Republic of Yemen and the IMF

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Country's Policy Intentions Documents

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Yemen—Letter of Intent, Supplementary
Memorandum of Economic and Financial Policies

October 10, 2001

The following item is a Letter of Intent of the government of Yemen, which describes the policies that Yemen intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Republic of Yemen, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Use the free Adobe Acrobat Reader to view the Tables (38 kb PDF file)

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431
United States of America

Dear Mr. Köhler:

1. Economic performance in 2001 has been in line with program objectives and all quantitative performance criteria for end-February, end-May and end-August have been met. Expenditure restraint and strong oil revenues have contributed to a significant accumulation of reserves—above program objectives—while a slowdown in monetary growth should help ensure that the recent reduction in inflation is sustained. As described in the attached Supplementary Memorandum of Economic and Financial Policies (MEFP), large one-off expenditures expected in the latter part of the year (related to emergency repairs in electricity production capacity and the cost of border demarcation with Saudi Arabia) should cause some slippage relative to the 2001 target for the non-oil deficit. However, the underlying budget position will improve thanks to the actions taken to reduce energy subsidies, limit recruitment and stem the losses of the electricity company.

2. The timing of structural reforms slipped relative to the target dates owing to local elections, the subsequent change in government, and strong parliamentary resistance to tax reform, which caused the legislative agenda to be delayed. As a result, we were unable to meet any of the five structural performance criteria and four benchmarks set for end-March and end-June. The pace of reform has since picked up and we have completed the actions related to two of the structural performance criteria (diesel price increase and transfer of large taxpayer files into and small taxpayer files out of the newly established Large Taxpayer Unit) and are working to secure passage of a revised investment law. All three measures constitute prior actions for completion of the review.

3. Completion of the measures related to the other three structural performance criteria (passage of a new General Sales Tax, passage of an amended banking law, and submission to Parliament of a reformed pension law) will require more time. However, we remain committed to working with Parliament to secure passage of a revenue-enhancing GST law and an amended banking law. In the area of pensions, we expect to complete a draft reform law by year-end, building on the follow-up technical assistance provided by the Fund in August 2001. We have also agreed with Fund staff that progress towards income tax reform, which was the object of structural benchmarks, will have to be deferred until passage of the GST is secured.

4. On the basis of the actions taken to date and in support of the policies detailed in the attached memorandum, we hereby request completion of the combined first and second reviews under the 3rd annual PRGF Arrangement, and fifth and sixth reviews under the Extended Arrangement, as well as waivers for the non-observance of the structural performance criteria. We do not intend to draw from EFF resources at this stage.

5. The Government and the Central Bank of Yemen believe that the policies outlined in the Supplementary MEFP are adequate to achieve the program objectives, but we stand ready to take additional measures as necessary, in consultation with Fund staff. In addition, we will continue to provide the IMF with such information as it may request in connection with implementation of the program.

Sincerely yours,

H. E. Alawi Al-Salami
Deputy Prime Minister
and Minister of Finance
Ministry of Finance
Hon. Ahmed Abdul Rahman Al-Samawi
Central Bank of Yemen


Republic of Yemen
Supplementary Memorandum of Economic and Financial Policies
October 10, 2001

I. Policies for 2001

1. The government of Yemen stands by the main macroeconomic objectives that were set out in the Letter of Intent (and related MEFP) of February 13, 2001, namely to achieve non-oil growth of 4½ percent and to reduce annual average inflation to 9 percent. Reserve money targeting will provide a nominal anchor, while the exchange rate will continue to be managed flexibly. The government's fiscal objective remains that of strengthening the fiscal position through adjustment in subsidized prices, containment of expenditures, and tax reform. Local elections in February, the subsequent change in the government, and the difficulties encountered in securing parliamentary approval of proposed legislation contributed to slow down the reform process, but the pace of reform has since picked up and we remain committed to completing the reforms envisaged under the program.

2. A number of macroeconomic and fiscal developments have, however, altered the macroeconomic framework. These developments include: (i) higher-than-programmed oil revenues in 2001, reflecting a combination of higher prices and lower production levels; (ii) the need to finance emergency repairs of electricity production capacity at a cost of US$30 million; and (iii) the cost of border demarcation with Saudi Arabia, following the signing of the border agreement with Saudi Arabia in 2000. The Yemeni share of the cost of this project comes to US$150 million to be disbursed beginning in September 2001. While this represents a considerable new expense for the budget, it will also contribute to improving the security situation.

Public finances

3. The deterioration in the non-oil deficit related to the developments cited above will be offset by higher government oil revenues. As a result, we now project that the overall fiscal surplus (commitment basis, including grants) will reach YR 58.8 billion, compared with YR 41.1 billion under the original program. In view of the one-off nature of the expenditures overruns, we believe that the revised fiscal target remains consistent with our objective of containing recurrent expenditures within the strict limits of the program and improving the underlying fiscal balance. In particular, the underlying balance will be improved by the recent measures taken to reduce subsides on diesel and to contain the losses of the Public Electricity Company (PEC). Further measures will be taken if necessary to ensure compliance with the revised fiscal target.

4. In order to contain wage expenditures below the budgeted level, we will limit recruitment to an even greater extent than indicated under the original program (8,000 instead of 9,000), and we will complete the process begun in 2000 of retiring 18,000 overage civil servants. The wage increases that were granted in connection with the adjustment in diesel prices will be accommodated within the wage and defense spending ceilings that were agreed under the program.

5. The government remains committed to phasing in market-based pricing for domestic petroleum products. At the end of July, we took a major step in this direction by raising the retail price of diesel by 70 percent to 17 rials per liter (prior action). This measure is expected to produce an annualized budgetary saving of 0.6 percent of GDP (based on current oil prices), and will contribute to reducing smuggling and water depletion. To avoid overburdening the consumer at this stage, we have decided to defer implementation of the 5 percent tax on gasoline and diesel that is earmarked to the Road Maintenance Fund. The government will also explore what steps could be taken in the future to minimize the impact of diesel price increases on the poor.

6. In order to protect the budget from contingent liabilities, we have taken action to stem the growing losses of the Public Electricity Company by raising electricity prices by
15-38 percent in August 2001. To restore the financial viability of the Public Electricity Company we will shortly begin implementing the restructuring plan as agreed with the World Bank.

7. In line with the program's objective of establishing a sound base for strengthening tax revenues, we will continue working with parliament to secure passage of a revised GST law which broadens the coverage of the tax, while addressing Parliament's social concerns.

8. On the tax administration side, we have made important progress towards making the Large Taxpayer Unit (LTU) fully operational. Following the appointment of the management of the LTU headquarters and the regional offices in Sana'a, Aden, Hodeida, and Taiz, and the staffing of these offices, we have completed the transfer of large taxpayers' files (tax on consumption, production and services; employee withholding tax; and income tax), into the LTU and of smaller taxpayer files out of LTU (prior action). The target date for completion of the process was missed because of administrative obstacles encountered in the initial phase of this process.

9. Given the need for proper sequencing of tax reform, we have decided in consultation with Fund staff to postpone income tax reform, pending passage of the GST law. The eventual reform of income tax, with a focus on rationalizing exemptions, aligning the top personal and corporate tax rates, and establishing modern collection procedures and administration, will draw from technical assistance provided by the Fund.

10. In line with our plans for civil service reform, we will accelerate work on the restructuring of the pilot ministries and agencies under the Civil Service Reform Project, and begin transferring identified redundant labor to the Civil Service Fund before the end of 2001. We have also launched a project to issue biometric cards to all civil servants, so as to

identify double dippers and ghost workers, and eliminate them from the payroll. The formation of the new government in April 2001 has been the occasion to merge and reorganize various ministries and agencies so as to increase efficiency.

11. In preparing pension reform, there emerged a need for follow up technical assistance in actuarial analysis. IMF technical assistance in this area was provided in August 2001. We have since begun to conduct actuarial simulations of possible adjustments to the benefit and contribution parameters of the public pension fund for public sector employees. We expect to present to cabinet by the end of 2001 a draft pension reform law that will provide for the long-run financial sustainability of the public pension fund.

Monetary and exchange rate policy and financial sector reform

12. We have increased our gross foreign exchange reserve target for December 2001 from US$3,205 million to US$3,320 million, reflecting the combination of higher oil revenues, higher imports, and our decision not to draw under the EFF.

13. In consultation with Fund staff, the 2001 broad money and reserve money targets set under the program have been raised to reflect developments through August. The revised targets still represent a considerable deceleration in monetary growth relative to 2000 (broad money growth decelerates from 25 percent in 2000 to 13.3 percent in 2001), which should help ensure that the recent reduction in inflation is sustained. We will continue to issue the newly created central bank certificates of deposit as required to sterilize foreign exchange inflows and maintain reserve money growth within its target rate.

14. Modern supervision regulations are now largely in place. We have made progress towards enforcing compliance with the required levels of capitalization and provisioning and prudential indicators have been improving markedly. We have presented to the Parliamentary Finance Committee an amendment to the banking law giving the Central Bank of Yemen greater powers to enforce compliance on banks and bank board members. The committee has asked for a number of additional changes which we will need to review. We will therefore not be able to secure passage of this amendment by parliament (structural PC for end-June) before the end of the program, but we remain committed to obtaining parliamentary approval by the end of the year.

15. Reform of the commercial courts is another priority in building a financial sector supportive of private sector growth. We have recently stepped up efforts to investigate judges accused of misconduct, to dismiss those found to be guilty, and to establish and train a specialized police force that will enforce court judgments.

Other structural policies

16. Parliament is soon due to pass a revised investment law (prior action), which streamlines procedures for approving and implementing investments covered by the law.

17. We have removed the seasonal import license requirements that were introduced in 2000 and have completed the publication of all trade-related regulations on the customs website.

External debt

18. Following the Paris Club agreement of June 14, 2001 on a stock of debt reduction on Naples terms, we will begin negotiating bilateral agreements with the concerned creditors, and we will continue to seek rescheduling and debt reduction agreements on comparable terms with non Paris Club creditors.

Statistical issues

19. In collaboration with a technical advisor provided by the Fund, we will take action and mobilize sufficient resources to ensure that work plans to improve price and national accounts statistics that were agreed with STA will be carried out. In this context, we are addressing deficiencies in coordination among government agencies involved in compiling statistics. In the area of data provision, we recognize that drastic improvements are needed on the provision of fiscal data and will ensure that Fund staff is provided with aggregated monthly budget execution data with a maximum delay of one month.

Poverty Reduction Strategy Paper (PRSP)

20. Building on the IPRSP and the joint staff assessment (JSA), we are in the process of preparing a full PRSP. The full PRSP will address concerns raised in the JSA and, in particular, it will elaborate on (a) the sources of growth, (b) the reasons why poverty increased in Yemen, and (c) a timetable for the implementation of the various measures. The full PRSP will also benefit from information gathered in the regional workshops that were the basis for the recently completed Five-Year Plan as well as the PRSP workshop. We expect to discuss a draft PRSP with Fund and Bank staff in October 2001.

Program monitoring and review

21. The measures that the Yemeni government intends to implement prior to IMF Executive Board consideration of the fifth and sixth reviews under the extended arrangement and the first and second reviews under the third annual Poverty Reduction and Growth Facility (PRGF) arrangement are summarized in Annex II. All of the end-February, end-May and end-August quantitative performance criteria have been met. The government places great importance on maintaining a liberal exchange and trade system, and will not impose restrictions on payments and transfers for current international transactions, introduce

multiple currency practices, conclude bilateral payments agreements that are inconsistent with Article VIII of the Fund's Articles of Agreement, nor impose or intensify import restrictions for balance of payments reasons.

22. The government of the Republic of Yemen believes that the policies described above are adequate to achieve the objectives of the program. It intends to remain in close consultation with the IMF and provide the IMF with any information requested for monitoring economic developments and implementation of policies under the program. The government stands ready to take any further measures, in consultation with IMF staff, which might be necessary to ensure that the objectives of the program are achieved.


Prior Actions for the First and Second Reviews Under
the Third Annual PRGF Arrangement and Fifth and Sixth Reviews
Under the Extended Arrangement
  1. Reduce diesel subsidies by raising the retail price of diesel as provided for in the budget for 2001.

  2. Complete transfer of all large taxpayers' files (tax on consumption, production, and services; employee withholding tax; and income tax) into LTU and of smaller taxpayer files out of LTU.

  3. Promulgate an amended investment law prepared in consultation with the Foreign Investment Advisory Service, to rationalize tax exemptions and streamline procedures for approving and implementing investments covered by the law.