Economic impacts oflifting subsidy from fuel [Archives:2005/871/Front Page]

August 25 2005

By Abdulelah Taqi
For Yemen Times

The latest price reforms have resulted in negative and positive outcomes. They are significant because the economy has not fulfilled a significant progress, the government failed to achieve goals of the Second Five-Year Plan and Poverty Reduction Strategy. Those failures have made the “price reforms” the easiest way to prevent from a likely economic collapse if the saved subsidies (US$ 700m) should be responsibly spent on troubled development sectors such as education and health. So far the government has not substantially activated any other income pumping sectors. Outcome of the extra budgetary account of YR 188b is still questionable according to the parliament Financial Committee (NewsYemen: 07.26.05). Some legislative reforms have not maintained consistency with the openness-based market and the underway WTO integration-oriented economy (NewsYemen: 07.26.05). The WB people say that having recourse to efficiency, justice and transparency in managing the public resources is significantly consistent with achieving poverty reduction and constant growth. They argue that Yemenis are the poorest in the planet (YObserver: 08.13.2005). They insist that poverty is the most significant challenge and are concerned of the fiscal adjustments without administrative or judicial reforms. A 2002 FAO report said that falling per capita incomes have aggravated further the food insecurity situation of low-income households, where access to food is also constrained by the short-term negative impact of structural adjustment measures. Inefficient and poorly integrated food markets coupled by geographical isolation are additional factors, which combine to further limit access to food for the poor. In the meantime, Increasing local and international reports are pointing out to the magnitude of corruption and governance low graded indicators in the country.

Petroleum local consumption & subsidies

The local consumption of diesel rose from 553.3 million liters in 1990 to 2753 million in 2004 (PEPA: 2005). Recently, significant development projects have been implemented in Aden and Safir oil refineries which together produce about 130,000 bpd in 2004 (eia: 2004). The Yemen Oil Refining Company estimated it 90,000 – 110,000 bpd from Aden refinery and 10,000 from Safir Refinery. Refineries' products are used to cover the local market needs and for export. Two new refineries have been promoted for the private sector the first, Adhaba- Hadhramout, 50,000 bpd, was approved in 2002 and the second, Ras-Essa-Hodieda, 45,000 bpd, was approved in 2003 (PEPA: 2005).

In 2002, ROYG subsidized oil with YR 42 billion, but the figure jumped, spurred by the additional allocations, to YR 102 billion in 2003 and to YR 134 billion in budget 2005. Oil is most unlikely to be smuggled to any GCC or neighboring African country because the new local prices are higher than that in those states, especially that Saudi Arabia, after the death of King Fahd, government reduced the oil rate to equivalent to YR 21 instead of YR 50/liter and increased government employees' salaries. Eritrea and maybe Somalia is the most possible receiver of the Yemeni smuggled oil due to its very expensive oil rates. Local consumption of oil will dramatically drop in the second half of 2005.

Depressing impacts:

The negative results will plight the people who are among the poorest in the world. The reforms will impact the cost of agriculture and fishery production and other products due to transport higher ensued costs. Some economists expect prices to rise 20% while others expect it 80% due to the weakness of government control on prices and fragility of the institutional system (NewsYemen: 07.26.05). Economists agree that such impacts are a normal short-term result if other adjustments are forged and economy is stimulated.

MP Abdul-Karim Shaiban refers to the official statistics and said that 1 million farmers funding for 8 million people and 40 thousand fishermen would be affected by those reforms. And subsequent decline in the agriculture and fishing sectors will ensue.

Constructive effects and commitments:

The 26-September newspaper said the relevant government bodies have started implementing the presidential instructions putting an end to oil smuggling and monopoly that would save YR 3.7b to the state treasury. President Saleh instructed the government to regulate the usage of petroleum derivatives; he urged to prevent changing petrol-fueled engines of vehicles to gas or diesel fueled ones, earmark the fuel allocations to each province in accordance to the population and agricultural and manufacturing industries in each one, sell oil out to the foreign commercial ships, planes and big foreign companies based on the international rates, and control the goods prices.

A couple of days before the reform was announced, president Saleh had approved three significant reform-driven legislations, Customs Tariff Law, General Sales Tax Law and Wages and Salaries Strategy Law. After the reform had been announced, the government came up with 15 reform-oriented policies that are designed to cushion the reform impacts on the government employees, farmers, fishermen and other segments of the poor. Government committed to expand the social welfare network, support the SFD and Public Works project, continue subsidizing other certain services, support irrigation, apply public spending rationalization program in all fields, reduce expenditures on overseas conferences, and ban government vehicles and furniture purchases.

The state's leaders stressed on the IMF and WB's long recommended comprehensive fiscal strategy which aims at strengthening expenditure control, improve revenues, enhance fiscal transparency, but has not touched on any intentions to dissolve extra budgetary accounts and special oil funds which lead to the creation of a fully-fledged Treasury Single Account TSA. YR 188 billion in 2004 and YR 130 billion in 2003 were credited to these accounts. Poverty reduction strategy priorities started to be reflected in the national budget and sectoral plans are being implemented. Improving tracking of poverty-related spending and functional classification of expenditures were stressed by the government (IMF: Spring 2005).

The 2004 fiscal deficit was estimated at 4.5% of GDP, about 1% higher than the original budget. The larger than expected deficit was due to higher development spending and larger petroleum subsidy due mainly to higher oil prices and the postponement of the envisaged increase in petroleum prices. The ROYG used, for the first time, macroeconomic indicators and indicative ceilings in the preparation of the 2005 budget, but very little has been done before July 2005 to improve internal expenditure, control mechanisms or to improve budget execution of fiscal reporting (IMF: Spring 2005). In early August 2005, the cabinet approved a draft law reforming the finance management. The draft law targets improving management of the state accounts and mainstreaming the government purchase and tender system (Al-Thawra: 08.09.2005).

MOF has been mandated to design and implement a nationally oriented public spending program. The short-term 1997 cabinet implemented a similar program for a very short time. The new program tends to reduce spending on the diplomatic missions, seminar representations, purchase of vehicles and furniture, and construction of administrative buildings and to channel its allocations to development. MOF decided to increase efforts to generate revenue in order to balance the budget by increasing revenue and limiting expenditure. It has promulgated a ministerial decision to control expenditures. Based on this decision, MOF and MOPIC will decide on priority projects and the least urgent will be delayed while projects of poverty alleviation will be given priority. MOF recommended strict observation on finance management departments in every public institution. No more new institutions will be created and the already existing ones will be continuously evaluated to ensure they fulfill their goals. The privatization law will be put into effect and extra assets of administrative bodies as well as those in the mixed sector will be sold out as stipulated by the law of tender and bid procedures, as well as passing their revenues to the public treasury. Finance management departments of the public sector will be kept under strict supervision. The funds allocated for conferences and overseas missions will be reduced by 50% and those for ROYG officials medical treatment reduced by 25% (Al-Thawra, 08.03.2005).

A good news reported that Prime Minister called off a youth activity in Venezuela with tickets costing about YR 400 million (Al-Wasat: 08.04.2005), but this came a few days prior to a FIFA decision freezing Yemen's international sport participation due to ROYG interventions in sport affairs and financial allocations. The cabinet decided to prevent importing the gas-fueled vehicles, prevent transform engines to gas or diesel instead of gasoline, and to close down the workshops that do this act. Ministry of Industry and Trade established an operation room to control prices and prosecuted about 480 traders for overpricing.

Failures of the reforms

While the government and MOF new commitments promise for improved revenue management and austerity measures, leaders of the ministry are complaining of centralization, “absolutely” neglecting the revenue sector, and huge magnitude of corruption there. The MOF Deputy Minister of Revenues accused the minister of focusing on expenditures, of lacking any vision on the goals of the newly passed laws and lacking any studies on their financial and economic effects, and lacking any plans for budget reform regarding the remaining subsidies. He ruled out any MOF supervision on the customs, tax, public sector or oil management, except for the COCA that practices a limited document-based auditing. He insisted that in 2004 the value of customs exempted on goods reached two thirds of the customs revenues and about YR 500 billion for the last four years (Al-Wasat: 08.17.2005).

The cabinet has amended the parliament-approved salaries strategy and reduced the lowest limit to only YR 15,500 instead of 20,000 and the highest limit to YR 60,000 instead of YR 160,000 (Al-Sahwa net: 08.21.2005), kept the MPs clause in the law as it is; it gives MPs minister grade, ensures their minister-grade salaries for good and gives them all other ministers' financial privileges, about 2000 liters of fuel monthly, 4 air flight tickets yearly, US$ 5000 medical allowance, housing allowance …etc. The government announced intentions to implement the strategy on four stages the first to take four years starting from July 2005, while the law states that the strategy is (wholly) in effect and has not mentioned any time plan. The strategy is still unclear and ambiguous according to parliament social affairs committee's recommendations.

As to the judicial sector, Minister of Justice told the opposition Al-Shoura newspaper that during 2004 he has received about 450 illegal mediations letters from Prime Minister, parliament MPs, Sheikhs and dignitaries to interfere in court jobs. The minister added that the judiciary reshuffle of about 668 judges has not taken place so far. He concluded that he is threatened not to be included in the next cabinet “change” due to his “firm stances”.

Corruption of oil sector:

The parliament member of Financial Committee and economist Abdul-Karim Shaiban denied the YR 215 b subsidies to fuel saying that the citizens' consumption is considerably much less than the government consumption and the “rulers' smuggling”. Gasoline is locally produced and, therefore, its cost should be based on the real production and refining costs rather than the international rate. Shaiban said the Yemeni crude oil is exported for much cheaper prices than the world rates and that importing diesel is not monitored, is not based on tenders, diesel exporter to Yemen is unknown and the purchase rate is also unknown. Oil officials gave pretext that Yemeni oil is of less quality than the worlds'. Oil minister promised but up to the moment failed to give any justification. The processes of purchasing diesel are plagued by fraud in vouchers. “Yemen imports diesel from Ethiopia and Switzerland which are not oil producers,” Shaiban wondered. He suggested to the government to open competition to the private sector in order the citizen to take advantage of the international oil fluctuating rates and to take into consideration the low individual income. Shaiban assumes that government carries out corruption in the name of “subsidies costs”; in 2003 (Al-Shoura: 07.14.2003), he made the following calculations based on 2003 rates:

1- Gasoline: $ 28/barel (crude oil rate) + $3 to $5/ton (refining costs) + $22/ton (transport costs ($3.1/barrel)) at the end, each liter costs YR 35 which was the same rate applied before the recent cabinet decision and which means that there is no subsidies given to gasoline.

2- Diesel: YR 35 (diesel market rate) – YR 17(diesel rate in Yemen) = YR 18 (the subsidy) X 2 billion liters (local consumption) = YR36 billion (diesel subsidies as in the budget). But the government requested an additional allocation that raised the subsidy to YR 102 billion, so that the different (YR 66 billion) is the share of government corruption.

Impacts on agriculture:

About 80,000 diesel-fired water pumps scatter all over Yemen. Each water pump consumes 6 to 7 liters/hour. About 1.116 million landlords possess 1.133 million hectares of which 431 thousand hectares are well-water irrigated (Alsahwa net: 08.05.2005).

The agriculture Cooperative Union report reveals that YR 25.8 b to YR 34.5 b is the agriculture sector loss due to the cabinet decision. Based on 2005 prices, costs of spending on machines, labor and power will rise by 180% and direct impacts on irrigation and mechanical systems will incur. The report refers to the 2002 FAO report that the annual consumption of diesel used for irrigation is 1.659 billion liters costing YR 28 billion. Poultry prices rise by 25% (YR 100), egg box by 20% (YR 1000). The union owned 6 livestock farms will lose YR 200 million. And the cost of their potatoes production project will rise by 150% (YR 120 million).

The individual share of water is 120-150 cubic meter/year. 90% of water resources are used up in irrigation. Estimates indicate to annual water deficit at 1 billion cubic meters and that rainfalls cannot replenish the natural stock and to cover needs in the rural or urban areas where the annual rainfall level is only 250 mm. agriculture is 30% of GDP and provides with about 50% of the workforce. It constitutes a resource of income to two thirds of population and contain 85% of woman labor. Qat is 32% of GDP, fruits 20%, and livestock 17% (NY: 07……… 2005). Since qat is a cash crop,. At growing is not affected by the diesel price surge simply because its price is not regulated. It has a broadly lucrative market and it does not have an external competitor.

Other reforms are essential

The failure of the Second Five-Year Plan and Poverty Reduction Strategy are an indication of incapability to achieve a significant public investment progress. In addition, COCA performance has not improved and the country recorded a lower rank in the Transparency International 2004 report. Budget yearly spends US$ 92 million on the treasury bills profits and about US$ 700 million to prevent local currency from depreciation (CBY: 2004). The CBY has not introduced a major policy reform since mid-1990s. Privatization program has not achieved a serious progress since 1998. government remunerated about US$ 230 million to the ACT former operator due to an inefficiently composed operation contract and other bureaucratic challenges. The country's free zone is not yet under the government spotlight.

The parliament passed the Wages and Salaries Strategy Bill which is designed to cushion impacts of the price reforms on the government employees. The strategy is so complicate and unclear that it does not address significant category of employees. The cabinet made “unconstitutional amendment” to the passed bill; they reduced the wage lowest limit to YR 15,500 and the highest limit to YR 60,000 instead of YR 20,000 and YR 160,000 according to the bill. In the meantime, they kept the privileges the bill gives to the parliament members; MPs are given salaries and other privileges of ministers for good (Al-Ayyam: 07.08.2005).


Authorities introduced positive macroeconomic and policy developments in the context of the 2005 budget. They introduced the GST Law to levy 5% on almost all goods and services. A flexible exchange rate policy, supported by structural reforms, should boost growth in non-oil sectors, streamlining the transition to a multiple revenue resource economy.

The prices surge is a leading force in boosting poverty and inflation which reached 13.3% in 2004. Rational monetary policy should be geared to contain inflationary pressures. Monetary authorities should put price stability under its spotlight especially that macroeconomic stability is at stake.

The IMF underscored the importance of strengthening fiscal adjustment and deepening structural reforms to ensure fiscal sector development, with macroeconomic policies guided by long-term considerations as well as strengthen the non-oil sector. The IMF, WB and other donors frequently noted that fiscal adjustments alone will not be sufficient to achieve long term sustainability. Complementary macroeconomic and structural policies to stimulate growth and diversify the production base, away from oil, is considerably required. (IMF: Spring 2005) Particular attention should be given to sectors with a strong potential cooperative advantage and large job creation prospects, including fisheries, transshipment activities and tourism. The country's LNG, proposed to generate US$ 17b in 20 years (Al-Sahwa Net: 08.17.2005), is a significant part of solutions to meet the challenges posed by the declining oil sector.

The government should adopt policies that would improve the business environment, including reducing costs of business startups and streamlining procedures to encourage private sector investment. Addressing governance indicators and slumping down corruption should enhance the climate for local and foreign investment. Under all circumstances, if a supplementary budget is to be adopted later in this year, it should be subject to stringent budgetary discipline designed to respond only to unforeseen developments or external shocks.