Yemen Economic Bulletin: Renewed rapid currency depreciation and diverging monetary policy between Sana’a and Aden

Yemen Economic Bulletin: Renewed rapid currency depreciation and diverging monetary policy between Sana’a and Aden

Summary:

Through October Yemen’s domestic currency, the rial (YR), lost almost 10 percent of its value relative to the United States dollar (USD) in market trading, dropping from YR 375 to the USD to YR 412. This drop was roughly equivalent to the loss in value over the previous six months and the second time in 2017 that the rial has experienced rapid devaluation.

As the Sana’a Center has previously documented, in the first half of February Yemen’s domestic currency lost some 20 percent of its market value. In both these instances, the authorities in Sana’a, (where the Houthi movement and the allied forces of former President Ali Abdullah Saleh hold sway,) and those in the southern city of Aden, (the de facto capital of Yemen’s internationally recognized government,) quickly implemented stop-gap measures to reduce the instability and slow the rial’s decline.

The latest currency instability highlights the continuing deterioration of the rial’s supports in the face of more than two-and-a-half years of civil war and regional military intervention, and has sparked widespread fears that the rial is on the cusp of further steep depreciation, and possibly hyperinflation. In a country that is overwhelmingly dependant on imports to meet the population’s nutritional needs – and which the United Nations has declared the world’s worst humanitarian crisis – the extreme loss of local purchasing power that hyperinflation entails would leave most Yemenis unable to buy food and other basic necessities.

Furthermore, Sana’a Center sources have confirmed that the authorities in Sana’a, in an effort to halt the rial’s depreciation, are preparing to impose a fixed currency exchange rate in areas of the country’s north which they control. While the Central Bank of Yemen (CBY) had previously maintained a fixed official exchange rate, CBY headquarters – relocated to Aden in September 2016 – announced in August this year that it would allow the domestic currency to float according to the market rate.

Should the authorities in Sana’a follow through on their plan and try to enforce a separate monetary policy, it would formalize the rupture of the CBY as an institution across the conflict’s frontlines. This formalization of North Yemen and South Yemen as distinct economic entities could represent a significant step towards the division of the country into separate statelets.

The Sana’a Center also foresees significant difficulties in operating one currency with differing monetary policy between the north and south. Separate monetary policies would likely precipitate a significant shift in remittances from Sana’a to Aden, incentivize massive currency smuggling between the areas, and shift ever greater financial flows away from the official economy.

Background

Over the course of more than two-and-a-half years of civil war and regional military intervention, Yemen has seen tens of thousands civilians killed and wounded, millions of internally displaced peoples, billions of dollars of damage to property and infrastructure, and the widespread collapse of economic activity, government services, security and humanitarian conditions. In specific regard to economic activity, the World Bank estimates that between 2014 and 2016 alone Yemen’s gross domestic product shrank 37 percent.1

The conflict has thus weighed heavily on the value of the Yemeni rial. Concurrently, the cessation of oil exports – previously the largest source of foreign currency and government revenue – has led to the depletion of foreign currency reserves and undermined the central bank’s ability to intervene to support the rial.

Yemen is overwhelmingly a cash economy, and the CBY has also been experiencing a severe shortage in domestic currency banknotes; in the third quarter of 2016 most public sector workers – roughly a quarter of Yemen’s employed – lost their income due to the CBY not having enough physical banknotes with which to pay them.2

In September 2016 President Abdu Rabbu Mansour Hadi, head of the internationally recognized government of Yemen, ordered the relocation of CBY headquarters from Sana’a to Aden. The central bank’s subsequent dysfunction further complicated the country’s fiscal and monetary management.3 Consequently, between early 2015 and November 2016 the rial lost more than half of its value relative to the USD.

Major currency instability in early 2017

Following the arrival of new rial banknotes from printers abroad in January 2017, the CBY in Aden began distributing public sector salaries. The market, however, quickly began to anticipate the injection of the full monthly public sector salary bill into the economy. Before the civil war began, this amount was roughly 65 billion rials nationwide, excluding the Ministry of Defence payroll. The market, aware that the central bank lacked the foreign currency reserves to support the rial, began short selling the domestic currency. This led to the rial’s market value diving as much as 20 percent in the first half of February.

In response, officials at the CBY in Sana’a convened meetings with private banks and financial institutions to coordinate currency stabilization efforts. Houthi-Saleh authorities forced currency traders to close and secured arrangements with major food and fuel importers to temporarily refrain from buying foreign currency from the market. In Aden, the CBY froze the distribution of public sector salaries, with the rial’s market value rebounding to YR 340 to the USD by mid-February.

Shortly thereafter President Hadi announced that the Saudi government had committed $10 billion in aid to Yemen – $2 billion of which would be direct currency support. The rial then experienced a gradual depreciation in market trading to YR 355 to the USD by end-March.   

Precursors of renewed currency instability

The Saudi funding that President Hadi promised was not forthcoming, and to date has not arrived. Meanwhile, the intensifying war through 2017 has ensured that the rial has remained under downward pressure since the first round of currency instability in February.4

However, increased foreign currency remittances to Yemen for the month of Ramadan, which ran between May and June, and for the Eid al Adha holiday at the beginning of September, helped slow the rial’s decline. As is normal for the period following Eid al Adha, remittances then began to decline through September. The end of this support for the rial was shortly thereafter followed by a number of new downward pressures.

Importers, seeking to replenish stocks of goods following the end of the holidays, began selling their rials in the market to purchase foreign currency. In Sana’a, this trend was accompanied by a particular complication: to compensate for their inability to pay public sector wages, the authorities had, in the second quarter of this year, paid civil servants in vouchers that they could use at selected business to buy goods.5 To cover the cost of these vouchers, the CBY had digitally created some 45 billion rials that it lent to the authorities to pay the businesses. After Eid al Adha, these businesses went to the market with these rials to purchase foreign currency to restock their inventory. Given the liquidity crisis there is currently a premium for physical cash relative to bank transfers in financial transactions, thus increasing the cost for businesses buying foreign currency using these digitally manufactured rials.

On September 24, Prime Minister Ahmed Obeid bin Daghr of the internationally recognized government announced that it would begin regularly paying public sector salaries across all governorates under their control, as well as the entire Taiz governorate. The Sana’a Center estimates that the monthly public sector payroll across southern governorates, plus Taiz, is some YR 20 billion, in addition to more than YR 20 billion in salaries for the army and police. Following a shipment of newly printed rials from abroad in September, the government began distributing public sector salaries on September 29. Notably, there had been no increase in government revenue or foreign currency reserves that prefaced the increased government expenditure on salaries.

The cumulative macroeconomic effect of the above-mentioned events in September was a decrease in rial demand concurrent with an increased rial supply. Thus, at the beginning of October the rial then began to rapidly depreciate in market value.   

The response in Sana’a

Through October Houthi-Saleh security services began arresting currency exchangers en masse in an effort to halt currency trading and speculation. (As of publication, most of the exchangers had been released from custody.)

On October 18, the deputy prime minister for economic affairs in Sana’a, Hussein Maqbouli, convened a meeting involving representatives from the National Security Council, the Saleh-allied General People’s Congress party, leading public and private banks, currency exchangers and major importers to discuss ways to halt the rapidly falling currency. (Notably absent from the meeting was a representative of the CBY in Sanaa.)

Following the meeting Maqbouli’s office released a six-point action plan. The first two points involved the parties committing to scheduling and facilitating the sale of foreign currency to the largest wheat and oil importers through CAC Bank, Yemen’s largest public bank. Specifically, fuel importers committed to immediately providing YR 6 billion to CAC Bank, which the bank would use to shop for foreign currency wholesale, rather than having the importers go individually to the market.

Points three and four of the action plan involved the implementation of currency controls. Specifically, the plan prohibits the exit of foreign currency from areas controlled by Houthi-Saleh forces – except with permission from the CBY in Sana’a – and bans the importation of large sums of rials from South Yemen, specifying that no one transfer should exceed YR 5 million.   

In the action plan’s fifth point, banks, fuel importers, telecommunications companies, tobacco merchants and basic commodities traders committed to not purchasing foreign currency on the market until at least the end of October. The sixth point stipulated that the security services would pursue and punish those who violated any of the previous points.

The prospect of one currency with two monetary policies

According to Sana’a Center sources, the authorities in Sana’a are also planning to publically announce a fixed currency exchange rate, at below market value, in areas under their control, and force money exchangers and banks to adhere to such. While ostensibly a move to halt currency depreciation, if implemented the Sana’a Center foresees it having myriad unintended consequences.

Among the immediate impacts will likely be a large-scale shift in Yemen’s remittance deliveries from Sana’a to Marib and Aden, with senders and receivers alike seeking a better exchange rate for arriving foreign currency. Given that Yemen’s largest population centers are in the north, and thus the north will remain the final destination for most remittances, large-scale currency smuggling is likely to ensue in order to subvert the newly-imposed currency controls.

Throughout the conflict trust in the banking system has waned and its economic clout has in large part shifted to the currency exchangers, many of whom are semi-official or entirely black market entities. The empowerment of new currency smuggling networks would thus entail the continued decline of the official economy.

Marib, held by nominally pro-government groups yet less than 200 kilometers from Sana’a, would likely play a prominent role is such smuggling, given the pre-existing tribal dynamics of the area that are already facilitating rampant smuggling between Yemen’s north and south. As a result, Marib’s relative economic ascendency through the conflict – thanks to businesses and capital relocating there from Sana’a – would likely continue, and thus further empower the aspirations of Marib’s political elite for autonomy from both Sana’a and Aden.  

Until its relocation last year, Yemen’s central bank had essentially been the last state institution truly acting as a national entity. The implementation of distinct monetary policy between the country’s north and south would formalize the schism of Yemen’s central bank. This creation of distinct economic areas would be in addition to the military and political division of the country, and thus should be understood as a significant step toward the creation of independent statelets.

A shared currency with distinct monetary policies, especially in the context of Yemen today, is also almost certain to wildly distort market mechanisms.  

Government reaction to currency depreciation

October 21, Prime Minister Bin Daher called a meeting with the CBY in Aden and the directors of private banks in the city to discuss ways to stabilise the rial. Following the meeting the internationally recognized government implemented a number of new policies; among the most immediate was to prohibit large transfers of both foreign and domestic currency to northern Yemen, and to dispatch security agencies to force the closure of unlicensed currency exchanges in the governorate.

The prime minister also announced that the internationally recognized government would continue to purchase fuel from abroad for electricity generator consumption, and thus partially cover the market’s needs.

As of this publication, the market was trading the rial at between YR 406 and YR 412 – the buy and sell prices, respectively – to the USD. However, in anticipation of further weakness in Yemen’s domestic currency, and thus increased costs in restocking inventory, many Yemeni business owners were pricing goods based on an exchange rate of YR 500 to the USD.

Looking ahead: Recommendations

It is in the best interests of all Yemenis that the authorities in both Sana’a and Aden refrain from flooding the market with rials. Both parties must recognize that increased spending in the absence of increased revenue risks triggering rapidly accelerating inflation, which would have catastrophic implications for millions of Yemenis.

Both parties should also refrain from enacting policies that are deeply problematic for the banking sector – such as a fixed currency rate and currency controls between northern and southern Yemen.

The Yemeni government and members of the Saudi-led coalition intervening in the war must expedite efforts to restart Yemeni government revenue streams – such as natural gas exports through Bilhaf terminal in Shabwa governorate, currently under the control of United Arab Emirates-affiliated forces. In the interim period, the Yemeni government should also repatriate the foreign currency holdings it has abroad, which amount to hundreds of millions of dollars. Saudi-led coalition member states should also provide the CBY with foreign currency funds to prop up the rial, support the import of basic commodities and pay public sector salaries.

When conditions permit, it is incumbent upon the CBY to begin paying commercial banks the interest they are due on deposits held in treasury bonds. This would help re-empower the banks in the market again, allowing them facilitate normal business, play a role in stabilizing the currency, and help restore public trust in the banking system.   

As previously detailed by the Sana’a Center, the CBY offices in Sana’a and Aden should coordinate to implement a dedicated exchange rate for humanitarian funds entering Yemen. This could be calculated using a moving average of the market rate of the previous three months. Given the size of foreign aid funds entering Yemen from international nongovernmental organizations and UN agencies, the use of such an exchange rate would help stabilize the domestic currency and the price of imports on the local market, as well as provide humanitarian organizations with a fair price for their foreign currency and curtail excessive arbitrage.

As the global currency authority, the International Monetary Fund should also bring its influence to bear on all parties in Yemen and the Saudi-led coalition regarding the above points.


Notes:

1 The World Bank, ‘Data; Yemen Rep.’; accessed October 30, 2017, available at https://data.worldbank.org/country/yemen-rep

2 Mansour Rageh, Amal Nasser and Farea Al-Muslimi, ‘Yemen without a functioning central bank: The loss of basic economic stabilization and accelerating famine’, Sana’a Center for Strategic Studies, November 2, 2016. Accessed October 30, 2017, available at https://sanaacenter.org/publications/main-publications/55

Ibid.

4 The Yemen Protection Cluster – a coordination body for humanitarian organizations led by the UN High Commissioner for Refugees – reported in August that through the first half of 2017 the frequency of coalition airstrikes per month in Yemen had tripled, and the frequency of frontline battles had increased roughly 56 percent relative to 2016. For more see: Protection Cluster Yemen Situation Update August 2017. 

5 For details regarding the initiation of the voucher program, please see the Sana’a Center’s Yemen at the UN – April 2017 Review; for details on the demise of the voucher program, please see the Sana’a Center’s Yemen at the UN – July 2017 Review.