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
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International Monetary Fund
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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

article image
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

article image
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)

article image
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)

article image
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)

article image
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.

A01ufig06

Yemen. Nominal Exchange Rate

(Rial per U.S. Dollar)

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

A01ufig07

Central Bank Monthly Foreign Exchange Sales

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

Sources: Yemeni authorities; and Fund staff estimates
A01ufig08

De Facto Flexibility of the Rial

(Proportion of monthly exchange rate changes over last two years that were less than+/- 1 percent)

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

A01ufig09

Actual and Equilibrium REER

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

There is no evidence of a major exchange rate misalignment. Yemen’s real effective exchange rate (REER) has been appreciating as in many oil-producing countries, but this appreciation has come primarily through higher inflation, given the CBY’s exchange rate policy. Estimates of the equilibrium REER (subject to very large margins of statistical uncertainty) based on the Consultative Group on Exchange Rate’s equilibrium real exchange rate approach suggest a modest undervaluation of Yemen’s REER by about 5 percent in 2006, well within the margin of error.

Over time, if Yemen’s oil runs out, the equilibrium real exchange rate can be expected to be much more depreciated than today. An assessment of Yemen’s REER factoring in the decline in oil production, suggests that the equilibrium REER may be some 30-40 percent more depreciated over the longer term than its current level.

11. The authorities were also hesitant to liberalize interest rates and pursue a more active interest rate policy. They fear that eliminating the minimum interest rate for rial deposits would reduce demand for rial holdings and put pressure on the rial. In staff’s view, the minimum rate has effectively acted as a benchmark for all rates, and liberalizing interest rates, and allowing them to rise (until inflation is sufficiently reduced), combined with some nominal appreciation, could actually strengthen the incentive to de-dollarize.

B. Medium-Term Policies: Ensuring Fiscal Sustainability

12. While the authorities are placing high hopes on finding new oil and gas reserves, they agreed that fiscal policy needs to be based on conservative estimates of existing reserves (Box 3). Exploration activities have intensified and any major oil or gas finds could significantly change Yemen’s outlook. Conservative estimates, shared by the authorities, of remaining recoverable hydrocarbon reserves, however, show that oil reserves could be depleted within some 10 years. A large liquefied natural gas (LNG) project will offer some compensation, but does not fundamentally alter the country’s outlook. Oil revenues constituted three-fourths of government revenues in 2006, or almost 28 percent of GDP. Over the coming years, the budget will lose on average about 2 percentage points of GDP in hydrocarbon revenues each year.

13. The authorities acknowledged that current policies are not sustainable over the medium term and may lead to domestic and external instability. Staff presented a scenario of unchanged fiscal policies (Text Table 3). Under this scenario, the fiscal deficit would rise from less than 1 percent of GDP in 2006 to 20 percent of GDP by 2012. Assuming that these deficits could be financed, net public debt would rise from a manageable level of 31 percent of GDP to almost 75 percent of GDP over the same period, putting Yemen at a high risk of debt distress. An increasing part of the deficit would likely need to be financed by the CBY and inflation would accelerate. Growth would suffer.

Text Table 3.

Yemen: Unchanged Policies Scenario, 2005-12

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

Hydrocarbon Sector Developments and Prospects

Yemen is a small oil producer, but the country is highly dependent on developments in its oil and gas industry. Oil accounts for three-fourths of government revenue, and over 90 percent of export receipts. 60 percent of production is concentrated in two of the twelve producing blocks, Masila and Marib. As of end-2006, proven reserves (1p) amounted to 671 million barrels, while “probable and possible” (2p+3p) reserves amounted to 883 million barrels. Assuming a 50 percent probability for the latter, remaining reserves would amount to some 1.1 billion barrels.

Official projections show a continuous decline in oil production. After peaking at 159 million barrels in 2000, production started to decline and fell to 130 million barrels in 2006. The slowdown is mostly associated with the maturing of the Masila and Marib fields. At current rates of production and reserve levels, proven reserves would be depleted by 2013. Adding 50 percent of probable and possible reserves, oil would run out by 2018. With growing domestic demand, Yemen would need to import petroleum products by 2015, when demand would exceed the government share of oil production.

The production and export of liquefied natural gas will not fully offset the expected decline in oil production. The LNG project will produce and export 6.7 million tons of LNG, the equivalent of some 60 million barrels of oil per year, starting in 2009, for at least 20 years. The project has an estimated investment of around $4 billion, entailing substantial imports of capital equipment during 2006-09.

A01ufig10

Oil: Production projections, Government share, and domestic demand, millions of barrels per year

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

A01ufig11

Oil operations in Yemen territory

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

A major new find could significantly alter Yemen’s outlook. Current oil producing fields comprise only 4 percent of Yemen’s overall territory. An additional 15 percent (26 blocks) of Yemen’s territory is currently under exploration, with more to follow. So far, exploration activities have not resulted in any major discovery, but most have just started. Meanwhile, the authorities and oil companies are aiming to improve the recovery ratio of existing fields. Based on current technologies, some 40 percent of the estimated oil in place could be economically recovered from the existing fields. While less dramatic, increasing this ratio could add a few years to Yemen’s oil horizon.

14. The authorities realized the need for a large fiscal adjustment effort. They agreed that the key for achieving sustainability lies in increasing non-oil revenues and a rationalization of government expenditures. Notably, fuel subsidies remain a big burden, taking up one-fifth of government spending. Staff also presented an adjustment scenario consistent with fiscal sustainability, aiming to keep the public debt-to-GDP ratio below 50 percent over the medium to long term. This implies that the non-oil primary deficit would need to be reduced on average by almost 2 percent of GDP per year for the coming years, limiting the overall deficit on average to 3-4 percent of GDP annually. Key measures include (i) the phased elimination of fuel subsidies in three years, accompanied by measures to safeguard the poor; (ii) a broadening of the tax base, including by eliminating tax exemptions, full implementation of the GST and increasing its rate from 5 to 10 percent, and introducing a fuel tax; (iii) civil service reform to contain the wage bill; and (iv) a streamlining of capital spending, while improving the quality of spending. Even with strong adjustment, vulnerabilities would remain, given the still relatively large overall fiscal deficits.

15. The authorities broadly accepted the staff’s adjustment scenario, but noted that implementation was likely to be slower due to political economy considerations. The authorities emphasized that while they intend to tackle the fuel subsidies in due course, they did not want to risk domestic instability, especially in light of the recent conflict in the north, the already high rates of inflation, and the weak social safety net. A fuel price increase in 2005 triggered strong and violent protests that resulted in considerable loss of life. The authorities could not give a specific time frame for fuel price increases. They have requested the World Bank to provide several scenarios for how to reduce the subsidies. Staff urged the authorities to start raising domestic fuel prices as soon as possible, and argued that the planned government wage increase could provide a good opportunity, but acknowledged that it should be done only in conjunction with improved targeting of the benefits provided by the Social Welfare Fund (SWF) and that part of the savings should be used to increase benefit levels and the number of beneficiaries. Work is currently underway to improve the targeting of the SWF, with technical assistance from the European Union. As part of this work, a revised law on social assistance will be submitted to parliament before end-2007.

16. Reforms aimed at increasing non-oil revenues by broadening the tax base and improving compliance are progressing, albeit slowly. The long-delayed GST is being implemented at 5 percent, but with concessions to overcome strong opposition from the powerful business community, which controls a number of key parliamentary committees. Full implementation will now start in 2009. The authorities also intend to reduce the corporate income tax rate from 35 percent to 20 percent later this year, to bring it more in line with neighboring countries, while simultaneously removing all existing exemptions in the income tax, customs, and investment laws, to avoid revenue losses. Because this also needs to pass the same parliamentary committees, there is a risk that at least some exemptions may remain. Efforts to modernize the tax administration, in line with FAD recommendations, to move to a self-assessment environment are continuing slowly, but are hampered by the generally poor state of record keeping by businesses.

17. The authorities have started an ambitious and comprehensive two-year public financial management reform program. This program has been developed with assistance from a group of donors. It aims to strengthen spending control, including by establishing a single treasury account, and to improve budget preparation, execution and reporting. In this regard, starting with the preparations for the 2008 budget, the authorities will cast their annual budget within an explicit medium-term macro framework and a three-year rolling Medium-Term Expenditure Framework.

C. Medium-Term Policies: Promoting Sustained Nonhydrocarbon Growth

18. As oil production declines, new sources of growth will need to be found, especially to absorb the rapidly growing labor force. While donor-financed projects will help boost non-oil growth in the coming years, the authorities are appropriately focusing on establishing an environment conducive to private investment as key to creating new employment opportunities and broadening the tax as well as the export base. In this context, a one-stop shop for new businesses will be established at the General Investment Authority. Continued reforms in the tax and customs administration, the new procurement legislation, and the creation of a national anticorruption authority will help address governance concerns. The authorities recently committed to join the Extractive Industries Transparency Initiative (EITI) with a view to further enhance transparency in the oil sector. The authorities also aim to improve the skill set of the relatively young Yemeni labor force by strengthening vocational training.

19. The authorities recognized that sustained growth also requires a much higher level of financial intermediation than currently exists in Yemen. By end-2006, credit to the private sector amounted to only 7 percent of GDP. Strong reforms will be needed to enhance financial intermediation, including the removal of the minimum interest rate for rial deposits (see above). Banks are also reluctant to lend because of weak mechanisms for contract enforcement, and typically lend only to well-known clients. As a result, high loan concentration ratios, as well as high levels of nonperforming loans, remain a concern (Text Table 4). Measures are needed to strengthen property rights and contract enforcement, and create a transparent and effective judicial system. At the same time, banking supervision needs to be strengthened further, focusing also on the growing share of Islamic banks in Yemen’s financial system. The authorities expressed interest in a Financial Sector Assessment update, to assess vulnerabilities and identify areas in need of further reform and assistance. Revisions to the Anti Money Laundering (AML) law, prepared with assistance of the UN, the World Bank, and the IMF are to be sent to parliament shortly.

Text Table 4.

Yemen: Financial Soundness Indicators 1/

article image
Source: Central Bank of Yemen.

Excludes Housing Credit Bank and Cooperative and Agricultural Credit Bank (CAC), except for 2006 data, which includes CAC Bank.

D. Data and Other Issues

20. The authorities expressed strong interest in a multi-sector statistics mission to conduct a comprehensive evaluation of the macroeconomic statistics and develop a strategy for improving the quality and timeliness of data. Shortcomings complicating economic analysis are concentrated in the real sector (national account statistics, wages, and, to some extent, prices). Long delays in the availability of data are prevalent in almost all sectors. Staff also recommended that the authorities request a fiscal ROSC, with a view to increasing fiscal transparency, including an assessment of resource revenue issues as a useful complement to the EITI.

21. Yemen has a very open trade regime and is seeking to enhance trade integration. Most imports are subject to a 5 percent import tariff, while the highest rate is 25 percent. The Yemeni authorities hope to finalize discussions on accession to the World Trade Organization in the near future, pending further bilateral talks, and are also looking to strengthen linkages with the GCC countries.

IV. Staff Appraisal

22. The Yemeni authorities face considerable challenges to promote strong economic growth to create new employment opportunities and reduce poverty, while ensuring fiscal and external sustainability in the context of declining oil reserves. Although the country’s outlook could be significantly altered by the discovery of new oil and gas reserves, the authorities appropriately base their policies on existing hydrocarbon reserves.

23. The envisaged tightening of fiscal and monetary policies will help reduce inflation. Fiscal restraint is particularly important to avoid placing the entire burden to achieve single-digit inflation on monetary policy.

24. Monetary policy should focus more closely on achieving low inflation. Monetary targeting is hazardous, because of the economy’s low monetization and high dollarization and conditions in Yemen are not suitable for formal inflation targeting. The CBY must therefore continue to rely to a considerable extent on the exchange rate as its nominal anchor. Swings in the country’s equilibrium exchange rate brought about by oil price increases (in the short run) or by declining oil production (in the long run) may require that the exchange rate anchor be allowed to move up, or down, as needed to achieve low inflation, rather than always follow a (more or less) steady nominal depreciation.

25. To help bring down inflation more swiftly, the CBY could allow some nominal appreciation of the rial in the short run. The exchange rate appears to be slightly undervalued at the present time. In recent years, all of Yemen’s real exchange rate appreciation was realized through higher inflation relative to its partner countries. It would be preferable for any real appreciation to become manifest in a stronger rial, rather than in inflation. A strengthening rial could also reduce the incentives to dollarize. Eventually, however, as oil production declines, a downward adjustment of the nominal exchange rate may be needed to bring about a depreciation of the real effective exchange rate so as to allow Yemen to become more competitive in the supply of nonhydrocarbon goods and services.

26. The minimum interest rate for rial deposits should be removed to allow the CBY to conduct a more active interest rate policy and to enhance financial intermediation. Deepening financial markets will be essential for ensuring strong non-oil growth. Commercial bank credit operations would be enhanced by better contract enforcement, improved collateral arrangements, and strengthened property rights. Banking supervision and AML controls need to be strengthened as well and an FSAP update would help to assess potential risks and develop an agenda for financial sector reforms.

27. Yemen’s fiscal policies will need to adjust to the prospective decline in oil production and revenues. Absent such an adjustment, Yemen would risk domestic and external instability. Although Yemen’s relatively low debt burden and large foreign exchange reserves allow for some delays in the adjustment process, a more front-loaded effort than envisaged by the authorities would avoid the need for more abrupt changes later on. The most difficult and at the same time the most pressing measure is raising domestic fuel prices. This should go hand in hand with substantial improvements in the social safety net. Stronger efforts will also be needed to increase non-oil revenues—and especially to overcome opposition from the local business community to new tax measures—and to improve the quality and effectiveness of capital spending. Even with strong adjustment, Yemen will remain vulnerable to downside risks, including lower oil prices and slower non-oil growth.

28. Yemen will need strong economic growth to achieve a significant reduction in unemployment and poverty. At the moment, Yemen does not appear to be competitive in non-oil exports, which remain low. Productivity-enhancing reforms are urgently needed to enhance competitiveness, including further efforts to improve the investment climate and the quality of labor. Such reforms would need to encompass further actions to address governance concerns and red tape, including in tax and customs administration.

29. Data provision is still adequate for surveillance, but improvements are needed to better facilitate the formulation and monitoring of economic policies. Notably, real sector statistics should be a priority area for improvement, but further technical assistance will also continue to be needed in other areas to improve the quality and timeliness of data.

30. It is proposed that the next Article IV consultation discussions be held on the standard 12-month cycle.

Table 6.

Republic of Yemen: Millennium Development Goals, 1990-2005

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Sources: World Bank; and Yemeni authorities.

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Cover IMF Staff Country Reports
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
Volume/Issue:
Volume 2007: Issue 334
Publisher:
International Monetary Fund
ISBN:
9781451840810
ISSN:
1934-7685
Pages:
59
DOI:
https://doi.org/10.5089/9781451840810.002

Real Per Capita GDP

(1998=100)

Per Capita Aid

(US Dollars)
Figure 1.

Yemen: Recent Developments, 2001-07
Figure 2.

Yemen: Fiscal Developments, 2001-12

Yemen: Interest Rates, 2000-2006

Hydrocarbon exports and current account balance

CBYreserves
Figure 3.

Yemen: Competitiveness Indicators

Yemen. Nominal Exchange Rate

(Rial per U.S. Dollar)

Central Bank Monthly Foreign Exchange Sales

De Facto Flexibility of the Rial

(Proportion of monthly exchange rate changes over last two years that were less than+/- 1 percent)

Actual and Equilibrium REER

Oil: Production projections, Government share, and domestic demand, millions of barrels per year

Oil operations in Yemen territory