The recently formed Yemeni government pursuant to the Riyadh Agreement is expected to face complex economic challenges that may paralyse its ability to fulfill the aspirations and hopes placed on it. The most important of those challenges are the significant decline in the Yemeni riyal exchange rate, and the difficulty of paying the salaries of public sector employees.

The decline of the Yemeni riyal exchange rate

Since mid-2020, the rate of decline in the local currency exchange rate has accelerated within the areas controlled by the internationally recognised government. This decline reached a new record in early December 2020, after it crossed the 900 Yemeni riyal barrier against the US dollar. This continuous decline in the exchange rate is attributable to the depletion of the Saudi deposit in the Central Bank of Yemen (CBY) and the continuation by the government to inject additional amounts of newly printed local currency into the market to cover its expenses in the light of the significant decline in its revenues, as well as to the Houthis’ decision to prevent the circulation of those newly printed cash amounts in their areas of control.

This decline has had serious repercussions for the living conditions of citizens in government-controlled areas, most importantly the increase in the prices of most imported commodities, especially the main foodstuffs, despite the fact that the CBY offers a preferential exchange rate to importers of those materials and bears heavy burdens due to the increasing difference between the market and the preferential exchange rates.

While the exchange rate has witnessed a relative improvement by returning to below the level of 800 Yemeni riyals against the US dollar after the announcement of the designation of members of the government, this level is in itself considered low compared to the beginning of 2020 when the exchange rate was at 650 riyals against the dollar.

In addition, local public opinion expresses great interest in the issue of comparing this deterioration with the situation within the areas controlled by the Houthi group, in which the exchange rate remained stable throughout 2020 at the level of 600 Yemeni riyals against the US dollar.[1] Naturally, this comparison serves the authority of the Houthis, regardless of the real facts and factors behind this disparity between the Houthi-controlled areas and the government-controlled areas.

Given that the new government’s own resources would not be sufficient to enable it to deal with this situation, there is talk about Saudi promises to provide a new deposit to the CBY, although the manner of using this deposit would have important repercussions that should not be overlooked:

  • After receiving this deposit, the CBY is assumed to set a specific exchange rate and seek to establish it in the market. In the event that this rate is high compared to the trade balance deficit and other related indicators, this would lead to the depletion of the new deposit in a short time.
  • Furthermore, seeking to support the exchange rate of the local currency in government areas may serve the Houthis in terms of the possibility of an additional increase in the exchange rate in their areas of control,[2] in addition to an increase in the volume/value of their revenues based on their collection in the old notes of the local currency.

Salaries of public-sector employees

It is impossible to obtain accurate figures about the government’s revenues and expenditures. However, estimates indicate that the salaries of civil and military public sector employees range from 800 billion to 1,200 billion Yemeni riyals annually, that is, between 1 and 1.5 billion US dollars, according to the current exchange rate (800 riyals to the dollar). It is usually indicated that the decline in government revenues from exporting crude oil even as its prices fell globally has led to the government’s failure to pay the salaries of civil and military employees for most of the months of 2020 (with the exception of some areas). Indeed, it has not been able to pay the salaries and overheads of its foreign missions and embassies around the world for nearly ten months.

However, the volume of crude oil exports from Yemen is currently basically modest (between 60 thousand to 80 thousand barrels per day), and the costs of its production from local fields are high, which reduces its sales revenues.[3] Therefore, it is difficult to rely on oil export revenues alone without other sources, regardless of expectations of a possible increase in oil prices in the coming period.

On the other hand, given the talk of a new Saudi deposit to the CBY, seeking to raise the local currency exchange rate would lead at the same time to an undesirable result, namely an increase in the size of the salary bill on the general budget,[4] especially that most of the government revenues come from the export of crude oil (in hard currency) and not from local sources (in local currency).

In addition, the government’s continued coverage of salaries and the rest of its expenditures through inflationary sources – such as the newly printed local currency – is a dangerous trend that raises the level of inflation and exacerbates the severity and manifestations of the humanitarian and economic crises in Yemen.

Conclusion

  • The new Yemeni government that has emerged from the Riyadh Agreement is facing complex economic challenges, mainly the continuous deterioration of the local currency exchange rate in areas outside the control of the Houthis. This has had serious repercussions for the living conditions of citizens, in addition to the difficulty of providing salaries for public sector employees in the light of the decline and limitedness of revenues.
  • The government seems to be attaching its hopes to a new Saudi deposit in the CBY in order to reverse the decline in the local currency exchange rate. However, using the deposit in this way may lead to serious complications such as allowing the Houthis to achieve financial and economic gains  and increasing the burden of public sector employees' salaries on the government, not to mention the depletion of the deposit itself in a short time.
  • The previous data confirm the need for a shift towards a new monetary policy that takes into account the trade balance deficit and various related indicators, and seeks to achieve realistic goals instead of repeating the mistakes of the previous period, namely focusing on reversing the exchange rate decline and trying to stabilise it in the short term at an unrealistic high level, or on covering key imports that have proved unfeasible.
  • It is important for the alternative monetary policy to be based on a balanced and realistic exchange rate that can be fixed in the long term with the least intervention on the part of the CBY, so that market and dealers’ confidence would be restored, the influence of speculators would be reduced, and the cash flows, most of which currently pass through informal channels,[5] would be attracted. These are more important gains and would contribute to a faster economic recovery.
  • Despite the harsh and expected repercussions of the alternative policy on the citizens' living conditions with the reduction of the official exchange rate, continuing to work with the current policy would ultimately lead to a new economic crisis when the anticipated deposit is exhausted, and perhaps to more difficult living conditions then, in addition to the fact that postponing economic reforms increases the costs and consequences.
  • The alternative monetary policy and the realistic exchange rate are also expected to contribute to alleviating the burden of public sector employees' salaries. However, they would not make up for the need to seek to reduce the government's budget deficit by rationalising its expenditures and following up on its neglected revenues, which calls for rectifying the conditions of public institutions and preventing local authorities from controlling central revenues, in addition to implementing effective control measures such as biometric fingerprinting for employees to eliminate cases of duplication and fictitious names.

Endnotes

[1] Due to the Houthi’s decision to prevent the circulation of the newly printed local currency and other factors, the exchange rate of the old banknotes has become high compared to the new ones. Since this decision has led to the movement of most of the old banknotes to the Houthi areas and the accumulation of the new notes within the government areas, the high exchange rate of the old notes became the norm In the Houthi areas, while the low exchange rate for the new notes is the one applicable in government areas.

[2] The variation in exchange rates between the government and Houthi regions will continue, given that the volume of the newly printed notes of the local currency far exceeds the volume of the old ones, and also given that the CBY in Aden assumes the task of covering most imports to Yemen at a time when most cash flows of the hard currency go to the Houthi-controlled areas with the largest population density. This discrepancy requires various measures to resolve it, such as canceling the circulation of the old notes.

[3] In an interview he gave to Asharq Al-Awsat newspaper in May 2020, the Governor of the CBY in Aden Dr. Ahmed al-Fadli indicated that the cost of producing one barrel of crude oil from local fields at the time was equivalent to its selling prices on the global market, meaning that the cost of producing a single barrel of crude oil locally ranges between 20 and 30 US dollars. This is a very high figure compared to the costs of producing oil in neighbouring countries, and indicates potential corruption, mismanagement and misplanning. See: https://aawsat.com/print/2269806

[4] For example, according to a scenario of improvement and a rise in the local currency exchange rate within the government-controlled areas to the level of 600 riyals TO the dollar, the total annual salaries will increase to a figure ranging between 1.3 and 2 billion US dollars (compared to 1-1.5 billion dollars according to the exchange rate of 800 riyals against the dollar).

[5] Expatriate Yemeni workers' remittances are the most important and largest source of hard currency flow to Yemen. Restoring the confidence of dealers in the exchange rate and convincing them to use official channels to transfer their money would give the CBY access to large hard currency stocks that can significantly contribute to alleviating its burdens.

 

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