In whatever post-conflict scenario eventually prevails in Yemen, the domestic currency and the institutions of state will be essential to the rebuilding process. To date, both have persevered despite the enormous pressure of a vicious civil war and foreign bombing campaign. The Central Bank of Yemen’s actions have successfully protected the value of the Yemeni riyal against the American dollar – essential in a country that imports 90% of its food requirements – while the central government, which even at the best of times held tenuous authority over large swathes of the country, has managed to keep the structures of its institutions intact by operating them at a minimum capacity.
None of the local, regional and international stakeholders in Yemen have an interest in seeing the currency or state institutions collapse – the only potential beneficiaries of the chaos that would follow such a collapse would be al-Qaeda or other extremist groups. Due to the intensity and length of the conflict, however, both the Yemeni riyal and government operations now face imminent, critical threats to their continuity. For stakeholders, preserving Yemen’s currency and state structures now will save the enormous expense and effort of resurrecting them later. More importantly and more immediately, it will help stave off incredible suffering for millions of people in Yemen.
The budget deficit and basic state functions
Many of the weakness in Yemen’s public finances are structural and predate the current conflict. Government revenues have for some time been undiversified and overly dependent on oil exports, while expenditures have been inflated by endemic corruption and sprawling patronage networks. The current civil war – which effectively began in September 2014 and escalated when the Saudi-led military intervention began in March 2015 – has dramatically intensified these weaknesses and their consequences.
Yemen’s last official tally of gross domestic product is from 2013, when it stood at $36 billion. Over the five years between 2009-2013 the Yemeni government ran budget deficits of between 4.6% and 8.3% of GDP, with spending exceeding revenues each year by between 16% and 27%, based on the final annual account statements for that period. The Ministry of Finance was not able to finalize the public accounts for 2014 due to the absence of a government legislature – the body constitutionally authorized to approve these accounts – thus there are no official records available for that year. For related reasons, there has also not been a new government budget issued since 2014. After the Houthi Movement and allied forces took over the capital Sana’a in September 2014, the new government they formed was unprepared to table a budget for 2015. Instead, it re-approved the previous year’s budget as a temporary measure. Since then the government has not finalized a new budget and indications are that the 2014 allocations for public financing will be rolled over again into 2016.
Successive cabinets between 2009-2013 have addressed the budget deficit through either internal debits – issuing Yemeni riyal (YER) denominated treasury bills to domestic banks and companies, and borrowing from the Central Bank of Yemen (CBY) – or external grants. As a result the government’s treasury bill accounts jumped from $2.8 billion in December 2012 to $6.8 billion in December 2014, equivalent to an increase from 7.8% to 19% of GDP (2013). The government’s general accounting exposure at the CBY increased $1 billion from December 2012 to December 2014, to a total of $3.5 billion (1% of GDP). Yemen’s foreign debt stood at $7.2 billion as of the end of 2013 (or 20% of GDP).
The major government’s most significant revenue weakness has been its dependence on oil: prior to 2014 energy exports made up roughly two thirds of government revenue, while in the 2014 budget (which carried over to 2015) oil was being counted on to contribute almost half of the funding. The single largest public expense – in the most recent budget amounting to $5 billion, or 37% of a total projected spending of $13.4 billion – is the public sector wage bill.
Estimated public revenues in the 2015 general government budget proposal was $10.3 billion, with the contribution of the oil sector set at 46%, taxes and customs 31.8%, anticipated external grants 8%, and the rest from other local resources. Since the beginning of the civil war, foreign companies, NGOs and international institutions have evacuated their personnel and capital, putting pressure on the riyal and economic activity generally. The Saudi-led military intervention in March 2015 was accompanied by a land, sea and air blockade of the Yemen which, along with the exodus of foreign oil companies, cut energy exports to zero. Customs receipts were also reduced to near zero, international grants largely ceased and lost economic activity (in large part due to widespread fuel shortages) has decreased general tax revenues. Aside from the war’s massive humanitarian toll and destruction of infrastructure, it has also ballooned the government’s budget deficit by well more than half, threatening its ability to carry out even the most basic functions and survive to a post-conflict scenario.
Government revenues are also being syphoned off as the warring parties in the conflict plunder the different state apparatuses. For instance, Houthi militias have taken control of the National Tobacco & Matches Company, among other public companies, pocketing revenues without releasing accounting data. Black market dealers have also usurped the Yemen Petroleum Company (YPC) as the country’s primary handler of commercial fuel products. Under normal economic conditions – when Yemen would also be receiving foreign currency in exchange for oil exports – the country would send roughly $300 million abroad each month to cover fuel imports. Following the current conflict and the cessation of oil exports, the CBY escalated measures to secure the Yemen’s foreign currency reserves. This included, since the spring of 2015, only partially fulfilling YPC requests for foreign currency to purchase its monthly fuel imports. Facing massive fuel shortages, the Houthis then effectively deregulated fuel imports by issuing fuel importation licenses to the local market.
The consequences of this have been myriad. First, these black market licences have been extremely lucrative for both the Houthis, in the form of licence fees, and the new importers, who have effectively become a new class of business elite through the war. Whereas the YPC regulates the official price of fuel, black markets dealers seek to maximize profits in setting their retail price. For example, in early February 2016, 20 liters of fuel on the black market in Sana’a cost 6,000 YER (US$28), far above the YPC’s official price, 2,800 YER (US$13) for the same amount. However, the black market is constantly supplied, while the YPC can only supply the market for a handful of days per month. Fuel importers’ profits are so large that they are able to buy dollars on the local black market – to pay for their fuel imports – regardless of where the USD-YER exchange rate stands, which has put downward pressure on value of the riyal. Deregulated fuel imports also represents a significant loss in government revenues in the form of import customs and fuel taxes.
Depending on the parameters of the data analysis, estimated government revenue actually available for collection in 2015 was $4.6 billion, 44% of the budget projection. It should be noted that official government statistics regarding the status of the Yemeni economy have not been made public since the last Central Bank Monetary Development Newsletter in January 2015. Thus, this analysis of the 2015 fiscal year has relied on extrapolations and estimations based on available official data, and reliable unofficial sources.
Estimated budget expenditure in the 2015 budget was $13.4 billion, of which 80% ($10.72 billion) was operational expenditures. This best-case-scenario estimate already projected a budget deficit of $3.1 billion, where spending was slated to be 30% more than revenues. However, based on the CBY’s January 2015 release, the government’s actual overall monthly operational expenditure for that month was roughly $700 million. Given that these monthly expenditures were almost fixed – being public sector salaries and debt payments to local creditors – it is reasonable to assume a similar operational expenditure for the next 11 months. By the end of December 2015 the 12-month total of actual operational expenses would sum to $8.5 billion, indicating that the original 2015 budget overestimated operational expenses by more than $3 billion. (Part of this discrepancy can be accounted for by government and CBY cutting all non-essential spending). Therefore, in order to cover strictly the government’s operational budget – what is necessary for state institutions to maintain basic functions – the public purse will be short some $3.9 billion for 2015.
Even if the war had stopped January 1, 2016, the resources available to the Yemeni government to fulfill its debt obligations would have been almost non-existent. Yemen’s commercial banks have also already parked most of their excess liquidity in T-bills. Thus, the government’s only other option is its lender of last resort, the country’s central bank, which has been under intense pressure in trying to maintain the value of the country’s currency.
Declining XE reserves and threats to the riyal
The scale of Yemen’s import needs is clear from the 2013 bill, which stood at $10.8 billion, representing 32% of the GDP (according to Central Bank Monetary Development Newsletter in December 2014). Crucially important is that nearly 90% of Yemenis’ nutritional needs are met by food imported from abroad. To limit suffering and the possibility of famine among the population, it has been essential for the CBY to maintain the value of the riyal and keep down the cost of basic food imports on the Yemeni market. While the CBY has been relatively successful at this on a macroeconomic level, on a microeconomic level the cost and availability of basic commodities has varied wildly across different areas of the country, depending on local conditions such as the intensity of the conflict, and the availability fuel and transportation networks.
Being both the prime supporter of the riyal and the government’s lender of last resort has put the CBY in a precarious, and costly, position for the last several years. In 2012 foreign currency reserves stood at more than $6 billion. As of December 2014, with the civil war sending local capital fleeing for safer investments abroad, total foreign currency reserves had fallen to $4.66 billion, an amount which would cover the country’s imports for a little more than 4 months under normal conditions. Under conflict conditions that depress economic activity and lower demand for imports, these foreign currency reserves could cover a greater duration of Yemen’s import needs. The Saudi-led military intervention began in March 2015 and over the next six months almost $2 billion was drained from the CBY’s foreign currency holdings, which were estimated at $2.8 billion as of August 2015. As of January 2016 the CBY’s estimated foreign currency reserves stood at $2.1 billion, enough to cover a little more than two normal month’s worth of imports. Of this, $1 billion is a loan from Saudi Arabia which matures in 2017. Without the Saudi deposit, the capacity of Yemen’s foreign currency reserves to cover imports drops to less than two months.
Policy measures the CBY has taken to limit the exodus of dollars include restricting local market access to foreign currency and instructing commercial banks and exchanges to do likewise. As well as limiting the YPC’s access to foreign currency, in February 2016 the CBY announced that it would no longer provide lines of credit for sugar imports at the official exchange rate, instead directing importers to find the necessary foreign currency on the black market.
As of February 2016, the CBY had maintained the official exchange rate at US$1 to 215 YER, while on the black market the riyal traded at 250 YER to US$1, a difference of only 16%. Anecdotal evidence suggests the riyal is still the primary currency used in the transactions – with all government transactions also mandated in YER – though the Saudi riyal (SAR) and American dollar have replaced the domestic currency in popularity as a “store of value”. Several market factors have assisted the CBY’s efforts to support the riyal, among them that the general decrease in economic activity brought on by the war has lessened demand for imports, in particular fuel, which has decreased general demand for foreign currency to purchase these imports and eased pressure on the YER.
Despite the resilience of the CBY to date, on current trajectories Yemen’s central bank will exhaust its foreign currency holdings in the near term and lose its primary means of maintaining the domestic currency. This will have disastrous implications for the value of the riyal, public finances and country’s economy generally, as well as the physical well being of the vast majority of Yemenis – 21 million of whom are already in need of humanitarian assistance, according to the United Nations, corresponding to some 80% of the population.
Potential policy interventions
The cessations of hostilities would be the largest single measure to take in stabilizing Yemen, however the various parties to the conflict have to date failed to reach a negotiated settlement. Thus, the following recommendations are steps stakeholders can pursue to help preserve the domestic currency and minimum state functions until peace is achieved:
- Foreign backers of Yemen’s warring parties – primarily Saudi Arabia and Iran – should pressure their local allies to stop plundering state institutions and appropriating state revenue streams.
- The Houthi Movement and its allies must be pressured to end the practice of selling fuel import licences, and to re-empower the Yemen Petroleum Company as the primary handler of commercial fuel in the country. Within the difference between the YPC’s official retail price for fuel and the current black market rate, there is room in the market for the central government to implement a temporary fuel tax which would serve two purposes: (1) raise public revenue; (2) help curb consumption such that undue pressure is not placed on the YER.
- All parties to the conflict should help facilitate Yemen’s public oil company, SAFER Exploration Production Operations Company, and foreign oil companies previously operating in the country to restarted limited oil exports, which would provide the government with revenue and allow the CBY to restock its foreign currency reserves. This step would require pressuring various warring parties in Yemen to ensure the safety of oil workers, pipelines and related facilities, as well as the Saudi-led coalition easing the blockade to allow for tanker traffic. Mechanisms would also need to be enacted to ensure oil revenues were not diverted to fund the conflict. Given the low global price of oil currently, however, it is unclear whether this approach would be sufficient to cover the foreign currency needs of the government and the CBY.
- The Saudi-led coalition should end its stranglehold on Yemen’s ports and facilitate the resumption of foreign trade and economic activity in the country, such that imports of fuel and basics commodities can pass through the coalition blockade without undue delays, while also ensuring the distribution networks for these within Yemen are not subject to coalition airstrikes. Coalition allies and Houthi forces on the ground in Yemen must also be pressured not to interfere with the resumption of commercial networks across the country.
- Until there is a marked improvement in public revenues, public expenditures should remain narrowed to public sector employee salaries and minimum public debt repayments; ie. operational expenses essential to preserving basic state functions.
- All parties to the conflict must allow Yemeni commercial banks to transfer their excess supplies of Saudi riyals (SR) out of the country in exchange for US dollars to meet domestic demand for the US currency and facilitate imports.
- The CBY’s neutrality from the warring parties must be maintained. The central bank has remained independent throughout the conflict and the central bank governor is widely respected as a skilled technocrat who has the trust of the financial sector. This represents an opportunity stakeholders can leverage. Regional and international stakeholders should develop mechanisms through which to back the CBY’s efforts to maintain the riyal’s value and support imports of fuel and basic commodities. These mechanisms should be structured to minimize the possibility that this aid could be used to fund the warring parties. Options include providing the CBY access to foreign currency aid from accounts outside Yemen from which the CBY could purchase YER and facilitate imports; foreign countries could purchase YER directly, in coordination with the CBY, as a form of financial aid; foreign aid and development programs could purchase YER to be spend through their operations in Yemen.