* Fuel subsidy cuts vital to strengthen state finances
* Could allow government to ease fuel shortages
* Austerity announcement seeks public support for reform
* But public anger makes reform risky
* Opposition from entrenched interests, not just the poor
By Yara Bayoumy and Martin Dokoupil
SANAA/DUBAI, July 21 A clampdown on state spending was an effort by Yemen's government this month to win public support before its biggest economic reform in years: higher fuel prices. But an angry public may not be won over.
In the capital Sanaa, where roads to petrol stations have been choked for months by queues of cars waiting for scarce fuel supplies, the frustration is palpable.
"I've been standing in line for six hours ... By the time I arrived at the front of the queue, they told me there was no fuel left," doctor Waddah Hashed said.
"Our lives have become hell."
Taxi driver Mohammed al-Heemi has organised a group of his colleagues to exchange information on which pumps in the city happened to have petrol.
"One day we work, the next day we stand in a queue. This has been our life for the past four months," he said. "It is obvious the government wants to persuade us of the need for the price rise, but the people cannot take this anymore."
"The people will go out ... to bring down the government if the price of fuel is raised."
The public mood is a big risk for the government as it tries to shore up its rickety finances. One of the poorest countries in the Arab world, Yemen's economy has always struggled, but political instability since the region's Arab Spring uprisings in 2011 have left it particularly vulnerable.
The government has been trying for more than a year to secure a loan of at least $560 million from the International Monetary Fund (IMF), which is pressing for reforms such as cuts in subsidies which keep down prices of petrol and other fuel.
In the long run, reducing the subsidies would be good news for the state budget; they cost about $3 billion last year, or a third of state revenue. Some of the money freed up by the reform could be used to increase fuel supplies, easing the shortages which anger the public.
But the immediate impact of the reform would be to raise fuel prices for Yemeni consumers - potentially, a politically explosive step. A previous attempt by the government to cut subsidies in 2005 led to unrest which left some 20 people dead and over 300 wounded. The reform was cancelled.
More civil unrest in the country of 27 million would feed into general instability which a range of anti-government forces could try to exploit, including al Qaeda-affiliated militants.
"With something like fuel subsidies, there's never a good time, so you have to look for the least bad time," Jane Marriott, Britain's ambassador to Yemen, told Reuters in May.
"From all the ministers, president and people I've spoken to, everyone knows that it needs to be done," she said. But for the plan to work, Yemen has to ensure there is enough fuel to satisfy demand at the higher prices, she said.
If people still have to queue after the subsidies are reduced, that will be a "recipe for disaster", Marriott said.
Pumps in Sanaa sell a litre of petrol - when they have it - at an official, subsidised price of 125 rials ($0.58), below roughly 300 rials charged on the black market, where prices have risen sharply because of the fuel supply crisis.
Yemeni officials refuse to say publicly when the subsidies will be cut, or how deep the reductions will be. But a senior oil ministry official, speaking on condition of anonymity because of the sensitivity of the issue, told Reuters that an announcement might be made as soon as the end of this week.
He said the government wanted to lift official prices of both petrol and diesel to 200 rials per litre. The price of diesel, widely used for generating electricity, is now 100 rials per litre officially and 250 rials on the black market.
The approach of the reform explains the timing of the austerity package ordered this month by Yemeni president Abd Rabbu Mansour Hadi. The steps include curbs on foreign travel by government officials, who must fly economy class, a freeze on recruitment and car purchases by ministries, and a review of the viability of state-owned firms.
"The aim of the measures ... based on President Hadi's orders was to convince people to accept the lifting of subsidies, by showing that the government has begun austerity on itself," Yemeni political scientist Ali Seif Hassan said.
The urgency of subsidy reform has increased in recent months as militant attacks on oil pipelines have hurt Yemen's export earnings. Sanaa earned a mere $671 million from exporting crude oil in January-May, down nearly 40 percent from a year earlier.
Foreign donors, who pledged $7.9 billion in aid in 2012, have hesitated to send the funds, discouraged by corruption and the poor security situation. Only a third of that aid package has arrived, an IMF official said in May.
The IMF, which forecast in April that the Yemeni government faced a 2014 budget deficit of 6.7 percent of gross domestic product, says it supports a gradual reduction of subsidies combined with welfare transfers to the poorest people.
Fuel subsidy reform would hurt not only Yemen's poor but also relatively affluent people. A July IMF report estimated 40 percent of fuel subsidies went to the richest 20 percent of households, while only 25 percent went to the bottom 40 percent.
The reform could also hurt some businessmen who have profited from the system, for example by obtaining fuel at subsidised prices to sell on the black market. A report by research institute Chatham House last year called fuel subsidies "a key source of corruption and patronage".
"There will be key people within the system who will lose a lot of money," said Marriott.
But she said that in the absence of reform, "the worst-case scenario is that salaries don't get paid, the economy starts to grind to a halt. Yemenis are incredibly resilient and resourceful. But everybody's got a breaking point." ($1 = 214.8 Yemen rials) (Additional reporting by Mohammed Ghobari; Editing by Andrew Torchia and Louise Ireland)