ECONOMIC HEALTH CHECK
Yemen: Reorienting Public Spending Would Create Jobs, Fight Poverty
July 31, 2013
- Yemen’s economy has stabilized, but recovery remains fragile
- Redirecting resources to pro-growth, pro-poor expenditure is key
- Donor support plays vital role in country’s development
As it goes through political transition, Yemen is at an important crossroads in its economic development.
The crisis of 2011 impacted the economy, leading to a GDP decline of more than 12 percent.
Yemen has since made progress toward recovery and restoring economic stability, thanks to strong donor support and prudent monetary policy. But it should move quickly to implement essential reforms in order to preserve and build on recent gains and fight poverty and unemployment.
In an interview, IMF mission chief Khaled Sakr discussed the challenges Yemen faces in cultivating this nascent recovery in fighting unemployment and poverty.
IMF Survey: Could you paint a broad picture of Yemen’s economy?
Sakr: Yemen is a strategically important country in the Arabian Peninsula and has great economic potential with its large labor force, long shoreline, and agricultural and mineral resources. Yet nearly half of its population lives below the poverty line and roughly one in two children suffers from malnutrition. The country is highly dependent on exhaustible hydrocarbon revenue and faces a serious water shortage. Unemployment is very high, especially among the youth, and social tension contributes to security challenges.
Yemen’s ongoing constitutional process, the National Dialogue, is considered by some a model for other Arab countries in transition, as it is based on broad participation across the political and social spectrum. The successful conclusion of this process would greatly facilitate the economic recovery by improving confidence. At the same time, economic reforms for strong, inclusive growth could support the political process.
IMF Survey: What progress has the government made on economic reforms to date?
Sakr: To give you one example, diesel was being sold to the population at 100 rials a liter and to the electricity sector at 40 rials, when it in fact costs more than 200 rials. Recently, the authorities took the wise decision to unify the price at 100 rials. At the same time, they are compensating the electricity sector to avoid an increase in electricity prices. This diesel price unification will bring some important benefits in terms of reducing smuggling and improving efficiency.
Transparency is also being increased with the publication of the IMF staff economic assessment reports and, for the first time, the full audited financial statements of the central bank. There are also ongoing efforts to strengthen the banking sector’s supervision and resolution framework and to establish institutions that will help expedite donor disbursements.
IMF Survey: How has the IMF helped Yemen during the transition?
Yemen was the first Arab country in transition to receive financial support from the IMF. This support, in the amount of about $94 million, came in April 2012 under our Rapid Credit Facility, which is a type of emergency assistance with modest reform objectives when capacity to implement policies is impeded by crises.
This facility helped to stabilize the situation. The authorities were able to meet—and even surpass—their reform objectives. The international community was also quick to act, and Yemen received exceptional support from donors, especially Saudi Arabia. External grants increased from around 1 percent of GDP in previous years to about 6 percent of GDP in 2012. Thanks to this combination of factors, the authorities were able to stabilize the exchange rate at its pre-crisis level, and inflation fell to single digits (although it has since rebounded somewhat). Most important, economic activity started to recover, with non-hydrocarbon growth registering 4 percent.
IMF Survey: What challenges does the Yemeni economy face in the near term?
Although the authorities carried out prudent monetary policy in 2012, in the second half of the year, money expansion accelerated, and that partly reflected the financing of a larger-than-planned budget deficit. This deficit expansion occurred because of an increase in untargeted energy subsidies and the public sector wage bill.
As a result, the government’s large financing needs are reducing the funds available for private investment. A full 70 percent of banking sector’s credit is to the government. So that leaves less for private investment. Plus, this drives the interest rate up, making it more expensive for small and medium-sized private enterprises to obtain sufficient financing to operate, which contributes to lower growth and higher unemployment.
IMF Survey: How can Yemen address this situation?
Sakr: Yemen’s overarching challenge is to create fiscal space to increase pro-growth and pro-poor spending. Generalized subsidies reached 9 percent of GDP in 2012, which means that they consumed two thirds of the country’s total hydrocarbon revenue. If you add the public sector wage bill of 11 percent of GDP, these two expenditure items leave little scope for expenditures to alleviate poverty and support growth.
Therefore, it is crucial that some of the resources be gradually shifted from generalized energy subsidies—which disproportionately benefit the rich and fuel smuggling—to direct social transfers for the poor. Even a small start in reducing generalized subsidies, say by 10–15 percent, would be sufficient to increase the average monthly allowances paid by the Social Welfare Fund to poor families by one half, from $18 to $27.
With regard to wages, there’s a “ghost worker” phenomenon in Yemen, meaning that many workers on the government payroll do not exist or actually perform a job. Many wages are paid in a lump sum to the workers’ bosses and it is not clear how they are distributed. The World Bank has helped the authorities to identify the problem and put in place an effective system of identification for people to use when they collect their salaries. As with energy subsidy reform, this change would be gradual in order to implement it carefully.
In addition, the country needs to continue to improve the compliance of large taxpayers. This would not require any increase in the tax rates or affect small and medium-sized enterprises. At about 7 percent, the tax-to-GDP ratio in Yemen is low by regional and international standards. The government has already made some progress on that front last year, and it will be important to continue this work in order to contain the budget deficit to reduce inflation, to the benefit of the whole population, especially the poor.
IMF Survey: Poverty and youth unemployment rates are alarming. What can the government do to boost job creation?
Sakr: Build roads and other infrastructure for economic development. For example, when you build roads, which are highly needed, you employ people immediately. There is also a lasting impact because small and medium-sized enterprises emerge around these roads. So not only are workers engaged in a productive activity, but also the roads—once built—provide access to markets and increase the value of land and feasibility of new enterprises. Investing in people, striving for a more business-friendly environment, promoting access to financial services, and strengthening public institutions are also essential medium-term measures.
IMF Survey: What is the role of international donors in helping Yemen during the transition?
Sakr: The country has received promises of about $8 billion in aid from the Friends of Yemen, a group of 20 countries and intergovernmental organizations led by the United Kingdom and Saudi Arabia whose purpose is to mobilize support for Yemen. So far, only $1.8 billion has been disbursed. Increasing donor grants in general—and especially to the budget in support of a sound macroeconomic framework—is vital.