Monetary Policy: From Bad to Worse [Archives:1999/18/Viewpoint]

May 3 1999

The exchange of the Yemeni Riyal vis-avis the US dollar continues to fall. The dollar now sells for YR 155 in the market, in spite of the best efforts of the Central Bank of Yemen.
The continued deterioration of the Riyal exchange rate is bringing havoc to an already fragile investment market and a difficult economic situation. Many investors and entrepreneurs have expressed alarm at the fall of the riyal and are having second thoughts about putting their money into Riyal investments.
“Our returns on investments are calculated at a certain exchange rate. When this rate falls, it means returns on investments will also fall. In other words, projects that are viable at a certain exchange rate, may turn out to be unprofitable,” explained one key investor who has decided to hold off.
Another fall-out from a falling Riyal exchange rate is that savings are now moved from Yemeni Riyal denominations to Dollar accounts. This leads to a run on the national currency, further exacerbating a difficult situation.
To address this situation, the Central Bank has recently increased interest rates on Riyal deposits, and has slashed interest on Dollar deposits. Unfortunately, this policy will not work.
The main reason it won’t work is simply because returns on dollar deposits are not decided in Sanaa, but in the world markets. So, if a Yemeni holder of dollar savings cannot get good returns in Sanaa, he/she will basically ship out his/her dollars to where-ever he/she can get a better deal. That is why this new monetary policy will simply lead to a flight of dollars from Yemen.
At the same, raising the interest on Riyal deposits will discourage investments in Yemen. Why would people with money to invest take project risks when they can get high returns by simply putting the money with the bank? At the same time, high interest rates become a forbidding factor for investors who need project funds.
Will the Central Bank of Yemen please wake up?