Public Information Notice No. 99/34

Public Information Notice: IMF Concludes Article IV Consultation with Yemen

April 15, 1999

On March 23, 1999, the Executive Board concluded the Article IV consultation with Yemen¹.

Background

In the mid-1990s, Yemen introduced a comprehensive macroeconomic adjustment and structural reform program. By late 1997, a considerable degree of macroeconomic adjustment supported by the Fund programs had been achieved. However, in 1998 the collapse of world oil prices reduced Yemen’s oil export receipts by the equivalent of almost 10 percentage points of GDP compared with 1997. Regional political and security uncertainties also adversely affected economic prospects. The adverse impact was felt across all sectors of the Yemeni economy, complicating economic policymaking and slowing the momentum for structural reform.

Growth in 1998 is estimated to have slowed to less than 3 percent as technical difficulties delayed expected oil production increases, while the sharp decline in national income dampened public and private demand. The inflation rate rose to 11 percent on average for 1998, driven by official price increases, the impact of floods on certain agricultural commodities, and the pass-through of the depreciation of the rial. The external accounts shifted back into deficits with the sharp drop in oil exports and slower growth in non-oil exports due to weak markets in neighboring oil-exporting countries. Nonetheless, gross official reserves still provided import cover for about 4.2 months at end-1998 and the external debt outlook improved following the 1997 Paris Club rescheduling.

The government sought to address the challenges posed by such a difficult environment while preserving the thrust of its longer-term economic strategy. It moved quickly to significantly curtail expenditure in various areas and reduce subsidies through large increases (in a range of 15 percent to 40 percent) in administered energy, wheat and flour prices at midyear. However, these expenditure reductions have been partly offset by wage increases granted earlier in 1998 and other spending increases. Overall, the fiscal deficit in 1998 widened to an estimated 6 percent of GDP, and the planned reduction of the government’s net debt to the banking system was not achieved.

The growth of credit to the private sector continued at a brisk pace, although from a very low base. Following a period of nervousness in the foreign exchange market, in October 1998 monetary policy was tightened, including through a cumulative 5 percentage point increase in interest rates and a tightening of reserve requirements on foreign exchange deposits. However, net foreign assets of the banking system declined while net domestic assets increased sharply, and for the year as a whole broad money growth is now estimated at 11.7 percent. In the external accounts, the oil price shock was reflected in a deterioration in the current account to a deficit estimated at 5.2 percent of GDP, financed largely by a drawdown in gross official foreign reserves.

Structural reforms moved ahead in a number of areas. Parliament canceled remaining import surcharges, import bans were further reduced, and the modernization of customs clearance operations for Yemen’s major sea and airports has been largely generalized to all customs offices. In January 1999, important tax reforms were promulgated, along with legislation designed to enhance competition. The substantial price increases in mid-1998 for wheat/flour and petroleum products (except diesel) and the subsequent full liberalization of wheat trade in early 1999, combined with lower world prices, reduced distortions and incentives for smuggling and monopolizing. Preparation of a major civil service reform, which is expected to reduce payrolls by at least 20 percent over five years, advanced with the completion of a census of all public employees and promulgation of a law establishing a fund for transitional income support and retirement/buyout packages for redundant public enterprise and civil service staff. In other areas, small-scale privatization continued in 1998 with the transfer of about 30 enterprises to the private sector through sale, lease, or liquidation. In preparation for the privatization of larger enterprises, a new privatization law, which would establish transparent procedures and a well-defined institutional framework for future privatizations, was submitted to parliament. Finally, parliament passed a new banking law that will strengthen the basis for prudential supervision. In this context, the central bank reached agreements with private commercial banks to achieve full compliance with capital adequacy rules by end-1999.

The government’s 1999 policy mix envisions further fiscal adjustment which, together with the expected rise in private savings, would allow for a reduction in the current account deficit byabout 2.5 percent of GDP. Monetary policy will aim at an average inflation rate of 9 percent and provide a tight anchor within a system of a freely floating exchange rate. Structural reform for 1999 will focus on further tax reform; implementation of the first phase of civil service reform complemented by an overhaul of the pension system; restructuring of public financial institutions; and other reforms of the regulatory framework with a view to attract higher domestic and foreign investments.

Executive Board Assessment

Directors noted that, following the impressive implementation of a market-oriented economic program in 1996–97, a confluence of domestic pressures and external shocks had taken the wind out of the reform momentum in 1998. Nevertheless, they commended the authorities for maintaining broad macroeconomic stability in 1998 in the face of the sharp fall in oil revenue. At the same time, the weaker than programmed performance in terms of growth and inflation underscored the vulnerability of Yemen’s economy to developments in world oil markets. Directors were also encouraged that the authorities had moved ahead with important structural reforms, in spite of a difficult political environment, but noted the limited progress to date in some areas, especially tax reform. Moreover, they noted that intervention to limit exchange rate movements had resulted in a higher than programmed use of official reserves, weakening adjustment of the external accounts through expenditure switching.

Against this background, Directors supported the authorities’ objectives to preserve the gains in stabilization achieved in the past three years, adjust to lower world oil prices, and continue the process of transforming the economy into a competitive market-based system. Directors considered that the authorities’ updated medium-term program represented an appropriate framework for achieving these objectives. They encouraged the authorities to ensure timely implementation of the envisaged program.

In considering the outlook for 1999, Directors broadly endorsed the planned macroeconomic policy mix, and stressed the need for the authorities to remain vigilant, in view of the uncertain outlook for oil prices. Directors agreed with the continued emphasis on front-loaded fiscal adjustment. They welcomed the planned reductions in subsidies and defense outlays as a share of GDP, as well as the budgeted increase in education outlays. However, Directors expressed concern regarding the planned sharp increases in the civil service wage bill, while noting the reasons for granting the wage increase in the present circumstances. Some Directors also expressed concern about the decision to defer increases in diesel prices. Looking forward, Directors welcomed the steps being taken to prepare for the introduction of a general sales tax in the next budget, and for an agreement on the mechanism for the automatic adjustment of domestic oil prices.

Given the weaknesses in the banking system and the openness of the current and capital accounts, monetary policy needed to remain cautious in order to raise confidence in thedomestic currency, and to ensure that inflation was brought back to a downward path. Directors recommended allowing market-determined exchange rate movements to support external adjustment, and limiting intervention to deal with genuine market volatility. Directors stressed the importance of measures to strengthen further the soundness of the banking system. In particular, they encouraged the authorities to strictly enforce prudential regulations, including on open foreign exchange positions, pursue the restructuring of weaker banks, and expand the flexibility of monetary management through increased reliance on indirect control and the use of the treasury bill market.

Directors expressed strong support for the government’s structural reform agenda as key to promoting economic diversification and raising productivity in the non-oil sector. They urged the authorities to adhere to the new implementation schedules for direct and indirect tax reforms, and to pursue with determination the civil service reform, as well as the strategies in the health and education sectors. Directors also stressed the need for timely and comprehensive implementation of the planned market-based pricing in the energy sector; assigning priority to social outlays and efficient infrastructure investment; legal and judicial reform; strengthening of the banking system; and the privatization program.

Noting the importance of public awareness to program success, directors stressed the need to redouble efforts to mobilize political consensus in support of the reform program. As important steps in this regard, they also welcomed the authorities’ intention to publish the policy framework paper, along with other steps in the program promoting greater transparency and better availability of statistics. Directors stressed the need to further improve fiscal and balance of payments data to enhance program design and monitoring.

Directors noted the valuable role played by the technical assistance program in ensuring effective reform implementation and institution building. They observed that realization of the goals of the structural program would continue to require substantial technical assistance, and they encouraged the authorities to utilize fully and effectively the envisaged assistance. Moreover, to improve policy formulation and implementation, Directors recommended improving key financial data and early implementation of the programs to upgrade national income and price data.