SALEH PURSUES TRIBAL APPROACH TO ECONOMIC REFORMS

C O N F I D E N T I A L SECTION 01 OF 03 SANAA 001919 SIPDIS PLEASE PASS TO MCC FOR A. BAYLOR E.O. 12958: DECL: 07/17/2015 TAGS: PREL PGOV ECON EFIN EINV KMCA KMPI YM ECON COM SUBJECT: SALEH PURSUES TRIBAL APPROACH TO ECONOMIC REFORMS IN YEMEN REF: A. SANAA 1875 ¶B. SANAA 37 Classified By: CDA Nabeel Khoury for reasons 1.4 b and d. ¶1. (SBU) Summary. Yemen's Parliament approved a general sales tax law in early July, which met with fierce protest from business leaders. After hearing their complaints regarding the potential for abuse and corruption, President Saleh locked business leaders in a room with ROYG officials and demanded they reach an agreement. Details of a tentative accord include cancellation of the law, to be replaced by a one-time tax of eight percent for imported goods and five percent for those produced domestically. The ROYG will continue its dialogue on remaining issues on shared committees with the business community. Although markedly different from the original IMF proposal, the new GST plan indicates some willingness on the part of the ROYG to find much needed sources of non-oil revenue. Nevertheless, most Yemenis remain suspicious about painful austerity measures, and implementation of the economic reform package remains slow. End summary. -------------- Saleh Hears GST Arguments -------------- ¶2. (C) Amidst controversy, Parliament passed the long-awaited general sales tax on July 5. The major opposition parties, including Islah and the YSP, opposed Sales Tax Law No. 19, which was approved with the support of the majority GPC party. With businessmen threatening to strike and a history of civil unrest over the issue, President Saleh agreed to meet with business leaders. According to Nabeel Hayel Saeed, President of NATCO (a domestic subsidiary of the Hayel Saeed Group, one of Yemen's biggest companies),Yemen's businessmen told Saleh that the GST would lead to increased corruption and declining business profits. Upon hearing this, Saleh turned to Prime Minister Bajamal, saying: "Is this true? Why didn't you tell me?" Bajamal then offered to create ministerial committees to study the concerns of the business community, but Saleh rejected the idea. -------------- "...And Don't Come Out Until You Agree." -------------- ¶3. (SBU) On July 10, President Saleh locked business leaders and government officials together in his compound, instructing them to find a solution to the GST impasse. Mahfoudz Shammakh, Chairman of the Sanaa Chamber of Commerce, recounted that Saleh provided food and qat, but that no one was allowed to leave until an agreement was reached. "In the end," said Shammakh, "the President was the only one who understood our point of view." ¶4. (SBU) After one day of negotiations, the parties did reach a tentative agreement on taxation. According to the Chamber, the ROYG capitulated to the demands of business and agreed to eliminate the GST as approved by Parliament. In exchange, the business community accepted a substantial tax increase of eight percent for imported goods and five percent for domestically produced items. The taxes will be collected only once at the point of entry/production. Coupled with recent tariff reductions to 5 and 10 percent, businesses hope these measures will reduce corruption and decrease the incentive for smuggling, as well as raise new revenue. ¶5. (SBU) The ROYG and business representatives also agreed to create joint committees to study pressing taxation issues. Among these is a proposed reduction in the corporate tax rate (currently 35 percent),implementation of tax exemptions under proposed amendments to the investment law, and a review of customs valuation (septel). The Chamber promised that if the negotiations are successful, they will accompany the ROYG to Parliament and explain the new agreement to MPs. According to government-controlled newspaper al-Thawra, the Federation of Trade Chambers and bank officials also agreed to help stabilize prices, which have been skyrocketing in recent weeks due to economic uncertainty (ref A). The President set the duration of the agreement at one and a half years, meaning it must be renegotiated following to the 2006 elections. -------------- The Winding Path to Economic Reform -------------- ¶6. (SBU) This is but the latest chapter in the ROYG's attempt to implement an IMF-WB economic reform package, which includes a sales tax, cuts to the fuel subsidy, civil service reform, and changes to the investment and financial laws. The package was finally presented to Parliament seven months ago when MPs demanded the ROYG respond to a list of twenty-five questions dealing with ROYG reform before they would approve the laws (ref B). The questions were never answered, however, and in June the ROYG resubmitted the economic reforms to Parliament, contending that it had taken measures to accommodate Parliament's demands. ¶7. (C) In a July 6 conversation with econoff, Islah MPs Abdul Karim Shaiban and Ansaf Mayo vehemently denied this claim. In their view, amendments to the laws provide for even more centralized control resting in the Ministry of Finance (MOF), which they believe will lead to increased corruption. The opposition MPs criticized the reform package for its focus on increasing the revenue stream by raising taxes, rather than on reducing tax evasion and corruption. ¶8. (U) With Parliamentary approval, the ROYG now has the green light to begin lifting the fuel subsidy, which the World Bank estimates at USD 800 million for 2005. It is unclear when the new prices will go into effect, however, long gas lines in Sanaa indicate that Yemenis believe it will be soon. Despite high profile debate and the passage of some laws in Parliament, it is also unclear when any of the economic reform package will actually go into effect. Even those laws that Parliament has passed are as yet unsigned by the President. -------------- ROYG Has Little Credibility on GST -------------- ¶9. (C) The business community and much of the political opposition remains suspicious of a GST, believing it to be a power grab by MOF and the Tax Authority. The private sector's main objection, explained Shammakh, is that the Tax Authority already falsifies tax claims during yearly audits in order to maximize personal benefit to ROYG officials. With the GST, tax collectors would visit businesses once a month, creating the opportunity to demand more regular tribute. Because the GST is a value added tax, the Tax Authority would also be able to collect revenue at every stage of production, creating entirely new opportunities for bribery and corruption. Shammakh insisted that the private sector has "no objection to paying taxes," but opposes a tax mechanism that will create additional friction with the Tax Authority. On a practical note, Shammakh suggested that considering most shopkeepers do not have cash registers or transaction records, the GST would be impossible to implement. He charged that tax collectors use the ignorance of most business owners to extract additional bribes. ¶10. (C) Khaled Mustafa, Vice Chairman of the Sanaa Chamber, contended that the GST law would allow the government to search private homes and businesses at will and prevent traders from leaving the country without a proper tax permit. Another concern is that the law encourages Yemenis to inform on each other by rewarding those who provide information with five percent of taxes levied in a successful tax evasion investigation. Based on these and other issues, the Sanaa Chamber of Commerce is suing the ROYG, charging that the proposed tax measures are unconstitutional. Shammakh said the Chamber would not drop its case until the objectionable clauses have been removed. -------------- Business: IMF Misses the Point -------------- ¶11. (C) Shammakh pointed to the IMF as the source of current discord, claiming that for several years the organization has refused to meet with the business community. In addition, he accused the IMF of relying on "false numbers" used by the Central Bank of Yemen to hide evidence of corruption. Shammakh contrasted this with the early years of economic reform (1997-2001),during which the IMF met regularly with the private sector and followed a results-based program with the ROYG, denying the ROYG funding if it did not enact specific economic reform policies. In general, Council representatives indicated that the IMF was out of touch with the reality of corruption in Yemen. ¶12. (C) Ahmed Bazara, Vice President of the AMTC Toyota Dealership, noted that the majority of products on the shelf in Yemen are smuggled goods rather than legal imports. According to ROYG figures, 63 percent of goods reaching the Yemeni market are smuggled in. As a result, Bazara estimated that the ROYG captures only about 20 percent of potential revenue under existing tax laws. This means that honest businessmen must compete with smugglers, now putting them at a further disadvantage as smuggler are unlikely to pay taxes. The business community believes that if current tax laws were implemented more effectively, the ROYG could recoup approximately 140 billion YR (over USD 725 million) in lost revenue without having to impose new taxes. In Shammakh's view, Yemen must first stabilize its economy, implement existing laws, and control corruption before creating new and complex systems of taxation. -------------- Like Making Sausage -------------- ¶13. (C) Comment: Passage of the GST law in Parliament served (after four years) as the opening of public debate on the issue, rather than the final word. President Saleh's tribal approach to crafting important macroeconomic policy appears to have succeeded in the short term, although it remains to be seen what new legislation will be submitted to Parliament. By negotiating an agreement with business representatives, the ROYG managed to avoid popular unrest in response to the tax hikes. Prices will still rise, but the average Yemeni will not feel the intrusions of the Tax Authority directly. There is much speculation that Saleh orchestrated the entire exercise to brandish his influence, highlighting his role in achieving consensus rather than in implementing unpopular austerity measures. International observers at the World Bank and IMF are unsure of how to react to these developments. Although confused by the Yemeni legislative process, most express satisfaction that the ROYG was able to expand its revenue base away from oil. End comment. Khoury