Yemen: ECONOMY

ECONOMY

Overview: At the time of unification, South Yemen and North Yemen had vastly different but equally struggling underdeveloped economic systems. Since unification, the economy has been forced to sustain the consequences of Yemen’s support for Iraq during the 1990–91 Gulf War: Saudi Arabia expelled almost 1 million Yemeni workers, and both Saudi Arabia and Kuwait significantly reduced economic aid to Yemen. The 1994 civil war further drained Yemen’s economy. As a consequence, for the past 10 years Yemen has relied heavily on aid from multilateral agencies to sustain its economy. In return, it has pledged to implement significant economic reforms. In 1997 the International Monetary Fund (IMF) approved two programs to increase Yemen’s credit significantly: the enhanced structural adjustment facility (now known as the poverty reduction and growth facility, or PRGF) and the extended funding facility (EFF). In the ensuing years, Yemen’s government attempted to implement recommended reforms—reducing the civil service payroll, eliminating diesel and other subsidies, lowering defense spending, introducing a general sales tax, and privatizing state-run industries. However, limited progress led the IMF to suspend funding between 1999 and 2001.

In late 2005, the World Bank, which had extended Yemen a four-year US$2.3 billion economic support package in October 2002 together with other bilateral and multilateral lenders, announced that as a consequence of Yemen’s failure to implement significant reforms it would reduce financial aid by one-third over the period July 2005 through July 2008. A key component of the US$2.3 billion package—US$300 million in concessional financing—has been withheld pending renewal of Yemen’s PRGF with the IMF, which is currently under negotiation. At present, despite possessing significant oil and gas resources and a considerable amount of agriculturally productive land, Yemen remains one of the poorest of the world’s low-income countries. It remains under significant pressure to reform or face the loss of badly needed international financial support.

Gross Domestic Product (GDP): For 2005 Yemen’s gross domestic product was estimated to be US$16.5 billion. GDP per capita was estimated to be only US$800. Yemen has repeatedly failed to meet its five-year (2001–5) plan for sustained average annual real GDP growth of 5.6 percent. Economists have estimated a real growth rate of 2.4 percent in 2005 based on a significant decline in oil production, leading in turn to a reduction in exports. Economists expect a continued decline in oil production and revenues in 2006–7, causing a decline in the growth of government revenue. Overall real GDP growth is expected to average only 2.4 percent in 2006–7. The World Bank has set a target of 7 percent GDP growth rate per year in order for Yemen to achieve sustained economic development.

Government Budget: In 1995, in order to comply with conditions stipulated by the International Monetary Fund (IMF), Yemen began an economic reform program, one component of which is fiscal policy reform aimed at reducing deficits and expanding the revenue base. However, the government has failed to significantly reduce its primary expenditure—subsidies, especially the fuel subsidy. In January 2005, Yemen’s parliament narrowly adopted a 2005 budget that forecast a reduced budget deficit of about 3 percent of gross domestic product (GDP). The budget was predicated on the adoption of a reform package that included a broad-based, 10 percent general sales tax (GST) and a 75 percent reduction in the fuel subsidy. Strong public opposition to these reforms led the government in July 2005 to defer the 10 percent GST for 18 months, adopting instead a hybrid 5 percent GST, and to modify the fuel subsidy reduction. These modified reforms resulted in an estimated budget deficit of US$137 million in 2005, about 1.5 percent of GDP. The government has budgeted a sharp (41 percent) rise in overall spending for 2006, which economists estimate will result in a deficit of US$800 million, or 4.2 percent of GDP.

Inflation: During the years immediately following unification (1990–96), Yemen experienced a very high average rate of inflation—40 percent. Economic reforms brought this rate down to only 5.4 percent in 1997, but high oil prices and cuts in the diesel subsidy in recent years have had a negative impact on the inflation rate, which has generally been on the rise despite some fluctuations. In 2004 efforts by the Central Bank of Yemen to tighten the money supply were offset by a weakening U.S. dollar, to which the Yemeni riyal is linked in a managed float, and by rising global commodity prices, resulting in an inflation rate of 12.5 percent. In July 2005, the government succumbed to public opposition and lowered the new general sales tax from 10 to 5 percent. This tax, coupled with reductions in government fuel subsidies, is expected to result in an estimated inflation rate of 18.4 percent in 2006, up from 12.6 percent in 2005.

Agriculture, Forestry, and Fishing: Agriculture is the mainstay of Yemen’s economy, constituting more than 20 percent of gross domestic product (GDP) since 1990 (22.4 percent in 2003) and employing more than half (54.2 percent in 2003) of the working population. However, a U.S. government estimate suggests that the sector accounted for only 13.3 percent of GDP in 2005. Numerous environmental problems hamper growth in this sector—soil erosion, sand dune encroachment, and deforestation—but the greatest problem by far is the scarcity of water. As a result of low levels of rainfall, agriculture in Yemen relies heavily on the extraction of groundwater, a resource that is being depleted. Yemen’s water tables are falling by approximately two meters a year, and it is estimated that Sanaa’s groundwater supplies could be exhausted by 2008. The use of irrigation has made fruit and vegetables Yemen’s primary cash crops. With the rise in the output of irrigated crops, the production of traditional rain-fed crops such as cereals has declined. No official statistics are published on the production of qat, a mildly narcotic and heavily cultivated plant that produces natural stimulants when its leaves are chewed, but its usage in Yemen is widespread. According to the World Bank and other economists, cultivation of this plant plays a dominant role in Yemen’s agricultural economy, constituting 10 percent of GDP and employing an estimated 150,000 persons while consuming an estimated 30 percent of irrigation water and displacing land areas that could otherwise be used for exportable coffee, fruits, and vegetables.

Although Yemen’s extensive territorial waters and marine resources have the potential to produce 840,000 tons of fish each year, the fishing industry is relatively underdeveloped and consists largely of individual fishermen in small boats. In recent years, the government has lifted restrictions on fish exports, and production has reached one-quarter of capacity, yielding revenues valued at US$210 million in 2004. Fish and fish products constitute only 0.6 percent of Yemen’s GDP but are the second largest export. In December 2005, the World Bank approved a US$25 million credit for a Fisheries Management and Conservation Project to be launched in all coastal governorates along the Red Sea and the Gulf of Aden. This project is expected to improve fish landing and auction facilities, provide ice plants for fish preservation, and enable Yemen’s Ministry of Fisheries to undertake more effective research, resource management planning, and regulatory activities.

Mining and Minerals: Yemen is a small oil producer and does not belong to the Organization of the Petroleum Exporting Countries (OPEC). Unlike many regional oil producers, Yemen relies heavily on foreign oil companies that have production-sharing agreements with the government. Income from oil production constitutes 70 to 75 percent of government revenue and about 90 percent of exports. Yemen contains proven crude oil reserves of more than 4 billion barrels, although these reserves are gradually dwindling, and output from the country’s older fields is falling. According to statistics published by the International Energy Agency, crude oil output averaged 465,000 barrels per day (bbl/d) in 2003 and 414,200 bbl/d in 2004. For the first half of 2005, crude oil output averaged only 380,000 bbl/d, increasing to approximately 400,000 bbl/d in September. Economists estimate that crude oil output averaged 391,000 bbl/d in 2005.

Since the mid-1990s, the primary focus of Yemeni natural gas development has been the export of liquefied natural gas (LNG). In 1997, in order to commercially develop Yemen’s 16.9 trillion cubic feet of natural gas reserves, Yemen Gas Company joined with various privately held companies to establish Yemen LNG (YLNG). In August 2005, following years of setbacks, the government gave final approval to three LNG supply agreements, enabling YLNG to award a US$2 billion contract to an international consortium to build the country’s first liquefaction plant at Balhat on the Arabian Sea coast. The plant is expected to deliver a total of 6.7 million tons of LNG per year; initial shipments could be made available by late 2008.

Industry and Manufacturing: The U.S. government estimates that Yemen’s industrial sector constitutes 47.9 percent of gross domestic product. Together with services, construction, and commerce, industry accounts for less than 25 percent of the labor force. The largest contributor to the manufacturing sector’s output is oil refining, which generates roughly half of total revenue. The remainder of this sector consists of the production of consumer goods and construction materials. Manufacturing constituted approximately 9 percent of Yemen’s gross domestic product in 2004. In 2000 Yemen had almost 34,000 industrial establishments with a total of slightly fewer than 115,000 workers; the majority of the establishments were small businesses (one to four employees). Almost half of all industrial establishments are involved in processing food products and beverages; the production of flour and cooking oil has increased in recent years. Approximately 10 percent of the establishments are classified as manufacturing mixed metal products such as water-storage tanks, doors, and windows.

Energy: Yemen’s state-owned Public Corporation for Electricity (PCE) operates an estimated 80 percent of the country’s electricity generating capacity (810–900 megawatts) as well as the national power grid. Over the past 10 years, the government has considered various means of alleviating the country’s significant electricity shortage, including restructuring the PCE, integrating the power sector through small-scale privatization of power stations, creating independent power projects (IPPs), and introducing gas-generated power plants to free up oil supplies for export. However, because of inadequate infrastructure, large-scale IPPs and privatization proposals have failed to materialize, although several smaller-scale projects in Al Mukalla and Aden have been completed, and contracts have been signed for future projects. In 2003 Yemen’s diesel-run power plants generated 3.9 billion kilowatt-hours of electricity, a level of production that is insufficient to maintain a consistent supply of electricity. Although demand for electricity increased 20 percent between 2000 and 2003, it is estimated that only 5 percent of rural households and 30 percent of urban households have access to electricity from the national power grid. To meet this demand, the government plans to increase the country’s power generating capacity to 1,400 megawatts by 2010.

Services: Economists have reported that Yemen’s services sector constituted 51.7 percent of gross domestic product (GDP) in 2002 and 52.2 percent of GDP in 2003. The U.S. government estimates that the services sector accounted for 39.7 percent of gross domestic product in 2004 and 38.8 percent in 2005.

Banking and Finance: According to economists, Yemen’s financial services sector is underdeveloped and dominated by the banking system. Yemen has no public stock exchange. The banking system consists of the Central Bank of Yemen, 15 commercial banks (nine private domestic banks, four of which are Islamic banks; four private foreign banks; and two state-owned banks), and two specialized state-owned development banks. The Central Bank of Yemen controls monetary policy and oversees the transfer of currencies abroad. It is the lender of last resort, exercises supervisory authority over commercial banks, and serves as a banker to the government. The largest commercial bank, the National Bank of Yemen, which is fully state-owned, and the Yemen Bank for Reconstruction and Development, which is majority state-owned, are currently being restructured with the goal of eventual privatization. Because of fiscal difficulties in both banks, in 2004 Yemen’s government adopted a plan to merge them; the new publicly owned Development Bank will have a minimum capital of US$50 million.

The large volume of non-performing loans, low capitalization, and weak enforcement of regulatory standards hamper Yemen’s banking sector as a whole. Numerous banks are technically insolvent. Because many debtors are in default, Yemen’s banks limit their lending activities to a select group of consumers and businesses; as a result, the entire banking system holds less than 60 percent of the money supply. The bulk of the economy operates with cash. Legislation adopted in 2000 gave the Central Bank the authority to enforce tougher lending requirements, and in mid-2005 the Central Bank promulgated several new capital requirements for commercial banks aimed at curtailing currency speculation and protecting deposits.

Tourism: Yemen’s tourism industry is hampered by limited infrastructure as well as serious security concerns. The country’s hotels and restaurants are below international standards, and air and road transportation is largely inadequate. Kidnappings of foreign tourists remain a threat, especially outside the main cities, and, coupled with terrorist bombings at the Port of Aden in 2000 and 2002, present a significant deterrent to tourism. As recently as December 2005, in separate incidents a German diplomat and his family and several Italian tourists were kidnapped by tribesmen in rural areas of Yemen and freed shortly thereafter. In April 2006, the U.S. Department of State reiterated previous warnings to U.S. citizens concerning the risks of travel to Yemen. Britain’s Foreign Office has issued a similar advisory. Recent statistics for tourist arrivals in Yemen are not available; in 2003 the number rose to 148,000 from 89,000 in 2002.

Labor: According to the U.S. government, the agriculture and herding sector employs the majority of Yemen’s working population (54.2 percent in 2003). Industry, together with services, construction, and commerce, accounts for less than 25 percent of the labor force.

According to the World Bank, Yemen’s civil service is characterized by a large, poorly paid work force and inadequate salary differential between high and low skilled jobs to attract and retain qualified workers. In 2004 the government increased civil service salaries by 20 to 40 percent in order to alleviate the impact of anticipated economic reforms that were never implemented. The result was a 20 percent rise in wage costs; civil service wages constituted 7 percent of gross domestic product in 2004. The 2005 budget reduced economic subsidies but in exchange required the government to make various concessions, including increasing civil service wages another 10 to 15 percent by 2007 as part of a national wage strategy.

The economic assistance package the International Monetary Fund (IMF) pledged to Yemen is contingent on the implementation of civil service reform, which the government has resisted because of the country’s estimated 20 to 40 percent unemployment rate. In 2004 the government claimed to have reduced the civil service labor force through retirements and layoffs, but it appears that the large salary increases have lessened the impact of any reforms. The IMF has stated that civil service salaries as a component of gross domestic product should be reduced 1 to 2 percent, a level that can only be achieved with continued reductions in the size of the civil service. It is unclear whether the national wage strategy, which may succeed in streamlining the system and removing irregularities, will in fact be able to reduce employment costs.

Foreign Economic Relations: During the 1990–91 Gulf War, Yemen supported Iraq in its invasion of Kuwait, thereby alienating Saudi Arabia and Kuwait, which both had provided critical financial assistance to Yemen. In addition to withdrawing this aid, Saudi Arabia expelled almost 1 million Yemeni workers. The resultant fall in expatriate remittances had a disastrous effect on Yemen’s governmental budget. The civil war of 1994 further drained the economy, and in 1995 Yemen sought the aid of multilateral agencies. In 1996 the International Monetary Fund (IMF) granted Yemen a US$190 million stand-by credit facility, and the following year it approved two funding facilities that increased the country’s credit by approximately US$500 million. The funding was contingent on Yemen’s adoption of stringent economic reforms, a requirement that the country had limited success in fulfilling. As a result, the IMF suspended lending to Yemen from late 1999 until February 2001. The extension of the two funding facilities, particularly the poverty reduction and growth facility (PRGF), through October 2001 was again contingent on Yemen’s commitment to economic reform. Because of Yemen’s failure to comply sufficiently with the terms imposed by the IMF, since 2002 the IMF has withheld US$300 million in concessional financing. Discussions over the renewal of the PRGF are ongoing. In 2000 Kuwait and Saudi Arabia resumed financial aid to Yemen.

In October 2002, bilateral and multilateral lenders led by the World Bank agreed to give Yemen a four-year economic support package worth US$2.3 billion, 20 percent in grants and 80 percent in concessional loans. This funding is almost eight times the amount of financial support Yemen received under the IMF’s PRGF. However, in December 2005 the World Bank announced that because of the government’s continued inability to effect significant economic reforms and stem corruption, funding would be reduced by more than one-third, from US$420 million to US$240 million for the period July 2005–July 2008. At present, Yemen owes approximately US$264 million to Japan, one of its largest donors. In December 2005, the Japanese government pledged to write off US$17 million of the debt. That same month, Germany pledged to increase its annual aid to Yemen to US$83.6 million over the next two years; funding will go primarily to education and water improvement projects.

Yemen is a member of the Arab Fund for Economic and Social Development, which since 1974 has contributed to the financing of economic and social development in Arab states and countries through loans and guarantees. In March 2004 the Arab League provided US$136 million to Yemen to finance infrastructure improvements. Yemen was granted observer status at the World Trade Organization (WTO) in 1999, and its application for full membership is currently under negotiation.

Imports: Imports totaled US $3.9 billion in 2004 and are projected to increase to US$4.2 billion in 2005 and to US$4.5 billion in 2006. Yemen is a net importer of all major categories of products except fuels. Principal imports are machinery and transport equipment, food and livestock, and processed materials. According to the United Nations, Yemen imports more than 75 percent of its main dietary staple—wheat. The principal source of Yemen’s imports in 2004 was the United Arab Emirates (12.2 percent of total imports); the bulk of these imports are actually re-exports from the United States and Kuwait. Yemen received 9.7 percent of its total imports from Saudi Arabia and 8.8 percent from China.

Exports: In 2004 Yemen’s exports totaled US$4.7 billion. Exports are expected to increase to US$6.3 billion in 2005 and decline subsequently to US$6 billion in 2006 and US$5 billion in 2007 as a result of lower oil prices and reduced output. Petroleum is Yemen’s main export, accounting for 89 percent of total exports in 2003 and 92 percent in 2004. Yemen’s non-oil exports are primarily agricultural products, mainly fish and fish products, vegetables, and fruit. In 2004 Asia was the most important market for Yemen’s exports, primarily Thailand (33.8 percent of total exports), China, Singapore, India, South Korea, and Malaysia.

Trade Balance: Yemen’s import and export values have increased and decreased dramatically in the past 10 years owing to shifts in global oil prices. As a result, the country’s trade balance has fluctuated significantly from a deficit of almost US$800 million in 1998 to a surplus of US$1 billion in 2000. Rising oil prices resulted in a surplus of US$800 million in 2004 and an estimated surplus of US$2.1 billion in 2005.

Balance of Payments: Yemen’s current account peaked in 2000 with a surplus of US$1.4 billion. The surplus dropped to US$176 million in 2003 because of a narrower trade surplus and higher income debits. As a result of strong oil prices and modest import gains, the country’s current account registered a surplus of US$200 million (1.6 percent of gross domestic product) in 2004, and a surplus of US$1.2 billion is estimated for 2005 (approximately 7.2 percent of gross domestic product).

External Debt: In 1990 the newly unified Republic of Yemen inherited an unsustainable debt burden amounting to roughly 106 percent of gross domestic product. Debt rescheduling by the Paris Club creditor countries in the 1990s coupled with assistance from the World Bank’s International Development Agency resulted in a drop in Yemen’s debt stock to US$5.4 billion (an estimated 39 percent of gross domestic product) by year-end 2004. Yemen’s international reserve position has improved gradually since its lowest point in 1993 as a result of current-account surpluses and a series of capital inflows. In July 2005, Yemen began to reverse the losses in foreign reserves that had occurred over the first six months of 2005; as of the third quarter of 2005, Yemen’s reserves of foreign exchange and gold were US$5.8 billion.

Foreign Investment: Yemen does not have a stock exchange, therefore limiting inward portfolio investment. Portfolio investment abroad is also very limited, with the result that portfolio flows are largely unrecorded by authorities. In the early 1990s, net direct investment was at its peak as foreign investors tapped Yemeni oil reserves, but since 1995 net direct investment flows have been negative because cost recovery for foreign oil companies has exceeded new direct investment. A five-year US$3 billion liquid natural gas (LNG) construction project involving a consortium of foreign companies is planned following government approval in August 2005. Such a project raises the prospect of increased foreign investment in the future as LNG facilities are built.

Currency and Exchange Rate: Yemen’s currency is the Yemeni riyal (YR), which was floated on the open market in July 1996. Periodic intervention by the Central Bank of Yemen has enabled the riyal to gradually depreciate since 1999. It was valued at YR195 per US$1 in December 2005, a decline of approximately 4.9 percent from the previous year. In late May 2006, the exchange rate was about YR196 per US$1.

Fiscal Year: Yemen’s fiscal year coincides with the calendar year.

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