Efforts of economic programme and structural adjustment

by Mohammed al-Maitami

Associate Professor of Economics, Sana'a University
Visiting Scholar, University of California, Berkeley

A paper presented to " Yemen in Focus" – a conference organized by the Center for Contemporary Arab Studies – University of Georgetown – Washington, on October 1, 1998.


In June 1998 the major Yemeni cities witnessed widespread popular unrest in reaction to the new government’s decision to raise the prices of fuel and other basic consumer goods. This decision came as one in a series of the measures and policies of the Economic Reform Program (ERP) which the Yemeni government adopted beginning in March 1995.

The unrest resulted in 52 killed and hundreds of wounded. Demonstrators demanded the resignation of the new government, which had just been formed one month earlier. During these bloody events the Prime Minister, Dr. Abdul Karim Al-Iryani, remained optimistic in the potential of the reforms and acted decisively and firmly to continue the implementation of the reforms. In an interview with Al-Wasat the Prime Minister was asked if these events would change the policies of the government toward the reforms and he responded, "reform will never be popular, and if I had some measure of popularity, I would prepare myself to lose it within 24 hours. Those who think that there is a magic stick that will make a bitter remedy sweet, will quickly lose their hope. There is no avoiding severity and there is no evading difficult decisions." This statement hints at the gravity of the Yemeni economic crises and of the difficulties ahead.

Yemen today is once again at war. But it is not military war like the war which had taken place in the summer of 1994. This is a kind of war in which nobody hears the roar of artillery or humming of airplanes. In this war victims are accounted not in hundreds or thousands, but in tens and hundreds of thousands of people. This is an economic war, multidimensional and multisided, its fronts are hidden from the public eye. The lines of battle are obscure, a friend might appear as an enemy, an enemy as a friend.

Indeed, as the prime Minister stated, economic reforms are arduous and that the process of reform is not a road lined with roses. In contrast, reforms require sacrifices and belt tightening. No doubt, without reforms the Yemeni people would be in far worse condition. There is also no doubt, that our people have faced far greater hardship than the current hardship resulting from the implementation of the reform program. These are facts with which nobody can argue.

In most cases, the need for a reform, whatever its nature or theoretical supports are, arises when the economy of a country is suffering an intensive crisis, manifested in the occurrence of external and internal deficiencies, which shocks the economy and causes disequilibrium. At this point it is essential to make immediate policy interventions in order to remove these deficiencies and to reform the path of the economy and finally to promote domestic sources of economic growth.

There are four points from the perspective of the economist that need to be considered, without regard to political or ideological sentiments. These points are:

  1. Why ERP was essential?

  2. What is the substance of the ERP implemented in Yemen?

  3. What are its initial outcomes?

  4. My viewpoints and evaluation of the ERP.

Pre-Economic Reform Program

Yemen perhaps is an unlucky country. History and circumstances always seem to rebel against it, as if someone wants to divest it of its epithet "Arabia Felix", Yemen’s ancient name, on the assumption that it doesn’t deserve it.

Yemen entered the new era of a single state in 1990 carrying a heavy burden of economic, social and political problems from pre-unification. Since the outbreak in the north of the Republican Revolution in September 26, 1962 and in the south of the National Liberation struggle on October 14, 1963, the two states have been involved in consecutive civil wars and have experienced a series of military overthrows (coup d’ etat) right up until the moment of unification. Immediately after the revolution in the north of Yemen the country slid into eight years civil war between Republicans backed by Nasser’s Egypt and Monarchists financed by Saudi Arabia. At the conclusion of the civil war, political instability continued in the form of four military overthrows and continuous. Similarly, the South witnessed 6 overthrows and bloody clashes between ruling factions in the leftist leadership. The latest clashes were in 1986, during which approximately 10,000 people were killed within a period of less than 3 weeks. In addition, the two states were involved in two military confrontations in 1972 and 1979. All of this unrest does not promote the conditions in which to think about development issues and social advancement.

In the latter part of decade of the 1970’s and the early 1980’s Yemen’s economic growth was fueled almost entirely on worker remittance from the neighboring oil states. These resources which Yemen obtained from international sources in the mid 1980’s declined as a result of the reduction of oil prices and changes in the structure of the labor market in the Gulf countries. Consequently, the remittances of Yemeni emigrants declined from around $2 billion dollars in the early 1980’s to half this amount immediately before the Second Gulf War.

Yemen’s unification came at the same time as the collapse of the former Soviet Union and as the proclamation of German unification. Yemen had strong ties with both of these countries and received important assistance from them. The collapse of the former Soviet Union left large debts to be settled. When Yemen announced its unification it already carried a heavy load of debt exceeding $8 billion dollars amounting to 1.5 times its GDP. Those debts contributed to the intensification of the economic crisis and to the hindering of economic growth. The announcement of Yemeni Unity came at the same time as the Gulf war on august 1990. As a result of the war, more than 800 thousand Yemeni emigrants were forced to return. Consequently worker remittances declined dramatically to $300 million dollars. Those returning joined refugees coming from the Horn of Africa to create overwhelming demand on domestic goods and services. At the same time, loans and aid which Gulf countries and Gulf based financial institutions granted Yemen, were discontinued because of Yemen’s position on the war which was interpreted as pro-Iraqi. Furthermore, the process of combining Yemeni institutions after unification led to existence of a "hyper-civil service". This double civil service exceeded the needs and capabilities of the government, causing a growing financial burden that the government had to confront in paying public sector salaries and growing infrastructural requirements. Finally, political conflicts and intrigue, wide spread bribery and corruption in the country multiplied the crises. The zenith of the crisis was perhaps the war of 1994 whose material cost reached $11-13 billion.

As a result of all of the above there was a precipitous fall in the rate of economic growth. The average annual growth of real GDP reached roughly 1.9% during 1990-1994. This number is less than the rate of population growth that reached - after the return of the emigrants - 5.5% within the same period. As a result of this abysmal gap between rates of real economic growth and population growth, the productive capacity of the Yemeni economy found itself unable to satisfy aggregate demand. The chasm between the production structure and the demand structure enlarged, expressing itself in a surplus of aggregate demand, calculated as the difference between effective aggregate demand and real GDP. The surplus of aggregate demand reached 174% of GDP in 1994. This is a significant indicator that illustrates the magnitude of the discrepancy between production and consumption. This indicator can also be used as an indicator for the inflationary gap as well. At the same time, a percentage of GDP, the current budget deficit increased from 8% in 1990 to 17% in 1994. Civilian and military wages and salaries made up more than 50% of total government expenditure. This deficit has been covered through issuing banknote and borrowing from the banking system. As a result, the rate of growth of money supply has increased from 11% in 1990 to 35% in 1994. The government’s wheat subsidy allocated to alleviate the pressure of poverty for needy social classes constituted 10% of GDP in 1994. Unfortunately, a large percentage of these subsidies found their way into the hands of non-target population. The national balance of payments has been afflicted by the same illnesses. The overall deficit within the mentioned period has increased from 12 % to 16% of GDP. As a result, the accumulation of debt arrears reached $4.4 billion dollars at the end of 1994. Consequently, the country has slipped into waves of hyperinflation. The rate of core inflation went up to 75% (or 120% according to other official sources) in 1994 against 33% in 1991. The Yemeni Rial recorded a very fast fall against dollar from 18 R/d in 1990 to 120 to 165 rials per dollar in 1994. This means that a person whose monthly income was $1,000 now received $150. The GDP per capita decreased from $650 in 1990 to $280 at the end of 1994. The unemployment rate reached roughly 35% and more than 21% of population fell below the poverty line. At this point, it was essential to take decisive action to confront and halt this rapid economic deterioration or the country would fall into complete collapse.

Reform period

Based on this background of economic and social retrogression the Yemeni government, in cooperation with the IMF and the WB, designed a multiphase ERP, which rested on – as it was put in a document of the WB a completely new strategy. The IMF and WB depict this new strategy as one which will lead Yemen into 21 century. The supposedly new strategy depends on 3 axis: opening the Yemeni economy to international markets to replace the domestically oriented import substitution economy; the use of the private sector as the engine of economic growth rather than the public sector; and reliance on domestic resources instead of external or international resources. This program includes 3 elements:

  1. Economic stabilization focusing on reduction of the budget deficit.

  2. Structural adjustment.

  3. Social protection measures.

These elements have been translated to the following policies and measures:

  1. Price liberalization

  2. Controlling the budget deficit and fixing it at no more than 3% of GDP at the beginning of 1997.

  3. Gradual reduction of subsidies.

  4. Devaluation and floating exchange rates.

  5. Controlling inflation and its reduction to 5% by 1997.

  6. The issuance of treasury bills beginning in December 1995, in preparation for establishing a stock market.

  7. Reform of taxation and tax collection.

  8. Trade liberalization, cancellation of import licensing and correction of the tariff system.

  9. Increasing the real growth rate in the non-oil sector in order to reduce unemployment and to improve the standard of living.

  10. Reform of the structure of the public budget to decrease the dependence on oil revenues, and to get rid of subsidies and surplus employment in the civil service.

  11. Expansion of expenditure of education, health, and social security.

  12. Privatization of public sector enterprises.

  13. Increase the coefficient of investment to 19% of GDP beginning in 1997.

Returning to the principal objectives of the Economic Reform Program and its background which we touched upon earlier, we can say with some certainty that the program has achieved its goals in terms of general financial and monetary indicators. The government budget has been reduced as a percentage of GDP to 6% in 1995, 4% in 1996 and roughly 2% in 1997, down from the high level of 17% recorded in 1994. (However the financial deficit has risen once again in the first half of this year as a result of the collapse of international oil prices and the impact of the Asian economic crisis.) The reduction of deficit was achieved through a reduction in general and current government expenditure on the one hand and on the other by an increase in government revenue. The government's payroll was reduced from 56% of expenditure in 1994 to 41% in 1996 and 27% in 1997. Government revenue increased in the period 1994-1997 790%, from 38 billion to 301 billion Rial, . The principle source of this increase in revenue was the increase in oil revenues from 7 billion to 150 billion YR and taxes revenues from 44.3 billion rial to 98.6 billion within the same period. This increase is partially due to the change in exchange rates over this period. The Rial fell from 35 to the dollar to 130 to the dollar. The rate of inflation declined from a high of 74% in 1994 to 56% in 1995, 29% in 1996 and roughly 6.3% in 1997.

Similarly, the deficit in the balance of payments was reduced from 14% in 1994 to 11.9% in 1995, 9.5% in 1996 . The reduction in the balance of payments deficit was accompanied by an improvement in the current accounts balance, mainly a result of an improvement in the capital account balance. The foreign exchange reserves of the Central Bank of Yemen rose from 357 million US dollars in 1994 to 825.5 million US dollars in 1995 and 1,237.4 million dollars in 1996/7. The balance in the Central Bank's foreign exchange account this year remains a healthy 295 million dollars. Foreign exchange reserves of the government have increased 3.4 times during the past two years which has raised the coverage of current foreign exchange reserves from 2.8 months of imports to 6 months of imports.

Furthermore, positive results were achieved in rescheduling Yemen's foreign debt in accordance with the conditions of the Paris Club and the Napoli terms supported by the agreements concluded with the IMF on economic reform. 67% of Yemen's debts to member countries of the Paris Club, amounting to 123 million US dollars, were forgiven outright and the remaining 41 million dollars were rescheduled on a long term basis extending payment into the first third of the next century at moderate interest rates and a long grace period. There were two basic reductions to Yemen' 5.8 billion US dollar Russian debt (inherited from the former Soviet Union) after it became a member of the Paris Club. The first reduction came as a result of direct negotiations with the Russian government in which they forgave 80% of Yemen's debt ($ 4.64 million US) . The second reduction of 67% of $ 1.16 billion US, the remaining former Soviet debt came as a result of the Napoli terms. These two sets of negotiations succeeded in reducing Yemen's total debt to Russia by 5 billion dollars.

At the same time, in accordance with the goals outlined in the ERP, the rate of growth of broad money declined from 35% in 1994 to 20.4% in 1995 and to 10.7% in 1997. The Yemeni Rial was allowed to float and reached a stable level of 125-130 rial to the US dollar with some occasional minor fluctuation.

Evaluation of the Results of the Program

The short life span of the reforms, and the limited and contradictory data preclude definitive judgements, whether positive or negative, on the impact of the reforms. Nevertheless, a preliminary evaluation of the program is required in order to predict future progress of the reforms, foresee its positive and negative elements and the challenges and difficulties the program will face. We can say with some certainty that a number of the positive outcomes of the reforms in the first stage of economic stabilization were achieved in accordance with the goals outlined in the program, particularly in the realm of finance and monetary policy (reduction of inflation, reduction of the government deficit, currency stabilization, reduction of the money supply and improvement in the balance of payments). However it is not the case that all of these goals were achieved as a result of the implementation of the economic reform policies. With the recent increases in oil production and in the price of oil, the revenue accruing to the Yemeni government has increased significantly from 589 million dollars in 1994 to 958.4 million dollars in 1996 and 880 million dollars in 1997. The Yemeni government has also received 150 million additional dollars from the oil companies' operations in Yemen. Large grants and aid from the IMF and donor countries amounting to a billion dollars have also arrived in Yemen in support of the economic reforms. All of this revenue greatly affected the early outcomes of the program. There is no doubt however that the reform policies slowed the rapid deterioration in the economic situation before March 1995.

Negative economic impacts

The architects of the economic reform program assumed that the problems of the Yemeni economy consisted primarily of government deficits, negative balance of payments, sharp fluctuations in the value of the Yemeni rial and the existence of an inefficient and unproductive public sector. Based upon these assumptions the economic reform program anticipated that simply relieving the pressure on the balance of payments, reducing the government deficit through cutting expenditure and cutting government subsidies, making social services cost effective and privatizing the public sector would achieve domestic accord and general economic equilibrium. The program assumes that simply freeing market forces from government regulation and closing inefficient public sector businesses will allow these market forces to mobilize and establish the proper levels of investment, production, consumption, importation and exports in light of current resource endowments. The program ignores that the deeper roots of the economic crisis which are not restricted to financial and monetary policy, but rather these are merely symptoms on the surface of more fundamental and ongoing contradictions and difficulties in the material production and political system. These are, in brief, the major negative aspects of the economic reform program.

  • In looking at the recessive nature of the economic program, it is clear that local producers cannot survive policies which place a heavy burden upon local consumers through a deteriorAAation in local wage rates. As a result, local producers are faced with slow markets and reduced demand for their products which in turn inhibits local productive capacity, causes closures of productive units, and increases unemployment. For example, twenty eight industrial units have closed in the past two years in Sana'a, Taizz, Aden and Hodeida and seven more factories are expected to close in the latter part of this year. In short, more 20% of Yemeni industry has declared bankruptcy during the period of implementation of ERP. The government anticipates the loss of 2.5 billion rial in taxes as a result of these closures and the loss of twelve billion rial in wages. Five thousand industrial workers amounting to 10% of the total industrial workforce are expected to lose their jobs.

  • Raising the local production costs (which some sources estimate rose at the rate of 150-250%) will not only reduce local demand, but will also destroy the marginal, but important, Yemeni exports in competitive international markets. In spite of the slight rise of 8% in non-oil exports in 1995, non-oil exports rose by less than 1% in 1997 and agricultural exports actually declined. The reduction of exports has been accompanied by a sharp rise in imports. Imports reached 1,522 billion US dollars in 1994 and climbed to 2,314 billion in 1997. Food imports alone rose from US $427 million to 805 million. Consequently, the projection that structural adjustment and devaluing the national currency will strengthen the competitiveness of local producers and will stimulate exports has not born fruit at this point in time. This projection about local response to policies designed to simulate local exports is dependent upon the following factors:

1. International demand for local production.

2. The existence of excess capacity or unemployed resources

3. The ability of local producers to be competitively flexible in terms of cost and quality.

4. The existence of an appropriate environment for investment to stimulate local production.

The question of investment has not made any significant progress. Investment is a principle condition for growth and the lack of investment in Yemen has been due to the lack of an appropriate environment for investments. The FIAS report for Yemen of June 1997 states that "..constrained public budget, low income level, decentralized population and difficult physical environment; under-developed legal system and weak institutional capacity; under-developed local capital markets; and (most critically) Yemen's high political risk rating, as well as....(the fact that) the state, the government of Yemen is still viewed as weak, unreliable and lacking credibility."

Consequently direct foreign investment outside the oil sector is virtually non-existent, in spite of good investment opportunities. Direct foreign investment is a stillborn hope for the local non-oil sector in this frustrating environment. As an illustration, the kidnapping of tourists has taken a direct toll on the promising tourist industry in Yemen. Sixty four cases of foreign hostage taking have occurred since April 1991 and 54% of these have taken place in the area of the capital city, Sana'a. Yemeni officials do not attempt to conceal the lack of security in their country. The minister of legal affairs responding to a question about lawlessness in Yemen from the political weekly, al-Magala, said "...that is true to a large extent. We have laws but we recognize that we are weak in implementing our laws." It is true that the Yemeni government is undertaking great efforts to reform the bureaucratic structure and organization in Yemen, but the challenges in this field are huge and the time needed for such fundamental reforms lengthy.

The rate of real economic growth in the non-oil sector is still less than the rate of growth of population which is an additional reflection of the recessive nature of the economic reform program. For example, the rate of real growth of agriculture (without qat) the main productive sector – was – 2.2 during 1995-1997, taking into consideration that qat production constitutes more than 30% of agricultural production. Indeed, the production of agricultural crops has collapsed during 1995-1997. The total product of cereals declined from 881 thousand ton in 1995 to 712 thousand in 1997, wheat production declined from 171 thousand to 129 within the same period. This economic recession is seen in the reduction of private consumer demand due to declining income, in the lack of proper atmosphere to attract foreign investment, in fair competition with international companies and in the move of domestic capital out of productive enterprises and into commercial activities and agencies of foreign companies since the policies freeing trade and annulling currency restrictions has raised profits in this sector. Consequently, complete economic collapse is not an impossibility in the near future if this equation is not altered.

There has been a dramatic decline in the real income levels stemming from falling wage rates. This has contributed to a deterioration of consumer demand at the same time that prices have risen as a result of the liberalization of consumer prices and currency markets and the reduction of subsidies on basic consumer items.

There has been a constant widening of those falling in poverty categories from 21% in 1992 to 33% in 1996. This rate is growing continuously in Yemen with a similar rise in unemployment, the principle source of poverty.

The expenditure for education and health has been reduced from 19.2% for education in 1994 to 16% of total government expenditure, and for health from 3.5% to 3.3% within the same period, in contrast of what was being said in the ERP. Taking into consideration that 50% of population illiterate and 70% of them without health care, we could imagine the effect of this reduction

The sharp contradiction between the fast pace of the reforms and the structural adjustment and the slow pace of judicial, administrative and bureaucratic reforms makes the fruits of the reforms limited. The danger of falling into a new crisis, perhaps one even more violent, as a result of the lack of foreign investment, of the widening recession, of the widening and deepening circle of poverty, exhaustion of local productive capacities (raising taxes, cutting subsidies and freeing prices), of the depletion of foreign resources (operating loans, aid, and grants), is a real probability.

It is enough that we remind that those carrying out the reforms, including those in the World Bank itself, of the statements made in the report of the World Bank in its yearly meeting held in Hong Kong on the 23-26 of September 1997: "In the absence of an effective state it is impossible to produce any economic or social progress... and without protection from theft and violence and repressive behavior by the state and without a fair judiciary which is able to enforce its rulings, it is difficult for markets to grow and develop.

References

  1. Reports of Yemen Central Bank.

  2. Statistical yearbooks. Central statistical Organization. Sana’a.

  3. Republic of Yemen: The Economic and structural Reform. Document of the World Bank. May 17, 1995

  4. Republic of Yemen: Memorandum of Understanding. IMF, February 16, 1995.

  5. Republic of Yemen: Public Expenditure Review. Document of the World Bank. November 27,1996.

  6. Republic of Yemen: Donors’ Meeting. Brussels, June 19-20, 1997. Statement by the representative of the IMF.

  7. Agreed minute of the consolidation of the debt of the Republic of Yemen, Paris, November 20, 1997.

  8. Yemen: Investors’ Perceptions and Diagnosis of the Environment for Foreign Investment. Document of FIAS, June 1997.

  


These elements have been translated to the following policies and measures:

  1. Price liberalization

  2. Controlling the budget deficit and fixing it at no more than 3% of GDP at the beginning of 1997.

  3. Gradual reduction of subsidies.

  4. Devaluation and floating exchange rates.

  5. Controlling inflation and its reduction to 5% by 1997.

  6. The issuance of treasury bills beginning in December 1995, in preparation for establishing a stock market.

  7. Reform of taxation and tax collection.

  8. Trade liberalization, cancellation of import licensing and correction of the tariff system.

  9. Increasing the real growth rate in the non-oil sector in order to reduce unemployment and to improve the standard of living.

  10. Reform of the structure of the public budget to decrease the dependence on oil revenues, and to get rid of subsidies and surplus employment in the civil service.

  11. Expansion of expenditure of education, health, and social security.

  12. Privatization of public sector enterprises.

  13. Increase the coefficient of investment to 19% of GDP beginning in 1997.

  


   Projected targets and actual indicators of Economic Reform Program (%) 1994-1997  

RATE OF GROWTH

GOALS

1997 1996 1995 1994
Actual Planned Actual Planned Actual Planned Actual
2 3 4 2 6 7 17

Public deficit as % of GDP

6.6 5 29 20 55 45 75 Rate of inflation
  - 9.4 18 11.9 17 14 Deficit of Balance of Payment as % of GDP
10.7   8.7 14 20.4 19 33 Rate of broad money growth
5.1 5.5 5.6 3.7 3.5 4.3 0 Rate of real non-oil GDP growth