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Omar Mashjari

The quiet collapse of Yemen's economy

A currency exchange deal on the streets of Sanaa [AFP]

Date of publication: 8 May, 2018

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Comment: The underreported collapse of Yemen's economy, and the absence of a functional central bank could worsen all of the country's problems, writes Omar Mashjari.
Today Yemen is in short supply of many things, having endured a bloody conflict for over three years, but it is certainly not in short supply of challenges. 

Ranging from the humanitarian to the political, the nation of 26 million people has proven itself to be resilient in the face of these wide-ranging and often very apparent challenges.

Yet perhaps the most pressing challenge, which genuinely has the potential to truly plunge the country into darkness for decades and make any effort at post-conflict reconstruction infinitely more difficult, is the least reported.

The collapse of Yemen's economy and the absence of a functional central bank in particular, if left unresolved, could further worsen all of the country's underlying problems.

The UN has described Yemen as 'the world's worst humanitarian disaster' and the international community pledged $2bn in humanitarian aid just last month, but without a viable banking system underpinned by a secure currency, all such efforts are in vain.

The primary factor underscoring Yemen's humanitarian crisis is not linked to the availability of food, as markets are generally well stocked, but rather the increase in prices and affordability of food, impacted by the widespread loss of livelihoods and the extremely weak Yemen rial (YER).
Without a viable banking system underpinned by a secure currency, all such efforts are in vain

For the first two years of the conflict, Yemen's Central Bank remained in Sanaa despite the exodus of the internationally recognised government of President Hadi.

Mohamed Bin Humam, a much-respected bureaucrat and the long-time governor of the Central Bank sought to navigate the difficult political lines in the conflict by paying the salaries of officials employed by both the internationally recognised government and the Houthi rebel group.

Central banks are crucial to the financial stability of countries - they control the flow of currency, manage inflation levels and support domestic commercial banks who in turn deal directly with the public.

Bin Humam's decision was arguably intended as a stop-gap to prevent the entire collapse of the economy and preserve what little confidence there was in the Yemeni riyal.

Demanding the creation of a new central bank with no or very little money was a recipe for economic disaster

However, unfortunately the reserves of the Central Bank, estimated to be the region of US$3-4 billion, ended before the war did. Accessing the reserves of the Central Bank located within their territory allowed the Houthis to greatly strengthen their power. In response, Hadi's government in exile, with little financial incentive left in light of the depletion of Yemen's reserves, made the decision relocate the Central Bank to his interim capital, Aden.

It is important to make clear that Yemen's Central Bank was, even in the best of times, far from perfect.

The country's economic mismanagement and historic debt accumulated by the merger of the northern Yemen Arab Republic and the southern People's Democratic Republic of Yemen in 1990 were ongoing issues which hampered its performance.

Yet President Hadi's decision to 'relocate' the Central Bank in September 2017 effectively meant that the previous Central Bank in Sanaa would cease to exist, and in turn, a new Central Bank would emerge.

Yemeni villagers receive food handouts as prices in shops soar [AFP]

The decision is better described as the legal and physical dissolution of the existing Central Bank rather than a relocation or transfer.

Indeed, the new Bank needed to be housed in new premises and new officials were appointed to run the new entity who, in actual fact, remained outside of Aden for some time following its establishment.

At the time, the move was criticised as being overtly political with no real positive economic justification. The concern was that it would only hamper confidence in the YER even further and potentially put inexperienced officials into a critical driving seat with disastrous results.

But for Hadi and his government, it was part of a longer term strategy to recapture political and economic control of the country. By moving the Central Bank to Aden, it set the groundwork for the rest of the establishment of a transitional state in the South.

Soaring prices have put some basic commodities out of reach for many Yemenis

It was a means by which Hadi could legitimise his governance and provide basic services to the citizens and state, the Central Bank's main customer. Hadi's government also needed a Central Bank, however nominal, under its control in order to pay salaries of state employees, receive foreign aid from international donors and support the war effort more generally.

In reality, the problems with this decision were evident.

Demanding the creation of a new central bank with no or very little money from scratch in a city which the government held a fragile hold over was a recipe for economic disaster.

The original officials appointed to roles in the new Bank appeared to be inept with no high-level experience of running a central bank, let alone one in the midst of conflict. Most recently, this has led to the replacement of the governor in February 2018.

Since the move, the YER has lost more than half its value against the dollar and soaring prices have put some basic commodities out of reach for many Yemenis.

[Click to enlarge]

The YER is the backbone of the country's economy and it is used to buy everything from spare parts to basic foodstuffs, its collapse would bear unimaginable consequences for the daily life of civilians.

If the currency did collapse, the only real alternative would be the adoption of the US dollar or another stable foreign currency, similar to the strategy adopted by Zimbabwe during its hyper-inflation crisis in 2000s.

But for Yemen, this might not even be possible since the country is heavily dependent on foreign imports, requiring - as it does - some 95 percent of all its foodstuffs from outside the country.

Read more: In Yemen, women bear the brunt of a merciless war

Imports are purchased on the international markets in dollars, which means that there is lack of the US dollar in circulation in Yemen, especially as those holding large quantities of YER are seeking the stability of the USD creating a flight on capital in the country.

In addition, Yemeni businesses who trade internationally have been forced to use the services of intermediaries and often pay upfront for any orders, as opposed to the usual trade terms which permit deferred payments.

Although intermediary services have been useful in allowing Yemeni businesses to import goods in the country during this time of crisis, they are expensive, and inflated prices are ultimately are passed on, causing price hikes for the end consumer. 

With Yemen's currency facing a 300 percent depreciation against the dollar in less than three years since the conflict started, limited, - or effectively no - credibility on the international markets, and rising prices for basic foodstuffs, it was only a matter of time before a major currency crisis occurred.

Indeed, some five months following the move to Aden, a massive run on the YER occurred at the beginning of 2018 which led the Yemeni prime minister to publically plead with Saudi Arabia to provide $US 2 billion in urgent capital reserves to the new Central Bank.

Prime Minister Ahmed bin Daghr argued that the reserves were needed to shore the currency up in order to prevent economic collapse, saying "Saving the rial means saving Yemenis from inevitable hunger".

On 17 January 2018, King Salman dutifully responded and confirmed that a deposit of $US 2 billion would be paid to the new Central Bank immediately to support the international recognised government.

The YER rebounded almost overnight and exchange rate high of $520 to each one YER was reduced. It was hoped that the salaries of state employees, and health workers fighting against cholera in particular, would be restored.

This would, it was hoped, have a knock-on impact by enabling desperately needed consumer spending in the domestic market. However, for some two months following the announcement by the King, the new Central Bank allegedly did not receive the promised deposit from the Saudis. It does now seem that some, if not all of the $2 billion has been received, but the systemic capacity of the new entity remains a major point of contention.

When Yemen's Central Bank moved, none of its existing and most importantly, none of its experienced staff moved with it. Yemen's new Bank has an evident knowledge gap internally which needs to be filled as soon as possible in order to make the most of the Saudis capital injection.

If the currency did collapse, the only real alternative would be the adoption of the US dollar

Indeed, one of the most obvious weaknesses of the new Bank is the failure of its leadership operate inside the country. The Central Bank's leadership has been operating from abroad (with senior management largely based in Amman and Riyadh) which is not conducive to effective central bank management as it not possible for a central bank to function without a physical presence.

The new Bank's problems are also compounded by issues outside of its control, including the stability of its temporary headquarters in Aden, the professionalism of the internationally-recognised government and the activities of the Houthis in the North who equally rely on the YER and therefore, could derail any positive developments.

For their part, in the absence of a central bank under their control, they have increasingly relied on domestic commercial banks who now act as their defacto central bank for northern region.

The Houthis continue to use the YER, with the US Treasury reporting that Houthi allies - Iran's Islamic Revolutionary Guard Corps - have been involved printing counterfeit YER bank notes potentially worth hundreds of millions of dollars.

The Houthis continued use of the YER means that regardless of what the new Central Bank chooses to do, it mustn't be a central bank just for Aden or Hadi's government, but one for all Yemenis.

Indeed, the use of the YER by the Houthis has already raised key challenges for the new Bank when determining the circulation of the YER notes in the country.

Putting the allegedly influx of counterfeit YER notes to one side, the new Bank must be able to control the supply of paper notes in the country, something it is clearly unable to do so since it's government has no reach in the more heavily populated north.

This inability to control paper money supply is reflected by the indecision of the new Bank when deciding how to release the millions of YER paper notes printed in Moscow by the Russian state.

These Russian-printed notes remain in the new Bank's premises in Aden and reportedly have no date for release as of yet.

Meanwhile, the actions of Hadi's internationally-recognised government have also undermined the legitimacy of the new Bank. Hadi's government has allegedly maintained accounts with Saudi domestic commercial banks for use by officials with no transparency or accountability.

The new Central Bank must be able to control the supply of paper notes in the country, something it is clearly unable to do

In particular, it is said that the internationally-recognised government holds an account at Ahli Bank in Saudi Arabia, where revenues from oil exports have been deposited. The cornerstone of the central bank and government relationship is that the state is the exclusive customer of the central bank.

By banking elsewhere, directly in name of the government, Hadi's government is directly undermining the role of the new Central Bank and potentially increasing the likelihood of corruption due to the lack of regulatory oversight over the accounts.

Most recently, however, there appears to be some progress with the development of Yemen's new Central Bank systemic capacity.

The new governor, Mohamed Zemam, recently concluded consultations with the International Monetary Fund, with the US confirming its continued support.

In addition, under Zemam's leadership, the new Bank has decided to return food subsidies which should help lower food prices for civilians.

Zemam has also made gestures towards creating a new Bank for all Yemenis, though it remains to be seen whether this will become reality. 

The collapse of Yemen's economy is now in the hands of the new Central Bank, and as Voltaire stated during the French Revolution, with great power comes great responsibility.

Zemam now resides over an uneasy economic compromise with each decision he takes, having the potential to plunge the country into an inescapable darkness.


Omar Mashjari is British-Yemeni lawyer and writer.

Follow him on Twitter: @OmarMashjari

Opinions expressed in this article remain those of the author and do not necessarily represent those of The New Arab, its editorial board or staff.

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