5089/9781451840810.002.A001

5. Inflationary pressures eased in early 2007, partly reflecting seasonal factors, but also because government spending was contained in the first quarter. Twelve-month core inflation fell to 12 percent in May 2007, mainly reflecting a very large drop in the prices of vegetables due to good rains. Annual average core inflation still stood at 20 percent in May. Partial data suggest that government spending remained below budgeted amounts in the first few months of the year as oil exports lagged behind annual forecasts. With less inflows, money growth slowed down, to 25 percent by end-May.

6. The approved 2007 budget envisages a significant increase in the deficit, to 6 percent of GDP. The budget maintains high spending levels and includes another wage increase of 20-25 percent, despite a sharp drop in oil revenues due to declining production and prices. Consolidating the PIP and related donor flows (which were not included in the budget) with the budget would further increase the overall deficit to 7 percent of GDP.

III. Policy Discussions

7. Against this backdrop, the 2007 Article IV consultation discussions focused on three key macroeconomic challenges:

  • bringing inflation down to levels below 10 percent, to prevent expectations of high inflation from becoming entrenched;

  • achieving fiscal sustainability in the context of declining oil reserves; and

  • promoting nonhydrocarbon growth to create employment opportunities and help achieve a lasting reduction in poverty.

A. Policies for 2007: Reducing Inflation

8. The authorities recognized the need to reduce inflation and agreed to undertake a modest tightening of fiscal and monetary policies. They realized that the planned wage increase would fuel inflation pressures. They agreed to delay the increase, at least until the associated civil service reforms (including the introduction of biometric cards) are fully implemented (expected by early or mid-2008 for most ministries). However, military wages were raised already, in light of the recent violence in the northern part of the country. Other nonwage current spending will be compressed. The authorities will also consider some streamlining of the budget’s own capital spending with the start of some of the (off-budget) development projects financed from last year’s CG pledges. Combined, these actions could reduce the 2007 budget deficit by some 2 percent of GDP. The CBY will resume issuing treasury bills in amounts above those required to finance the budget deficit, to mop up excess liquidity, and may resort to issuing its own certificates of deposit as well. With implementation of these measures, staff estimates that core inflation, which ended 2006 at 22 percent, could be reduced to about 12-14 percent by end-2007.

9. To help bring down inflation more firmly, especially as the wage increase will only be delayed, staff urged the authorities to allow some nominal appreciation of the rial and to liberalize, and possibly raise, interest rates. Yemen is a highly dollarized and largely cash-oriented economy, with a strong exchange rate pass-through, which makes the exchange rate a more effective monetary tool to influence inflation (and the incentives to dollarize) than interest rate policy. With CBY foreign exchange reserves at a comfortable level, staff advised the CBY to increase its sales of foreign exchange in order to at least halt the depreciation of the rial, but possibly even to allow some nominal appreciation in the short run, as the rial seems to be moderately undervalued at the present time (Box 2).

10. The authorities agreed to slow the rate of depreciation of the rial, but were reluctant to allow a nominal appreciation, for fear of losing reserves and hurting competitiveness. Mindful of the prospective decline in oil reserves over the medium term, the authorities wish to preserve foreign exchange reserves as much as possible. Staff acknowledged that competitiveness, which already appears low (Figure 3), could suffer, but argued that the adverse impact of high inflation on the overall economy was likely to outweigh any dampening effects of an appreciation on non-oil exports. Moreover, competitiveness could be undermined as much from inflation as from a stronger exchange rate.

Figure 3.
Figure 3.

Yemen: Competitiveness Indicators

Citation: IMF Staff Country Reports 2007, 334; 10.5089/9781451840810.002.A001

Exchange Rate Regime and Level

The nominal exchange rate of the rial vis-à-vis the U.S. dollar has been slowly, but steadily depreciating over the past several years, in a de facto crawling peg, in which the rate of crawl has recently slowed to resemble a conventional peg. While the rial depreciated by on average 3¼ percent per year since 2000, the rate of depreciation slowed to a little less than 2 percent in 2006 and to 1 percent in the 12 months through June 2007. Most of Yemen’s foreign exchange inflows accrue to the CBY. The CBY supplies foreign exchange to the market through its foreign exchange auctions, which are held irregularly and infrequently. The timing of, and the amounts sold at, the auctions are determined so to achieve a slow depreciation. The authorities, however, maintain that the exchange rate regime is an independent float and that the rial is appropriately valued.