Identifier
Created
Classification
Origin
05SANAA1875
2005-07-11 09:39:00
CONFIDENTIAL
Embassy Sanaa
Cable title:  

YEMENI RIYAL SHOWS SIGNS OF INSTABILITY

Tags:  ECON EFIN EINV YM COM 
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This record is a partial extract of the original cable. The full text of the original cable is not available.
C O N F I D E N T I A L SECTION 01 OF 02 SANAA 001875 

SIPDIS

PLEASE PASS TO MICHAEL GRIFFERTY, US TREASURY REGIONAL
OFFICE ABU DHABI.

E.O. 12958: DECL: 07/11/2015
TAGS: ECON EFIN EINV YM ECON COM
SUBJECT: YEMENI RIYAL SHOWS SIGNS OF INSTABILITY

Classified By: CDA Nabeel Khoury for reasons 1.5 b and d.

C O N F I D E N T I A L SECTION 01 OF 02 SANAA 001875

SIPDIS

PLEASE PASS TO MICHAEL GRIFFERTY, US TREASURY REGIONAL
OFFICE ABU DHABI.

E.O. 12958: DECL: 07/11/2015
TAGS: ECON EFIN EINV YM ECON COM
SUBJECT: YEMENI RIYAL SHOWS SIGNS OF INSTABILITY

Classified By: CDA Nabeel Khoury for reasons 1.5 b and d.


1. (U) Summary. The Yemeni Riyal has fluctuated dramatically
in recent months, and the Central Bank of Yemen (CBY)
intervened on at least two occasions to combat devaluation.
Despite these efforts, for the first time in three years a
black market has emerged for buying foreign currency, and the
falling Riyal has led to rising commodity prices and
increasing uncertainty for the average Yemeni. IMF and World
Bank analyses indicate that the Riyal is overvalued, and
recommend gradual depreciation to encourage Yemen's non-oil
production and export capacity. Nevertheless, the ROYG
appears committed to a strong currency and the import economy
it supports. The CBY's interventionist policy may buy
short-term stability during upcoming economic reforms, but
could easily spin out of control. End summary.

--------------
Cracks Appear in Yemen's Monetary Policy
--------------


2. (U) Spring came to Yemen with an air of instability.
Recent conflict in Sa'ada and declining economic indicators
(septel),undermined confidence in the value of Yemeni
currency. At the beginning of April, the exchange rate stood
below 190 YR to the US Dollar, but by late June had fallen to
197 and appeared headed for a rate of 200 YR to the Dollar.
The press reported that the devaluation was causing hardship
for low-income Yemenis due to higher prices for food and
construction commodities. According to al-Ayyam newspaper,
wholesalers raised their prices by 20-30 percent. (Note:
Yemen's inflation, as measured by the consumer price index,
was already averaging an annual rate of 12 percent, and has
recently reached as high as 15 percent. End note.) Other
reports indicate that distributors of such products as Coca
Cola are hoarding supplies, awaiting clear indication of the
direction of the Riyal.


3. (U) On July 1, the Riyal rebounded to 190 and the official
rate appears to be holding steady for the time being (the

current rate is 192.25). There are reports that a black
market for currency has emerged in Sanaa, and that the USD is
fetching 194 YR or higher on the street. (Note: The absence
of such a black market until now indicated that the official
exchange rate represented the true market value of the Riyal.
This is no longer the case. End note.) The Riyal slipped a
total of 0.7 percent against the USD in 2004. In contrast,
before the Riyal rebounded this month, it had fallen 6.6
percent. Devaluation on this scale is considered a severe
threat by the Ministry of Finance (MOF). According to Dr.
Mohamed al-Mansoub, Assistant Deputy MOF, the MOF instructs
the CBY to restrict the Riyal's depreciation against the USD
to a maximum of five percent per year.

--------------
Devaluation: Good or Bad for Economy?
--------------


4. (U) Current devaluation appears severe to many Yemenis,
but may actually be necessary for the health of Yemen's
economy. A strong Riyal supports imports and discourages the
development of new export sectors. Strategic devaluation
could assist infant industries and prevent a sudden and
painful correction in the value of the Yemen's currency in
relation to the domestic economy. The IMF reports that when
measured against inflation rate differentials of Yemen's
major trading partners, the real exchange rate of the Riyal
actually appreciated by 3.5 percent in 2004, meaning the
Riyal is significantly over-valued. The World Bank contends
in its Spring 2005 Yemen Update that a managed devaluation is
necessary for developing the Yemeni export market and
diversifying the economy. The IMF adds that pursuing such a
policy now will help avoid sudden and drastic devaluations in
the future, brought on by declining oil and foreign currency
reserves.


5. (C) Despite this advice, the ROYG appears intent on
maintaining the strength of its currency against the USD.
According to Abdulaziz Tarmoom, Professor of Finance at Sanaa
University, the ROYG allocated USD 100 million from its
foreign reserves in two July installments as part of an
effort to curb rapid devaluation. In its March report on
Article IV consultations with the CBY, the IMF wrote that the
CBY "strongly contested any suggestion that they were
pursuing a managed float." According to the CBY, the ROYG's
policy was to intervene only to "dampen exchange rate
volatility." An intervention on the scale described by
Tarmoom indicates that the CBY is pursuing a more activist
approach to monetary policy than indicated to the IMF. On
July 9, a CBY spokesperson was quoted in the government daily
al-Thawra, saying: "The Bank will...intervene in the
currency market whenever necessary." In reality, the CBY is
responding directly to political pressures from the ROYG,
rather than pursuing a course of independent monetary policy
for Yemen's long-term economic health.

--------------
Crude Tools to Support Riyal
--------------


6. (C) In another effort to control devaluation, on June 14,
the ROYG instituted a new requirement that banks keep thirty
percent of foreign reserves at the CBY (up from 20 percent).
The apparent goal of this move, which met with the outrage of
commercial bankers and the businesses, was to tie up foreign
currency liquidity in the market, making it more expensive to
borrow in dollars and reducing flight from the Riyal. The
business community, on the other hand, contended that such a
move would slow economic activity and make it more difficult
for banks to meet their obligations to the market and
investments. The CBY already follows a strong Riyal policy.
It offers treasury bills at high rates to soak up liquidity
and create demand for the Riyal, and offers negligible
interest rates for foreign currency and high rates for Riyal
accounts to encourage savings in Yemeni currency.

--------------
Decline of Riyal Could Contribute to Unrest
--------------


7. (C) Comment: During a recent visit to Yemen, US Treasury
Department Regional Representative Michael Grifferty reported
that a shock to the currency, "Could lead to a sudden
adjustment to lower purchasing power and higher real external
debt service, likely with social implications." The more the
CBY attempts to stabilize the currency, the more vulnerable
it appears to such a shock, which would likely accompany any
deterioration in Yemen's security situation or a fall in oil
prices. Until now, Yemen's single greatest economic strength
has been the accumulation of USD 5.5 billion of foreign
currency reserves from oil sales, considered by the World
Bank to equal about 17 months of imports. The ROYG's
reserves allow it to ride out fiscal crises, but they may be
quickly exhausted if used continuously to support an
overvalued currency. The more the ROYG intervenes, the more
it undermines confidence in its currency, creating the need
for more intervention.


8. (C) Comment continued: Yemen is nearing implementation
of painful economic reform policies, including the
introduction of a sales tax already adopted by Parliament,
civil service reform, and the lifting of diesel subsidies
(septel). These measures already controversial on their own,
would be exacerbated by the simultaneous devaluation of the
currency and may lead to significant social unrest. The ROYG
is likely unwilling to entertain a much-needed gradual
devaluation at this time. As a result, the CBY is resorting
to increasingly blunt instruments to support the Riyal, and
may be running out of policy options. Ironically, the lack
of investment in Yemen may have prevented a more extensive
monetary crisis, as there are few foreign investors looking
to sell Riyals. Nevertheless, the CBY's current monetary
policies are short sighted and could lead to a real currency
crisis as they undermine confidence in the Riyal and tap into
valuable reserves. Many of Yemen's business elite make their
profits from imports, and average Yemenis depend on cheap
imports for basic staples such as wheat. A currency collapse
would be devastating to nearly every segment of society and
would likely lead to civil unrest. End comment.
Khoury