IMF: High oil revenues have reduced the urgency to advance Economic Reforms [Archives:2007/1095/Business & Economy]
Compiled by: YemenTimes Staff
A recent report by the International Monetary Fund (IMF) focusing on Yemen has indicated that the economic performance of Yemen in 2006 we generally favorable, stating that non-oil growth have been strong and did off-set the decline in oil production. However, the report also stated that inflation during 2006 have doubled to over 20 percent, as reflected in the rising food prices and the domestic spending driven by high government spending from record oil revenues, the increase in spending resulted from a large wage increase and rapid money growth among other reasons.
The report also warned that the fact that Oil resources could run out in ten years, and the fact that oil revenues currently account for over three quarters of the government revenues, make Yemen's fiscal and external sustainability a worrisome issue, unless the government takes corrective actions and makes a large fiscal adjustment, or major new oil finds, the government finances would deteriorate rapidly in coming years, risking domestic and external instability.
The report, entitled The Article 4 consultations staff report, has listed a number of policy discussions and recommendations for the government in Yemen in order to reduce inflation and improve fiscal sustainability, these recommendations were formulated after IMF staff meetings with the Government of Yemen Officials as well as local economists and development experts. These recommendations also build on the implementation of the Government of Yemen for the previous recommendations of the IMF (see adjunct Box), as well as the recent economic developments in the country.
These policy recommendations are:
– Bringing inflation down to levels below 10 percent, to prevent expectations of high inflation from becoming entrenched;
– Achieving fiscal sustainability in the context of declining oil reserves;
– Promoting nonhydrocarbon growth to create employment opportunities and help achieve a lasting reduction in poverty.
– The authorities recognized the need to reduce inflation and agreed to undertake a modest tightening of fiscal and monetary policies.
– The authorities are urged to allow some nominal appreciation of the rial and to liberalize, and possibly raise, interest rates in order to help bring down inflation more firmly, especially as the wage increase will only be delayed.
– The authorities agreed to slow the rate of depreciation of the rial, but were reluctant to allow a nominal appreciation, for fear of losing reserves and hurting competitiveness.
– The authorities were also hesitant to liberalize interest rates and pursue a more active interest rate policy.
Ensuring Fiscal Sustainability
– While the authorities are placing high hopes on finding new oil and gas reserves, they agreed that fiscal policy needs to be based on conservative estimates of existing reserves
– The authorities acknowledged that current policies are not sustainable over the medium term and may lead to domestic and external instability.
– The authorities realized the need for a large fiscal adjustment effort.
– The authorities broadly accepted the staff's adjustment scenario, but noted that
– implementation was likely to be slower due to political economy considerations.
– Reforms aimed at increasing non-oil revenues by broadening the tax base and improving compliance are progressing, albeit slowly.
– The authorities have started an ambitious and comprehensive two-year public financial management reform program.
Promoting Sustained Nonhydrocarbon Growth
– As oil production declines, new sources of growth will need to be found, especially to absorb the rapidly growing labor force.
– The authorities recognized that sustained growth also requires a much higher level of financial intermediation than currently exists in Yemen.
– The authorities expressed strong interest in a multi-sector statistics mission to conduct a comprehensive evaluation of the macroeconomic statistics and develop a strategy for improving the quality and timeliness of data.
– Yemen has a very open trade regime and is seeking to enhance trade integration.
IMF Staff Appraisal
– The Yemeni authorities face considerable challenges to promote strong economic growth to create new employment opportunities and reduce poverty, while ensuring fiscal and external sustainability in the context of declining oil reserves.
– The envisaged tightening of fiscal and monetary policies will help reduce inflation.
– Monetary policy should focus more closely on achieving low inflation.
– To help bring down inflation more swiftly, the CBY could allow some nominal appreciation of the rial in the short run.
– The minimum interest rate for rial deposits should be removed to allow the Central Bank of Yemen to conduct a more active interest rate policy and to enhance financial intermediation.
– Yemen's fiscal policies will need to adjust to the prospective decline in oil production and revenues.
– Yemen will need strong economic growth to achieve a significant reduction in unemployment and poverty.
– Data provision is still adequate for surveillance, but improvements are needed to better facilitate the formulation and monitoring of economic policies.
Assessment of the IMF Executive Board
The Executive Board welcomed Yemen's generally favorable recent economic performance, including the decline in the poverty rate, as well as the progress being made on a number of structural reforms. Nevertheless, Directors concurred that the authorities face considerable macroeconomic and structural policy challenges to promote strong economic growth, create ample employment opportunities, and reduce poverty, while ensuring fiscal and external sustainability. In this regard, Directors welcomed the authorities' strategy of basing policies on existing hydrocarbon reserves, while recognizing that the country's economic outlook could be significantly altered by the discovery of new oil and gas resources.
Directors, noting that inflationary pressures have not fully abated, were encouraged by the authorities' commitment to reducing inflation. They agreed that monetary policy should focus closely on price stability and welcomed the CBY recent efforts to keep the exchange rate of the rial vis-a-vis the U.S. dollar broadly stable, which should help limit imported inflation. Given the limitations of monetary policy in Yemen, Directors generally considered it to be appropriate for the CBY to continue to rely substantially on the exchange rate as a nominal anchor, in order to achieve lower inflation. While the exchange rate currently appears to be broadly in line with fundamentals, over time and in view of the expected decline in oil production, it will be important for the exchange rate to reflect evolving economic conditions.
Directors observed that the shallow financial intermediation, along with a relatively high level of dollarization, is limiting the effectiveness of monetary policy. They viewed that the removal of the minimum interest rate for rial deposits would allow the CBY to conduct a more active interest rate policy and enhance financial intermediation.
Directors noted that fiscal restraint, including public sector wage restraint, should provide an important complement to monetary policy in reducing inflationary pressures. They also
underscored that frontloading fiscal adjustment will be needed, given the prospective decline in oil production and revenues.
Directors agreed that the gradual phasing out of domestic fuel subsidies will be central to fiscal adjustment, while recognizing that this will require political support. They noted that raising fuel prices should go hand-in-hand with strengthening the social safety net, in order to cushion the impact on the poor, including through persevering with ongoing efforts aimed at improving the Social Welfare Fund. Directors also were of the view that, if the authorities wished to cushion the impact of high wheat prices on the poor, it would be preferable to do so through the SWF. Strong efforts will also be needed to increase the government's non-oil revenues, reorient spending towards priority areas, and improve the quality and effectiveness of capital spending. Directors supported the progress being made towards strengthening the budgetary frameworkand improving fiscal transparency. Directors underscored the importance of productivity-enhancing reforms to strengthen Yemen's competitiveness in non-oil exports. Further efforts are needed to improve the investment climate and the quality of labor, enhance governance and reduce red tape, including in tax and customs administration. Directors stressed that deepening financial markets will be essential for ensuring strong non-oil performance, and also recommended further strengthening of banking supervision. In this regard, they encouraged the authorities to request an Financial Sector Assessment Program update, which would help to assess potential risks in the financial system and to develop an agenda for financial sector reforms. Directors welcomed the revised Anti-Money Laundering law, and looked forward to its approval by parliament.
Directors looked forward to further efforts to improve the quality and timeliness of macroeconomic statistics, to better facilitate the formulation and monitoring of economic policies.
Implementation of Past IMF Recommendations
Fiscal policy: A General Sales Tax (GST) was introduced in 2007, after seven years of preparation, but with concessions regarding the valuation of imports to gain support from the business community. Full implementation is now envisaged only in early 2009. Customs tariffs were substantially reduced in 2006. Generous tax exemptions remain. The tax administration is moving towards a functional-based organizational structure and use of self assessment, but progress has been slow. A large tax payer unit was established. The authorities have not begun phasing out fuel subsidies, except for a one-time increase in domestic fuel prices in July 2005.
Monetary and exchange rate policy: Full liberalization of interest rates is yet to be implemented. Monetary policy remains geared more toward targeting the exchange rate than toward controlling inflation. Banking sector supervision needs to be strengthened and staff has repeatedly encouraged the authorities to request an update of the 2001 FSAP.
Structural reforms: Staff has called for reforms that boost private sector growth through improving the business climate and governance. New procurement legislation and implementation regulations have been prepared.
Macroeconomic data: Progress has been made in improving statistics, notably in monetary, balance of payments, and fiscal data, but further efforts are needed to improve the quality, timeliness and dissemination of Yemen's statistics. Areas particularly in need of improvement include national accounts and price statistics.