ANALYSIS-Yemen seen struggling to keep currency afloat

19 Jan 2011

Source: reuters // Reuters

* Rial seen coming under pressure as finances shaky

* New weakness may spark social tensions

* Tunisia highlights links between economy and stability

By Martin Dokoupil and Mohamed Sudam DUBAI/SANAA, Jan 19 (Reuters) - Impoverished Arab state Yemen is struggling to keep its currency afloat as it ploughs through cash reserves to fight rebellions, al Qaeda militancy and crushing poverty in order to maintain social order.

Yemen's central bank spent $1.6 billion last year -- equivalent to a quarter of its current reserves -- to lift the rial from historic lows and help fund imports of basic goods.

The bank's sub-governor told Reuters in Sanaa recently that it would not allow further moves in the currency which it felt were not, in its view, economically justified.

Yet as Yemen edges closer to becoming a failed state, analysts believe that it will be harder this year to keep its currency stable in the face of declining confidence.

And as authoritarian Arab leaders look anxiously at Tunisia, where unrest fuelled by poverty has unseated a veteran autocrat, gloomy economic news may be troubling to the administration of President Ali Abdullah Saleh, who has ruled since the 1970s.

"There are possibilities of all kinds of emergencies that may lead to additional pressure on the exchange rate," said Abdul-Ghani al-Iryani, a political analyst in the capital.

"Given the fact that production of oil continues to slide, sooner or later there will be another exchange rate crisis they will have to deal with."

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After tumbling 17 percent to a record low of 250 rials to the dollar last year, policymakers determined to halt its slide hiked the key interest rate to 20 percent from 12 percent in a single move, sold dollars and capped currency outflows.

That, plus higher oil prices, has helped the rial rate to recover to around 214, easing imported inflation pressures.

GRIP OF POVERTY

Still, inflation in the Arab world's poorest country is hovering at around 12 percent and unemployment at 35 percent. And more than 40 percent of the 23 million Yemenis live on less than $2 a day, making hunger a commonplace reality for many.

Retailers in Sanaa price more expensive goods such as TV sets in dollars to shield against sudden currency swings, although payments in rials are accepted.

The global rise in food prices is also a growing concern.

"In case the prices of food supplies continue to rise ... this will lead to big risks to social peace and stability in the country," said Abdul Karim Sallam, editor in chief of local al-Ektisad al-Youm weekly.

Widespread protests over soaring food prices and high unemployment were instrumental in toppling Tunisia's ruler in the past week and Algeria is witnessing similar protests.

Libya is cutting taxes on food, and Kuwait introduced measures this week to subsidise food costs for its citizens.

"We had to increase prices repeatedly and customers turn away as a result," said Ali Muhammad Nasser, a bakery shop owner in Sanaa. "Sometimes we don't achieve profits because we sell with lower prices to encourage costumers to come."

SHALLOW RESERVES

Yemen's government is being forced to spend more to prop up the currency and the economy at a time when it needs to improve its finances, depriving it of the firepower it would need to avert another currency crisis.

"Even if oil prices go to $100 (a barrel), there is a possibility that they will exhaust their foreign assets," said John Sfakianakis, chief economist at Banque Saudi Fransi.

"Without any intervention, the currency may well go into a downward spiral."

Ibrahim al-Nahari, the Yemeni central bank's sub-governor, told Reuters that the central bank would not allow exchange rate moves that were not economically justified and was coordinating with the finance ministry to tackle the budget gap.

Yemen's foreign currency reserves stood officially at $5.9 billion last month, down from $7.1 billion at end-2009, he said, but some analysts disputed the figure, saying it may be much lower.

Lacking access to international debt markets, the state has few options to plug a $1.5 billion budget hole other than to borrow from the central bank or to raise funds from donors.

The government, which relies on oil proceeds for 60 percent of its income, plans to sell $500 million worth of Islamic bonds this year but few believe that the issue can succeed.

Only a fraction of $4.7 billion promised at a donor conference in 2006 has been disbursed so far.

Moreover, the IMF, which expects a budget shortfall of 5.0 percent of GDP this year, has said it is not considering new loans for Yemen after a $370 million loan approved in August.

As part of economic reforms, Yemen has begun reducing fuel subsidies, a major burden on state finances, but is having to do this gradually to avoid stoking public anger. Previous moves to raise fuel prices provoked riots.

But the government's commitment to improving finances remains in question after it announced this week that would cut income taxes for its employees to 15 percent from 20 percent.

Caught between spending to keep citizens happy and the need to conserve cash, Yemen has its hands tied.

"The Yemeni currency is in a very fragile situation," said Mohamed al-Maytami, economics professor at Sanaa University.

"Looking at the central bank reserves and the budget deficit I do not know how long they will be able to withstand new currency weakness." (Editing by Reed Stevenson and Alastair Macdonald)

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