Yemen's internationally recognized government has taken several measures and steps to contain the depreciation of the local currency in its areas of controls across the country. The national currency has suffered an unprecedented crash after the riyal exchange rate against the US dollar jumped above the 1,000 riyals barrier. This paper evaluates the Yemeni government's response to the national currency devaluation and success prospects.
A Currency in Crisis: Background & Context
After Yemeni President Abd Rabbuh Mansour Hadi decided to relocate the headquarters of the Central Bank of Yemen to the provisional capital, Aden, in September 2016, the government printed new banknotes of the local currency (the riyal) to meet its financial obligations and compensate for a lack of liquidity in the market. The new banknotes were circulated in all regions of the country, at the same price as the old banknotes until late 2019, when the Houthi "Ansar Allah" group issued strict directives preventing the circulation of the new banknotes in its areas of control and threatened to punish those who violate this decision.
Soon afterwards, the Houthi move led to a growing difference in the exchange rates of both the new and the old banknotes, in part because the monetary base of the new notes is larger than the old ones. The new banknotes have also been piled up in government-controlled areas at a time when most of the population and commercial activity is concentrated within Houthi-controlled areas. Also, most of hard currency inflows go to Houthi-controlled areas, while the central bank in Aden finances and covers most of the major imports to all regions of Yemen.
Since then, the exchange rate of the old banknote used in Houthi-controlled areas has remained fixed at 600 riyals against one US dollar, while the new banknote used in government-controlled areas continued to depreciate until it finally crossed the barrier of 1,000 Yemeni riyals per dollar. Undoubtedly, this was a very dangerous development which undermined the purchasing power of citizens, who are already suffering from catastrophic living conditions. It also contributed to establishing an image of the Houthis as being more capable of managing state affairs than the internationally recognized government.
In light of these developments, the government has taken an array of measures and arrangements, introducing new and more robust mechanisms to monitor the exchange market and recalling the new banknotes that differ in shape from the old ones from the market and replacing them with new banknotes in the same old shape. It also sought to market government bonds and Sukuk and raise customs tariffs, before moving on to using Special Drawing Right from the International Monetary Fund (IMF).
Government Policy to Reverse the Riyal Devaluation
1. Monitor and Control the Exchange Market
The government and the administration of the Central Bank in Aden are betting heavily on new mechanisms that have been recently approved to monitor and control the local exchange market and to curb speculation, which is believed to be one of the main reasons for the depreciation of the currency exchange rate. Prime Minister Maeen Abdulmalik Saeed has indicated in a recent television interview that the Central Bank's estimates assume that the exchange rate should be less than 800 Yemeni riyals against the US dollar.
However, it is difficult to accept the figure quoted by the Prime Minister from the estimates of the Central Bank, because the bank does not have accurate figures about the value of hard currency inflows to Yemen, neither the amount that goes from them to Houthi-controlled areas, nor the mass that remains in government-controlled areas. Yemen lacks controls and mechanisms that regulate financial operations and ensure that figures on the volume of these flows are accurate. Perhaps the most reliable information that the bank has is limited to the size of the monetary base of new and old banknotes, and therefore it is not sufficient to establish sound estimates/ statistics in this aspect.
While it is recognized that speculation in the exchange market played a major role in the decline in the riyal exchange rate, it is known that the margin of maneuver available to speculators is based on a single major factor which is the lack of confidence in monetary policies. Such mistrust would speculators to create an unreal demand or supply in the exchange market, and then persuading dealers and traders to engage in a frantic buying or selling wave to protect their assets or make quick gains.
The central bank’s move to create a unified network that brings together exchange companies to monitor trading and capture and investigate any irrational patterns of transactions may help in relatively mitigating the decline in the local currency exchange rate in government-controlled areas. However, these steps are not expected to help much in stabilizing the exchange rate and cushioning the impact of speculation as long as the lack of confidence in monetary policies and in the ability of the government and the central bank to meet demand and cover imports persists.
2. Recall of the New Banknotes
The Houthi group’s success in imposing a strict ban on the circulation of new local currency notes in its areas of control is due to an insufficiently studied approach pursued by the Central Bank in Aden. The new banknotes were different in shape and size from the old ones, which later helped people to differentiate between the two notes very easily. The bank has recently announced that it intends to replace a quantity of the new banknotes of different shape with new ones bearing the same old shape as part of an effort to address distortions in the local currency. The bank also announced its intention to sell Sukuk and bonds worth 400 billion Yemeni riyals to reduce the local currency in circulation, and ease demand for hard currency.
However, there is a burdensome challenge that may prevent such efforts from bearing fruit. The new banknotes of different shape total up to about 2 trillion riyals, while the new notes of the old shape will not exceed 300-400 billion riyals at best. Thus, the central bank in Aden will only be able to exchange a limited amount of the new notes of different shape.
To make matters worse, the Houthi group preempted these endeavors with several decisions and steps, including banning the circulation of the local currency of the old shape if it carried certain serial numbers. Reports indicated that the group was able to find out these numbers based on what is believed to be information leaked to it from the Central Bank in Aden about the presence of distinct serial numbers on the new banknotes of the old shape. The group also imposed a ban on transferring any sums of local currency in excess of 100,000 riyals from government-controlled areas to areas under its control, even if they were old banknotes and carried serial numbers approved by it. It is understood that this step takes into account the possibility that the groups' checkpoints will not be able to scrutinize large amounts or discover old-style banknotes.
As for the move by the Central Bank in Aden to issue Sukuk and bonds worth 400 billion Yemeni riyals, many experts rule out the possibility of its success, given the lack of confidence in the government’s ability to pay interest on these Sukuk and bonds, or even that their holders can recover their value in the future. Although the Central Bank offers a high interest rate (27%) on these Sukuk and bonds, private sector banks will not see it as a sufficient incentive to give up their concerns. So far, neither the government nor the Central Bank has ever paid the dues on public debt and bonds, which date back to the pre-current war era. In addition, private sector banks have been holding limited financial assets in the past few years because citizens have resorted to keeping their savings in their homes or other places for fear of banks being subject to looting or incurring heavy losses that may lead to losing their savings. In sum, this means that banking sector will most likely not be able to provide the financial resources required to purchase the bonds and Sukuk that the central bank in Aden intends to sell.
3. Raising Customs Duties
In order to dispense with inflationary sources of financing (pumping new banknotes of the local currency into the market), the government of Maeen Abdulmalik Saeed decided to raise customs tariffs on imports to Yemen by applying an exchange rate of 500 riyals against one US dollar in the customs tariff, instead of the previous exchange rate (250 riyals to one US dollar). The government says that this decision will boost its customs duties revenue from about 350 billion riyals to 700 billion riyals annually, and will help it meet its obligations and finance public sector payrolls on a regular basis, without resorting again to inflationary sources of financing that contributed to the devaluation of the local currency.
It can be said that this decision is the best step taken by the internationally recognized government in recent times in its quest to control fiscal and monetary policies. Although some objected to this step, claiming that citizens were unable to bear any additional financial burdens, the government indicates that there is a customs exemption that covers basic commodities such as flour, sugar, cooking oil, wheat, rice, milk, medicine, and fuel. The government also asserts that this hike will not lead to a significant rise in the prices of non-essential imports, since most of them (80%) are commodities on which a simple customs tariff (5%) is imposed, in addition to the fact that customs duties on other commodities are also low (10%). The government also says that customs tariffs in Yemen are still among the lowest regionally and globally.
However, this step may require the government to assume a greater role in monitoring the local market in order to prevent traders from raising the prices of goods in a manner disproportionate to the rise in customs tariffs. Perhaps competition in ideal market conditions would have prevented traders from such practices, but the market in Yemen today is governed by illegal monopolies and privileges that prevent the activation of free market tools and real competition.
The success of the government on this path also requires obligating the local administrations in the governorates not to tamper with central streams of revenue and to hand them over to the branches of the Central Bank if it is to feed the public treasury with greater resources and enhance its financial standing. For example, the local administration in Marib insists on interfering in the pricing of oil derivatives by selling them at a lower price than the rest of the governorates, causing the government to lose tens of billions annually.
4. Use of the IMF's Special Drawing Rights
Last July, the International Monetary Fund agreed to provide a share of its special drawing rights, equivalent to 555 million dollars, to Yemen to boost the country's hard currency reserves and support its national currency. The administration of the Central Bank in Aden has recently announced that it expects these allocations to be made available at the end of August. It seems that the administration of the Central Bank in Aden intends to use these allocations to finance basic imports, as it did with the Saudi deposit. It was selling hard currency to importers at a price lower than the exchange market prices as part of a strategy aimed at stabilizing the prices of the main imports in the local market, hoping that this would contribute to stopping the pace of decline in the local currency exchange rate in the exchange market in general.
Regardless of the fact that many experts doubt the extent to which these goals can be achieved, and rumors alleging that the Central Bank administration is involved in corruption crimes and that has been colluding with importers, this strategy drained the Saudi deposit ($2.2 billion) in less than two years. Thus, this strategy will most likely waste the funds expected from the International Monetary Fund in about half a year. Ultimately, the government will find itself in the same vicious circle again and will search for other options to confront an inevitable and new decline in the exchange rate at that time.
Projections and Options
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