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.

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Saleh Hears GST Arguments
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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.

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"...And Don't Come Out Until You Agree."
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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.

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The Winding Path to Economic Reform
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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.
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ROYG Has Little Credibility on GST
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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.

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Business: IMF Misses the Point
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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.

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Like Making Sausage
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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