Friday, April 08, 2011

Why Yemen is on the Brink of Economic Collapse

FT: Yemen Stalemate Stifles Economy
CIA: The World Factbook

Located in the Southeast corner of the Arab Peninsula, bordered by Saudi Arabia to the north and Oman to the West, Yemen is a relatively poor country that has faced hightened political turmoil in the last two months. The wave of political upheaval that started in Tunisia quickly spread to Yemen, where demonstrators have been calling for President Ali Abdullah Saleh to step down after 33 years in power. In response to the protests, Saleh instituted socio-economic reforms that are likely to lead to an economic collapse.

Even before protests broke out, Yemen faced serious economic pressures, including high unemployment and a current accounts deficit (a current account is calculated by adding the net exports minus imports, interests and dividends, and transfer payments such as foreign aid— if the number is negative, then there is a deficit). Essentially, Yemen was spending more money than it was making. At the onset of demonstrations, Saleh introduced an economic policy to calm demonstrators. Key features of the reforms were tax cuts, higher salaries for government employees, and new public sector jobs. The total cost for the reforms were substantial, at 3% of the GDP. In order to pay for the reforms, Saleh borrowed from the Yemenis Central Bank, which in turn began to print more money to meet the government’s demands.

Saleh’s policy has been catastrophic for the economy. First, printing money is causing inflation because there is more money in the economy. Second, government spending has put pressure on the Yeminis currency, the rial. Because there are more rial generated by artificially printing money, the rial has dropped in value by 7% in the last two months compared to the dollar.

Neighboring Saudi Arabia introduced similar economic policies, which have had a calming effect on unrest and a positive effect on economic stability in the country. See Saudi Arabia’s Second Public Spending Package Does More than Diffuse Political Pressure. The key difference between the two countries is that Saudi Arabia is a major oil producer that can afford similar reforms. In Yemen, oil production comprises 70% of government revenue, yet production has dropped significantly as a result of the unrest. Moreover, oil resources are rapidly declining in Yemen unlike in Saudi Arabia. As a result of the reforms, the current accounts deficit has grown because spending has increased while government revenues have decreased.

Commentators believe the deficit, coupled with social and political unrest, will lead to a collapse of the economy. An economic collapse is a threat not only to Yemen, but a global threat given that Yemen is increasingly, a safe-harbor for Al-Qaeda.

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