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DE RUEHYN #0835/01 0841356
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P 251356Z MAR 06
FM AMEMBASSY SANAA
TO RUEHC/SECSTATE WASHDC PRIORITY 3348
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C O N F I D E N T I A L SECTION 01 OF 03 SANAA 000835 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: DECL: 03/23/2016 
TAGS: PGOV EFIN ECON EPET EINV KALR KMCA KMPI YM
SUBJECT: IMF OFFERS GLOOMY PROGNOSIS FOR YEMEN'S ECONOMY 
 
REF: A. SANAA 2005 2957 
     ¶B. SANAA 2005 1976 
     ¶C. SANAA 2005 1919 
     ¶D. SANAA 146 
     ¶E. SANAA 647 
 
SANAA 00000835  001.2 OF 003 
 
 
Classified By: DCM Nabeel Khoury for reasons 1.4 (b) and (d). 
 
¶1. (C) SUMMARY: On March 20, the International Monetary Fund 
(IMF) completed its Article IV Consultation for Yemen.  In a 
briefing for donors, the Fund's macroeconomic projections 
were decidedly bleak, emphasizing an impending fiscal crisis 
caused by declining oil reserves and increased spending. 
This analysis largely confirms existing studies, and will 
mean a series of tough choices for the ROYG in the next five 
years.  The IMF's remedy includes cutting subsidies, reducing 
the civil service, new taxes and partially devaluing the 
currency, all likely to bring a period of instability.  There 
is some indication that the IMF may be willing to become more 
engaged with the ROYG in implementing these reforms.  The 
Fund's representatives also diverged from the usual script to 
support donor reform objectives to improve governance and the 
investment climate. END SUMMARY. 
 
--------------------------------------------- 
"One of the Toughest Outlooks I've Ever Seen" 
--------------------------------------------- 
 
¶2. (U) A delegation of the International Monetary Fund 
recently completed its 2005 Article IV Consultation on 
Yemen's macroeconomic health.  The report will likely be 
published at the end of May.  On March 20, USAID Director and 
Econoff attended a donor meeting at which the IMF offered a 
summary of their findings. 
 
¶3. (C) Lorenzo Perez, Deputy Director for the Middle East and 
Central Asia, estimated steady GDP growth of four percent for 
2005, with 4.5 percent non-petroleum growth.  The overall 
macroeconomic picture presented by the IMF, however, was very 
negative.  According to Perez, the combination of three 
percent population growth and declining oil reserves will 
place enormous pressure on the budget in the near future. 
Privately, Perez told Econoff:  "Yemen's outlook is one of 
the toughest I've ever seen." (NOTE: 80 percent of annual 
revenues in Yemen are derived from oil sales. END NOTE.) 
 
-------------------------------------- 
Declining Oil Will Bring Fiscal Crisis 
-------------------------------------- 
 
¶4. (U) Declining oil production will dominate this year's 
report, warned Perez.  After collecting data from both the 
ROYG and private companies, the IMF predicts a drop in 
production from 390,000 barrels per day to 260,000 within 
five years.  Without a major new discovery, Yemen may run out 
of oil reserves by 2016.  The ROYG is currently tendering a 
number of new blocks for exploration, but most experts 
predict additional production of only 20-30,000 barrels per 
day.  Liquid natural gas exports are expected to begin in 
2009, generating USD 1 billion a year, but even this will not 
significantly offset declines in oil. (Septel) These negative 
trends will ultimately put pressure on Yemen's foreign 
currency reserves, which recently exceeded USD 6 billion. 
 
¶5. (SBU) The IMF warned that the ROYG's budgeting practices 
were dangerously expansionary.  In a year of record high oil 
prices, Yemen is expected to show a deficit of three percent 
of GDP in its 2006 budget.  With declining oil revenues, this 
could increase to a deficit of 20 percent by 2010.  Yemen 
routinely underestimates oil revenues (this year it projects 
prices at USD 40 per barrel), requiring supplementary budgets 
to allocate additional funds. (Ref A) According to the IMF, 
however, this revenue is likely to be largely consumed by 
fuel subsidies.  Despite a significant reduction in the 
subsidy last July, rising oil prices have largely negated 
these gains, with the cost for this year's subsidy running at 
approximately USD 800 million (more than five percent of GDP). 
 
------------------- 
An Eye on Inflation 
------------------- 
 
¶6. (U) Maintaining a stable exchange remains the Central 
Bank's highest priority, said IMF representatives.  Currently 
trading at 196 YR to the dollar, the riyal has lost less than 
five percent of its value against the dollar over the past 
year.  The ROYG regularly intervenes to bolster the riyal, 
most recently in January, when it pumped USD 215 million from 
foreign currency reserves into the local market. 
 
 
SANAA 00000835  002.2 OF 003 
 
 
¶7. (U) The Fund is more concerned with inflation, however, 
which has fluctuated between 10 and 13 percent in recent 
years.  Some contacts at the Central Bank predict that 
overall inflation for 2005 will be closer to 20 percent, but 
this includes a one-time inflationary spike caused by the 
partial lifting of oil subsidies. (Ref B)  Nevertheless, the 
IMF predicts a steady increase in inflation rates, due 
largely to high oil prices.  Ultimately, Perez said the ROYG 
must allow for a more flexible exchange rate, which would 
likely result in a significant devaluation of the riyal. 
(NOTE:  This would be a serious blow to average Yemenis, who 
are largely dependent on import commodities. END NOTE.) 
 
--------------------------- 
Fund Offers Bitter Medicine 
--------------------------- 
 
¶8. (U) The Article IV report will note several positive 
developments in the ROYG's efforts to increase revenue.  The 
long-delayed value-added tax is expected to go into full 
effect by January 2007. (Ref C) Combined with more effective 
methods of tax collection and customs fees, this could 
generate as much as three percent of GDP in new revenues. 
Perez also warned that the ROYG must restrain growth in the 
wage bill, which doubled the minimum wage this year.  Despite 
low salaries for civil servants, the IMF contends that the 
ROYG simply cannot afford a spending increase of this size. 
If implemented, civil service reform could also reduce 
expenditures.  The ROYG claims it will issue biometric cards 
to government employees within two months, in order to cut 
down on "ghost workers" and those drawing more than one 
salary.  Perez also suggested that the rising defense budget, 
approximately seven percent of GDP, was high for the region. 
 
¶9. (SBU) All of these reforms combined, however, would not 
have the same impact as eliminating fuel subsidies, which 
amount to nine percent of GDP.  Perez recognized that 
removing subsidies is painful for average citizens, as 
evidenced by last July's riots, and recommended a more 
gradual approach. (Ref B) Fuel prices could be adjusted to 
international prices over a period of three years, said 
Perez.  Without such measures, said Perez, not only will 
Yemen face declining revenues, but debt levels (mainly 
domestic) will also become unsustainable, perhaps rising to 
100 percent of GDP within five years.  This would almost 
certainly cause a crisis of confidence in Yemen's economy, 
leading to a currency collapse and capital flight. 
 
------------------------------------- 
IMF Joins Call For Governance Reforms 
------------------------------------- 
 
¶10. (SBU) The Article IV delegation diverged this year from 
strict monetary policy to address broader issues affecting 
Yemen's investment climate.  These issues are more difficult 
to address from a macroeconomic standpoint, as there are few 
available statistics for unemployment, poverty levels and 
other key measures of standard of living.  Perez stressed 
that the IMF was committed to pro-growth policies, and noted 
problems in the banking sector, accounting standards and rule 
of law as impediments to investment.  In general, Perez 
expressed strong support for the donors' coordinated approach 
to governance reform, and stressed the importance of such 
measures for Yemen's business climate. (Ref D) "Ultimately," 
said Perez, "Yemen must clean up its own house." (NOTE: This 
defense of the Fund's pro-growth position was a direct 
response to the UN, which has charged that the IMF does not 
sufficiently emphasize job creation and poverty reduction in 
Yemen. END NOTE.) 
 
¶11. (C) The team was somewhat encouraged by the new Minister 
of Finance, Seif Al-Asali, and his outspoken commitment to 
reform. (Ref E) Asali recently replaced the Ministry's budget 
director and is reportedly eager to replace a large number of 
middle managers who have become complacent or corrupt.  Perez 
was cautious about a number of Asali's specific initiatives, 
however, describing him as "a man in a hurry."  Some of 
Asali's more dubious priorities include setting up a stock 
market and reducing the corporate tax, which stands at a 
relatively high 35 percent.  IMF analysts were concerned that 
despite the potential of a tax cut to stimulate growth, it 
could deprive the ROYG of critical revenue when it needs it 
most.  The IMF was willing to contemplate such a move only if 
accompanied by the elimination of some of Yemen's multiple 
tax exemptions. 
 
--------------------------------------------- ------ 
Comment: Desperate Times Call For Enhanced IMF Role 
--------------------------------------------- ------ 
 
 
SANAA 00000835  003.2 OF 003 
 
 
¶12. (C) This year's Article IV Consultation does not come as 
a shock to close observers of Yemen's economy, and confirms 
many of the more dire predictions of the World Bank and 
others.  Declining oil reserves lie at the heart of the 
problem, and replacement revenues cannot be found without 
major changes in Yemen's economic and fiscal policies.  IMF 
representatives do not expect any of these difficult 
decisions to be made before the September elections, but they 
hope to engage the ROYG immediately thereafter with another 
visit in October.  The IMF currently has no presence in Yemen 
and essentially cut its program in 2001 when reforms stalled. 
 The Fund said it cannot return in force without an 
invitation from the ROYG, but some in the donor community 
feel that the time is ripe for full engagement.  Many of the 
IMF's recommended macroeconomic reforms will likely bring 
serious instability, and require the Fund's expert guidance 
to be implemented effectively. 
Krajeski