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IMF: Non-oil economic activity grew reasonably in Yemen

Global Arab Network - - John Short

Saturday, 05 December 2009 18:59

IMF_-_Non-oil_economic_activity_in_Yemen_grows_reasonably

According to International Monetary Fund (IMF) Report, Yemen is one of the poorest countries in the Middle East. An estimated 35 percent of the population lives below the poverty line. Oil reserves are expected to be depleted in about 10–12 years. Yemen has few other natural resources and is also facing depletion of its groundwater. These challenges are compounded by an expanding population, poor infrastructure, weak institutional capacity, a fragile security situation, and the widespread use of Qat—a mild narcotic accounting for over one–third of agricultural production and about a quarter of total water resource use.

The following is an extract of International Monetary Fund (IMF) Report:
Economic reforms slowed after the 1990s, and urgently need to be reinvigorated. Although a number of reform initiatives emerged in recent years—including civil service and public financial management (PFM) reforms, a major adjustment to fuel subsidies in 2005, a new general sales tax (GST), an anticorruption drive, and improvements to the social safety net—most have been only partially implemented and with significant delays.

Fund advice on preparing for the transition to a non-oil economy has had limited traction, particularly in the context of record world oil prices and increasing political and security constraints. However, recent developments—the sharp decline in oil output in 2007 and the even sharper decline in oil prices in late 2008—are bringing a new sense of urgency to the debate on economic reform.

Recent economic performance in Yemen has been mixed. Oil production continues to decline. Non-oil economic activity has grown at a reasonable rate but is likely to have slowed moderately in 2008.

Inflation has been a key concern. Pressures related to the global slowdown and the falling price of oil began to materialize in late 2008.

Overall real GDP grew by about 3.3 percent in 2007, reflecting real non-oil growth of 5.3 percent and a 13.1 percent decline in oil output. Overall growth pick up in 2008, with somewhat lower non-oil growth of 4.8 percent compensated for by a smaller decline in oil output.

Core inflation (excluding qat) rose to 27 percent by May 2008—reflecting the surge in global commodity prices. Inflation has since declined to about 18 percent in October. Some spillover to nonfood items may have emerged. Inflation excluding qat and food reached a record 18 percent by June—mainly due to the cost of services, clothing, housing, and fuels (Box 1).

A sizeable fiscal deficit emerged in 2007, and another is likely for 2008. A sharp decline in oil production, coupled with inflexible government expenditure, led to an overall fiscal deficit of 5.8 percent in 2007. For 2008, a deficit of around 5–6 percent of GDP is possible in the wake of the recent drop in international oil prices, continued rigid expenditures, and limited non-oil revenue improvements.

Monetary policy in 2008 focused on exchange rate stability and controlling excess liquidity in the domestic banking system. The rial has remained steady against the U.S. dollar since mid–2007, helping to mitigate imported inflation. In real effective terms, the rial appreciated by 9.5 percent in the 12 months to October. The Central Bank of Yemen (CBY) used its full allowance of Treasury bills to absorb domestic liquidity in the first nine months of the year, and has since relied on central bank certificates of deposit (CDs) and additional foreign exchange auctions. Broad money and reserve money growth through October were 15.5 percent and 10.9 percent, respectively. The benchmark deposit rate remains fixed at 13 percent.

The external current account shifted to a deficit of 7 percent of GDP in 2007, compared with an average surplus of about 2.4 percent during 2002–06. This shift reflected mainly FDI-financed imports for a liquefied natural gas (LNG) plant. The external accounts benefited from record oil prices during the first part of 2008, but pressures appear to be emerging in the wake of declining oil prices. The current account is projected to remain in deficit (about 2 percent of GDP) in 2008. CBY foreign exchange reserves look to remain roughly the same as at end-2007.

Financial intermediation is deepening but remains shallow compared to the region. Nonperforming loans (NPLs) remain high but have fallen steadily as a share of total loans in recent years. Capital adequacy improved in mid-2008 compared to end-2007. Further improvements in capital adequacy are expected by end-2009, in line with revised minimum capital requirements for banks in Yemen. Dollarization has declined steadily in the past few years.

Yemen maintains close cooperation with the donor community, but a substantial portion of the 2006 Consultative Group (CG) pledges have yet to be translated into actual disbursements or commitments.

Yemen remains relatively insulated from the financial side of the current world economic crisis (Box 2). Yemeni banks have relatively low exposure to private foreign lending, which centers around trade flows. Portfolio investment is quite limited, given the absence of a domestic stock market or commercial credit market.

Yemen’s main foreign asset—the CBY’s reserves—are highly liquid and kept predominantly in the form of deposits in international banks. While Yemen could suffer from a decline in external financing (either through lower remittances, FDI, or official financing flows), these risks have yet to materialize, and would move more slowly than financial contagion.

Yemen remains vulnerable to commodity shocks and the effects of slower regional and world economic activity. Although government revenue and the balance of payments benefited from the high price of oil during the first half of 2008, the economy suffered from higher imported food and input prices. With the global slowdown and sharp decline in crude oil and other commodity prices, these risks have essentially reversed.

Pressures expected to materialize over the medium term with declining oil production have become near-term considerations. Without substantial expenditure and revenue reforms, the fiscal deficit will become increasingly difficult to finance, and balance of payments pressures will mount (notwithstanding the CBY’s substantial reserve cushion). Slower regional growth is also projected to bring lower levels of non-oil foreign investment than might have been expected (contributing to lower growth), as well as lower inward remittances from expatriate Yemeni workers in the Gulf and elsewhere.

The authorities recognized the need to further reduce inflation and address emerging imbalances. Recent data suggest that the worst of the turbulence in international food prices has passed. Price pressures in Yemen should continue to ease with lower world commodity prices (and falling transport costs). Nevertheless, the authorities agreed additional efforts would be necessary to bring twelve-month inflation to 15 percent or less by end-year.

The authorities also concurred that the risks to public finances and external sustainability had increased considerably since the end of the oil-price boom and that fiscal and monetary policy would need to be carefully coordinated to meet this challenge.

Global Arab Network

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Last Updated on Saturday, 05 December 2009 19:29

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