Mission Concluding Statement 

Republic of Yemen- December 2012 Staff Visit Mission Concluding Statement

December 9, 2012

I. Recent Developments and Outlook

1. Yemen’s economic situation remains very difficult in 2012, but there has been some improvement thanks to the government’s steps and support from foreign partners. There has been an intermittent progress towards starting the national dialogue which is now scheduled for early 2013. In the meantime, there have been continued attacks on oil pipelines and electricity transmission lines, leading to interruptions of oil production and electricity delivery. Nonetheless, there are signs of economic activity reviving after over 10 percent decline in 2011, and inflation has come down to single digits. The exchange rate has appreciated then stabilized at pre-crisis levels, and foreign exchange reserves (including the recently received $1 billion deposits from Saudi Arabia) have increased to over $5.0 billion. These developments have allowed the authorities to reduce the policy interest rate from 20 percent to 18 percent. The fiscal deficit is expected at around 5.5 percent of GDP, as a result of the Saudi oil grant and cuts in capital expenditures and transfers. Non-hydrocarbon revenues have also exceeded the budget estimates due to strengthened collection efforts. All indicative targets under the government’s reform program that is supported by the IMF’s Rapid Credit Facility have been met.

2. Yemen’s economic challenges will continue to be very serious in 2013 especially in view of the high poverty and unemployment rate particularly among the youth. However, there are signs of recovery, with GDP expected to grow by over 4 percent and inflation to further decline. The fiscal framework for the 2013 budget projects a deficit of 5.7 percent of GDP, almost equivalent to the estimated outcome in 2012 in spite of a projected decline in total government expenditures. This reflects a large decline in grants, mostly due to the phasing-out of the Saudi oil grant. Other government revenue is expected to increase significantly as oil production recovers gradually and tax receipts improve due to higher collection of taxes on goods and services. On the expenditure side, a significant decline in current expenditures—mainly lower interest payments and fuel subsidy in relation to GDP—will provide room for higher capital expenditures. The non-hydrocarbon primary fiscal deficit (excluding grants) is projected to remain high and increase somewhat to about 14 percent of GDP. The current account deficit and foreign exchange reserves would also worsen unless large external grants materialize.

II. Policy Challenges

3. In view of the above challenges, the overarching focus of economic policies should be boosting inclusive growth while preserving macroeconomic stability. In this regard it is important to redirect public outlays to more efficient and growth-promoting expenditures, strengthen tax collection especially from large tax payers, and improve the underlying fiscal position. In addition, it is essential to strengthen the ability of the financial sector to provide credit to the private sector, especially small and medium-sized enterprises, and enhance governance and transparency.

4. Notwithstanding the increase in domestic prices of some oil derivatives in 2012, fuel prices remain substantially lower than international prices. As a result, energy subsidies amount to about 8 percent of GDP. This large untargeted subsidy benefits the richest segments of the population disproportionately. Furthermore, the lower prices lead to substantial inefficiencies and smuggling, and contribute to environmental deterioration. To further improve governance and transparency, the authorities are encouraged to further adjust these prices and launch other reforms to increase efficiency in the energy sector, while broadening the social safety net and increasing compensation for the poor through well-targeted cash transfers. Furthermore, special attention should be paid to the use of diesel for “rental” power generation, to avoid inefficiencies, leakages, and smuggling.

5. Yemen’s wage bill, at more than 10 percent of GDP is very high by international standards. Containing this bill is crucial for achieving fiscal sustainability and would also help direct resources to more efficient social protection and to investment in infrastructure to support growth, job creation, and poverty reduction. Reforms in this sector should include eliminating ghost workers and double-dippers. Civil service reforms would also help improve public service delivery.

6. Continuing to strengthen the tax and customs revenues is also a key priority. In this regard, the Government should refrain from granting any exemptions as they will introduce more distortions and reverse the gains of past reforms. In addition, it would be important to press ahead with full implementation of the increased threshold for the GST, promoting self-assessment, and enhancing cooperation between the Tax and Custom Authorities and providing strong political and logistical support to their efforts to improve administration and collection.

7. Lowering further the benchmark policy interest rate gradually and more flexibility of exchange rate would help expand credit to the private sector and improve competitiveness to support non-oil growth and job creation. The lowering of the benchmark interest rate earlier this year was a good first step given the downward trend in inflation and stable exchange rate. In addition, more flexibility in the exchange rate would also help to preserve foreign exchange reserves.

8. The central bank should refrain from any additional lending to the government. It will be important for it to reach an agreement with the Ministry of Finance to bring down the government’s outstanding credit within legal limits. Furthermore, publishing the detailed audit reports of the bank would be a step further towards best international practices.

9. Preserving the financial system’s health and developing it is needed to promote private sector led growth. Banks’ assets, which are currently concentrated heavily in government papers, need to be diversified in order to minimize the risk for banks’ income in case government needs to issue such papers shrink. To facilitate credit growth, while protecting the health of the banks, it is essential to improve prudential regulations, strengthen supervision and audit enforcement, reduce ownership concentration and connected lending, enhance bankruptcy and closure laws and procedures, and improve and expedite court procedures including out-of-court settlement.

10. Meeting Yemen’s economic challenges and ambitions require urgent actions as well as a medium term reform strategy. The efforts of Yemen need the support of the international community. It is essential that the Friends of Yemen expedite disbursement of their pledges, and that the authorities spend these pledges effectively and efficiency. The IMF stands ready to continue to provide technical assistance and policy advice in support of Yemen’s home-grown reform efforts and to consider any further financial assistance the authorities may request.