Yemen became the focus of international attention late in 2009 when a Nigerian man, trained in the Arab Gulf country, attempted to blow up a US airliner over Detroit. A meeting called in late January in London by UK Prime Minister Gordon Brown aimed to improve international coordination in addressing Yemen’s economic and development issues, as well as more immediate threats to the country’s security, such as al‐Qaida. But Yemen has been suffering from economic hardships since the early 1990s and is now faced with complex and intertwined challenges, says Yemen expert Ginny Hill in a Briefing Paper published by Chatham House in January. These include an economic crisis forced by declining oil reserves, the strain on political stability posed by the impending transition of power and multiple internal threats to security – the ongoing civil war in the northern Sa’da province against Shi’ite Zaidi rebels, growing separatist sentiment in the South and remote areas falling under the control of al‐Qaʹida-linked militants. Whether Yemen coheres and progresses or reverses and fragments will depend on the foresight of the ruling elite, the position adopted by Yemen’s neighbors and the policies pursued by the international community, concludes Ms Hill.

A Faltering Economy And Security Concerns
Yemen is one of the poorest countries in the Arab region, and progress toward meeting the Millennium Development Goals (MDGs) has been slow, according to the International Monetary Fund (IMF). Crude oil output has been in decline since 2000. Barring major new discoveries, exploitable oil reserves could be exhausted in a relatively short period. The $4.5bn Yemen LNG project started production in October 2009 from the first train and is expected to provide some cushion for dwindling oil, while recent gas discoveries may prolong the life of the hydrocarbon sector as a whole (MEES, 19 October 2009 and 1 December 2008). Nevertheless, the magnitude of adjustment required by continued declines in oil output is substantial, even over the medium term. Generating strong and sustainable non-hydrocarbon growth, ensuring fiscal and external sustainability, and meeting Yemen’s pressing social and development needs will be key challenges, warned the IMF in its conclusion to the 2009 Article IV consultation with Yemen (see below).

As political and economic instability increased, Yemen became a foreign policy priority for Western governments. Concern also grew among Yemen’s neighbors, and the Saudi Arabian army was deployed to the Yemeni border following incursions by the rebels in the northern Sa’da province. Growing concerns forced the Yemeni authorities to boost security at energy installations and guard against militant attacks. Armed tribesmen have blown up pipelines in the past two years, threatening crude exports, and could also target new gas projects (MEES, 12 October 2009). The latest attempt to bomb an oil pipeline was reported in the Yemeni capital Sanʹa on 31 January. Oil and gas pipelines crossing the country are seen by some analysts as more vulnerable to attack than export facilities, threatening export interruptions which would add pressure on the budget of an already poor country.

Yemen’s current security challenges are a symptom of much deeper problems, according to Ms Hill. The London meeting was intended to foster international coordination to support the Yemeni authorities (MEES, 1 February). In fact, it is generally acknowledged that the underlying drivers for future instability in the country are economic and a long term solution to its security and stability problems lies in a comprehensive approach. Participants in the January meeting were not expected to make financial pledges to Yemen, although renewed efforts are required to improve donor coordination and ensure that existing pledges are fulfilled – Yemen has managed to spend only a fraction of the $5bn pledged at a 2006 conference (MEES, 20 November 2006). Direct Western mediation would be inappropriate and counter-productive but the Arab states, working in partnership with key international actors, may have a role to play in this respect, says Ms Hill.

In its current fragile condition Yemen remains vulnerable to unexpected shocks, according to the report by the UK-based think tank. In the meantime, uncertainty over Yemen’s future prevents sustained, integrated investment on a scale that would salvage the economy. Implicitly and explicitly, aid money should encourage good governance, improve planning and mitigate the impending economic crisis caused by the projected decrease in oil revenues. However, Yemen’s window of opportunity to shape its own future and create a working post-oil economy is narrowing as oil production falls closer to consumption levels.

Lower Oil Prices Increased Risks To Macroeconomic Stability
Recent economic performance has raised some concerns, said the IMF in its conclusion to the 2009 Article IV consultation with Yemen. While direct financial contagion from the global crisis has been limited, Yemen has suffered from a range of indirect effects and risks to macroeconomic stability have increased. The overall deficit is projected to reach 8-9% of GDP in 2009. Non-hydrocarbon economic growth appears to have weakened, from 4.8% in 2008 to an estimated 4.1% in 2009, reflecting slower activity in such areas as agriculture (possibly linked to Yemen’s growing water shortages), construction, manufacturing, and real estate. Inflation has hit record lows, due largely to the sharp decline in international food prices. Given the many challenges ahead, the authorities signaled interest in Fund support for the design and monitoring of a Yemeni strategy to reduce macroeconomic and structural imbalances, the IMF says.

The heaviest impact from the global recession has come through lower oil prices. A significant decline in government oil exports was due to lower production, combined with the sharp drop in average prices and lower government share of output between 2008 and 2009. The loss of oil revenue has put pressure on the government fiscal balance. The authorities have sought to mitigate the impact but overall the adjustment effort has not kept pace with declining oil receipts. Non-hydrocarbon revenues, meanwhile, have been stagnant. Full implementation of the General Sales Tax (GST), expected in 2009, did not materialize.

The main focus of monetary policy shifted from containing inflation to providing liquidity, says the IMF. The monetary policy by the Central Bank of Yemen (CBY) has been largely accommodative. In addition to re-injecting sizeable liquidity into the banking system through a repurchase of central bank CDs, the CBY also made the first adjustment to the benchmark deposit rate in nearly 10 years, lowering the rate from 13% to 10% during January-May. The impact on broad money growth has been muted given the decrease in net foreign assets. However, the surge in credit to government may have contributed to lower private sector credit growth, which turned negative by mid-2009.

Pressure on the balance of payments was also visible. From September 2008 to September 2009, usable foreign exchange reserves of the CBY declined by $1.6bn but remain comfortable at $6.6bn or about 9 months of imports. The sharp decline in oil exports was the driving force. However, strong import demand (especially for food and fuel, which together account for 60% of total imports) and an apparent slowdown in foreign direct investment and inward remittances also played a role. Although pressure may have eased in the last quarter of the year as oil prices rose, the current account deficit is projected to widen from 4% of GDP in 2008 to about 6% in 2009. Non-performing loans remain high but they are declining, according to the IMF statement. Capital ratios are also on the rise, in line with a legal requirement to increase capital by end-2009. However, dollarization appears to be rising after several years of steady decline.

Lower oil prices and production, coupled with weaker foreign direct investment and remittances, have put pressure on the fiscal and external accounts. These pressures are likely to continue as oil reserves dwindle. The immediate challenge is to restore fiscal sustainability while supporting growth and reducing poverty. The IMF also stressed the need for prudent macroeconomic policies and sustained structural reforms; Yemen’s medium term prospects hinge critically on progress in enhancing competitiveness, creating an attractive investment regime and promoting non-hydrocarbon growth.

IMF Underlines Adequate Donor Support Along With Fund’s Financial Support
The IMF executive directors underscored the urgency of reducing the fiscal deficit in 2010, while protecting social and development spending. They welcomed measures to curtail non-priority public expenditures and restrain wage increases and encouraged ambitious fiscal consolidation, focusing on aligning expenditures with revenues, reducing structural rigidities in expenditures and boosting non-oil revenue. Key priorities in this regard include full implementation of the GST and reducing fuel subsidies. At the same time, the directors stressed the need for larger and better-targeted direct transfers to protect the poor.

Directors viewed the stance of monetary policy as broadly appropriate and endorsed the decision to lower the benchmark deposit rate. They broadly considered that gradual further rate cuts could be explored with a view to eventually liberalizing Yemen’s interest rate regime. Directors emphasized the role of exchange rate flexibility, together with fiscal consolidation, in facilitating adjustment of the external accounts and protecting the reserve position. The IMF supported the plans to issue Islamic financial instruments and commended the authorities for the recent ratification of new legislation on money laundering and the financing of terrorism. Given the significant challenges ahead, the IMF executive directors welcomed the authorities’ interest in closer engagement with the Fund, although adequate donor support will also be critical. The IMF also encouraged close cooperation with the World Bank and other multilateral institutions.

Republic Of Yemen: Selected Macroeconomic Indicators, 2004–09

	2004	2005	2006	2007	Est 2008	Proj 2009
	(Annual % Change)
National Income and Prices
Real GDP	4	5.6	3.2	3.3	3.6	3.8
Real Non-Hydrocarbon GDP	5.4	6.5	4.7	5.3	4.8	4.1
Real Hydrocarbon GDP	-5	-0.8	-8.3	-13.1	-8.1	0.2
Core Consumer Price Index (end of period) 1	13.6	12.3	9.3	12.2	13.1	4.5
	($Mn, unless otherwise indicated)
External Sector
Exports, fob	4,676	6,413	7,316	7,050	8,977	5,499
Of which: Hydrocarbon (oil and gas)	4,303	5,952	6,733	6,264	7,895	4,428
Imports, fob	3,859	4,713	5,926	7,490	8,829	6,638
Current Account, Including Official Transfers (in % of GDP)	1.6	3.8	1.1	-7	-4.1	-6.2
Overall Balance (deficit-)	648	328	1,452	296	440	-1,166
	(% of GDP)
Fiscal Variables
Overall Balance (cash basis) 2	-2	-0.6	-0.7	-5.8	-3.4	-8.6
Non-Hydrocarbon Primary Balance (cash basis)	-22.4	-24.7	-27.2	-26.1	-28.7	-22.4
Debt Ratios
Total Government (gross) Debt	52.1	43.8	40.8	40.4	36.4	45.9
Total External Debt	38.5	30.9	28.7	26.9	21.9	22.8
	(Annual % Change, unless otherwise indicated)
Monetary Sector
Broad Money	13.9	13.7	27.7	16.8	13.7	10.6
Credit to Private Sector	33.5	21.3	16.7	35.7	17.5	3
Benchmark Deposit Interest Rate (% per annum)	13	13	13	13	13	10
Central Bank Own Gross Foreign Reserves 3
In $Mn	5,068	5,338	6,798	6,969	7,323	6,123
In Months of Next Year Imports of Goods and Services	15	11.6	10.2	8.5	11.6	8.4