DUBAI Yemen has room to gradually reduce interest rates to support economic recovery and needs to focus on consolidating its public finances, an International Monetary Fund official said.
"In view of the continued decline in inflation, there is scope for a further gradual reduction in the interest rate to stimulate bank lending to the private sector," Khaled Sakr, the IMF mission chief for Yemen, told Reuters.
The central bank cut its key deposit rate by two percentage points to 18 percent in October as inflation came down to single digits and the Yemeni rial currency stabilized.
The official inflation rate in Yemen, the poorest Arab country which is torn by unrest and clashes with militants, spiraled as high as 25 percent year-on-year in October 2011. It subsided to 5.5 percent in November 2012, the latest central bank data show.
The rial fell to about 243 to the dollar in 2011 during a year of political turmoil, which toppled President Ali Abdullah Saleh in February 2012 and led to a rise of al Qaeda militants. Although some violence continues, the rial is now at 215.
Yemen's economy should expand by around 4 percent this year after having stabilized in 2012, Sakr said. It shrank 10.5 percent in 2011, its first drop since the 1990 unification of north and south.
"The prospects, however, remain clouded by the political transition challenges and security concerns; in particular the frequent attacks on key oil and electricity facilities," Sakr said in an e-mailed response to Reuters' questions.
International support is critical to enable Yemen to consolidate its stabilization and advance reforms to boost employment and reduce poverty, Sakr said, adding that donor aid improved in 2012 thanks to Saudi Arabia.
The IMF is ready to consider further financial aid in 2013 if it is approached, he added. The Fund resumed lending to Yemen last April, approving the payment of a $93.7 million loan.
Last week, Yemen's planning minister told Reuters that Gulf Arab states had promised aid on top of the $7.9 billion pledged by foreign donors last autumn.
Yemeni officials have said that Riyadh provided over $2.2 billion of oil and fuel products in 2012, plus a $1 billion central bank loan that helped anchor the rial.
Sakr also said Yemen's 2013 government budget deficit should be slightly larger than the 2012 estimate of around 5.5 percent of gross domestic product. That is still a more optimistic forecast than the government's recent forecast of a 9 percent gap.
In order to cut the shortfall, Yemen should mainly focus on slashing energy subsidies of around 8 percent of GDP and the public sector wage bill now at more than 10 percent, he said.
The subsidy, which keeps fuel prices well below international levels, benefits the rich and results in "smuggling, waste and environmental deterioration", Sakr said.
"This subsidy needs to be reduced, while protecting the poor through more effective and less distortionary measures," he said.
"Containing the (wage) bill is crucial for achieving fiscal sustainability and for freeing resources for efficient social protection and investment in infrastructure," he added.
Yemen depends on crude oil exports for about 60 percent of its budget income, and its finances have been shaken by frequent bombings of oil and gas pipelines by insurgents or tribesmen.
As a result, strengthening tax and customs revenues is also a priority for Yemen, according to the IMF.
"Political support is essential for ensuring improved compliance by large taxpayers and to stop granting of any tax exemptions as they would introduce more distortions and reverse the gains of past reforms," Sakr said.
(Editing by Andrew Torchia and Jane Baird)