Republic of Yemen and the IMF

Country's Policy Intentions Documents

See also:
Poverty Reduction Strategy Papers (PRSPs)



Republic of Yemen
Enhanced Structural Adjustment Facility
Medium-Term Economic and Financial Policy Framework Paper 1999-2001

Prepared by the Yemeni Authorities in Collaboration with the Staffs of the International Monetary Fund and the World Bank
March 5, 1999

Use the free Adobe Acrobat Reader to view Table 1 and Table 5.

Contents

  1. Introduction


  2. Policy Reforms and Economic Development in 1998


  3. Medium-Term Macroeconomic Framework and Strategies: 1999-2001


  4. Economic Policies for 1999-2001


    1. Fiscal Policy
    2. Financial Sector Policies
    3. External Sector Policies and the Exchange System
    4. Privatization and Public Enterprise Reform
    5. Other Regulatory Reforms
    6. Sectoral Policies and Environment
    7. Social Safety Net and Poverty Alleviation Arrangements


  5. External Financing Requirements and Debt Sustainability


    1. Balance of Payments and Financing Requirements
    2. External Debt Sustainability


  6. Technical Assistance Requirements and Statistical Issues and Other Program Issues


Tables
Use the free Adobe Acrobat Reader to view Table 1 and Table 5.

  1. Structural Policy Matrix, January 1999-December 2001
  2. Selected Economic Indicators, 1995-2001
  3. Income and Social Indicators, 1995-2001
  4. External Financing Requirements, 1995-2003
  5. Key Indicators of External Indebtedness, 1996-2016
 

I. INTRODUCTION1


  1. Yemen's economic performance during 1990-94 was poor, reflecting exogenous factors as well as domestic political difficulties following the 1990 reunification of the country. Although crude oil production climbed by 70 percent over this period, real non-oil GDP stagnated (the average annual growth rate was about 1 percent). Growing fiscal imbalances fueled inflation and the external debt burden--largely reflecting heavy borrowing from the Soviet Union in the preceding decades--rose to unsustainable levels. With a high population growth rate of about 3 percent, Yemen remained one of the most impoverished countries in the region, with poor social indicators.


  2. With the emergence of a broader domestic political consensus following the 1994 civil war and against a background of rising oil prices, the government initiated a macroeconomic adjustment and structural reform program in 1995 that signaled a sharp break from past policies and set out the broad outlines of the economic policy strategy still in place today. Under this strategy, supported by the International Monetary Fund (IMF) under the 1996 Stand-By Arrangement and the 1997/98 arrangements under the Enhanced Structural Adjustment Facility (ESAF) and Extended Fund Facility (EFF), and by the World Bank with the Economic Recovery Credit, fiscal and monetary discipline were established and the official and parallel exchange rate unified at realistic levels. Recognizing the need to reduce dependence on the oil sector, a program of structural reforms aimed at establishing a market environment attractive for growth and investment in the non-oil sector was introduced.


  3. The fiscal component of the package included containment of government wages, improvements in revenue collection with the introduction of reforms in tax administration, and a sharp reduction in subsidies bills by increasing prices on subsidized goods. Aided by rising oil export receipts, the fiscal cash deficit was reduced from 16 percent of GDP in 1994 to 0.9 percent in 1997. In turn, this fiscal adjustment permitted a prudent monetary policy which freed resources for the private sector. Buoyed by these and other important structural reforms, including interest rate liberalization and tariff reform, the economy began to shift on to a more market-oriented footing. At the same time, to protect the most vulnerable segments of society, reforms of the education and health sectors, and the social safety net were initiated.


  4. Economic performance responded favorably to these policy reforms. Real non-oil economic activity expanded by an average 5.6 percent during 1995-97.2 Inflation decelerated to 6.3 percent in 1997--despite sizable increases in administered prices--and the exchange rate remained broadly stable in a range of YRls 124-135 per U.S. dollar. As oil production continued to expand with new fields coming fully on line, the current account strengthened, despite the weak performance of non-oil exports. Two successive Paris Club agreements in 1996 and 1997 substantially improved Yemen's external prospects by halving the stock of external debt.




II. POLICY REFORMS AND ECONOMIC DEVELOPMENT IN 1998


  1. However, in 1998 unexpected changes in the external and domestic environment have posed tough new challenges. The steep slide in oil prices since 1997 (from an average US$18.5 per barrel of crude oil exported by Yemen in 1997 to an average US$12 per barrel in 1998) has complicated macroeconomic management and contributed to a weakening of domestic and external balances in 1998. At the same time, implementation of the structural reform agenda was delayed in 1998 by difficulties in mobilizing the necessary political consensus. As a result, a number of structural reforms envisaged for the first program year under the ESAF, particularly those requiring parliamentary action, were delayed. In addition, the intensive civil unrest following the June 1998 increases in administered prices pointed to the need to enhance public awareness of the reform program to ensure that further progress on reforms is not delayed.


  2. The drop in oil prices reduced government oil-related receipts in 1998 by 9.6 percentage points of GDP. The government reacted by sharply curtailing budget expenditure, including by raising subsidized prices despite lower world market prices (also for cereals), thereby significantly reducing subsidies, and by cuts in development expenditure. These reductions have been partly offset by the wage increases granted in 1998--aimed at partially reversing the erosion of the purchasing power of civil service wages in preceding years--and unexpected increases in certain other expenditures. As a result, the fiscal deficit in 1998 is projected to reach about 6 percent of GDP.


  3. The targeted reduction of the government's net position vis--vis the banking system has not been achieved, given the need to finance the larger deficit and lower-than-expected external financing. Private credit growth continued at a brisk pace in 1998--although from an extremely low base. Net foreign assets of the banking system declined sharply in 1998--facilitated by the Central Bank of Yemen's (CBY) accommodation of demand for foreign exchange for official transactions and some intervention to smooth unexpected volatility in the exchange rate--reversing the buildup realized in 1997. Altogether, broad money rose by 11.7 percent during 1998. Sociopolitical factors may have also contributed to increased dollarization.


  4. Economic indicators in 1998 reflected the difficult external environment. Real growth in 1998 is estimated to have slowed to about 2.7 percent as technical difficulties delayed expected oil production increases and the sharp decline in national income owing to lower oil prices, depressed public investment, and private demand for non-oil goods and services. Inflation is now expected to reach 11 percent on average for 1998. The external current account and overall balance shifted back into deficits in 1998, mainly due to the lower oil prices, which additionally triggered a contractual reduction in the government's share of overall oil production. Growth in non-oil exports also slowed, partly as markets in neighboring oil-exporting countries weakened. Thus the gain in gross official reserves achieved in 1997 was lost in 1998, although import coverage remained at about 4.2 months. One positive note is the external debt outlook. The commercial debt buyback under the International Development Association (IDA) facility is on track to be completed by mid-1999. In addition, Yemen has requested relief from non-Paris Club creditors on terms comparable to those received under the 1996 and 1997 Paris Club rescheduling agreements. On this basis, Yemen's external debt burden would be reduced to a level that under reasonable assumptions should be sustainable for the foreseeable future.


  5. Despite the delays in key legislative reforms, structural reforms have proceeded in a number of areas. Customs administration reform advanced with the streamlining and computerization of customs clearance operations for Yemen's major seaports and airports. Substantial price increases in mid-1998 for wheat/flour and most petroleum products combined with lower world prices have reduced distortions and incentives for smuggling and rent seeking. At prevailing prices, most domestic prices of petroleum products now exceed world market prices. However, diesel prices are only at about 60 percent of world market prices, encouraging excessive water pumping, proliferation of private electricity generators, and other environmental damage.


  6. Preparation of a major civil service reform, expected to reduce payrolls by at least 20 percent, advanced in 1998 with the completion of a census of all public employees. Preparatory work has progressed on a draft new pension law, clarifying the scope and coverage of public pensions and disability insurance. Small-scale privatization continued in 1998, with the transfer of about 30 enterprises to the private sector through sale, lease, or liquidation. Preparation for the privatization of larger enterprises also continued and a new privatization law was submitted to parliament, providing for transparent procedures and a well-defined institutional framework for future privatizations.



Remaining tasks and risks
  1. For the medium term, the government's overall goal is to build on the substantial progress made on both the macroeconomic stabilization and structural reform fronts during 1995-98 in order to establish a firm foundation for accelerated and sustainable non-oil sector growth. To realize these objectives, a number of fundamental weaknesses which continue to confront the economy need to be addressed.


  2. First, a broad range of structural impediments continue to slow the shift to the higher private sector-led non-oil sector growth that is needed to improve per capita income and employment conditions--particularly given the rapid growth of the population. Therefore a significant broadening and deepening of the structural reform program is essential, providing greater scope for private sector activity within a transparent and well-functioning regulatory, administrative, and judicial framework. Second, there is a critical need to improve social indicators, as human resource development will be essential for sustained rapid growth and poverty reduction. This will require improving the structure of public expenditure and addressing institutional and managerial inefficiencies due to the low quality of the civil service. Third, the structure of the budget remains weak owing to, on the revenue side, a large dependence on volatile crude oil export receipts, a still narrow non-oil revenue base, and tax system inelasticity and inefficiencies. Obstacles on the expenditure side include the drain on budget resources resulting from the untargeted subsidization of wheat and flour, civil service overstaffing, insufficient operations and maintenance (O and M) outlays, and the large and generally inefficient public enterprise sector. Fourth, the financial sector is underdeveloped and contributes little toward mobilizing financial saving and its allocation to productive use. In particular, private banks are excessively focused on short-term lending to major clients, while nonbank financial institutions and markets are largely absent. The soundness of the banking system is vulnerable because of weak enforcement of prudential regulations, high levels of nonperforming loans in certain (mostly state-owned) banks, and a weak judiciary system. Fifth, owing to the narrow non-oil export base, the balance of payments remains dependent on crude oil exports receipts and remittances, and thus highly vulnerable to oil price volatility. To a lesser extent the volatility of international cereal prices also poses risks to the external accounts. Sixth, the country needs to address the difficult environmental problems of water scarcity and deforestation in order to be able to sustain economic growth and absorb its growing population.




III. MEDIUM-TERM MACROECONOMIC FRAMEWORK
AND STRATEGIES: 1999-2001


  1. To address the problems noted above, during 1999-2001 the government will continue its macroeconomic adjustment efforts as well as broaden and deepen structural reforms in order to provide an environment conducive to an acceleration of growth led by private sector activity and investment and characterized by a free and open economy, domestic financial stability, and external viability. A parallel objective will be to ensure a significant improvement in social indicators. The government's structural reform program is summarized in Table 1.


  2. For the 1999-2001 period, the government's macroeconomic targets are non-oil sector real annual growth of 4.9 percent on average, an average annual inflation rate of 7.4 percent, and a deficit on the external current account of about 2.5 percent on average to ensure balance of payments viability along with rising international reserves in order to maintain an average level of 4.9 months of import cover (Table 2). In 1999, crude oil production will increase as new fields come fully on line. For the remainder of the period, however, crude oil production is expected to taper off gradually from 1999 levels as declining production from older fields would be offset only partly from new oil fields coming on line. There are, however, possibilities for increased petroleum output and the development of natural gas resources.3 The acceleration of non-oil export and production growth will depend critically on the performance of private agricultural, manufacturing, construction, and service activities. To expand the delivery of social services and enhance social indicators, budget expenditures relative to GDP for 1999-2001 are to be increased to average 8.2 percent for education, 1.6 percent for health, and 1.2 percent for social safety net programs. In addition, reform programs will be implemented in the education and health sectors to ensure better management of scarce public resources.


  3. Realization of the government's growth targets will require that total investment relative to GDP be sustained at 24.7 percent on average--a ratio above the levels of recent years. Given the outlook for external capital inflows, realizing the targeted total investment ratio will depend on maintaining an average national savings ratio of about 22 percent of GDP. Both the public and private sectors will need to contribute to this savings effort. To expand public savings, the government intends to pursue a fiscal policy targeting a sustained increase in non-oil revenues and a sustained reduction in nonessential current spending. With this fiscal stance, public sector savings would reach 5.7 percent by 2001.


  4. To achieve a targeted increase in private savings to 18 percent of GDP by 2001, the government intends to continue its efforts in freeing up the economy, increasing private sector confidence, and improving financial sector intermediation. Reliance on foreign savings is anticipated to average about 2.3 percent of GDP over 1999-2001. At this level, the external current account deficit and debt service would be sustainable if the required external financing were available on concessional terms. This strategy would allow broadly stabilizing real per capita private consumption in order to maintain support among the population for the adjustment and reform program.



IV. ECONOMIC POLICIES FOR 1999-2001

A. Fiscal Policy
  1. Fiscal policy will be key for achieving the above savings and investment goals, as well as for preserving financial stability, freeing up resources for the private sector, and allowing for a fiscal-monetary policy mix conducive to the deepening of financial intermediation. The government will target an average fiscal deficit of 3 percent of GDP over 1999-2001, financed from concessional foreign resources and to a limited extent from domestic nonbank sources. Recourse to central bank borrowing will be avoided. Realizing this fiscal strategy will require increasing non-oil revenues relative to GDP and curtailing current expenditures. Furthermore, should oil prices persist below the levels assumed in the medium-term projections, additional fiscal measures will be taken as needed to achieve the program targets, with the focus on further cuts in expenditure.


Revenue mobilization and tax reform

  1. The decline of oil revenue experienced in 1998 underscores the urgency of increasing non-oil revenue through further tax system and tax administration reforms aimed at broadening the tax base and improving tax elasticity. In the area of income taxation, building on steps taken in January 1999, the government will therefore vigorously implement further reforms by mid-1999 which will harmonize personal and corporate tax rates, rationalize exemptions and deductions, and strengthen tax compliance. Its performance will be kept under review and further reforms will be implemented in 1999-2001 as needed.


  2. In the indirect tax area, following the harmonization of excise rates on domestic and imported goods, further reforms of the production, consumption, and services tax will become effective in early 1999, as a step toward introduction of a general sales tax (GST) with limited exemptions, a basic rate of 10 percent, and an input tax credit mechanism including zero rating for exports. The GST will be effective with the 2000 budget.


  3. To facilitate the tax and customs administration reform, the taxpayer identification number system (TIN) will be extended beyond the current range of major taxpayers to medium- and smaller-sized contributors and will be enforced through penalties for non-observance. In addition, the need for computerization to enhance the effectiveness of the TIN's use will be reviewed.


  4. Since October 1998, a cigarette bandroll has been applied to imported cigarettes to facilitate combating smuggling, and ink-stamped packages and counters have been installed in domestic factories to prevent tax evasion. In early 1999, the Customs Department will begin seizure of smuggled cigarettes. Remaining customs surcharges have been canceled so that the Customs Department only collects revenues from tariffs and the excise tax. The extension of tax and import duty exemptions provided under the Investment Law beyond an initial five years will be terminated during 1999, and the government will continue to avoid granting exemptions outside the Investment or Tax Laws to specific entities (excluding legal charity and diplomatic arrangements).


  5. Implementation of a comprehensive customs administration reform began in mid-1997 in order to establish simplified and efficient clearance and duty collection procedures as well as duty drawback and temporary admissions procedures. Following the introduction of the Harmonized System of Nomenclature (HS) in 1997, computerization of customs clearance operations is underway utilizing the ASYCUDA system. The modernization of customs operations at Sana'a airport and the Hodeida seaport achieved during 1998 will be gradually phased in at all other customs offices. In addition, an amended customs law has been prepared and will be submitted to parliament for approval by June 1999. This law would underpin the modernization of customs procedures and bring Yemen's regulations closer in line with international standards. The existing tariff structure will be reviewed for efficiency and further reforms planned and taken as needed. Finally, the Government of Yemen will begin the application process to the World Trade Organization (WTO) in 1999.


  6. In the energy sector, beginning with the 1999 budget, transactions, accounting and payments between the energy sector public enterprises and the Ministry of Finance for crude oil and petroleum products will be based on world prices. The share of revenue from domestic petroleum sales that accrues to the Yemen Petroleum Company (YPC) will be based on actual incurred costs, with the balance transferred to the budget with short delays. Arrears accumulated by energy sector public enterprises will be eliminated in 1999 through a five-part program: (i) implementing the timetable for reduction of cross arrears outstanding as of 1997 between the Public Electricity Company (PEC), YPC, and the government; (ii) continuing the policy that PEC and YPC cease deliveries to all customers in arrears for more than 90 days, and that no electricity will be delivered free of charge to staff and other ministries; and (iii) establishing specific budgetary allocation rules for utility use.


Expenditure reforms

  1. The government's expenditure reform program for the next three years will focus on reductions in nonessential current spending and a further reorientation of outlays toward priority areas. Remaining subsidies will be phased out, the government wage bill rationalized, and nonproductive expenditures contained relative to GDP. To address environmental issues (see para. 49), remove incentives for rent-seeking activity such as smuggling, and to shift incentives from production of crops such as qat to wheat, the government will move diesel prices toward world market prices by 2001 and agree by June 1999 on a mechanism to regularly adjust administered petroleum prices in line with world market prices and the exchange rate, to preserve positive differentials. In the context of this agreement, the distributor's share in oil revenue will be reviewed. In addition, in January 1999 the government eliminated the wheat subsidy by liberalizing the trading and pricing of wheat--well ahead of the initial target date--and plans to halve the flour subsidy through an increase in price early in 1999. The flour subsidy will be abolished in full by the start of 2001. At the same time, the number of poor reached under the cash transfer program operating under the Social Welfare Fund (SWF) will be increased in 1999 by 150,000 to about 350,000. Such a substantial expansion of cash transfer programs will require rapid strengthening of the SWF's capacity to manage the associated expansion in its payments system. Administrative reforms based on recommendations by the World Bank will be introduced, with technical assistance to be sought from other donors.



  2. A comprehensive civil service reform will be implemented (see para. 28-30 below) and is expected to facilitate reducing the aggregate civil service wage bill to 9.4 percent of GDP by 2001 while allowing for a substantial increase in real wages and a strengthening of public education and the health service. Certain nonproductive expenditures, such as aggregate current transfers to public enterprises and entities, will be sharply reduced. A list of those noneconomic and public utility enterprises which may continue to receive current or capital transfers has been established for 1999, and the number of enterprises on the list will be reduced annually. Current expenditure will be reoriented toward the priority areas of education, health, operations and maintenance (O and M) for infrastructure and the social sectors, vocational training programs, and the social safety net, including the Social Welfare Fund and the IDA public works, and Social Fund for Development projects.


  3. The relatively high levels of development expenditure in past years have had little measurable impact on economic growth, reflecting weaknesses in selecting the most productive projects and in monitoring implementation. Therefore, to ensure the quality of public investment, a strengthening of the government's capacity to select projects with the highest economic return and to monitor implementation will be pursued in consultation with the World Bank. In the meantime, development expenditure will be limited mainly to ongoing projects. In the context of the ongoing budget management reform, which is expected to be fully effective with the 2000 budget, a new budget classification system, consistent with GFS guidelines, will be operational for use in the 2000 budget. Major new public investment projects will be evaluated in terms of economic efficiency from 2000 onwards.


  4. Nonetheless, as the country has pressing physical infrastructure needs, development outlays will be maintained at a high level, with priority given to basic education and health, power, water and wastewater, transport (roads, ports, and airports), and agricultural extension and research. Public investment in the power and water sectors will be supplemented by the opening of these sectors to private investment.


Civil service reform

  1. The civil service has continued to expand at an unsustainable pace since the early 1990s owing to the merger of public administrations at national unification, the absorption of large numbers of staff from public enterprises, and the use of government service as an employer of last resort. While the total wage bill rose steadily, rapid employment expansion led, at the same time, to substantial real wage declines and an even sharper real wage compression in the higher civil service ranks. The result was a notable deterioration in the quality of public services. The government is aware that there cannot be a durable fiscal consolidation or improvement in the quality of public administration without civil service reform. Accordingly, the government has initiated a fundamental reform including job classification on the basis of a new national grade structure, determination of all job positions to be filled in each grade for each ministry or agency on the basis of functional needs, elimination of absentee employees, multiple job holders, and overdue retirees from the payroll; the matching of workers to retained job positions, the removal of redundant staff with transitional financial arrangements, and implementation of a new salary structure to increase real wages and correct compression. Significant technical and financial assistance will be required.


  2. With the completion of the civil service census in August 1998, the reform is about to be launched. The government anticipates that it will achieve a 20 percent reduction in staff over 1999-2003. Further quality improvements would be pursued over the longer term by establishing job position requirements for new recruits and modern personnel management policies. The Civil Service Fund (CSF) Law establishing a fund for transitional income support and retirement packages for redundant public sector employees was promulgated in January 1999. Under the pilot program in 1999, at least four ministries will prepare and implement reorganization plans and identify redundant staff for transfer to the CSF. Under subsequent stages of the reform process, other ministries will follow in 2000-01.


  3. The government has prepared a reform of the General Authority for Pension and Social Security (GAPSS) to enhance its financial viability and facilitate civil service reform and privatization. The reform program will first complete a record of participants, based on the civil service census, including personal history and financial records regarding contributors and beneficiaries. Representatives of employers and trade unions will be added to the GAPSS' investment board. Finally, a high level steering committee, including representatives of government ministries, employers, and trade unions, will prepare a new Pension Law governing the GAPSS, with technical assistance from the Fund and the World Bank, that addresses, inter alia, legal autonomy, actuarial and financial analysis, further reforms of the contribution base, and the need to rationalize survivor benefits.


B. Financial Sector Policies
  1. The government is committed to strengthening Yemen's financial system as an essential requirement for higher economic growth. The banking system suffers from a large volume of nonperforming loans, inadequate loan provisioning, low bank capitalization, and weak enforcement of prudential standards. Lending to the private sector is held back by continued weakness in effective and timely judicial recourse for loan recovery. Interbank market activities are limited, and there are no institutional arrangements for stock and bond markets. Accordingly, the reform program over 1999-2001 will include specific steps aimed at advancing reintermediation in a competitive market environment and in particular to unblock the loan recovery process.


  2. Indirect monetary control based on open-market operations will be underpinned by further development of CBY's database for estimating and forecasting weekly movements in banks' reserves and the CBY balance sheet. The treasury bill market will be deepened through the introduction of bearer bills, the encouragement of an active interbank market, the conversion of government debt at the CBY into negotiable treasury bills, and the use of repurchase operations. Following a period of satisfactory use of indirect tools of monetary control, the CBY would eliminate the minimum benchmark deposit rate and move to full free-market determination of interest rates.


  3. To overcome banks' reluctance to provide credit to the private sector, a steering committee, including representatives from the private sector, will prepare an action plan by March 1999 on steps to make the special courts for loan contract enforcement effective in the resolution of nonperforming loans. Measures such as requiring that all court decisions be made in writing and published promptly, strengthening enforcement through introduction of a bailiff system, establishment of a quantitative system for monthly monitoring of court operations, and reducing the fee for filing a case in court will be considered. The delinquent borrower notification system implemented in 1997 will be continued. In addition, a medium-term program for developing the legal framework needed for leasing operations at commercial banks will begin in 1999.


  4. The government is committed to withdraw the public sector from the financial system. After absorbing the nonperforming loans of public enterprises at commercial banks in 1997, essentially held by the public Yemen Bank for Reconstruction and Development (YBRD) and the National Bank of Yemen (NBY), the emphasis will now be on completing privatization of these public commercial banks by 2000. As the three specialized banks (Housing, Industry, and Agriculture) also presently confront solvency problems, action plans to restructure, privatize, merge or liquidate the three banks will be completed by end-1999.


  5. A reform program for strengthening the prudential supervision of commercial and specialized banks started in 1997, supported by an IDA Financial Sector Adjustment Credit (FSAC). The program includes recent passage of a new banking law to update, strengthen and/or liberalize, as appropriate, rules regarding licensing, credit concentrations, insider lending, director probity and accountability, remedies and penalties for unsound banking practices, seizure and liquidation, and financial leasing. The law also allows for the establishment of central bank capacity for annual comprehensive on-site inspections of all banks, and implementation of required schedules for provisioning and capital increases to meet an 8 percent Basle capital adequacy ratio. In addition, the pending amendment of the income tax law will permit deductibility for provisioning. Also under the FSAC and with technical assistance from the Fund, measures will be introduced during 1999 to enhance off-site inspection and on-site monitoring, design and implement a rating and early warning system, and enforce penalties and corrective measures. Stricter regulations pertaining to credit risk management, loan classification and provisioning, foreign exchange positions, and external auditors have already been issued.


  6. A new Central Bank Law will soon be approved by the cabinet with the goal to become effective by end-1999. It will give the central bank greater independence and focus its mandate on price stability through changes in the composition of the Board of Directors, allow it to issue its own securities, if needed, for open market operations, limit public sector financing to emergency loans, grant it freedom to define and adopt its own monetary and exchange rate policy, and require greater accountability.


  7. The government recognizes that the development of stock and bond markets would greatly assist the private sector-led growth strategy. To this end, the government intends to adopt in 1999 an action plan for the medium term to establish a capital market, with International Finance Corporation (IFC) assistance.


C. External Sector Policies and the Exchange System
  1. The government is committed to maintaining the freely floating exchange rate arrangement, with intervention limited to smoothing short-term fluctuations in the rate. External performance will be monitored through key indicators such as non-oil export growth, the real effective exchange rate, and the level of foreign exchange reserves, and the targets in these areas would be achieved primarily through reliance on financial policies. Export promotion will rely essentially on policies directed at freeing up and improving the overall functioning of the economy and at eliminating obstacles to exports and investment. The government will continue to improve resource allocation by limiting protection while taking steps to reduce smuggling. In the coming years, the emphasis will be on improving customs administration costs and rationalizing customs valuation procedures. To promote an efficient and competitive agricultural sector, the wheat subsidy reform and the continued phasing out of remaining import bans (on fresh fruits, vegetables, and coffee) will be crucial. Import bans of approximately equal economic importance will be eliminated with the 1999-2000 budgets, and replaced by tariffs. By the start of 2000, the government will publish a negative list of all remaining import bans, to ensure transparency of the trade regime. The recent trade system reforms and adoption of revised customs rules will bring Yemen's trade regime broadly in line with WTO rules and the government intends to initiate the process for accession to the WTO.


D. Privatization and Public Enterprise Reform
  1. To reduce inefficiencies and broaden the scope for private sector-led growth, the government will accelerate and deepen the privatization process. During 1995-98, about 40 small- and medium-sized enterprises were privatized by restitution to their owners, transfer to the enterprises' labor, lease or sale. This process allowed the authorities to gain valuable experience and has led to the formulation of a more comprehensive privatization program over 1999-2001 involving annual programs broadly oriented on the agricultural, industrial, tourism, trade, and transport sectors (Table I). The program's focus in 1999 will continue to be on small enterprises where preparations and privatization should move forward quickly. To ensure transparency and provide a clear institutional framework, a draft privatization law has been submitted to parliament in 1998, providing for transparent rules and procedures regarding tendering, sales, conditions, liquidation, use of financial proceeds, the treatment of redundant labor, and buyout policies. The law is expected to become effective in early 1999. The privatization of larger enterprises will be targeted for 2000 as more in-depth preparations will be needed, to be managed by the overhauled Technical Privatization Office (TPO), with World Bank support. The enterprises to be privatized account for about 70 percent of total public enterprise employees. In addition to these annual programs, the government intends to fully open the wheat trade to the private sector in 1999 and to encourage private investment in the electricity and water sectors.


  2. Major obstacles to rapid privatization are the potential for conflicting property claims and labor redundancy. To address the first issue, an interministerial committee will review the procedures under existing laws for titles and registration of properties (including land) to be privatized and propose interim procedures for proving clear title and registration, pending completion of the broader review of the Land Law under the judicial reform program (see below). Second, the CSF will be allowed to also accept redundant public enterprise workers while relocation/buyout/pension arrangements are being worked out.


  3. For enterprises not expected to be privatized over 1999-2001, the government intends to improve their financial performance through downsizing and developing the greater pricing, managerial, and hiring autonomy granted in 1997. The government has agreed on a list of core public enterprises and entities which will continue to receive current or capital transfers, to be reviewed and shortened annually. Performance of all enterprises that are financially important, receive budget transfers, or are identified as retained enterprises are being closely monitored on the basis of quarterly balance sheets and operating statements of accounts that are being submitted to the Ministry of Finance. These financial submissions will remain a condition for continuing to receive current or regular capital transfers from the budget.


E. Other Regulatory Reforms
  1. To address an important deterrent to private investment (domestic or foreign) in Yemen, the government gives immediate priority to introducing the legal, judiciary, and regulatory framework necessary to establish a free market environment for private sector activity and investment. In early 1999, amendments to the Trade and the Agencies Laws were made effective which eliminate provisions providing for price and trade monopoly enforcement by the government. In light of the performance of private investment during 1999, further reform of the Investment Law will be undertaken in line with FIAS recommendations. The government will also embark on a medium-term overhaul of the judiciary system which in the past two decades has become increasingly immobilized by pervasive rent-seeking activity. A program of judicial training will begin by mid-1999, with refresher courses for the judiciary in commercial and business law, including modernized curricula and arbitration. A thorough diagnosis and reform action plan of the legal framework for land law, and other business, economic and financial activity will be prepared by June 1999 and resulting reform plans will be implemented over 1999-2001. An awareness program of the need for judicial reform will be launched in mid-1999.


  2. The government recognizes that investment in Yemen is further discouraged by the current complex and opaque regulatory structure. Therefore, a steering committee will be created by end-1998, involving both the public and private sector, to review the regulatory structure, administrative procedures for domestic and foreign trade and investment, remaining trade monopolies and to agree on the reforms necessary to improve the market incentives for investment. The reform proposals resulting from this review will be submitted to the cabinet by June 1999. Finally, an action plan to develop the Aden Free Zone as a test case for a modern legal, regulatory, and judicial framework for investment will be prepared by late 1999.


  3. Transportation costs in Yemen are much higher than in neighboring countries, adding to the impediments to private investment. To improve the sector's efficiency, the government will break up by mid-1999 the domestic trucking cartel (ferzah), which has kept transport costs high through price fixing and by preventing free entry. Measures to be taken will include public posting in prominent areas (visible at road checkpoints and port gates) of an official statement of the illegality of the trucking monopoly and of new penal terms for infractors. In cooperation with the World Bank, reforms of the two port authorities will be pursued to remove inefficiencies and reduce shipping costs.


F. Sectoral Policies and Environment
  1. With greater reliance on private sector initiative and competitive market forces the government's development role will be largely limited to establishing a macroeconomic and regulatory environment conducive to promoting efficient private sector decisions. Sectoral planning will essentially be limited to the social sectors (education and health) and infrastructure (power, water, and transport). In agriculture, the focus would be on enhancing extension and research services. In these areas, the government will elaborate sectoral reform programs and development plans for 1999-2001 in close collaboration with the World Bank, in particular on defining the size and composition of the annual public investment programs and on related current outlays--including for operations and maintenance--for 1999-2001 that would be included in the budget.


  2. As noted earlier, the country's education and health indicators lag behind those of many other developing countries, and improvements in these indicators are necessary to maintain support in the country for sustained implementation of the reform program by passing the economic benefits of reform to the general population. Therefore, in the education sector, the overall goals would be to increase primary and secondary enrollment--particularly the enrollment of students in rural areas and female students--as well as the quality of education and to strengthen vocational and technical education. To achieve these goals, the principles that would guide government outlays would be: establishment of national per pupil current and capital expenditure allocations; allocation of current and capital expenditures among governates on the basis of enrollment; provision of additional per pupil allocations by governates to the extent that male and female enrollments, particularly in rural areas, are below the national averages; and implementation of school mapping to improve the quality of school construction programs. These objectives will be achieved within roughly the current levels of spending in education (around 8 percent of GDP) mainly through greater efficiency, and in particular by limiting government involvement in higher education and reducing administration overhead. The hiring of teachers will be limited essentially to replacing costly expatriate teachers or addressing specific shortages (female teachers); real salary increases for teachers (and health workers, see below) will be linked to qualification, performance, and willingness to redeploy to rural areas.


  3. For the health sector, the overall goal would be to significantly increase the access of the population--particularly rural and low-income groups--to health care facilities below the tertiary level and to preventive and promotive care programs. The quality of delivered care would also need to be enhanced. The principles that would guide the higher spending levels would be: the upgrading of existing medical facilities; increased staffing with qualified personnel; adequate training for health personnel particularly at the primary level; increased funding for materials and supplies; and higher medical personnel salaries. To support this effort, trade in pharmaceuticals will be delegated to the private sector by eliminating the government procurement monopoly effective by the year 2000.


  4. The major policy components of reform in the power and water sectors have been agreed with the World Bank. For the power sector, the reform program will entail: implementation of a formula for automatic adjustments in tariff rates to ensure full pass through of petroleum product price adjustments and achieve full total cost recovery; enactment by parliament of a legal framework for the power sector including the respective roles of the public and private sectors; restructuring and computerization; establishment of regional power utilities and tariff structures; and the clearance of cross arrears among the energy sector public enterprises and the government. For the water (including wastewater) sector, the 1999-2001 reform program will encompass: implementation of formulas for automatic adjustments in tariff rates to ensure full pass through of electricity and petroleum product prices and full cost recovery; specification of a national water policy and enactment by parliament of a national water law; establishment of regional water authorities with private sector participation and independence to set regional tariff structures; and the restructuring of the National Water and Sanitation Authority (NWSA).


  5. Important environmental issues relating to water and energy need to be addressed urgently. First, ground water is being depleted at an unsustainable rate, partly as a result of price distortions. To alleviate these distortions, the government will: increase the price of diesel fuel to world price levels as part of the elimination of petroleum product subsidies; require public sector entities to cease providing concessional credit and pricing for agricultural water pumps; and discourage concessional donor financing for such pumps. Second, as a result of low-income levels, large segments of the population continue to depend on freely available firewood, generating serious deforestation problems. To contain the problem, the government intends to continue the subsidization of liquefied propane gas.


G. Social Safety Net and Poverty Alleviation Arrangements
  1. In 1996, the government launched a major overhaul of its Social Safety Net (SSN) and poverty alleviation programs, with technical and financial support from IDA and other donors. The Social Welfare Fund (SWF), which provides direct income support for very low income families, was strengthened. A public works program was created entailing execution by local governments of labor-intensive small infrastructure and social services projects to generate employment for unskilled workers as well as a multi-year project for vocational training. A Social Fund for Development project was initiated to support the delivery by nongovernment organizations (NGOs) of technical assistance, training, and access to credit for small-scale labor-intensive public works, provision of community services, and development of micro and small enterprises. In order to strengthen NGO sector operations, the government is in the process of eliminating regulations that hinder the development and funding of private welfare initiatives; establishing transparent criteria for NGO operations; and delegating to NGOs involvement with local councils in advancing community development projects.


  2. The management of all government cash support programs has been consolidated under the High Social Council and a database is being developed for better targeting, while expanding the availability of budget resources and seeking donor contributions. With these improvements, the government will significantly increase over 1999-2001 the budget resources provided to the SWF in order for it to expand its regular cash support operations. The government will also increase the SSN resources available to local authorities, and will delegate collection of certain taxes to the local authorities in the coming years.


V. EXTERNAL FINANCING REQUIREMENTS AND DEBT SUSTAINABILITY

A. Balance of Payments and Financing Requirements
  1. Implementation of the reform program described above will contribute significantly to strengthening the balance of payments. The current account deficit is expected to average about 2.3 percent of GDP during 1999-2001, under the key assumptions of crude oil export receipts remaining at an average of US$1.45 billion per annum and commodity prices moving in line with the levels envisioned in the WEO. Exports of non-oil goods are projected to rise by about 10 percent (in U.S. dollar terms) on average annually in response to the government's reform policies. The growth of non-oil sector nonfood imports is expected to rise broadly in line with the targeted non-oil sector growth rate. The growth of food imports would be less as the wheat/flour marketing liberalizations should reduce incentives for smuggling and rent-seeking. The net services and net private transfers positions are envisaged to remain unchanged in real terms.


  2. The financial account is projected to move into surplus in 1999. Annual average inflows from loan disbursements are forecast at about US$215 million during the period. Non-oil net private capital inflows are forecast to rise briskly in line with expanding private sector activity and investment. Official own gross foreign reserves are targeted to maintain import cover at about 5 months.


  3. The multi-year debt relief provided under the 1997 Paris Club rescheduling, including the up-front discount on debt owed to the Russian Federation, has substantially improved Yemen's external outlook. Assuming comparable relief from non-Paris Club creditors--which is under negotiation--the gross remaining financing requirements for 1999-2001 are projected to average about US$0.7 billion annually. Regular disbursements of official grants and project loans from bilateral and multilateral sources are expected to contribute on average about US$285 million annually over 1999-2001. Presently identified balance of payments support from IDA is projected to total US$130 million. Total disbursements under the ongoing Fund arrangements would provide net external financing of US$153 million.


B. External Debt Sustainability
  1. Yemen's external debt situation appears sustainable under these assumptions, and the need for exceptional financing would be virtually eliminated by 2001. The external current account deficit (on a commitments basis) would have stabilized at 2.3 percent of GDP, balance of payments sustainability would have been achieved, and Yemen's debt indicators would improve significantly over the long run. In particular, the debt service/ratio (on a commitments basis over exports of goods and nonfactor services) would decline from 33 percent in 1996 before rescheduling to 12.5 percent in 2000.


  2. This assessment is nonetheless subject to certain downside risks. For example, prospects would weaken significantly if: the magnitude and concessionality of new donor financing were substantially less than anticipated; oil and non-oil export growth were not as strong as anticipated; there were a prolonged weakness of world oil prices or substantial increases in world grain prices; or inflows of private capital were sharply lower than assumed. Given vulnerability to such factors, the balance of payments position will remain fragile, and therefore the government intends to continue avoiding nonconcessional borrowing, maintain sound macroeconomic policies, and pursue the timely implementation of structural reforms.


  3. On the positive side, the exploitation of proven natural gas resources could boost exports (at least after 2000) beyond the levels assumed for and additional oil reserves may also be developed during 1999-2001. However, the substantial private investment needed to develop these resources will only materialize once firm long-term contracts with potential buyers can be concluded.


VI. TECHNICAL ASSISTANCE REQUIREMENTS AND STATISTICAL ISSUES
AND OTHER PROGRAM ISSUES
  1. The government believes that Yemen will continue to require sizable technical assistance to implement the structural reform program envisaged for the proposed arrangements. Presently technical assistance is being provided under the UNDP/IMF program initiated in November 1995 and by other IMF programs as well as bilateral programs. As a result of these programs, there have been significant gains in improving the government's reform policy implementation capacity, and the government will request a renewal and broadening of the UNDP/IMF program beyond 1999, focusing on banking supervision, external debt management, statistics, budget management, pension reform, and tax reform. UNCTAD is providing assistance with customs and external debt data computerization in coordination with the UNDP/IMF program. The World Bank is expected to provide technical assistance in the areas of financial sector and civil service reform, privatization, rationalization of public sector investment, and sectoral reforms.


  2. Considerable further progress in improving the statistical data base is required to obtain accurate and timely data as a solid basis for economic policy decision making and to better inform the broader public. Significant shortcomings continue to affect national accounts and price statistics and improvements, including the allocation of required technical and human resources, will be implemented in line with the recommendations of Fund technical assistance. Severe shortcomings affecting balance of payments data, and labor and employment statistics are being addressed with technical assistance provided under, respectively, the UNDP/IMF and bilateral programs. Under the current budget management reform, it is expected that detailed and reliable fiscal data will become available on a monthly basis.


  3. The government expects that public understanding and acceptance of its reform program will strengthen as the reforms address long-standing governance issues. These include, for example, greater fiscal transparency through tax and budget management reform, removing opportunities for rent-seeking behavior through the liberalization of the wheat trade, reform of the petroleum distribution system, the break up of domestic (transportation) cartels, and the adoption of streamlined and more transparent regulations in many areas. To enhance public awareness, a campaign about the importance of the reform program for the Yemeni economy will commence in early 1999. In addition, based on the recent successful campaign to explain the civil service reform, broad involvement of different sectors of the public in reform plans for the pension fund, the regulatory/legal framework and the special courts for loan contract enforcement will be ensured.


1. This paper updates the previous MEFP and in particular reports on performance in 1998 and extends the policy framework to 2001.

2. These growth rates partly reflect a rebound from damages due to the unification and civil war in 1990-94. In addition, the statistical apparatus remains weak and economic/financial statistics should be taken as only indicative of broad trends.

3. In early 1997, agreements were signed with foreign private companies for investments totaling US$3 billion over four years to produce natural gas for domestic distribution and LNG for export. Since implementation of these investments is still tentative, their effects have not been incorporated in the present medium-term framework.

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