The Second Yemeni Economic Conference
Sana'a  18 - 20 April, 1998

Abstract 6:

Economic Reform and the Domestic Resource Gap

Dr. Yahya Y. Almutawakel
Dept. of Economics
Sana’a University

Achieving economic development and economic and social objectives depends, to a large extent, on the economy’s ability to mobilize adequate resources necessary for undertaking investments. There are two main sources to finance investment projects. Domestic savings -private and public- represent the first source, while foreign resources provide the second source that make investment possible in a national economy. Foreign resources can be provided through either government and private sector loans, or, in the form of attracting direct foreign investments.

A low domestic savings ratio is one of the main characteristics of economic underdevelopment, which in itself, is due to factors that in turn pertain to the same underdevelopment. There are some constraints that impede the increase of the savings ratio in developing countries in their early stage of development. Thus these countries are forces to resort to foreign sources in order to finance the existing gap between domestic savings and the required investments needed to reach growth targets. Moreover, the extent of the domestic resource gap depends on the objectives to be sought, and hence on the amount of investments needed to achieve those objectives.

However, the Republic of Yemen is a late starter in development. The major factor that has influenced the economy since the mid-1970s has been the large labor demand in the neighboring countries which could not be met locally. Yemen was able to export part of its labor force, and therefore benefited indirectly from oil windfalls.

The immediate economic impact of emigration has been an unprecedented increase in personal incomes. Thus, remittances had been by far the most important force behind the strong performance of the economy during that period. But, since the national economy was unable to meet the growing demand through domestic production, imports increased steadily to cover the growing gap, especially imports of foodstuffs and luxury items. Hence, during this period Yemen managed to live beyond its means.

During the first half of the 1990s, the Yemeni economy underwent an unexpected transition. The main influencing factors were the unification process between the two parts of the homeland, the Second Gulf War which resulted in the return of some 800,000 emigrants from the Gulf States, and the suspension of foreign aid. Hence, the performance of the economy was disappointing as real non-oil GDP contracted resulting in a decline in real per capita income.

Whereas incomes declined, unemployment, inflation and demand for basic goods and services increased, exerting greater pressures on the economy. The root of the problem pertains to the Government’s expansionary spending policy at a time of deteriorating revenues. Large budget deficits were recorded. They were primarily financed by the domestic banking system, mainly the Central Bank through Fiat money leading to rapid monetary growth.

Large balance of payments deficits were also recorded, despite sizable increases in oil exports. This situation exemplifies a narrow export base, a heavy dependence on imports, and the continuous decline of remittances. Moreover, the country’s credit rating was tarnished because of its inability to service its debts, posing an obvious challenge to economic and social development.

The Government, in its endeavor to solve the major problems facing the economy initiated a comprehensive program of stabilization and structural adjustment. The program aims at preventing further deterioration at the macro level, and then moves towards sustained growth. In March 1995, the Government launched the first set of reform measures in order to stabilize the economy and remove structural economic imbalances. Those measures were intended to mobilize public revenue and to tighten spending through various price adjustments.

As to the impact of the reform program on the macroeconomic variables in general and on the factors influencing the domestic resource gap in particular, we can attest to the increase in both saving and investment rates, as well as to the reduction in budget and trade deficits. Furthermore, reform measures succeeded in controlling inflation but were unable to confront unemployment. Finally, despite the above achievement, further policy reforms are required to achieve financial and exchange rate stabilization.