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Program note

Republic of Yemen

Last Updated: October 5, 2012

Current IMF-Supported Program

US$100 million concessional loan under the Rapid Credit Facility (RCF), approved by the IMF's Executive Board on April 4, 2012.

Background

Yemen is confronted with a range of difficult economic and security issues. The country’s oil reserves, on which the economy depends heavily, are expected to run out within a decade in the absence of new discoveries, and its groundwater is depleting. These challenges are compounded by a difficult security situation and civil unrest, a rapidly growing population, poor infrastructure, and weak institutional capacity. Yemen witnessed widespread protests calling for political reforms and more equitable access to economic opportunities. The 2011 political crisis has taken a serious toll on the economy.

The past few years have been exceptionally difficult for the Yemeni economy. Oil production dropped substantially beginning in 2007. With the collapse of international oil prices in late 2008, the country’s oil revenues—which account for about 60 percent of government revenues and over 90 percent of export revenues—have declined. Although Yemen began producing liquefied natural gas in late 2009, this positive development only partially offset the impact of the drop in oil revenues. Because of the hydrocarbon sector’s dominance of the economy, the loss of oil revenue and continued large energy subsidies had a strong negative impact on public finances and the balance of payments.

The political events of 2011 exacerbated these challenges. The uprising continued through the year, despite sporadic episodes of deadly clashes and armed violence. Damage to infrastructure, though not extensive, was far-reaching in its impact: attacks on a key oil pipeline and electricity facilities caused severe fuel shortages and electricity outages. The damage to the pipeline further weakened oil production, and placed additional strain on the fiscal and external balances. The political crisis also resulted in policy paralysis, scarcity of basic commodities, lack of bank financing, and shortages of foreign exchange to finance imports.

As a result, economic activity fell sharply in 2011 and inflation soared to 23 percent. The compression of public investment, which was the first line of defense for the government to contain the budget deficit, contributed to the sharp fall in output. The conflict worsened the already high poverty and unemployment levels: aid agencies estimate that half the population is going hungry and a third of the children in some areas are severely malnourished.

While the budget deficit was contained at 4.4 percent of GDP, it masks serious weaknesses. Populist measures adopted at the beginning of the crisis, partially implemented in 2011, led to a significant increase in the wage bill.

At the same time, government revenues were hard hit not only by the decline in oil revenues but also by a collapse in tax collections, reflecting low tax compliance, during the crisis.

As donor financing and demand for government paper dried up during the crisis, the fiscal deficit was financed almost entirely by borrowing from the central bank. The rial came under pressures at the beginning of the crisis but subsequently stabilized and, recently, started to appreciate, regaining almost entirely its lost value. Favorable oil prices and a Saudi oil grant helped reduce external pressures stemming mainly from increased oil imports to compensate for the loss of domestic refined oil. The compression of expenditures also helped offset exchange rate pressures.

Role of the IMF

Following the political resolution, reached in late November 2011, a coalition government was formed and a new president elected to manage a two-year transitional period. To address the deteriorating economic situation, the new government outlined a program for the transitional period, focusing on maintaining macroeconomic stability, creating jobs, and reducing poverty. The government’s economic program emphasizes the need to contain the budget deficit and address electricity outages, shortages of basic commodities, and distortions in the domestic fuel market. Governance also featured highly in the new government agenda.

The government requested IMF help through an emergency loan under the Rapid Credit Facility (RCF) to support its program. The RCF is meant to give the new government time to formulate its strategy for addressing underlying challenges. The approval of the loan makes Yemen the first Arab country in transition to have a program arrangement with the IMF. The program is part of the country’s broader medium-term development plan, which focuses on accelerating inclusive growth outside the hydrocarbon sector while maintaining inflation within moderate levels and putting public finances on a more solid medium-term footing.

The key objectives of the RCF arrangement are to safeguard foreign exchange reserves and maintain macroeconomic stability. The program envisages a significant increase in social expenditure, which is budgeted to be higher than pre-crisis levels while capital spending is expected to be doubled relative to 2011. It is also aimed at stopping the hemorrhage in tax revenue and streamlining the untargeted and expensive fuel subsidies.

The Challenges Ahead

The challenges facing Yemen are enormous and multifaceted and are further complicated by the still-difficult security situation and fragile political settlement. The magnitude of these challenges and the need to react quickly, through economic and other reforms, underline the need for expeditious and significant donor support. Donors pledged nearly US$8 billion in assistance for the transition period (2012–14) in Riyadh on September 4–5, and on the sideline of the UN General Assembly in New York on September 27, 2012. Quick disbursement of the pledges will help address many urgent problems facing Yemen.