1. On behalf of the Yemeni authorities, I would like to thank staff for their continued engagement with Yemen and the valuable policy advice during both the Article IV mission and the program negotiations.
Recent Developments and Request for an ECF
2. In spite of a challenging political and security environment, the authorities have maintained macroeconomic stability in the past year, thanks to their prudent policies and continued support from the Gulf Cooperation Council and particularly from Saudi Arabia, which provided last month an additional sizable support to the government of about $1.2 billion, about a third of it earmarked for social spending. However, the country continues to face significant social and development needs, with more than 50 percent of the population living below the poverty line. In addition, the recent attacks on oil pipelines and the electricity grid led to severe fuel and electricity shortages and resulted in a rapid deterioration in the fiscal and external positions in the first half of 2014. In response, the authorities took bold measures under difficult social and political circumstances in order to preserve macroeconomic stability. These included the removal of subsidies on key fuel products at the end of July 2014.
3. The Yemeni authorities are requesting an Extended Credit Facility (ECF) in support of their strong economic program which aims at responding to the country’s urgent balance of payments needs and closing the fiscal financing gap. Under the program, the authorities plan to restore macroeconomic stability while protecting the most vulnerable groups and laying the foundation for inclusive and sustainable growth. The authorities have already demonstrated strong ownership and commitment to this program by implementing or exceeding all of the prior actions, including the removal of fuel subsidies at a critical juncture, ahead of schedule and beyond what was agreed in the Fund program.
4. It is hoped that the ECF arrangement will continue to catalyze additional support from donors and international institutions. So far, only a third of the Friends of Yemen’s pledged resources have been disbursed. The authorities are particularly grateful to all the donors who are supporting their transition efforts. Speeding up donor disbursement remains essential to help Yemen address its challenges and promote stability in the near future.
The Government’s Economic Program for 2014–2017
5. In response to the challenging economic situation, the authorities have started implementing a reform program aimed at (i) maintaining macroeconomic stability, (ii) enhancing fiscal and external sustainability, and (iii) promoting sustained and inclusive growth.
6. The authorities’ fiscal strategy is focused on the need to contain the deteriorating fiscal position in the wake of repeated sabotage of the country’s oil and gas pipelines. They plan to reduce the fiscal deficit to more manageable levels while creating the space needed for poverty reduction and development spending. Fiscal adjustment will be mainly achieved by significantly reducing energy subsidies, containing the wage bill, and increasing non-oil tax revenues. The negative impact on the most vulnerable will be offset by increasing targeted social transfers.
7. On the revenues side, the authorities will continue their efforts to increase tax revenues, which are low compared to regional and international standards, thereby reducing their dependence on oil revenues. They will increase the revenue of the General Sales Tax and expand its coverage while improving payment compliance of the registered large tax payers in line with FAD recommendations. Exceptional efforts will be made to recover tax arrears, improve tax compliance, strengthen customs controls to combat smuggling, and reform the revenue administration. In addition, the authorities will review all existing tax and customs exemptions with the objective of limiting them.
8. On the expenditures side, corrective measures will produce considerable savings mainly through reducing by more than half petroleum subsidies, and controlling the growth of wages and capital expenditures. In addition, the government has adopted an action plan to pay wages and salaries using bank accounts and postal offices. This will contain the wage bill by reducing the number of ghost workers and double dippers. Moreover, a presidential decision has been taken recently to cut government spending including by freezing recruitment at all state institutions, and modifying government officials’ travel and transport benefits.
9. Public financial management reforms will continue to be implemented to improve the efficiency and transparency in public expenditures, throughout the strengthening of the treasury at the Ministry of Finance, as well as the improvement of processes for planning and execution of government spending. The authorities are well aware that the shift to fiscal federalism would require careful design and adequate capacity building, and will take all the necessary measures for a smooth and well planned transition. In order to avoid budgetary overspending, the authorities will enforce strict spending rules. They will resist any new spending request that exceed the allocated spending envelopes, except for any necessary requirements.
10. Energy subsidies reform measures are the centerpiece of the program and will lead to a reduction in subsidies of more than 5 percent of GDP over the program period compared to an initial saving of 4 percent of GDP under the Fund program. The domestic price of gasoline, diesel, and kerosene were increased respectively by 60 percent, 95 percent, and 100 percent beyond what was agreed initially. In addition to these significant fuel price adjustments, the government will work on introducing an automatic fuel price adjustment mechanism to respond to fluctuations in international prices in order to preserve the savings from the energy subsidies reforms. More importantly, and in order to offset the impact of the price increases on the poor, the authorities will increase the Social Welfare Fund (SWF) transfers by fifty percent starting with the last quarter of 2014. In parallel, the government will continue to improve the coverage of the SWF in collaboration with the World Bank and other development partners.
11. The government will adopt a program to clear outstanding payment arrears over the medium-term. Given the pressing development and social needs of the country, the focus will be on mobilizing budgetary grants to avoid increasing the debt burden.
Monetary and Financial Sector Policies
12. Monetary policy will continue to aim at maintaining price stability and supporting economic growth while preserving reserves. The Central Bank of Yemen (CBY) has lowered its benchmark interest rate last year in order to encourage credit to the private sector. However, and given that inflation is projected to increase to double digits as a result of the fuel price increases, the CBY will continue to monitor economic developments and stands ready to adjust policies as needed.
13. The authorities are committed to preserve the independence of the CBY and will refrain from monetizing the fiscal deficit going forward. In this regard, the CBY has signed a memorandum of understanding with the Ministry of Finance to bring down the government’s outstanding credit within the CBY legal limits. In addition, the CBY has recently published the full set of its audited financial statements, in an effort to enhance transparency and good governance.
14. While the banking system remains stable and profitable, the CBY is committed to ensure its soundness and to increase consolidated and cross-border supervision. The CBY will also continue to improve prudential regulations especially those related to Islamic banking.
Other Structural Reforms
15. The Yemeni government will continue its diversification efforts as well as promoting alternative sources of growth and employment generation. The authorities are committed to improve the business environment and promote private sector investment. They have identified the main challenges to doing business in Yemen and have launched several actions to address them.
16. The reform of the electricity sector remains a top priority for the government. The Public Electricity Corporation has been asked to review all the ongoing power lease contracts as well as unify and lower the cost price of purchasing power. The government is working on expanding gas and coal powered plants to replace diesel plants. In this regard, plans to install and operate Mareb’s second gas powered station will be expedited. In addition to resolving outstanding security problems at production sites, the cost of drilling and extracting oil will be reviewed with the aim of bringing costs down to the global averages.
Republic of Yemen: 2014 Article IV Consultation and Request for a Three-Year Arrangement Under the Extended Credit Facility-Staff Report; Press Release; and Statement by the Executive Director for the Republic of Yemen
Author:International Monetary Fund. Middle East and Central Asia Dept.