Yemen Country Report Economic policy outlook 2009 [Archives:2009/1227/Business & Economy]
By: Economist Intelligence Unit
Rising public discontent will ensure that the government is slow to implement much-needed fiscal reforms, especially fuel-subsidy reductions, despite the pressing fiscal need. Instead, it will seek to maximize Yemen's remaining hydrocarbons reserves by accelerating the pace of oil and gas exploration, offering more generous contract terms to international oil companies. However, as oil reserves, which currently provide most of its fiscal and export income, are expected to be depleted in 10-15 years, the government will also seek to promote development of the non-oil sector. To support these efforts, at a conference in London in 2006, international donors pledged some US$5bn (to be disbursed in 2007-10) to finance projects outlined in the government's five-year Development Plan for Poverty Reduction (DPPR). However, if the recent oil price fall is sustained, Yemen is unlikely to be able to afford its share of the projects in the DPPR, forcing it to turn to its international donors once more, especially those in the Gulf.
In 2009-10 the government plans to encourage local private enterprise and attract foreign investors by strengthening the financial sector, increasing the number of microfinance banks, modernizing the local commercial courts, reducing red tape and updating investment regulation. These efforts will continue to be hindered, however, by a poorly educated workforce and an unstable security climate, as well as by the increased risk aversion of banks in the wake of the global financial crisis.
Yemen's fiscal account is set to deteriorate markedly over the outlook period, as oil prices fall steeply from their highs of mid-2008. The fall in oil prices and production is expected to push overall revenue down by some 22% in 2009, despite the coming on stream of Yemen's first liquefied natural gas (LNG)
project, known as Yemen LNG. In response, the government has proposed a relatively conservative budget for 2009, and has included a provision to cut back spending further if required. It should be assisted in this by the steep drop in oil prices, which will allow outlays on the fuel subsidy to fall significantly, although the decline in fuel import costs may also reduce the urgency of further subsidy cuts. This will be insufficient to prevent a sharp widening of the fiscal deficit in 2009, from an estimated YR352bn (US$1.8bn), or 7.1% of GDP, in 2008 to YR747bn (13.7% of GDP).larger than the Economist Intelligence Unit's previous forecast, owing to a downward revision in our oil price projections.
In 2010 revenue will recover slightly, as oil prices pick up and the second LNG train comes on stream. Nevertheless, political concerns will prevent any major fiscal rationalization, such as the elimination of the fuel subsidy or a reduction in the public-sector workforce, and, as a result, the fiscal deficit should remain large, at around YR692bn. Financing this deficit may prove challenging. Although the Ministry of Finance can use Treasury-bill sales to the banking sector, local banks will struggle to absorb the entirety of the shortfalls, and thus the government will have to rely increasingly on concessional foreign lending (and, possibly, even assistance from the IMF).
Yemen's financial system is highly underdeveloped, and the economy is largely cash-based. This is expected to limit the direct impact of the global financial crisis on the country. However, it also reduces the efficacy of interest rate adjustments, depriving the Central Bank of Yemen (CBY) of an important monetary policy tool. As a result, the CBY's efforts to manage liquidity will remain primarily focused on the issuance of certificates of deposit and T-bills. Although this policy enjoyed considerable success in 2007, it was challenged by rising inflation in 2008, which halted an earlier fall in the T-bill rate. Over the outlook period, we expect interest rates to remain high, as difficult external conditions and rising government debt constrain the CBY's ability to lower rates.
We forecast that world economic growth (at purchasing power parity rates) will slow sharply in 2009, to just 2%, as the deepening recession in the EU and the US drags down non-OECD growth. Growth is expected to recover to around 3% in 2010, but there remain high downside risks. The gloomy outlook for global demand has led us to lower our forecasts for the price of the benchmark dated Brent Blend, which we project will decline from an estimated average of US$98.4/barrel in 2008 to an annual average of US$66.6/b in 2009-10, although there still remains considerable downside risk to this forecast.
We estimate that real GDP growth will have slowed to 3.2% in 2008, as falling oil output in several of Yemen's larger oilfields and a slowdown in private consumption growth on the back of a sharp increase in the cost of living have been only partly offset by continued growth in government spending and sustained investment (as the construction of the new LNG plant nears completion).
In 2009-10 the continued decline in oil production, combined with lower oil prices, will force the government to rein in spending growth markedly, which will in turn help to depress private consumption. Over the same period, investment growth will slow, as work on the LNG facilities winds down and Gulf Arab companies rein in their outward investment plans in the wake of the global financial turmoil. More positively, however, the disbursal of monies pledged at the London donor conference in November 2006 should continue. Overall, we still expect real GDP growth to rise in 2009-10, to an annual average of 5.2%, lifted by increased export volumes as production at Yemen LNG commences in mid-2009.
We expect inflation to fall steeply over the outlook period, as the prices of foodstuffs and other commodities decline from 2008 levels. With Yemen heavily reliant on imported goods, it suffered from fast-rising global food prices, in particular, in 2008, which we estimate will have pushed consumer price inflation up to an average of 18%. However, the commodity price boom has begun to rapidly unwind, and we now expect the global price of foodstuffs and beverages, for example, to decline by over 25% in 2009 (and remain stable in 2010). With domestic demand also set to be restricted by weak investment and stagnating wages, and the Yemeni riyal likely to remain relatively stable, we expect average inflation to slow to 7.7% in 2009, before rising to its trend rate of around 12% in 2010.
The CBY is expected to allow the Yemeni riyal to depreciate against the US dollar over the outlook period, as it seeks to balance the aims of controlling inflation and protecting investor confidence against the need to maintain the competitiveness of non-oil exports. As inflation moderates and the dollar strengthens, the riyal. which we estimate will have depreciated to around YR200:US$1 by end-2008.is expected to fall to YR212:US$1 at end-2010.
We have revised up our forecast for Yemen's current-account deficit, reflecting a lowering of our oil price projections and the deteriorating outlook for workers' remittances inflows. However, with Yemen also importing some 60,000 barrels/day of refined fuel products, and global non-oil commodity prices also set to decline steeply, we export the import bill to contract by some 10% in 2009, to US$8.3bn, before remaining largely stable in 2010 as global commodity prices remain relatively stable and the LNG project reaches completion. Despite the start of LNG sales, export revenue is forecast to decline to US$6.3bn in 2009, as oil prices and production both drop, although earnings should partly rebound the following year, as oil prices begin to recover and the second LNG train comes on stream. As a result, the trade deficit, which we estimate will have reached US$463m in 2008, is expected to grow to US$2bn in 2009, or 7.4% of GDP, before narrowing to US$1.4bn in 2010.
This impact of the trade deficit on the current-account position will be compounded by Yemen's large non-merchandise deficit. However, this is now expected to narrow over the outlook period, as services debits dip, in line with the fall in the import bill in 2009, and income debits decrease as oil firms' profit repatriation declines in the wake of falling oil prices. The country's main non-merchandise inflow, foreign transfers, is likely to stagnate, however, as workers' remittances from abroad slow. We now expect the current-account deficit to widen from an estimated US$2.6bn (10.3% of GDP) in 2008 to US$3.5bn in 2009.which, at 13.3% of GDP, would be the largest deficit since 1993. In 2010 the deficit will narrow, however, to US$2.8bn, as LNG exports are ramped up.
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