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O C C A S I O N A L   P A P E R       208       Yemen in the 1990s: From Unification to Economic Reform Klaus Engers, Sherwyn Williams, Nada Choueiri, Yuri Sobolev, and Jan Walliser ©2002 International Monetary Fund May 3, 2002 Preface List of Abbreviations   Overview   External Environment: Politics, Oil, and Debt     Political Developments: Unity, Gulf Crisis, Civil War,       and Democracy     Yemen's Emergence as an Oil Producer     External Debt   Macroeconomic Policy During 1990–99     Crisis, Controls, and Stagnation: Macroeconomic Policies       During 1990–94     Reform and the Return of Stability and Growth During 1995–99     Preserving the Oil Wealth: A Long-Term View of Yemen's Fiscal       Policy Stance   Microeconomic Reforms     Foreign Exchange Regime and Foreign Trade Reforms     Tax Reform     Public Expenditure Reform     Reform of the Regulatory Environment     Privatization     Financial Sector Reforms   Poverty and Social Safety Net Policies     Pensions     The Social Welfare Fund and Other Cash Transfers     The Social Fund for Development     Informal Safety Nets and Development Support Organizations   Economic Performance from 1990 to 1999     Growth and Employment     Inflation     Poverty and Social Indicators     Saving, Investment, and External Vulnerability Annexes Tourism Sector in Yemen: Problems and Prospects Summary of the Tax System as of end-June 2000 References Statistical Appendix Boxes IV     1. Reduction of Subsidies, 1995–99     2. The Aden Free Zone     3. The Yemeni Banking System VI     4. Accounting for Growth in the Non-Oil Sector     5. The Role of Qat in the Yemeni Economy     6. Provisions of Current Labor Legislation Tables Section II     1. Selected Economic Indicators, 1990–99     2. Sensitivity to Oil Price Changes, 1990–99     3. Oil-Related Volatility in the Economy, Compared with         Other Oil Exporters in the Region     4. Balance of Payments, 1990–99 III     5. Central Government Finance, 1990–99 IV     6. Middle Eastern and North African Countries: Trade         Restrictiveness Rating     7. Petroleum Products Prices Compared to World Market         Levels (March 2000)     8. Adjustments in Administered Retail Prices, 1994–99     9. Distribution of Public Employees by Sector, 1998   10. Regional Comparison of Expenditures on Defense,         Education, and Health, 1994–98 V   11. Social Fund for Development—Accumulated Investment,         Disbursement, Number of Expected Beneficiaries,         and Job Opportunities, up to September 30, 1999,         According to Sector VI   12. Macroeconomic Indicators Comparing Pre-Reform         and Reform Period, 1991–99   13. Distribution of Labor Force by Employment Status,         Age Group (+10 Years), and Gender, 1994   14. Student Enrollment and Graduation from Colleges         and Universities in 1998/99   15. Phasing of Macroeconomic Adjustment, 1990–99   16. Vulnerability Indicators Annex I    17. Visitor Arrivals and Tourism Revenues   18. Average Tourism Statistics Since Unification Statistical Appendix   A1.  Social and Demographic Indicators 1995 and 1997   A2.  Selected Economic and Financial Indicators, 1994–99   A3.  Sectoral Origin of Gross Domestic Product at Current Prices,            1994–99   A4.   Use of Resources at Current Prices, 1994–99   A5. Sectoral Origin of Gross Domestic Product at Constant Prices,            1994–99   A6. Distribution of Employment (Age 15 Years and Over)            by Economic Activity   A7. Distribution of Employment (Age 10 Years and Over) by            Sectors in Urban and Rural Areas, 1998   A8. Household Income and Expenditure, 1998   A9. Distribution of Population (10 Years and Over) by            Education Level, Region, and Sex, 1994, 1998 A10. Crude Oil Summary, 1994–99 A11. Oil Exploration Blocks Awarded in 1996–99 A12. Domestic Consumption of Petroleum Products, 1994–99 A13. Output of Industrial Products, 1994–99 A14. Production, Area, and Yield of Major Crops, 1994–99 A15. Noncrop Primary Production, 1994–99 A16. Consumer Price Index for Urban Areas, 1994–99 A17. Domestic Retail Prices for Petroleum Products and Electricity,            1995–2000 A18. Summary of Central Government Finance, 1994–99 A19. Composition of Central Government Revenues, 1994–99 A20. Composition of Central Government Expenditure, 1994–99 A21. Current and Capital Transfers to Public Enterprises, 1994–98 A22. Monetary Survey, 1994–99 A23. Factors Affecting Domestic Liquidity, 1994–99 A24. Balance Sheet of the Central Bank, 1994–99 A25. Balance Sheet of the Commercial Banks, 1994–99 A26. Interest Rates, 1994–99 A27. Distribution of Commercial Bank Credit to the            Nongovernment Sector A28. Commercial and Specialized Banks as of December 31, 1999 A29. Indicators of Banking System Financial Soundness, 1997–99 A30. Balance of Payments, 1994–99 A31. Composition of Exports and Re-Exports, 1994–99 A32. Direction of Exports and Re-Exports, 1994–99 A33. Composition of Imports, 1994–99 A34. Sources of Imports, 1994–99 A35. Enterprises Privatized/Liquidated, 1997–99 A36. Enterprises to be Privatized/Liquidated A37. Social Fund for Development: Total Investment and            Disbursement up to September 30, 1999 Figures Section II     1. Actual and Projected Crude Oil Production and         Government Share     2. Republic of Yemen and Selected Comparators:         Crude Oil Exports and Revenue III     3. Real and Nominal Effective Exchange Rates     4. Government Revenue from Oil and Taxes     5. Customs Revenue     6. Fiscal Balance and Civil Service Wage Bill     7. Interest Rates     8. Government Non-Oil Saving and National Wealth IV     9. Nominal Rial-Dollar Exchange Rates   10. Domestic Wholesale Prices of Petroleum Products   11. Credit and Currency Ratios   12. Money Velocities and Multipliers   13. Republic of Yemen and Selected Comparators:         Liquidity and Credit Ratios   14. Republic of Yemen and Selected Comparators:         Money Multipliers and Credit Indicators VI   15. Composition of Real GDP   16. Inflation, Money Growth, and Budget Financing   17. Selected Commodity Price Indices   18. Republic of Yemen and Selected Comparators:         Dependency Ratios   19. Republic of Yemen and Selected Comparators:         Adult Illiteracy Rate   20. Republic of Yemen and Selected Comparators:         Life Expectancy at Birth   21. Republic of Yemen and Selected Comparators:         Infant Mortality Rate   22. Republic of Yemen and Selected Comparators:         Access to Safe Water   23. Saving and Investment   Annex   24. Visitor Arrivals

I  Overview The decade of the 1990s was surely one of the most dramatic periods in Yemen's rich history. Unification of the two Yemens, rapid development of an oil sector, and a radically changed external environment fundamentally transformed the opportunities and challenges the Yemeni people face. This paper summarizes economic developments in Yemen during the 1990s, takes stock of the many structural changes in the economy during the decade, and identifies reforms that are needed if Yemen is to move to a path of rapid and sustainable growth, reduce rampant poverty, and responsibly manage the highly volatile economic rents from its oil wealth. It is hoped that this paper will contribute to the ongoing debate in Yemen on the appropriate development strategy for the coming years. Section II summarizes the main political and exogenous events that shaped the decade. The decade began with the unification of the Yemen Arab Republic (YAR, or North Yemen) with the People's Democratic Republic of Yemen (PDRY, or South Yemen). The YAR had emerged in the 1960s as the republican successor to the medieval regime of the imam; the socialist PDRY had its origins in the struggle for independence in the British colony and protectorates around Aden in 1967. Only a few months after unification Yemen experienced a major shock: the onset of the second Persian Gulf crisis led to the return of about three quarters of a million Yemeni workers from the Gulf states, challenging a fragile socioeconomic fabric already weakened by a severe two-year drought. The development of the country's oil fields during the same period may have been the element that kept Yemen away from the brink. Oil exports provided a new and growing source of foreign exchange earnings, even if fluctuations in world oil prices added a new vulnerability. The strains from these developments eventually led to a brief civil war in 1994, following an attempt at secession by elements of the former PDRY leadership. It was only after the secessionists were defeated militarily—and as the new constitutional system providing for a multiparty democracy, a free press, and an essentially market-based economic system took hold—that the political consensus could be forged for the urgent economic reforms that had been delayed since unification. In 1995 Yemen initiated an economic reform program, supported by the IMF as well as by the World Bank and other institutions and countries, aimed at strengthening the foundations of a market-based and private sector-driven economy, integrated into world markets and operating in a context of broad financial stability. This approach underpins government policy today. The first priority of reform was obviously to restore macroeconomic stability, which was threatened by large fiscal imbalances; by price distortions resulting from the attempt to suppress excess demand through price, foreign exchange, and interest rate controls; and by a huge debt overhang arising largely, but not solely, out of the former PDRY's debt to the Soviet Union. Section III describes the emerging macroeconomic policy mix. Fiscal policy was obviously key, and in light of the importance of oil for government revenue, it is assessed also from an intertemporal perspective, given the fact that Yemen has only limited proven reserves. Although stabilization policy was highly successful, structural reforms faced greater difficulties and greater resistance and were more severely constrained by Yemen's limited administrative capacity. Section IV describes the progress on structural reform to date, pointing to impressive success in liberalizing the exchange and trade regime and lifting price controls, but also to a huge unfinished agenda in tax and budget management reform, privatization, and civil service reform. Deep-rooted obstacles to economic growth, notably including weaknesses in the judicial system and governance, have barely been touched; reform in these areas, perhaps more than in others, will have to emerge from and be shaped by civil society itself. Section V looks at some of the "formal" social safety net measures put in place to protect the most vulnerable segments of society not only against the adverse effects of certain reform measures (notably the reduction in generalized subsidies), but also—and probably more important—against the often brutal exogenous shocks that Yemeni society has had to absorb. These included not only the return of expatriate workers in 1990–91 and the dislocations from the civil war in 1994, but more recently the collapse of oil prices in 1998. No data exist to gauge the scope of traditional, often tribal- or religious-based, social support systems. Such systems likely remain far more important than formal systems and must have been at the core of Yemen's ability to absorb the workers returning from the Gulf region. Finally, Section VI looks at the Yemeni economy's performance in terms of growth and inflation, social indicators, and saving and investment balances; the analysis also compares Yemen's record with that in other, similar countries. Clearly, during the second half of the 1990s, performance improved on all three fronts—remarkably so for macroeconomic stability, but considerably less so for social indicators. This reflects several factors: the return to political stability and peace, oil sector developments that were on the whole favorable, and the first fruits of reforms. But in order to build on these achievements, an even greater focus on growth and poverty reduction will be needed. The Yemeni authorities have therefore embarked on preparing a comprehensive poverty reduction strategy, in the context of the next Five-Year Plan (2001–06) and in broad consultation with civil society. The plan was launched in early 2001. It is hoped that this paper can contribute to formulating such a strategy by providing some of the needed background and by drawing some first lessons from Yemen's adjustment experience to date.