Report No. 16147-YEM

Republic of YemenPublic Expenditure Review

November 27, 1996

Country Operations DivisionCountry Department IIMiddle East and North Africa Region

Document of the World Bank

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This report is based on the findings of a mission which visited Yemen betweenMarch 9 and 28, 1996. The mission consisted of the following staff members andconsultants: Sudhir Chitale (Mission Leader), Ishac Diwan (Adviser), Nelly Batchoun(Transfers to Public Enterprises), Sethaput Suthiwart-Narueput (Sectoral Analysis),Youssef Fuleihan (Agriculture), Sarosh Sattar (Health and Education), GeorgeTharakan/James Reichert (Transport), Josephine Masanque (Power), Alexander McPhail(Water), Sulayman Al Kudsi, Nicholas van der Windt and Marion Eeckhout(Consultants). The report also draws on the substantial ongoing project work in theWorld Bank. Messrs. John Hansen, Ehtisham Ahmad and Ms. Antonella Bassani werepeer reviewers for the report.

Finally, we gratefully acknowledge the substantial help and hospitality wereceived during the preparation of this report from many officials of the Government ofYemen especially those in the Ministries of Planning and Development and of Finance.

A draft of this report was discussed with the Yemeni authorities during the courseof a mission to Yemen in November 1996. The suggestions and comments received havebeen incorporated in the present report.

Vice President : Mr. Kemal Dervi,Director : Mr. Inder K. SudDivision Chief : Mr. Adil KanaanStaff Member : Mr. Sudhir Chitale

Exchange Rate

As of February 3. 1995:

Primary Official Exchange Rate: YR12/US$Parallel Market Exchange Rate: YR1 15/1US$

As of September 1996:

Exchange Rate for the Budget: YR100-1 15/US$Parallel Market Exchange Rate: YR125-130/US$

ABBREVIATIONS AND ACRONYMS

AREA Agricultural Research and ExtensionAuthority

BOO Build Own and OperateBOP Balance of PaymentsCACB Cooperative and Agricultural Credit BankCAMA Civil Aviation and Meteorological

AuthorityCBY Central Bank of YemenCPI Consumer Price IndexCPPR Country Portfolio Performance ReviewCSO Central Statistical OfficeERC Economic Recovery CreditESMAP Energy Sector Assistance ProgramGAEI General Authority for Educational InstitutionsGAREWS General Authority for Rural Electrification

and Water SupplyGCRB General Corporation for Roads and BridgesGDP Gross Domestic ProductGLTC General Land Transport CorporationGNP Gross National ProductGOY Government of YemenGWH Giga Watt HourHBS Household Budget SurveyHTB High Tender BoardIDF Institutional Development Fund

IDA International Development AssociationIFAD International Fund for Agricultural

DevelopmentIMF International Monetary FundIMR Infant Mortality RateKfW Kreditanstalt fir WiederaufbauMAWR Ministry of Agriculture and Water ResourcesMCSAR Ministry of Civil Service and Administrative

ReformsMEW Ministry of Electricity and WaterMOC Ministry of Construction, Housing and

Urban PlanningMOE Ministry of EducationMOF Ministry of FinanceMOPH Ministry of Public HealthMOT Ministry of TransportMW Mega WattNGOs Non-Govermnental OrganizationsNWRA National Water Resources AuthorityNWSA National Water and Sanitation AuthorityO&M Operation and MaintenancePEC Public Electric CorporationPEs Public EnterprisesPDRY Peoples' Democratic Republic of YemenROY Republic of YemenSTC Surface Transport CompanyYAR Yemen Arab RepublicYPA Yemen Ports AuthorityYPC Yemen Petroleum CompanyYR Yemeni RiyalYR/KWH Yemeni Riyal Per KiloWatt Hour

REPUBLIC OF YEMEN

PUBLIC EXPENDITURE REVIEW

Table of Contents

page No.

PrefaceExecutive Summary (Arabic) ............................................... i-xviiExecutive Summary (English) ............................................... xviii-xxix

Chapter 1. Macroeconomic Developments and Fiscal Adjustment ........................... I

A. Economic Developments Since Unification, 1990-96 ....................................1B. Fiscal Deterioration ............................................. 2C. Government's Reform Program .............................................. 4D. Medium Term Macroeconomic Framework ............................................. 5E. Resource Envelope for Public Expenditure .............................................. 6

Chapter 2. Restructuring Public Expenditure ............................................... 10

A. Strategy for Restructuring ............................................. 10B. Wage Bill and Public Sector Employment ............................................. 13C. Subsidies and Protecting the Poor ............................................. 18D. Budgetary Transfers ............................................. 25

Chapter 3. Sectoral Expenditure Programs ............................................... 31

A. Development Strategy and Structure of Expenditure ......... ......................... 31B. Issues Common to all Sectoral Expenditure Programs ................................. 34C. Agriculture ......................................... 38D. Education ......................................... 40E. Health ......................................... 45F. Power ......................................... 48G. Water ......................................... 51H. Transport ......................................... 56

Chapter 4. Operationalizing the PER ........................................... 61

Annex 1.0 Yemen -- Country At a GlanceAnnex 1.1 Financing RequirementsAnnex 2.1 Grades and Salaries (YR/Month) for Civil Servants, 1990-1995Annex 2.2 Average Wage According to Education and Age of Civil ServantsAnnex 2.3 Beneficiaries Wheat and Flour Subsidies

Annex 2.4 Subsidies on Petroleum ProductsAnnex 2.5 Subsidy on ElectricityAnnex 2.6 Transfers to Public EnterprisesAnnex 2.7 Status of Privatization Effort March 1996Annex 2.8 Government Share of Profits from Public EnterprisesAnnex 3.1 Budget for 1996Annex 3.2 Ministry of Education, Branch (1)

General Budget Estimates for the Financial Year 1996Annex 3.3 Timetable for Settling ClaimsAnnex 3.4 Yemen - Investment ProgramAnnex 3.5 Technical Note - Projecting Public Expenditures in the Social Sectors

Preface

This report is based on a mission which visited Yemen in March 1996. Theestimates for 1996 and beyond contained in this report are based on data available inMarch 1996. They are consistent with those presented in the Bank's documentation forthe Economic Recovery Credit (ERC) and the published government budget for 1996.

Recent (September) data show some improvements in Yemen's economicperformance compared to what was expected in March in the following two areas:

* First, there has been a significant improvement in the fiscal situation. Ihxcash deficit for the whole of 1996 is estimated to be around 2.5% of GDP.including pension payments. compared to 4.5% expected in March. Thebudget has benefited by about a 15% increase in oil prices in the past sixmonths. Partly as a result of this improved fiscal outturn, the annualizedinflation is now estimated to be about 9% compared to about 20% anticipatedin March 1996.

* Second, the oil price increase has also resulted in an improved balance ofpayments (BOP). The official gross foreign exchange reserves at endSeptember were about $850 million compared to a year end target of $640million set in March. Yemen also reached an agreement on debt relief at aParis Club meeting held in September 1996, at terms which were in line withthose presented in the report. Finally, with the tight fiscal conditions, and animproved BOP situation, the unified floating exchange rate has remainedstable in the range of YR 125-128/$ over July-October without Central Bankintervention.

These positive developments have, however, yet to be translated into substantialgrowth in the non-oil sector. With the reduction in inflation, the interest rates havebecome substantially positive, putting a dampening effect on ne'w investments. Similarly,there has been no spurt in new foreign investments or remittances. Over the mediumterm, the oil production and price forecasts continue to remain in line with thosecontained in the report. Finally, the structure of expenditure, the main focus of thisreport, continues to remain similar to that observed in March. In sum, the majorconclusions of the report, on the overall resource constraint over the medium term, theneed to restructure expenditures and sectoral policies remain unaffected by the recenteconomic developments.

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Yemen - Public Expenditure ReviewExecutive Summary

I. Overview

1. The government of Yemen is in the process of implementing a challengingeconomic reform program. The objectives of this are to reduce inflation, achieve asustainable balance of payments and restore growth based on an expansion in investment.In order to meet these objectives, as per the macroeconomic framework' discussed inSection II of this executive summary, Yemen would need to restructure publicexpenditures as well as significantly reduce them from their present level by the year2000. This report outlines a restructuring strategy which involves generating savingsthrough a reduction in subsidies and transfers, and through sector specific efficiencyimproving policies. The savings thus generated could be deployed to increase outlays onoperations and maintenance, capital expenditures, developing a targeted social safety netfor the poor who may suffer, at least transitionally, from the reform and for improving theworking of the civil service. Section III discusses the specific cross-sectoral policiesrecommended to restructure the expenditures on wages, subsidies and transfers. SectionIV discusses the issues in restructuring sectoral expenditure programs includingcorrecting the imbalance between capital and operating costs, reorganizing institutions toimprove efficiency, improving the implementation of projects and implementingappropriate cost recovery measures.

II. Macroeconomic Framewor

Fiscal Deterioration 1990-95

2. Over 1990-94 Yemen experienced severe economic difficulties arising from aseries of shocks such as the Gulf war, the collapse of the Soviet Union, problems ofunification of two very different political and economic systems, and the civil war.Output fell, unemployment increased, and the economy faced severe balance of paymentsdifficulties, including an inability to service external debt.

3. A sharp deterioration in public finances has been at the heart of Yemen's recenteconomic problems. This deterioration resulted from the government's response to theexternal shocks by a series measures such as acting as an employer of last resort to thereturnees, retaining workers of public enterprises and by increasing subsidies to protectliving standards. As a result:

I Discussed in detail in Chapter 1 of the report.

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* The overall budget deficit increased to over 16% of GDP during 1992-94 fromabout 10% in 1991, resulting in high inflation which reached over 60% in1995.

* There was also a deterioration in the structure of budgetary expenditures interms of their contribution to growth. Much of the increase in expenditureswas due to an increase in government employment and poorly targetedsubsidies at the expense of crucial outlays on operations and maintenance --which remained at only 3% of GDP; and development expenditures which fellfrom 11% of GDP in 1990 to only 3.3% by 1995. This led to a deteriorationin public services and long term growth potential.

The Resource Envelope

4. The objectives of the government's reform program are to reduce inflation andachieve a GDP growth of almost 5% p.a. by the year 2000. The growth objective wouldrequire an acceleration in total investment from about 14% of GDP in 1996 to about 20%by 2000 on the basis of an Incremental Capital Output Ratio (ICOR) of about 4.2. Thisinvestment would be financed by foreign savings, private domestic savings and publicsavings.

5. Balance of payments projections consistent with such a growth target show thatthe availability of foreign savings2 is constrained by the high debt burden, modestprospects for oil exports and the limited availability of official concessional finance. Theprospects for an increase in private domestic savings are also limited by low per capitaincome and the impact of a withdrawal of subsidies on incomes. This means that publicsavings need to be increased, or the budgetary current account deficit must be decreasedfrom about 2% of GDP in 1996 to a surplus of at least 4% of GDP by the year 2000.Including budgetary capital expenditures, the overall budget deficit needs to decline from6.2% of GDP in 1996 to about 2.4% of GDP by 2000.

6. The prospects for further reducing the overall budget deficit by increasingrevenues are modest and therefore most of the adjustment in the future is likely to fall onexpenditures. Oil revenues, estimated to be nearly 80% of budgetary revenues in 1996,cannot be increased further in the future because oil production is expected to declinebeyond 1997. Non-oil revenues could only be increased by implementing a difficult taxreform centered around the introduction of a general sales tax. Even if this program wasimplemented, over the medium term, the fiscal revenue would remain at the 1996 level ofabout 31% of GDP. This means that total expenditures have to be reduced from the 1996level of about 37.6% of GDP to about 33.5% of GDP by 2000 to meet the deficitreduction targets. Given the need to increase capital expenditures, the fall in current

2 Foreign savings are defined as the net exports of goods and services.

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expenditures will have to be even higher--from 33% of GDP to 27% of GDP,highlighting the need for a substantial expenditure adjustment program.

Restructuring Strategy

7. A restructuring strategy to meet the objectives of the reform program wouldinvolve generating savings by: (i) replacing subsidies on wheat, petroleum and electricityby a cheaper, targeted social safety net; (ii) reducing transfers to public enterprises; and(iii) implementing sector specific efficiency improving policies. These savings couldthen be deployed to: (i) increase outlays on capital expenditure to develop infrastructureand strengthen the basis for long term growth; (ii) increase operations and maintenanceexpenditures to improve the utilization of existing facilities; and (iii) to improve theefficiency of the civil service.

III. Cross Sectoral Policies

Reform of Wage and Employment Policies

8. The wage bill in Yemen is very high, amounting to about 13.5% of GDP in 1995.This is due to a rapid rise in employment, especially in the lower grades, rather than aliberal wage policy. Over 1990-95 real wages for civil servants have fallen by 80% whilethe employment has doubled. Further, in Yemen, the compression ratio--the ratio of thehighest to the lowest salary is only 3 compared to around 9-12 in more developedadministrations. Such a salary structure creates disincentives amongst the seniorservants. In order to improve the quality of public service the government is consideringinitiating a comprehensive civil service reform. It is recommended that elements of sucha reform include, a freeze on gross recruitment into government service, eliminatingretired and ghost workers, transferring workers from cities to provinces, and developing amenu of severance packages for excess workers. Although in the medium term such aprogram would result in a reduction in the wage bill, in the near term, the savingsgenerated from the elimination of ghost and surplus workers are likely to be counterbalanced by the cost of severance packages, costs associated with transferring civilservants from cities to rural areas, and the need to raise salaries of senior civil servants inorder to rationalize incentives.

Subsidies and Protecting the Poor

9. The current system of universal - untargeted - subsidies for wheat, petroleum andelectricity is very inefficient and expensive, amounting to almost 9% of GDP in 1996.For wheat, nearly 25% of the subsidy goes to smuggling and inefficiencies in theprocurement system. In addition, because the subsidy is untargeted, i.e., equally availableto all consumers, of the total subsidy, only 6.7% reaches the bottom 20% of households.However, an outright elimination of subsidies would hurt the poor because wheat is animportant component of their consumption basket. Therefore the elimination of subsidiesneeds to be accompanied by the introduction of a targeted social safety net. A possible

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cheaper alternative to the present system of subsidies is the wheat voucher systemdescribed in detail in para. 2.23 in the main report. Although the voucher system couldsubstantially reduce the outlay on subsidies, it could prove to be administrativelycomplex. It would therefore be a good idea to test the feasibility of the voucher systemby implementing a pilot project in a province before extending it to the whole country. Inthe medium term, the best form of assistance to the poor will be through employmentcreation, increased provision of social services especially in the rural areas, andencouraging NGOs to deliver assistance to the poor. Such a program is being developedby the government in the context of the proposed IDA-supported Social Fund forDevelopment. In the short term, the safety net could consist of implementing the civilworks program (being supported by an IDA credit) to generate employment, charginglow tariffs for the first block of electricity consumption, cross-subsidizing kerosene anddeveloping the wheat voucher system.

Budgetary Transfers

10. Current and capital transfers, which are estimated at about 4.7% of GDP in 1996,provide one more source of potential savings. Within transfers, there are two areas wherepotential savings could be realized. First, are transfers to social welfare, medical grantsand "other" ad hoc transfers, carried out through the Ministry of Finance amounting to1.4% of GDP. These programs could be combined with other programs in the socialsectors and redesigned to improve their efficiency and generate savings. Second, itshould be possible to reduce the transfers to all public enterprises (PEs) from an estimated1.9% of GDP in 1996. In the short term this could be achieved by increasing the prices ofgoods and services they produce, and over the medium term, through privatization, andwhere needed, liquidation. The government has launched a comprehensive privatizationprogram supported by technical assistance from the IDA under the Economic RecoveryCredit (ERC). As of March 1996, out of the 100 PEs targeted for privatization, 16 PEshave been brought to the point of sale/liquidation, work has progressed on an additional60 enterprises while the remaining have merely been identified for sale.

IV. Sectoral Expenditure Programs

Intersectoral Priorities

11. Yemen's sectoral expenditure priorities are broadly evolving in the right direction.Yemen has ceased any new public investment in manufacturing, oil and gas and otherpurely commercial activities. Existing PEs in manufacturing inherited from the south atunification as well as agricultural farms and enterprises engaged in commercial activitiesare covered by the recently launched comprehensive privatization effort. The remainingpublic investment is in infrastructure -- mainly road construction, in human resourcedevelopment and in electricity. In agriculture, the program consists of building capacityfor research and extension, and projects for irrigation and water conservation -- areasnormally in the domain of the public sector.

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12. The main challenge before the authorities is, however, setting priorities for publicexpenditures within a very tight resource envelope. At present, Yemen's needs for publicexpenditures are very high. In almost all sectors a strong case may be made to increaserecurrent expenditures and find public investment projects with very high returns. Inview of the tight resource envelope, however, hard tradeoffs have to be made at themargin between urgently needed recurrent expenditures in different sectors and furtherprioritize projects with high returns.

13. Section 3.1 in the main report, compares the proposed priority expenditures for1996-98 with the resource envelope dictated by the macroeconomic framework. Priorityexpenditures are estimated on the assumption that the sectoral policy reforms torestructure expenditures (identified below in paras. 16 and 17) are implemented whileachieving the sectoral and macroeconomic objectives of the reform program. In makingthe expenditure projections the first priority is given to making adequate provisions forO&M and other recurrent expenditures to fully utilize the current facilities and thosecoming on stream in 1996-97. The priority capital expenditures are estimated on thebasis of first completing ongoing projects with high returns. New projects are few andshould be initiated only if the existing capacity is fully utilized and adequate recurrentresources are available to operate new capacity coming on stream.

14. Even with the highly selective approach described above, as indicated in Table3. 1, in the main report, the total priority expenditures for 1996-98, exceed the resourceenvelope dictated by the macroeconomic framework. Priority current expenditures areroughly in line with the resource envelope, while priority capital expenditures exceed theresource envelope by nearly 30%.

15. Thus further prioritization of the proposed priority investment program isnecessary to stay within the overall resource envelope3 . This requires increasedselectivity in all sectors to ensure that only projects with highest returns are continued.On the basis of the sectoral analysis presented in sections G-H inr the main text, thefollowing are possible candidates for realizing further savings4:

* The electricity investment program could be further prioritized by protectingthe investments in transmission and distribution -- which have high returnsand slowing the expansion in generating capacity. The extension of theHadramawt power station and the construction of the Marib power station

3 This assumes that the institutional problems in sectors which affect project implementation areresolved and the government is able to spend the full allocation of the capital budget. In the past, thegovernment managed to spend only 70% of the capital budget (see section 3B). If institutionalconstraints are not resolved, expenditures could well remain within the envelope. However, the cutswould not necessarily fall on the lowest priority projects and could therefore adversely affect growth.

This is only one possible pattern of expenditure reduction to stay within the overall resourceenvelope. It is possible for the government to choose to protect the investments in electricity - butthis would, for example result in falling short on targets to expand education and health or water.

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could be delayed to beyond 1998. Finally further savings on public resourcescould also be achieved by accelerating the privatization program, thepreparation of BOO schemes for foreign participation and finallyimplementing a faster increase in electricity prices to equal the long runmarginal cost.

Savings are also possible for the nearly YR2 billion p.a. (about 8% of the totalinvestment program) GAREWS program for small water and electricityprojects.

* Further savings are also possible in the large road construction program. Thiscould only be done after the detailed analysis of the ongoing projects beingcarried out under the transport rehabilitation project is completed. Similarly,nearly half the public resources planned for the airport reconstruction programcould be saved if the privatization program is rapidly implemented.

* Finally, the functional classification of the total expenditures shows that in1996, only about 27% of the total expenditures can be identified as current andcapital expenditures in specific sectors. Of the remaining, 56% are for interestpayments, subsidies and defense, and an additional 17% are adhocadministrative expenditures whose developmental impact is often dubious. Inshort, even small improvements in efficiency/expenditures reduction in areassuch as defense, administration could release large resources for increasing thegrowth potential of the economy.

Issues Common to Sectors

16. There are three issues common to most sectoral expenditure programs. First, inalmost all sectors the allocation of Operations and Maintenance (O&M) expenditures isinadequate to operate existing facilities and those coming on stream upon completion ofongoing projects. Second, the data base on projects is weak. For most projects no dataare available on the original cost of the project, expenditures carried out so far and theextent of its physical completion. This makes it very hard to project investment needsinto the future. Third, project implementation faces severe problems. The main reasonsare a weak and low-paid though very large civil service, and the institutional constraints.A particular problem is the complex and centralized system of disbursement of fundsagainst amounts approved in the budget which results in inordinate delays in projectimplementation. Addressing these problems would involve the following actions.

* In all sectors, before initiating new projects which add to new capacity,additional resources must first be deployed to increase the O&M expendituresto fully utilize the existing facilities as well as those coming on stream byprojects currently under implementation.

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* Improve the data base for the projects. First, a reliable data base for projectshas to be developed to include the total cost of the project, amount spent so farand the financing needed for completion. This is necessary to set prioritiesconsistent with available resources. Second, small schemes should beaggregated for planning purposes into a smaller, manageable number ofexpenditure programs so that their relative priorities could be assessed.Currently, the government is engaged in creating a computerized data base forall ongoing projects with the assistance of the KfW. Completion of this workwould provide inputs to further work in this area.

* Improve project implementation. To begin with, the civil service reformbeing considered by the Government would improve administrative efficiencyand result in improved project planning and execution. Working closely withthe authorities, IDA's Country Portfolio Performance Review (CPPR) processhas already succeeded in streamlining the procedures for IDA-financedprojects. Prior to this review,5 all tenders above $0.2 million were sent to theHigh Tender Board (HTB) which had become a bottleneck. Under the CPPR,the limit of tenders needing the HTB approval has been increased to $1million. Further, contractors are now denominating their contracts in foreigncurrency rather than in Riyals and there is improved compliance with auditreporting and submission of financial statements. An IMF study carried out inApril 19966 also makes a number of suggestions in the area of budgetexecution, expenditure control and government accounting. These include:devolving more spending powers to the spending agencies, disbursing funds tothe spending agency according to a quarterly as against monthly advanceschedule of work and giving greater freedom to the spending agency toreallocate expenditures between budget subitems. This report is currentlybeing used to develop a financial management improvement program.

Sector Specif c Expenditure Restructuring Policies

17. In addition to the policies common to all sectors, the expenditure restructuringpolicies recommended for major sectors are listed below.

Agriculture

Privatize agricultural parastatals which are currently engaged in purelycommercial activities, to reduce the transfers from the budget as well as toimprove their operational efficiency. These parastatals include, the Machinery

5 These were mainly focused on IDA projects rather than the "systemic" problem of the investmentprogramn.

6 Republic of Yemen, "An Evaluation of Government Budgetary, Accounting, and Expenditure Controlsystems", IMF, April 1996.

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Rental Stations, Mareb Poultry Company, the General Organization for theMarketing of Fruits and Vegetables, General organization for Drilling and theGeneral Organization for Agricultural Services.

Eliminate subsidies on wheat to remove the bias against domestic production aswell as to reduce the burden on the budget. The program for the elimination ofthese subsidies is discussed in Chapter 2 in the main report.

Substitute the current import ban on fruits and vegetables with a tariff to enhancerevenues and promote efficiency in production. This policy is being supported bythe Bank's Economic Recovery Credit (ERC).

CACB should be exposed to market forces to improve its efficiency. The highlysubsidized, negative lending rates should be raised to levels closer to market rates,and the recovery rates should be raised substantially. Administrative costs shouldalso be reduced considerably by reducing the overstaffing.

Raise the incomes of the displaced tenants and other very poor people livingbelow the poverty line, in the four southern governorates through irrigationdevelopment and promotion of off-farm economic activities such as micro-enterprise development, fisheries and tourism related business. This priorityprogram is expected to be supported by the proposed IDA-supported SouthernGovemorates project.

Improve productivity in agriculture by improving the availability of quality seedsand by upgrading extension and research services. This program is expected to besupported by the proposed IDA-assisted seeds and services project.

Education

Increase recurrent budgets to ensure that all the existing facilities and thosecoming on stream during 1996-98 are fully utilized.

Make budgetary allocations to Governorates by developing a formula whichaccounts for differences in enrollment rates, population, migration, and unit costdifferentials.

Eliminate mandatory fees in elementary and secondary schools. These fees do notmobilize significant revenues, and can act as a significant barrier to enrollment,especially for girls.

Upgrade physical facilities in schools especially by providing toilets andwashrooms to create an environment to attract and retain more female students.

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Currently school buildings are overdesigned. Building designs could be revisedto reduce costs by as much as 20%.

Priority expenditures in education are estimated on the basis of an expansion inthe enrollment rate of girls at primary school from 35% in 1996 to 50% by 2000and maintaining boys rate at its comparatively high current level of 80%. (SeeAnnex 3.6.)

Health

Increase O&M budget for the Ministry of Public Health (MOPH). Restrictinvestment in new health facilities until existing health centers and districthospitals have adequate supply of essential drugs and equipment.

Increase the availability of health workers in rural areas.

Retain the present model of full public finance for (a) purely preventive activitiese.g. malaria control, vaccinations; and (b) catastrophic care, while moving toincreased cost-sharing for other services.

Develop quality secondary care facilities in major regional centers to address thedual problems of (a) providing the full-range of health services to a widelydispersed population and (b) increasing tendency to by-pass primary care facilitiesand go straight to tertiary facilities. These facilities could be run in partnershipwith the private/ NGO sector with public finance being complemented by cost-sharing with beneficiaries.

Power

Further prioritize the PEC program by emphasizing transmission and distributionprojects and slowing generation projects.

Increase electricity tariffs to allow PEC to achieve and maintain a break-evenposition and restrict demand growth to about 6% p.a. over 1996-2000.

Settle inter-enterprise arrears between PEC, the Yemen Petroleum Company(YPC) and major consumers of electricity.

Prepare the grounds for an eventual privatization of PEC. Give PEC moremanagerial autonomy. Create an regulatory framework to encourage privatesector participation in the power sector.

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Water

Expand the mandate of NWRA to include all water resource planning, assessmentof water sector investments and donor coordination.

To return water use to a sustainable level

Support NWRA institutionally as well as financially to enable it to developregional water management plans, with priority given to particularly vulnerableareas such as Taiz and the Sana'a basin.

NWRA should begin to test the feasibility of the licensing and control of wellsand drilling rigs to control the mining of groundwater.

NWRA, together with the MAWR should develop a program for waterconservation in agriculture. Such a program could include: further research andextension in irrigation, subsidies to maintain terraces and giving users theresponsibility for spate irrigation schemes.

Facilitate Transfer of Water From Rural to Urban Areas

Carryout a program of exploration and development of new sources of supply forcities in the context of the regional management plans being developed byNWRA.

Set up a regulatory framework which defines ownership, rights to market andrules for conservation to develop the current informal water markets to allow asustainable transfer of water from rural to urban areas.

To increase the availability of safe potable water

For rural areas, expand the GAREWS program especially in the poorerGovernorates such as Dhamar, Al-Beida and Al-Mahwit. In expanding theGAREWS program emphasize community participation and ownership ofprojects.

For urban areas, implement a two stage restructuring plan for reforming NWSA.In stage 1, decentralize NWSA and grant autonomy to regional offices. In stage II,convert the regional offices into corporations and invite private capital andmanagement to participate in these regional corporations.

Create a framework for expanding the role of the private sector by passinglegislation defining the rights and duties of private operators and developing aseries of model concession agreements for organized private supply to towns.

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The urban program should be carefully prioritized by first focusing on townswhere water is very short.

Transport

In the road transport sector, make the Yemen Road Fund created with IDAassistance operational to generate the financing necessary for road maintenance.In the near term, improve the working of the intracity operations of the GeneralLand Transport Corporation (GLTC) by creating autonomous municipalauthorities, contracting the services to private operators and making subsidiesexplicit. In parallel, privatize the intercity transport operations of GLTC.

In the civil aviation sector, complete the ongoing investments for the emergencyrehabilitation of Aden and Sana'a airports. Increase the overflight charges andimprove their collection to make the Civil Aviation and Meteorological Authority(CAMA) profitable. In parallel, invite private participation in CAMAinvestments as well as operations except in the provision of air navigationservices. Complete the merger of the two airlines (Yemenia and Al Yemen) andprepare them for privatization.

In the port sector, invite private participation in investment as well as operationsof the Aden port. The Aden port has the potential to be an independent profitcenter requiring no budgetary support. Some complementary public investmentis, however, required for institutional strengthening and key equipment such astugs and container handling equipment.

Operationalizing the PER

18. The findings of the PER have operational implications in three areas. First, theresource envelope estimates in the PER could be used as an input into the discussion ofthe Five Year Plan. The macroeconomic framework could be updated to provideestimates of sustainable level of public investment to the annual budget exercise, whichcan be carried out within the framework of a three year rolling plan.

19. Second, The PER brings together in an integrated framework three issues whichhave a high priority in the government's reform effort. The analysis on the civil service,which uses civil service survey data could be used as a basis to define the elements of acivil service reform. The analysis of subsidies could be further refined to design a socialsafety net and as an input into the design of the food voucher scheme. The analysis of thehousehold budget survey data could also be used in the design of the Social Fund project.Finally, the analysis of the transfers to PEs needs to be extended further to assess theimplication of the government's privatization efforts to the budgetary transfers.

20. Third, the analysis of the PER needs to be extended to formulate sector strategiesand expenditure programs within the overall resource envelope. First, more analysis is

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needed of the issues of inadequacy of O&M budgets, poor project implementation andlack of counterpart funds. The work could be done by forming a series of workinggroups within the government with participation from the World Bank and other donorsto identify the reasons for inadequate O&M budgets and work out the resourceimplications of fully meeting these needs. The lessons of the Country PortfolioPerformance Review (CPR) for IDA - supported projects could be extended to allprojects to improve project implementation. Second, more analysis is needed to improvethe effectiveness of the sectoral expenditure programs. Better information is needed toassess the outlays needed to complete ongoing projects in health, education and roadconstruction. Following this, the overall sectoral expenditure program could be assessedby a working group consisting of the government, the Bank and other interested donors.

000 -

Chapter I

Macroeconomic Developments and Fiscal Adjustment1

A. Economic Developments Since Unification, 1990-96

1.1 Beginning in 1990, the Yemeni economy was adversely affected by a series ofexternal shocks and domestic upheavals:

* Gulf war: The Gulf war led to large return migration which amounted tonearly 10% of the population and a decline in the aid from the Gulf states.Over 1990-96, workers remittances dropped from $1.5 billion in 1990 to 1.1billion in 1996, i.e., from 100 to 50% of merchandise imports, and externalassistance dropped from 40 to only 7% of merchandise imports.

* Collapse of the Soviet Union: This resulted in a decline in the aid to thesouth and left a heavy burden of external debt.

* Unification: The unification resulted in the deterioration in public financesdue to the costs associated with the merger of the two civil services as well asthe burden imposed by the money losing public enterprises inherited from thesouth.

* Civil war: This led to a sharp increase in military spending, extensivedamage to productive facilities and also contributed to deteriorating publicfinances.

1.2 Output: The adverse effects of the civil war and the break-up of the formerSoviet Union, resulted in a sharp decline in GDP in 1990-91. The GDP, however,rebounded in 1992 and 1993 to about 5% p.a. on average due to favorable rains in 1992and an increase of 19% in oil production in 1993. Although oil production increased by afurther 56% in 1994 due to the coming on stream of new fields, output in the non-oilsectors declined by 5.6% due to the effects of the civil war, resulting in a stagnant overallGDP in 1994. GDP, however, is estimated to have grown by about 3.6% in 1995 and isfurther expected to grow by 2.5% in 1996 due to the continued increase in oil productioncombined with a return to normality following the civil war.

1.3 Inflation: The uneven GDP growth was accompanied by a sharp rise in urbaninflation. Measured by the CPI, urban inflation accelerated from about 30% in 1990 toalmost 65% by 1994, despite attempts to repress it through controlling prices of keycommodities. Fiscal measures implemented beginning 1995 (see Section 1 C) reduced the

This chapter focuses on the fiscal problems facing Yemen. For a more detailed description of thetrends in the Yemeni economy, see: Yemen, "Country Assistance Strategy ", January 1996, andYemen, "Report and Recommendation of the President, Economic Recovery Credit (ERC)", February1996.

-2 -

inflation to about 44% in 1995 and are expected to reduce it further to about 20% by theend of 1996. Because of stagnant per capita output in recent years, and the depreciationof the exchange rate, per capita GNP for 1994 in US$ terms per Bank's Atlasmethodology, is estimated at only $280.

1.4 Balance of Payments: The balance of payments continued to suffer fromstructural weaknesses such as a heavy dependence on private transfers, a limited exportbase (non-oil exports accounted for less than 10% of total exports of goods in 1994-95),and volatile crude oil export revenues. The current account deficit before grants widenedfrom 24% of GDP in 1992 to 30% in 1993. Due to a doubling of oil export revenues in1994 and a further increase in 1995, this deficit turned into a surplus of 5.2% of GDP in1994 and 2.1% of GDP in 1995. These surpluses have, however, not been sufficient tofinance the debt obligations falling due and contractual repayments to oil companies.This has led to the accumulation of arrears, which amounted to almost $5.2 billion by end1995.

B. Fiscal Deterioration

1.5 A sharp deterioration in public finances has been at the heart of Yemen's recenteconomic problems. This deterioration resulted from the government's response to theshocks in an atmosphere of intense political competition between the two political partiesimmediately following unification. The government took it upon itself to smooth theeffects of the negative shocks through a series of populist measures.

* The government acted as the employer of last resort for the returnees and newuniversity graduates. It also retained workers of defunct pubic enterprises onthe government payroll.

* The government tried to protect the living standards by increasing subsidieson wheat, flour, petroleum products and electricity.

* Defense expenditures increased as a result of the civil war.

1.6 The deterioration in public finances (Table 1.1) had two dimensions:

* First, the overall deficit on a cash basis increased to over 16% of GDP during1992-94. As access to external financing dried up, these fiscal deficits werefinanced through domestic bank financing and resulted in high inflation.

* Second, there was a deterioration in the structure of the budgetaryexpenditures in terms of their contribution to growth. Much of the increase inexpenditures was due to an increase in government employment and poorlytargeted subsidies. This came at the expense of crucial outlays on operationsand maintenance -- which remained at only 3% of GDP; and developmentexpenditures which fell from 11% of GDP in 1990 to only 3.3% by 1995.

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This led to a deterioration in public services and constrained growth (due tothe squeeze in capital expenditures).

Table 1.1: Central Government Finance, 1990-96(% of GDP)

1990 1991 1992 1993 1994 1995 1996Act Act Act Act Act Act Est.

TOTAL REVENUES 23.7 28.5 21.9 20.4 14.2 21.7 31.4Oil Revenue 10.1 13.4 7.1 6.5 4.3 11.5 21.1Non Oil Revenue 13.6 15.2 14.9 13.9 9.8 10.2 10.4

TOTAL EXPENDITURES 42.0 39.5 40.7 38.2 31.7 29.7 37.6

Current Expenditures, (o/w) 29.6 32.8 34.8 34.5 29.2 26.4 33.4Wages 20.4 22.5 24.2 24.1 19.6 13.5 11.6Goods & Services 2.4 2.6 3.2 2.3 2.0 3.4 3.5

Defense (non-wage) 1.9 2.1 1.6 1.4 2.0 0.6 0.6Interest 2.8 2.8 2.5 3.5 3.2 2.8 4.7

Subsidies ... ... ... ... ... 3.4 9.1Current Transfers 2.2 2.8 3.2 3.3 2.4 2.1 3.2

Development Expenditures 12.4 6.6 5.9 3.8 2.5 3.3 4.2

OVERALL BALANCE (comm.basis) -18.3 -11.0 -18.8 -17.8 -17.5 -8.0 -6.2

OVERALL BALANCE (cash basis) -17.4 -9.9 -17.3 -16.6 -16.7 -7.0 -4.5External Financing (net) 6.1 5.3 1.1 0.4 0.5 0.5 4.3Domestic Financing (net) 10.3 6.0 16.0 18.6 17.5 6.5 0.3

Discrepancy 1.0 -1.3 0.1 -2.4 -1.3 ... ...

Memorandum ItemGDPatMarketPrices (YR Bill) 96.4 111.9 134.7 169.8 262.7 434.7 633.7

Source: Ministry ofFinance and the IMF.

1.7 The fall in the availability of operation and maintenance expenditures alsoaffected the sustainability of projects. First, once projects were completed there wereinsufficient funds to operate the facilities created. Second, the nature of developmentexpenditures changed, i.e., more and more "projects" were restructured as recurrentexpenditures bunched together for additional donor financing. Donors seem to havereacted to this situation by financing more and more local costs.

1.8 The situation was exacerbated by severe implementation constraints whichrepresents a more entrenched problem. These are: (i) Some categories of public sectoremployees have low salaries, which affects their efficiency. (ii) The budgetary system iscomplex and bureaucratic. (iii) The high inflation that had prevailed and exchange ratechanges led to contracting difficulties. Civil works contractors were not willing todeliver on promises they had made when the exchange rate was much higher. This led torenegotiating the old contracts, further slowing down project implementation. In 1994,only 34% of the funds budgeted for projects were actually spent.

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C. Government's Reform Program

1.9 The government responded to the deteriorating economic situation byimplementing a series of measures in 1995 which were further strengthened in 1996 anddeveloped into a comprehensive reform program. The program consists of the followingthree main components: (a) macro-economic stabilization centered around a reduction ofthe fiscal deficit; (b) structural reform; and (c) social protection measures. The followingsection discusses the fiscal adjustment.

1.10 Fiscal Adjustment: The most pressing challenge that faced the authorities at thestart of their reform effort in 1994 was the reduction of the fiscal imbalance and theresulting inflationary pressures. The government has already implemented a series ofdifficult fiscal measures 1995 and in 1996. As a result of these measures, the budgetdeficit on a commitment basis fell from 17.5% of GDP in 1994 to 8% in 1995 and isexpected to fall further to around 6.2% by end 1996.

1.11 This adjustment was mainly due to increases in revenue. Of this large (nearly11.3% of GDP) reduction in the deficit, 7.4% was due to an increase in revenue and theremaining 2.7% was due to a decrease in expenditure. Almost all the increase in revenuecame from an increase in oil revenues, which multiplied nearly 12 times in Riyal termsfrom about 4.3 to 21.1% of GDP while non oil revenues remained at around 10% ofGDP. The increase in oil revenues was mainly due to the revaluation of oil revenuesgoing to the budget from YR1 2/$ to YR1 00/$ while oil production remained at about340,000 barrels per day during 1994-96. Nevertheless, the additional fiscal measuresimplemented to merely maintain the share of non-oil revenues in GDP at about 10% ofthe total revenue were significant. These included: (i) depreciation of the customsevaluation rate; (ii) freeing up cement prices and increasing petroleum prices (80%); and(iii) increasing transport and communication prices. The main measure on theexpenditure side was the reduction of the wage bill by almost 4 percentage points ofGDP. This was, however, compensated by the increased burden of subsidies. As a resultof these measures, inflation is estimated to have declined from 65% in 1994 to 44% in1995 and is expected to fall further to 20% in 1996.

2 The government's program is being supported by a 15-month stand-by arrangement (SBA) from theIMF of SDR 132.4 million ($192 million) and a proposed IDA Economic Recovery Credit (ERC) of$80 million.

Other components of the reform program, including exchange rate and monetary policies, arediscussed in the documentation for the Economic Recovery Credit (ERC) and the IMF, "Staff Reportfor Request for Stand-By Arrangement", March 5, 1996.

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Table 1.2: Macroeconomic Framework

1994 1995 1996 1997 1998 1999 2000act act est. projected -

National Accounts

Real GDP growth (%/p.a.) 0 3.6 2.5 5.1 4.3 4.3 4.8Oil Sector - 2.1 1.0 5.8 .7 .8 1.3Non-Oil Sector - 4.3 3.7 4.8 5.2 5.4 6.0

GDP Deflator (Domestic Inflation, % p.a.) 64.6 43.4 20.0 10.0 5.0 5.0 5.0

Investment (%ofGDP) 9.7 10.1 13.7 15.6 16.6 18.5 19.7Private 7.6 8.1 11.0 11.5 11.5 13.0 13.2Public 2.1 2.0 2.7 4.1 5.1 5.5 6.5

Balance of Payments (% of GDP)

Exports of goods andNFS 60.3 57.8 40.7 41.4 40.2 38.3 36.9Imports of goods and NFS 65.5 65.9 52.5 54.9 54.3 53 51.6Net exports of goods and NFS -5.2 -8.2 -11.8 -13.5 -14.1 -14.7 -14.7

Current Account Balance 5.2 2.1 -3.1 -3.2 -3.1 -3.2 -3.0DOD/GDP (%) 196.0 185.5 115.5 115.5 118.9 120.8 121.7Debt Services /Exports of Goods & Services(%) I/ 30.8 27.6 6.7 4.9 4.5 6.1 11.4

Public Finance (% of GDP)Revenues 14.2 21.7 31.4 31.0 31.3 31.8 31.0Expenditures 31.7 29.7 37.6 34.0 33.8 34.3 33.5Budget Deficit (accrual basis) -17.5 -8.0 -6.2 -3.0 -2.5 -2.5 -2.5Budget Deficit (cash basis) -16.7 -7.0 -4.5 -3.0 -2.5 -2.5 -2.5

Financed by:Foreign Borrowing 0.5 0.5 4.3 3.0 3.0 3.0 3.5Domestic Borrowing 17.5 6.5 0.3 0.0 -0.5 -0.5 -1.0

I/After debt rescheduling.Source: MOF, IMF, World Bank staff estimates.

D. Medium Term Macroeconomic Framework

1.12 Table 1.2 outlines the macroeconomic framework underpinning the adjustmentprogram adopted by the government. If all the policies in the program are successfullyimplemented and the required external financing and assumed debt relief is achieved, theeconomy could grow modestly by about 4.8% p.a., to the end of the decade. Most of thisgrowth is expected to come from the non-oil sector, which is expected to reach a growthrate of 6% p.a. by 2000, while the oil production is expected to stagnate after 1997 (adiscussion of the pattern of growth and public investment is presented section 3).

1.13 The prospects for Yemen's balance of payments crucially depend upon obtainingdebt relief as well as additional external assistance on highly concessional terms. Inresponse to the structural reform measures being implemented, non-oil exports areprojected to grow by nearly 10% p.a., albeit from a very low base. However, since oilexports, which account for 90% of the merchandise exports, are expected to stagnatebeyond 1998, exports of goods and NFS will decline as a share of GDP. Over 1996-2000, imports are projected to grow roughly in line with overall GDP. Workers'

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remittances are projected to grow from the present level of about $ 1.1 billion to about 1.5billion by the year 2000. On this basis, the current account deficit, would remain at about3% of GDP until the year 2000.

1.14 External Financing Requirements and Debt: Yemen's financing requirements4

arise from the initially widening current account deficit, repatriation of oil companyprofits, and the need to settle nearly $5.2 billion of arrears at end 1995. Yemen's futurefinancing strategy is based on the following assumptions: (i) the arrears and additionalpayments falling due on Yemen's external debt are restructured at Naples terms; i.e., twothirds forgiven and one third rescheduled at market rate of interest, (ii) Yemen has accessto regular financing of about $150 million p.a. consisting of the disbursement of bilateraland multilateral loans and grants; and (iii) an additional exceptional financing of around$300 million p.a. over the next three years are obtained at highly concessional terms.Under this scenario, Yemen's external debt situation would be restored to sustainablelevels. The external debt service ratio and the debt/GDP ratio would decline from the1995 (pre-restructuring) level of 36.9 and 185, to 11.4 and 122 respectively by the year2000.

E. Resource Envelope for Public Expenditures

1.15 The availability of foreign and domestic savings consistent with themacroframework indicates that the public savings need to be increased, or the overallbudgetary deficit needs to be reduced from the estimated 1996 level of 6.2% of GDP toabout 2.5% of GDP by the year 2000.

1.16 The sustainable level of public savings, i.e., the budgetary current account deficit,depends upon the trends in three variables: investment needed to meet the growth targets,foreign savings consistent with the balance of payments, and private domestic savings.As per the macroeconomic framework, the trends in each of these variables areconstrained as follows:

* Investment: The achievement of the medium term growth targets will requirea steady increase in the investment/GDP ratio from about 13.7% in 1996 toabout 20% by the year 2000 on the basis of an Incremental Capital OutputRatio (ICOR) of about 4.2 over the five year period 1996-20005. Futuregrowth in Yemen is likely to arise largely from an expansion in the privatesector activity in petroleum, agriculture, small and medium scalemanufacturing, tourism and construction activity. Public investment ishowever crucial to support this growth in the private sector by providing

A detailed financing plan is presented in Annex 1. 1.

This is a reasonable ICOR for countries at Yemen's level of income undergoing adjustment.Comparisons with the past are not possible in the absence of a long enough time series on investmentfollowing unification.

physical infrastructure, develop water resources and for human resourcedevelopment. The needed public investment to support the growth isestimated to be in the range of 4-5% of GDP. Thus of the total investment, bythe year 2000, about 30% is projected to be public investment and 70% isprojected to be private investment.

* Foreign savings: The availability of foreign savings6 is constrained by thehigh debt burden, modest prospects for oil exports and the limited availabilityof official concessional finance. The balance of payments projectionspresented in Table 1.2 show that under reasonable assumptions on theavailability of external financing, Yemen can afford to run a current accountdeficit of 3% of GDP at most, in order to achieve a sustainable debt position.Including net factor income from abroad7 which, under reasonableassumptions amount to around 10% of GDP, the availability of foreignsavings on average is at most around 13-14% of GDP over 1996-2000.

* Private savings: The prospects for an increase in private domestic savingsare quite limited. Private domestic savings are expected to remain at aroundonly 1% of GDP during 1996-2000, much lower than about 6-7% achievedduring 1994-95. There are two reasons for this decline. First, per capitaincomes have considerably eroded during 1994-96 and are expected to remainstagnant during the adjustment period, thereby depressing savings. Second, inthe past, the government transferred substantial income to households in theform of subsidies amounting to about 10% of GDP. The private householdsector was therefore able to save (and consume) on account of this income.The net result of eliminating subsidies under the adjustment program is totransfer some of this income back to the public sector thereby increasing

8public saving and depressing private domestic savings (and consumption) .

1.17 Given the trends in foreign and private domestic savings (Table 1.3), the publicsavings need to be increased or the budgetary current account deficit of about 2% of GDPin 1996 must be turned into a surplus of at least 4% by the year 2000 to meet theinvestment targets. Including budgetary capital expenditures, the overall budget deficitmust decline from 6.2% in 1996 to about 2.4% by 2000. As indicated in Table 1.2, the

6 Foreign savings are defined as the net export of goods and services.

7 These consist of: inflows of remittances, grants and outflows on interest and repatriation of oilcompany profits.

8 The fact that the total domestic savings increase over 1996-2000 implies that the marginal propensityto save/invest from the income transfer due to subsidy elimination is higher in the public sector thanin the private household sector. The model is not specified in sufficient detail to demonstrate thisimplication. Finally, this discussion applies to only private domestic savings. The foreign savings arelargely private savings and will continue to increase.

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Table 1.3: Availability and Use of Resources (1995-2000)(% of GDP)

1995 1996 1997 1998 1999 2000Variables Act Est. Proj Proj Proj Proj

Total Investment I 10.1 13.7 15.6 16.6 18.5 19.7Govemment Investment 1/ Ipub 3.0 4.2 4.1 5.1 5.5 6.5Private Investment Ipvt 7.1 9.5 11.5 11.5 13.0 13.2

Financed by:Foreign Savings 2/ FS 8.2 11.8 13.5 14.1 14.7 14.7Domestic Savings S =I-FS 1.9 1.9 2.1 2.5 3.8 5.0

Private Savings Spvt 6.9 3.9 1 -0.1 0.8 1Public Savings Spub = 1- FS - spvt -5.0 -2.0 1.1 2.6 3.0 4.0

Revenue R 21.7 31.4 31 31.3 31.8 31Current Expenditures Ecu = R-Spub 26.7 33.4 29.9 28.7 28.8 27.0Capital Expenditures Ipub 3.0 4.2 4.1 5.1 5.5 6.5

Memorandum Items:

Total Expenditures E = Ecu +Ipub 29.7 37.6 34.0 33.8 34.3 33.5Total Budget Deficit DEF = R -E -8.0 -6.2 -3.0 -2.5 -2.5 -2.5

Current Expenditures (YR billion) 115 212 220 233 256 262Capital Expenditures (YR billion) 14 26 30 41 48 63

1/ Capital Expenditures in the Budget.2/ Defined as Net Exports of Goods and Services.Source: Table 1.2 macroeconomicframework

projected budget deficits are expected to be financed essentially from external sourcesincluding project aid and exceptional financing. Recourse to domestic financing will beeliminated in 1996, thereby releasing financial resources for private sector investment,enhancing the effectiveness of the monetary policy, and providing a fiscal and monetarypolicy mix that would be conducive to financial sector intermediation and financial sectorreform.

1.18 Revenues and Sustainable Expenditures: A recent study carried out by theIMF9 shows that the prospects for further reducing the overall budget deficit byincreasing the revenues are modest and therefore most of the adjustment in the future islikely to fall on expenditures. Oil revenues are expected to account for nearly 80% of thebudgetary revenues in 1996. These cannot be increased further because, as discussedabove, oil production is expected to increase up to 1997 and would decline thereafter.Non-oil revenues can only be increased by implementing tax reform centered around theintroduction of a general sales tax, which is not envisioned at present. Still, non-oilrevenues could be increased by: rationalization of tariffs including valuations of importsat the market exchange rate, reductions in exemptions from the business income tax, and

9 International Monetary Fund, " ROY: The Tax System - Recent Developments and Possibilities forRevenue Mobilization", November 1995.

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stepped-up efforts to collect revenue arrears. Even if these measures are implemented,over the medium term, the fiscal revenue would remain at the 1996 level of about 31% ofGDP. This means that the total expenditures have to be reduced from the 1996 level ofabout 37.6% of GDP to about 33.5% of GDP by 2000 to meet the deficit reduction target.Given the need to have higher capital expenditures, the fall in current expenditures willhave to be even higher--from 33% of GDP to 27% of GDP (Figure 1).

Figure 1.

Government Expenditures & Investment, 1996-2000as%of GDP

40.0 .

Total Expenditures35.0 ll t _

30.0

25.0

20 619719819900

5.0

0.0L 1996 1997 1998 19'99 20'00

1.19 These projections in relation to GDP imply that, in nominal terms, the totalaffordable public investment can grow by almost 9% p.a. over 1996-2000; i.e., from theestimated 1996 level of YR26 billion to YR63 billion by the year 200010. Given theaverage projected inflation of about 7% p.a. over 1996-2000, real public investment couldgrow by about 2% p.a. over 1996-2000. At the same time, the current expenditures couldgrow in nominal terms only by about 5% p.a. as shown in Table 1.3 indicating a fall inreal terms of almost 2% p.a. over 1996-2000, highlighting the need for a substantialexpenditure adjustment program.

10 In dollar terms this translates into a total cumulative investment of about $1.5 billion over 1996-2000,or about $300 million p.a.

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Chapter 2

Restructuring Public Expenditures

A. Strategy for Restructuring

2.1 As discussed in Chapter 1, the expansion in public expenditures during 1990-94,was due to an increase in government employment and poorly targeted subsidies at theexpense of expenditures on materials, maintenance and developmental expenditures. By1996, subsidies are estimated to account for nearly 24% of the total expenditures anddevelopment and material expenditures only 8-9% each. This has resulted in a seriousdeterioration in public services and long term growth potential.

2.2 In order to lay the basis for sustainable and equitable growth in Yemen, within thetotal expenditure envelope dictated by stabilization considerations, a substantialrestructuring of expenditure is necessary. For instance, substantial increases in outlaysare required on capital expenditures, which are presently only around 4% of GDP.Urgent increases are also needed for operations and maintenance, for creating a socialsafety net, including improving the efficiency of the civil service, and for the provision ofbasic social services such as health and education given Yemen's weak social indicators.If the government has to achieve these increases in outlays necessary for growth, savingswill have to be generated in the wage bill, transfers to public enterprises and byrestructuring subsidies, as described below and summarized in Figure 2 and Table 2.1.

Figure 2.

Expenditure Restructuring Strategy 1996-2000

INCREASE REDUCE

+ Capital + Wage Bill

+ O & M + Transfers

+ Safety Net + Subsidies

+ Health & Education

Areas to Increase Outlays:

* Capital expenditures, to create basic infrastructure and lay the basis for longerterm growth.

* Operations and maintenance expenditures, to improve the delivery ofgovernment services by fully utilizing the existing facilities and those beingcreated by the ongoing investments.

* Social safety net, for protecting those who stand to lose from reforms.Specifically, poor consumers and redundant workers in public enterprises.Further, it is urgently necessary to deploy more resources towards expandingbasic social services such as health and education and improve the availabilityof water.

* Program to improve the efficiency of the civil service. This would includeadministrative reforms, training, a less compressed wage schedule and perhapshigher wages.

Areas to Generate Savings

* The high wage bill. To begin with, the restructuring program must include anelimination of ghost workers, and workers with multiple jobs. It would alsoinvolve a shift of civil servants from cities to rural areas, and perhaps somelayoffs in the longer run.

* The current system of subsidies, amounting to almost 9.1% of GDP, is highlyinefficient and costly in meeting its objective of assisting the poor. If thepolicies suggested in section 2C are implemented, it should be possible toreplace it by a far cheaper, better targeted social safety net.

* Improving the finances of public enterprises (PEs) by liberalizing the prices ofthe goods and services they produce and making progress on privatizationalong the lines suggested in section 2D. This could result in a reduction intransfer payments on both current and capital accounts.

* As deficit is reduced, reduced borrowing would reduce interest payments.

* It should also be possible to generate savings through an improvement in theefficiency of resource use at the sector level by which, same outcomes couldbe achieved using less resources. The aggregate impact of these policies,identified in Chapter 3, are difficult to quantify.

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2.3 Table 2.1 summarizes the restructuring strategy under two scenarios. If thegovernment fully succeeds in implementing policies identified above, it would bepossible to generate savings of almost 12.6% of GDP over 1996-2000 (Case A). In thisscenario, after providing for a reduction in deficit (3.7%) and a small shortfall in revenue(0.4%), resources amounting to almost 8.5% of GDP would be available to increaseselected public expenditures. As shown in Table 2. 1, in this scenario, the governmentcould expand the recurrent outlays for O&M, for improving the delivery of socialservices and for assisting the poor, by 6.1% of GDP as well as increase in capital outlaysby 2.4% of GDP thereby meeting the growth targets of the macroeconomic framework.

Table 2.1: Expenditure Restructuring Strategy(% of GDP)

Case A Case B

Change Change

1996 2000 2000-1996 2000-1996

Deficit -6.2 -2.5 -3.7 -3.7

Revenues 31.4 31 -0.4 -0.4

Expenditures 37.6 33.5 4.1 4.1

Kcourefq ssaed :N1 1 . -12. 6 Xi K

Wages (Civilian) 1/ (6.8) (6.8) (0) (0)

Defense (5.3) (5.3) (0) (0)

Interest Due (4.7) (2.9) (-1.8) (-1.8)

Subsidies (9. 1) (0) (-9.1) (-5)

Transfers (3.2) (1.5) (-1.7) (0)

Resourees Deployed 8 5 17 1J X i 2 7

Other Recurrent 2/ (4.4) (10.5) (6.1) ?

Capital (4.1) (6.5) (2.4) 9

Source: Bank staff estimates.I/As indicated in section 2B, the savings will be balanced by the costs of administrative reform.

2/ 7his includes outlaysfor O&M, safety net andfor health and education.

2.4 The policies to generate savings, however, will not be easy to implement.Withdrawal of subsidies will be politically difficult and the development of an alternativesafety net could prove to be complex and expensive. Similarly, while the privatization ofPEs could reduce transfers in the medium term, as discussed in Section 2C, in the shortterm, privatization has costs which must be borne by the budget. Finally, in the nearterm, the costs of a civil service reform are likely exceed the savings. As indicated inTable 2. 1, as Case B, if the Government is not able to reduce subsidies and transfers tothe projected levels, resources amounting to only 2.7 percentage points of GDP (vis a vis8.5 percentage points under the Case A) would be available. This implies that resourceswill not be available to expand outlays on crucial operations and maintenance and capitalexpenditures cannot be increased as required by the macroeconomic framework. This, in

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turn, means that the growth targets will not be met and delivery of social services willdeteriorate resulting in a fall in standards of living.

B. Wage Bill and Public Sector Employment

2.5 In 1995, the year for which the latest firm data are available, Yemen's publicsector employed about 633,000 persons'1 amounting to about 17.5% of the total laborforce (see Table 2.2). Of these, 322,000 were employed by the government in the civilservice, about 237,000 were employed by the military and the remaining 74,000 wereemployed by the public enterprises (PEs).

Table 2.2: Employment in Yemen in 1995('000 Persons)

Sector Employment Share of total

Civil Service 322 8.9Military 237 6.5Public Enterprises 74 2.0

Total Public Sector 633 17.5Private Sector 2669 73.6

Working 3302 91.1Unemployed 1/ 324 8.9Total Labor Force 3626 100

Source: Civil Service Survey (1995) and Population Census (1994).1/ Estimate.

2.6 The wage bill in Yemen is high amounting to almost 13.5% of GDP in 1995compared to about 6% in Jordan and 8% in Lebanon. The wage bill is also the largestsingle category of expenditures in the budget. The share of wages (civilian and military)in total expenditures increased from about 50% in 1990 to almost 60% during 1992-94(Table 2.3). It has since estimated to have come down to about 30% in 1996, mainly as aresult of the growth in subsidies.

Employment

2.7 The high wage bill in Yemen is mainly due to a rapid growth of employmentrather than a liberal wage policy. The number of civilian government employees, almostdoubled from about 170,000 in 1990 to about 320,000 by 1995 (see Table 2.3). Thisincrease took place in response to external shocks in an atmosphere of rapid political

I I Recent data indicate that this could be an underestimate.

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changes during the period immediately following unification, for the reasons outlinedbelow:

* First, the two civil services of YAR and PDRY were joined together resultingin a great deal of duplication. Further, the combined civil service had toabsorb a number of workers of the public enterprises inherited from the southwhich were not functioning.

* Second, the government acted as an employer of last resort for the returneesfollowing the Gulf war.

• Third, the civil service also absorbed a number of retirees from the army andcontinued to absorb a large proportion of new college and school graduates.In Yemen, like in some other countries in the Middle East, there is a publicemployment guarantee scheme for university graduates. According to theCSO, about 4400 students graduate every year from universities. This meansthat the civilian employment could potentially grow at least by about 1.5%every year.

* Fourth, because the government's pension fund'2 was insufficient to financeregular retirement pensions, the government allowed retirees to continue inservice beyond the normal retirement age.

2.8 The civil service faces three problems: First, it is overstaffed. Given theresource constraints, the number of civil servants in Yemen is inconsistent with theavailable complementary goods and services, equipment and vehicles to make themeffective in doing their job. Second, there is a skill mismatch within the civil service,with overstaffing at lower grades and understaffing at the higher grades. During the pastfive years, the growth in civil service employment has been concentrated in grades 3 and4 which are typically staffed by junior college and high school graduates. Workersclassified in these two grades increased from 58% of the total labor force in 1989 to 66%of the total civil service employment in 1995. Third, the civil service is highlycentralized with overstaffing in urban centers such as Sana'a and Aden and understaffingin the rural areas, where the bulk of the population lives. For example, in agriculture,nearly 70% of the extension staff is based in Sana'a, while remote villages suffer forminsufficient extensionists. The same problem exists in health and education sectors whereteachers and health workers prefer to stay in the big cities rather than serve in rural areas.

Wages

2.9 The overstaffing of the civil service combined with the pressure to reduce costshas resulted in a sharp decline in wages over the years. Between 1990 and 1995, average

12 The financial problems of the pension funds are discussed in section 2D.

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(real) wages for civil servants have declined by about 85% as shown in Table 2.3.Furthermore, salaries of the civil servants do not increase sufficiently withresponsibilities or grades. Not only are basic salaries not sufficiently differentiated, thefinal salary has a large element of cost of living allowances. As a result, the ratio ofhighest to lowest salaries (the compression ratio) is only about 2-3 (see Table 2.3).International comparisons indicate that an efficiently functioning civil service has acompression ratio in the range of 9 to 1213.

Table 2.3: Trends in Nominal and Real Wages and in Employment

1990 1991 1992 1993 1994 1995 1996

Wage Bill Total (YR billion) 1/ 19.6 25.2 32.5 40.9 48.6 67.3 73.3Military 8.4 10.5 16.3 18.8 23.5 28.5 29.9Civilian 11.2 14.7 16.2 22.1 25.2 34.8 43.4

As a%ofTotal Expenditures 48.5 57.1 59.5 63 61.7 45.4 30.7As a % of GDP 20.4 22.5 24.2 24.1 19.6 13.5 11.6

No. of Civil Servants ('000) 168 203 235 267 295 322 350

Av. Nominal Wage (YR' 000 /month) 2/ 5.56 6.03 5.74 6.89 7.11 10.04 10.33

Av. Real Wage (YR'000/month) 5.56 4.16 2.64 1.94 1.16 1.02 0.81

Compression Ratio 3/ 2.7 3 2.5 3.5

Memorandum ItemsCPI (1990=100) 100 145 218 355 609 987 1274

Source: Ministry of Finance, Ministry of Civil Service and Administrative Reform (MCSAR).1/ Wages include all allowances.27/For civil servants only.3/ This is the ratio of the highest to the lowest salary, see Annex 2.1 for details

Elements of a Comprehensive Administrative Reform

2.10 To deal with the problems of falling salaries, rising employment and lowcompression ratios, the Government should consider initiating a comprehensive civilservice reform. The objective of such a reform would be to improve the quality of thepublic services by restructuring public employment and wages. Although in the mediumterm the program outlined below would result in a reduction in the wage bill, in the nearterm, the savings generated from the elimination of ghost and surplus workers are likelyto be counter balanced by the cost of severance packages, costs associated with

13 Barbara Nunberg and John Nellis, 'Civil Service Reform and the World Bank', PPR working paper422, May 1990.

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transferring civil servants from cities to rural areas, and the need to raise salaries of seniorcivil servants in order to rationalize incentives.

2.11 In order to successfully implement the reforms described below, we suggest thatthe President appoint a 5 - member Oversight Committee (OC) with full powers andresponsibilities for the overall program. The details of the program such as matchingstaff to jobs and deciding the grade structure could be worked out and implemented bythe head of each agency/ministry who could be made responsible for the quality of staffand work performance. Technical assistance to support the OC as well as othercomponents of the program could be provided by the UNDP and by the IDA. Elementsof a proposed civil service reform in Yemen would involve the following steps:

* Carry out a civil service census. The first step is to carry out a civil servicecensus. This would allow the reconciliation of the personnel managementrecords in the Ministry of Civil Service and Administrative reforms(MCSAR) and payroll records in the Ministry of Finance. In parallel, a studyneeds to be done to compare the wages and employment conditions in theprivate and the government sector. Such studies would help identify surplusworkers, workers who are beyond their retirement age and help designseverance packages.

* Freeze gross recruitment into government employment. Unless the rapidincrease in public employment is arrested, the government is likely to face agreater political problem of large-scale layoffs in the coming years. A freezewould force the government to restrict critical new employment to reductionsachieved through retirement or attrition. Further, within the overall ceiling,there would be scope for reallocating employees from sectors in surplus tosectors where there is a shortage of personnel. In this context, the governmentshould reconsider the current system of job guarantees to the 4400 newuniversity graduates new graduates amounting to 1.5% of the civilianemployment every year.

* Eliminate ghost and retired workers. A Civil Service Survey conducted in1995 indicates that there are at least 28,000 workers who are eligible forretiring but have not been able (or allowed) to retire. This was either becauseretirement rules were not enforced or because the government was not able topay their pensions because of the financial problems in the pension funds. Asshown in Table 2.4, if only those who are above 55 years old and have studiedfor less than four years are retired, it would be possible to annually save thebudget nearly YR4.7 billion or about 7% of the 1995 wage bill. In addition,there is a significant number of workers who hold multiple jobs and drawsalaries from several government agencies. Carefully scrutinizing such doublesalaries would also result in additional savings.

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Table 2.4: Budgetary Impact of Retiring old Workers in 1995

Age Group Number Years of Years of Wage Savings perEducation Public Year (YR Million)

Service

55-59 11061 4.0 23.9 --

60-64 8596 3.21 19.9 --

65-69 8902 3.03 29.3 --Total 55-69 28559 - - 4,709

As a % of wage bill 7

Sowre: Civil Service Survey, MCSAR

* Stop paying surplus PE workers through the budget. In the hope ofexpediting and simplifying privatization, redundant workers and retirees ofPEs used to be transferred to the Ministry of Civil Service and their salarieswere paid by the Ministry of Finance. This was done recently in the case ofprivatization of tourism establishments, when nearly 840 employees weretransferred to the budget. This practice should be stopped and laborredundancy should be handled as an integral part of the privatizationtransactions. During 1996, the government plans to retire nearly 25,000 "athome" public enterprise workers, whose jobs were eliminated by past plantclosings and labor shedding but who presently are provided salaries from thebudget. These workers, will be eligible for suitable severance packages andpension. Further they would also be covered by the restructured social safetynet described in section 2C.

- Improve the finances of the pension system. (Discussed in section 2D)

- Improve the regional distribution of workers. Sectoral analysis shows thatsubstantial improvements in delivery of government services in agriculturalextension, health and education is possible by transferring the excess stafffrom the big cities and urban centers to rural areas.

* Surplus workers. A more difficult step, both politically and administratively,is the voluntary retirement of surplus workers. For this to work, it would bebest to offer a menu of separation options. A typical separation packageoffered in other countries (e.g. Sri Lanka, Tunisia) involves 1.5 to 2 months ofsalary per year of service. In addition, there is also a compensation for deniedservice between termination and the worker's 55th birthday. The menu couldalso include cash offers for starting new businesses and retraining.

* Improve performance over the medium term. To upgrade the publicadministration and to improve the efficiency of the civil service, the followingsteps need to be taken:

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* On the basis of the civil service census and other studies to be carriedout, the government needs to prepare an action plan focused on: (i)simplification of procedures, starting with the ministries of finance andplanning, (ii) reforming the structure and organization of theministries, (iii) over time, as the number of employees is controlled,resources would be available to raise wages for senior civil servants tobring the compression ratio from the present level of 3.5 to more inline with international norms of close to ten.

* Establish modem personnel, information and records managementsystems.

C. Subsidies and Protecting the Poor

2.12 Yemen currently subsidizes three main items of consumption: wheat and flour,petroleum products and electricity. The current system has three consequences. First, thesubsidies place a very heavy burden on the budget. In 1996, the three subsidies areexpected to amount to almost 9% of GDP. Second, the wheat'4 subsidy had a negativeimpact on the domestically produced wheat prices and depressed the incomes of thewheat farmers. Third, despite all the leakages, an elimination of the subsidies wouldreduce the income of the poorest in Yemen by as much as 18% and, therefore, calls forthe development of a social safety net.

The Current System of Subsidies

2.13 Wheat Subsidy: The government's stated objective of the wheat and floursubsidy program is to assist the poor by providing inexpensive food items15. Under thepresent system, importers of wheat and flour selected on the basis of a tendering process,are provided foreign exchange at the highly subsidized implicit food exchange rate ofYR30/$ compared to the exchange rate of YRl 151$ used for most other budgettransactions' . The GOY sets the retail (consumer) price for wheat and flour, allowing amargin for wholesalers (for loading, unloading and distribution) and a margin for retailers.The importers are then expected to sell the imported wheat and flour to wholesellers and the

14 The wheat subsidy refers to both wheat and flour subsidy.

The subsidy on rice was phased out in 1994.

16 If 1$ of wheat is imported, the Ministry of Finance provides a cash subsidy of YR (115-30) = 85/1$worth of wheat imported. This is the subsidy borne by the budget. The total subsidy borne by theeconomy is the difference between the cost of wheat at the implicit wheat exchange rate of YR30/$and the cost at the market exchange rate of YR 135/$. See Annex 2.32 for details.

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wholesellers to retailers at the official prices. In the past, wheat was imported by fourpublic sector companies but recently private sector companies have also been involved ingrain imports.

2.14 The budgetary subsidy for wheat is defined as the difference between what theimporter (and hence the consumer after adding the official margins) would have to pay ifwheat were to be imported at the official exchange rate applicable to all budgetarytransactions and what he pays because it is imported at a highly subsidized implicit foodexchange rate and sold at the official retail prices. As indicated in Table 2.5, the wheatsubsidy in 1995 amounted to YR1O billion which is estimated to increase to YR34 billionor 5.4% of GDP in 1996.

2.15 Petroleum Products: Government's share of crude oil which is earmarked fordomestic consumption is sold to the refineries at the going export price (in dollars)converted into Yemeni Rials at a highly subsidized exchange rate of YRl2/$. Therefined products are delivered from refineries to the Yemen Petroleum Company atadministratively set prices (YR/Litre) determined by the government. The YPC sells theproducts to the consumers adding a margin for operation, transport and marketing costs.From the sales proceeds, the YPC pays the refineries for certified deliveries. Therefineries then pay the government the Rial value of the crude delivered to them. If thegovernment increased the final prices to the consumers, the YPC pays the government thedifference between the new prices to the consumers and the agreed refinery deliveryprices.

Table 2.5: Subsidies and Price Adjustments

1995 1996 1997 1998 1999Act Est. Proj. Proj. Proj.

Subsidies (YR Bill.) 14.4 57.4 52.7 37.4 18.4

Wheat " 10.1 34.0 32.6 26.6 18.4Petroleum 2.5 19.3 17.0 9.3 0.0Power 1.8 4.1 3.1 1.5 0.0

GDP 434.7 633.7 735.1 814.5 889.0Subsidies as % of GDP 3.30 9.07 7.17 4.60 2.08

Prices D

Wheat (YR/50 kg bag) 3/ 1260 1526 1737 1940 2187Petroleum4/ (YR/litre) 5.85 10.77 13.18 15.58 17.98Power (YR/KWH) 2.09 4.6 6.81 8.83 10.56

Source: Ministry of Finance.l/lncludes wheat andflour.2/Prices which reflect the exchange rate adjustment and would eliminate subsidies by 2000.3/ The price is an average price assuming 20%o goes through the official channels, and 80% sold on open market.4/ Weighted average of the domestic retailprice - the budgetprice + retail margin..

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2.16 The subsidy to petroleum is the difference between what the government isentitled to receive if the proceeds from the sale of crude were valued at the officialexchange rate of YRI 151$ (used for the rest of the budget transactions) and what itactually receives under the current system. (See Annex 2.4 for details).

2.17 In 1995, domestic prices were well below the Gulf ex-refinery prices as well asthe Saudi domestic prices (encouraging smuggling to Saudi Arabia). This situation hasbeen corrected with the latest round of price increases announced in January 1996.Yemeni prices although still below the world prices, have now been adjusted to aboveSaudi prices, thereby eliminating smuggling. As indicated in Table 2.5, the total subsidyon petroleum products in 1996 is estimated at YR19.3 billion.

2.18 Electricity: The subsidy for electricity arises because the electricity tariffs arenot adequate cover costs of operations (See Annex 2.5 for details). In 1996 for instance,even with an increase in tariffs from YR 2.09/KWh to 4.60, operating revenues are lowerthan operating costs by nearly YR4.1 billion. These are covered partly by transfers fromthe budget and partly by running arrears to YPC.

The Budgetary Impact

2.19 The estimated subsidies for 1996, YR57 billion (about 9% of GDP) are clearlyunsustainable. The government's current policy is to steadily move towards a system inwhich all prices will be market determined in order to eliminate all explicit or implicitbudgetary subsidies by 2000. Table 2.5 shows one possible time path of prices whichwould achieve this objective. For wheat and flour, given the potential impact on thepoor, the price would be adjusted to end the subsidy within a five year period beginning1996 (See Annex 2.3 for details). For petroleum and electricity, prices would be adjustedin line with the exchange rate so as to eliminate the subsidies frilly by 1998. TheGovernment has already made progress towards meeting this objective. In 1996,petroleum prices were increased by 84% and the electricity tariffs were increased bynearly 120% (Table 2.5). As per the analysis, the petroleum and electricity tariffs need tobe raised further by 67% and 130% respectively from their 1996 levels in order to fullyeliminate the subsidies by 1998.

Inefficiency of the Current System of Subsidies

2.20 In addition to its large impact on the budget, the current system of general subsidiesis a highly inefficient instrument of helping the poor. In the case of wheat, for instance, alarge part of the outlay is simply wasted. Of what remains, only a small portion reaches theconsumer, and of what reaches the consumer, only a fraction reaches the poor. In otherwords, large budgetary outlays are being used to transfer a small benefit to the poor.

* The wheat inport/distribution system is inefficient and therefore expensive:The government has not been efficient in importing wheat. For instance, in

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1994, government imported wheat at $166/ton, while the comparableinternational price was 140/ton. This price premium arose because: (i) thegovernemnt's inability to make timely payments (ii) the govememnt'sreputation of not honouring its contracts, and (iii) Yemeni ports are very slow inunloading the wheat and there are reports of corruption which adds to the cost ofimporting wheat.

* The system results in smuggling of wheat: In 1995, the cost of obtaining wheatwas $50/ton if the importer had access to foreign exchange at the food rate,compared to the international price of wheat of around $166/ton. This largeprice differential provides an incentive for the wheat to be diverted from theofficial distribution channels and smuggled out of the country, especially toSaudi Arabia where the domestic price of wheat is higher than the world price toprotect domestic production. It is estimated that smuggling and port lossesamount to nearly 25% of the imported wheat.

* Only a smallproportion of the subsidy reaches the consumers: The amount ofsubsidy reaching the poor depends upon the proportion of wheat sold at theofficial price. As the system is set up, wheat ownership changes four times in itspath from the foreign supplier to the Yemeni consumer with the price beingcontrolled at each point of transfer. It is our assessment that, only about 20% ofthe domestic supply of wheat is sold through the official channels and theremaining through the parallel market reflecting the depreciated rate. Theanalysis in Table 2.6 shows that in 1996, of the total subsidy of $314 million,about 42% went to traders, 25% went to smugglers and only 33% went toconsumers.

Table 2.6: Benefits Across Social Groups( million)

Social Groups 1994 1996

Traders 99 132

Consumers 76 104

Smugglers 58 79

Total Subsidy 233 314

Source: Ministry of Finance, World Bank staffestimates.

* Only a small proportion of what reaches consumers reaches the poor: Thesubsidies in Yemen are not targeted, i.e., they are equally available to allconsumers regardless of their income. Therefore, the subsidy on any item ofconsumption is distributed across different income groups in proportion to

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their respective expenditure on the subsidized commodity. As indicated inTable 2.7, of a general subsidy of YR 100 on wheat, about YR 31 reaches thetop 10% of the households and only YR 6.7 reaches the poorest 20% of thehouseholds. A similar pattern emerges for the benefits from the subsidies onelectricity and petroleum products.

Table 2.7: Benefits of YR 100 General Subsidyby Commodity to Various Income Groups

PetroleumWheat Electricity products

Decile

Poorest 2.5 6.4 2.0Second 4.2 7.5 3.3Third 5.0 8.9 3.5Fourth 6.0 9.2 5.1Fifth 7.2 9.8 6.1Sixth 8.2 10.9 6.8Seventh 9.6 10.6 8.8Eighth 11.9 11.7 12.4Ninth 14.6 11.7 14.9Richest 30.7 13.1 37.1

100.0 100.0 100.0

5ource: Household Budget Survey (HBS), Round 4, 1992.

Impact on the Poor

2.21 Although the current system of subsidies is highly inefficient and only a smallproportion of the total outlay reaches the poor, subsidies are indeed important for thewelfare of the poor. Table 2.8 gives an illustrative example of the income loss for differentdeciles of the population over the four year period 1995-99 due to the price increasesnecessary for the elimination of the subsidies on wheat, electricity and petroleumproducts. As indicated in this table, over 1995-99, the poorest 10% of the householdswould suffer an income loss of about 1 8%'7 while the richest 10% would suffer a loss ofabout 23% of income. This loss of income is mitigated to some extent by the rise in percapita income of about 6% over 1995-99, the multiple tier pricing for electricity and thecross subsidy on kerosene. Even taking these into consideration, removal of subsidieswould hurt the poor. Therefore action on subsidies needs to be accompanied by theintroduction of a targeted social safety net.

2.22 The design of a targeted social safety net must distinguish between theemployable poor and the unemployable poor such as old people, invalids, widows and

17 On a per capita basis they would have 18% less income in 1999 compared to 1995.

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orphans. For the unemployable poor, the government already has a transfer program.According to the Ministry of Social Affairs, Social insurance and Labor (MSOL), about31,000 households are assisted with food and cash assistance estimated at YR3 1 millionin 1994.

Table 2.8: Total Impact of Price ChangesLoss of Income over 1995-99

(%)

Income Per Capitaloss over Income(1995)

Decile 95 - 99 YR p.a.

Poorest 17.7 6910Second 17.7 9865Third 16.4 11670

Eighth 18.2 19670Ninth 18.4 27340Richest 22.8 43645

Price increases over 1995-99 (%/6)Wheat 74Petroleum 207Electricity 405

Source: Household Budget Survey.

Design of a Targeted Social Safety Net

2.23 For the employable poor, the best form of assistance can be given by creatingemployment, increased provision of social services especially in the rural areas, anddeveloping NGOs to deliver assistance to the poor. The Government is currently engagedin creating a "Social Fund for Development" in the context of a proposed IDA project.The social fund would finance small scale labor intensive activities, deliver communityservices, encourage small and microenterprise development, and build capacity at thelocal levels to plan and execute development projects. The fund is however very much amedium term solution because its activities are not likely to begin until late 1997. Inaddition the proposed IDA southern governorates project which develops and distributesland to the landless also would assist the poor in the medium term.

2.24 Over the short term, designing programs that target cash or goods to the poor isdifficult. Most of the poor live in small geographically dispersed communities, andtherefore are difficult and expensive to reach through targeted programs especially inview of the government's weak institutional capacity. One way around this is to expandpublic works programs which are self targeting. If the work is sufficiently difficult andthe wages are low, there is little incentive for the non poor to participate in suchprograms. Furthermore, the poor can be protected to some extent if the withdrawal of

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subsidies on electricity and petroleum products, is accompanied by low tariffs on the firstblock of power consumption and by cross subsidizing kerosene, which is mainlyconsumed by the poor. The package of reforms to restructure social safety net can besummarized as follows:

Social welfare programs

* To improve coordination, the government should consider making the MSOLresponsible for all social welfare programs, currently being managed bydifferent ministries. These include: the Public Works project, the socialwelfare fund, the southern governorates project and the proposed IDA socialfund project.

* Implement a civil works program, included in the Public Works projectcurrently being supported by the Bank, which will create jobs and assist thepoor.

In the 1996 budget, the Government has set aside YR1 billion, for theestablishment of a Social Welfare Fund (SWF). The SWF augments theexisting programs of the MSOL for assisting the poor. Further work needs tobe carried out to develop transparent criterion to identify beneficiaries andensure that there is no duplication.

Restructuring subsidies

* Raise prices to eliminate subsidies on electricity and petroleum by 1998 andwheat by 2000.

m For electricity, have a graduated payment schedule. Cross subsidize the firstblock of power consumption by charging low tariffs.

* Cross subsidize kerosene. As per the household budget survey (HBS) it is aninferior good i.e. it's consumption falls with income, and is therefore, selftargeting.

* Substantial savings could be generated by eliminating the wheat flour importsas they are costlier and no better targeted than wheat.

* Substantial saving could also be realized by improving the wheat importsystem by: (i) reducing margins on transportation and handling byrenegotiating prices with trucking unions and port handlers, (ii) complyingwith contracts made with importers, (iii) providing secured letters of credit forimport commitments. These actions could reduce the subsidy by an estimated30%.

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* Government can reestablish its reputation in the wheat market, by installing asystem to make prompt payments to importers which would lower the price ofwheat. This benefit could be then passed on to the consumers.

* The current subsidy could be phased out and replaced by a wheat voucherscheme. One possible design for the scheme would be to give a wheatvoucher to all households for an amount of wheat equal to the per capitaconsumption of the poorest two deciles of the population. This wouldcircumvent the problem of targeting using a means test and could reduce thesubsidy bill by about 4% of GDP p.a. The main difficulty in introducing sucha scheme are the administrative weaknesses in Yemen which would hamperthe efficient operation of the voucher system and therefore would not yield theprojected savings. The complexity of the proposed voucher system should notbe underestimated. The vouchers, have to be distributed nationwide to allfamilies. The distribution and redemption will have to be coordinated acrossCentral Bank branches, offices of the Central Registration Authority and postoffices. It would therefore be useful to carryout a more detailed analysis ofthe administrative feasibility and costs prior to launching the voucher scheme.Alternatively, the government could test feasibility of the scheme byimplementing a small pilot project before extending it to the whole country.Finally, it should be made clear to the public that the voucher scheme is beingintroduced as an interim measure. There should be a built in sunset provisionto end the scheme or gradually reduce its scope, say, over the next five years.

D. Budgetary Transfers

2.25 There are two kinds of transfers taking place in the budget -- current (underChapter 3 of the budget) and capital (under Chapter 418 ). Current transfers decreasedfrom 3.2% of GDP in 1992 to about 1.7% of GDP in 1995 and are estimated to increasesharply to 3.2% in 1996, mainly as a result of an increase in pension payments. Nearlyall the capital transfers from the budget, on average about 1.5% of GDP, are to PublicEnterprises (PEs). Of the current transfers, nearly 70 to 80% is accounted for by socialtransfers and pension payments, and the rest are to PEs (Table 2.9).

8 Chapter 4 in the budget also contains other items such as amortization payments and govermmentlending to the public sector. These have been netted out in this discussion.

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Table 2.9: Current and Capital Transfers from the Budget(% of GDP)

1992 1993 1994 1995 1996Act Act Act Act Est.

Current Transfers 3.25 3.23 2.59 1.67 3.20

Public Enterprises 0.79 0.89 0.66 0.45 0.45Social Welfare 0.87 1.08 0.74 0.61 1.00Pension Contribution 11 0.52 0.25 0.20 0.15 1.36Medical grants 0.18 0.12 0.05 0.07 0.11Other 2/ 0.89 0.89 0.93 0.39 0.27

Capital transfers 1.31 1.16 0.41 1.27 1.44

Investment expenditure 4.60 2.57 2.10 2.05 2.67GDP (YR Billion) 134.71 169.79 262.71 434.71 633.67

Source: Ministry of Finance.1/For 1996, YR8000 Million are budgeted to supplement the pension system.2/ Consists of transfersfor social and sports activities.

2.26 There are two areas where potential savings could be realized. First, the transferslisted in Table 2.9, under the headings social welfare, medical grants and "other"amounting to 1.4% of GDP are ad hoc transfers carried out through the Ministry ofFinance. These programs should be combined with other programs in the social sectorand redesigned to improve their efficiency and reduce costs. Second, it should bepossible to reduce the transfers to all PEs, first by improving their finances and, second,over the medium term, through privatization where possible, or liquidation. While thetransfers to the pension system could be reduced if a reform of the pension system issuccessfully implemented, these gains are likely to be neutralized by an increase ingovernment's contribution to match the increased pension contribution of employees.

Transfers to Pension Funds

2.27 Yemen currently has four main pension funds--one each for public sectoremployees (civil servants and public enterprise employees), military personnel, police,and private sector employees. All four funds are administered by the Insurance andPension Authority. There are also some group pension schemes operated by privateinsurance companies.

2.28 The operations of the public sector employees' pension fund are illustrative of allstate-operated funds. Participation is mandatory for all public sector employees, who arerequired to contribute 6 percent of their salary. This amount is matched by an equalcontribution by the government. Full retirement benefits can be drawn at age 60 and after

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35 years of service. Annual retirement benefits are calculated according to a formulawhich takes into account the years of service and the last annual salary.

2.29 The resources of the pension fund are primarily invested in private sectorcompanies and real estate where the returns have been relatively low. The pension fundalso keeps part of its resources (about YR12.6 billion as of November 1994) in the formof deposits with the CBY, receiving currently about 9 percent per year. These negativereal returns could present problems in funding future liabilities should there be asignificant change in the balance between current contributors and retirees arising fromlarge scale staff retrenchments.

2.30 Over the next two years --1996-97, the government is committed to maketransfers of YR8 billion p.a. to the pension fund to cover the additional actuarial financialcommitments, stemming from the retirement of the 25,000 "at home" public enterpriseworkers in 1996. Even with these transfers, recent analysis indicates that the pensionsystem would make losses beginning 1998, and therefore, would require the followingpolicies to restore its viability:

- Improve compliance. Currently only 75% of the dues are collected.- Limit survivor's benefit to immediate family.- Improve the base for pension contributions by consolidating the large number

of allowances of the public sector employees into the base salary.- Merge public and private pension schemes to reduce overheads.

2.31 Our analysis shows that the program outlined above would restore viability to thepension system over the next 2-3 years. In other words, the budgetary transfers to thepension funds (1.36% of GDP) are likely to continue for the next 2 years and could begradually eliminated thereafter provided the program outlined above is successfullyimplemented. This decrease in budgetary transfers is, however, likely to be neutralizedby an increased budgetary outlay for the government's share of pension contribution tomatch the increased contribution from employees.

Public Enterprises

2.32 The unification of the two Yemens in 1990 brought together a large number ofsouthern and northern public enterprises and created a PE sector consisting of about 140entities employing some 73,000 workers. As indicated in Table 2.10, in 1995, the totalcurrent and capital transfers to the PEs in 1996 are likely to amount to around YR12billion or about 1.5% of GDP.

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Table 2.10: Transfers to Public Enterprises(YR million)

1992 1993 1994 1995 1996

Current Transfers 1075 1565 1745 1759 2844

Broadcasting and Television Corporation 233 293 314 372 1017Al-Thawra Hospital 174 236 214 331 432

Organization for Agriculture Research 110 143 139 148 203Touhama Development Organization 58 90 98 96 157Yemen News Agency(Saba'a) 39 52 52 57 68Rural Development Org. 30 61 67 70 104Oil Exploration Organization 52 107 143Mineral Resources Exploration Org. 89 78 151Other Agricultural & Industrial Enterprises in trouble 249 449 262 160 240Others 183 241 459 339 329

Capital Transfers 1225 1867 1178 8897 9281

Broadcasting & Television Corporation 59 38 29 479 518Al -Thawra Hospital 4 9 26 166 189Civil Aviation (CAMA) 38 52 60 194 257Posts & Postal Service Organization 26 20 75 56 95Rural Areas Development Organization 91 144 129 119 260GAREWS 0 336 369 1376 1935Public Electricity Corporation (PEC) 652 457 246 4741 4076Water & sewage Corporation (NWSA) 191 643 198 1059 1395Others 164 168 47 707 556

Total Transfers 2300 3432 2923 10656 12125

GDP (YR billion) 134.7 169.7 262.7 434.7 633.7

Source: Ministry of Finance.

2.33 Current transfers to PEs are small, estimated to be less than 0.5% of GDP in 1996.Moreover, these transfers are to entities such as hospitals, research organizations andbroadcasting, which are likely to remain in the public sector, have no source of revenuesand therefore will continue to need transfers. Four PEs, CAMA, GAREWS, PEC andNWSA are the biggest recipients of capital transfers, accounting for almost 80% of thetotal capital transfers in 1996 (Table 2. 10).

2.34 The current and capital transfers reported in Table 2.10 understate the truemagnitude of the current and future burden of the PEs on the budget. The PEs face anumber of problems which could result in a sharp deterioration in their finances andconsequently increase the burden on the budget.

A large number of PEs are not operating and generating any revenue.However, under the current laws, the workers cannot be fired. Thegovernment is therefore obliged to carry these workers on the government

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payrolls. The Ministry of Finance indicated that the salaries of nearly 30,000workers amounting to about 10% of the wage bill or 1.2% of GDP cannot bepaid by their enterprises and hence are paid by the Ministry of Financethrough a special account.

* The electricity utility, PEC has large accounts receivable (from governmentdepartments, defense) which, in turn appear as dues to the Yemen PetroleumCompany. Clearing these interenterprise arrears will need further transfersfrom the budget to the entities.

* The PEs have borrowed heavily from the two public sector banks--the YemenBank of Reconstruction and Development and the National Bank of Yemen.In 1994'9, the credit to the PEs amounted to nearly 18.5 of the total portfolioof the banking system. The Government is currently in the process ofevaluating the increased non performing loans. Depending on the extent ofthese loans, budgetary transfers may be required in the future.

2.35 Improving the finances of the PEs through pricing and other efficiencyimprovements is therefore crucial to minimize the current and future demand forbudgetary resources. First, the government needs to continuously adjust the prices of

20goods and services in order to allow the enterprises to break even . Amongst the PEswhich require transfers, the government is already committed to raise the prices ofelectricity and water as a part of the reform program. Transfers to GAREWS could bereduced by increasing the community participation in the rural water projects further from

21the current level of 35% . As discussed in Chapter 3, CAMA could be fully financiallyindependent by increasing overflight charges and improving their collection.

Privatization

2.36 Relief to the problem of the demand on budgetary resources, be it in the form oftransfers or wages, or interenterprise arrears, would come from privatization. In addition,privatization would also attract new investment and increase the efficiency of the PEsector as a whole. The Government's privatization program is outlined in Cabinet decreeN-8 passed in January 1995. According to this decree, about 100 PEs in ten sectors -mainly the productive sectors are targeted for privatization. The government has set upthree privatization committees, one each for industry, non-industrial sector and forhousing sectors. The entire program is being coordinated by the Technical PrivatizationOffice (TPO) with technical assistance being provided by the World Bank under the

19 The last date for which data is available.

20 As per covenants included in Bank projects for PEC and NWSA this is defined as, generatingadequate revenues to cover operating costs including depreciation on revalued onsets and interestchargeable to operations.

21 A study of GAREWS is currently being carried out by the Bank.

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ERC. As of March 1996, out of the 100 PEs targeted for privatization, 16 PEs have beenbrought to the point of sale/liquidation, about 60 more have been planned for sale andsome work have already been done; while the remaining have been merely identified forsale. The government's privatization program, so far, excludes the big utilities22 (electricpower and water) and oil exploration.

2.37 On the whole, in the short term, privatization would not significantly reducetransfers from the budget. The savings realized from the sale /liquidation of the PEs inmanufacturing and agriculture23 will be off set by the following costs of privatization.

* A significant proportion of debts from the public enterprises to thegovernment owned banks are in default. Budgetary transfers would probablybe needed to compensate the banks for non-performing assets which amountedto between $20-50 million in 1995.

* The cost of transactions, hiring of consultants, bringing PE accounts upto dateand locating buyers, themselves amount to $10 - 20 million.

* The cost of redundancy pay is estimated at about $30-50 million. First, thegovernment has yet to formulate a clear policy on labor retrenchment inprivatization. Various ministries are delaying the problems or dealing withthem as they arise on a piece meal basis. The tendency is to shift the workerson to the government (MOF) payroll which would only exacerbate theproblem and not solve it. Second the PE employees pension fund -- especiallyin the south is in severe financial difficulty because of mismanagement andirregularities. Budgetary transfers would be needed to make this fundfinancially viable.

2.38 The second reason behind the limited impact of privatization on the budget is thatso far, the big PEs in utilities and infrastructure (electricity, telecommunications andairlines) have not been put up for privatization, nor have some of the more profitable PEssuch as the cement company. Expanding the scope of privatization in these areas isnecessary not only to generate revenues, but also to signal the objective of theprivatization program and to attract foreign investors to Yemen.

22 A study for public utilities regulatory and institutional reform is planned to be completed under theWorld Bank's ERC during this year.

23 Reported in Table 2.10 as "other agricultural and industrial enterprises in trouble".

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Chapter 3

Sectoral Expenditure Programs

3.1 Policies on wages, transfers and subsidies which cut across all sectors need to becomplemented by policies which affect expenditures within each sector. Section Adiscusses the relationship between the development strategy, the structure of expendituresand intersectoral priorities within the overall resource envelope presented in Chapter 1and 2. Section B discusses common problems facing all sectoral expenditure programsand their solutions, and Sections C-H discuss restructuring the expenditure programssector by sector.

A. Development Strategy and Expenditure Priorities

3.2 Future growth in Yemen is expected to arise from an expansion of private sectoractivity in agriculture, small and medium - scale manufacturing, tourism and constructionactivity. These, taken together would also provide the basis for an expansion in non-oilexports. In addition, privatization of the port sector could also attract private investmentand provide an additional source of growth. The strategy of the reform program istherefore to create an environment for the expansion of the private sector savings andinvestment while public investment is channeled to provide crucial physical and socialinfrastructure and to improve the quality of life.

3.3 The sectoral composition of expenditures for 1996 presented in Table 3.1 and thedetailed sectoral analysis in Sections C-H in this Chapter indicates that Yemen'sexpenditure priorities are broadly evolving in line with the development strategy outlinedabove and the generally accepted role of public expenditures discussed in para. 2.2.Subsidies and transfers are being reduced. No new public investment is planned inmanufacturing, oil and gas and other purely commercial activities. Existing PEs inmanufacturing inherited from the south at unification as well as agricultural farms andenterprises engaged in commercial activities are covered by the comprehensiveprivatization effort. Public investment is mainly directed to the creation of infrastructure-- mainly road construction and electricity, and for human resource development. Inagriculture, the public investment program consists of building capacity for research andextension, and projects for irrigation and water conservation -- areas normally reservedfor the public sector.

3.4 The main challenge before the authorities is, however, setting priorities for publicexpenditures within a very tight resource envelope. At present, Yemen's needs for publicexpenditures are very high. In almost all sectors a strong case may be made to increaserecurrent expenditures and find public investment projects with very high returns. Inview of the tight resource envelope, however, hard tradeoffs have to be made at themargin between urgently needed recurrent expenditures in different sectors and furtherprioritizing projects with high returns.

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Table 3.1: Sectoral Composition of Proposed 1/and Budgeted Expenditures(YR billion)

1996 1996 1997 1998 rotalProposed

Budgeted Proposed Priority 1996-98

Current Expenditures 2/

Administration 40.5 40.5 47.0 52.1 139.6Agriculture 2.2 2.2 3.5 3.9 9.6Education 29.6 29.6 34.7 38.6 102.9Health 4.9 4.9 6.8 8.6 20.3Other 3/ 1.9 1.9 3.0 3.3 8.2

Total Proposed CurrentExpenditures 79.1 79.1 95.1 106.5 280.6Envelope CurrentExpenditures 4/ 79.1 79.1 88.9 114.0 282.0Envelopeasa%ofGDP 12.5 12.5 12.1 14.0

Capital Expenditures

Agriculture 3.8 3.8 4.4 4.9 13.1Education 5.8 5.8 9.3 13.2 28.3Health 2.6 2.6 3.7 5.2 11.5PEC 4.0 9.7 11.9 17.0 38.6Electricity - GAREWS 1.3 1.3 1.5 1.7 4.5Water - GAREWS 0.7 0.7 1.3 1.5 3.5Water-NWSA 1.4 1.4 1.6 1.8 4.8Road Construction 6.1 6.1 8.0 10.0 24.1Other Transport 0.3 2.8 2.8 2.4 8.0

Total Proposed Capital Expenditures 26.0 34.2 44.5 576 136.4Envelope Capital Ependitures 4/ 26.0 26.0 30.) 41.5 9Z6Envelope as a % of GDP 4.1 4.1 4.1 5.1

Interest, Subsidies and Defense 132.9 132.9 124.8 126.1 383.8

Total Expenditures - Proposed 238.0 246.2 264.4 290.1 800.8Total Expenditures - Envelope 5/ 238.0 238.0 250.0 274.0 762.0

Source: Macroeconomic framework, sections G-H, Chapter 1, 2.1/ On the basis of priority expenditures to meet sectoral objectives.2/Excludes: interest payments. subsidies and defense.3/ Mainly covers housing expenditures.4/As dictated by the macroeconomic framework - Chapter 1.5/Includes: interest payments, subsidies and defense.

3.5 Table 3.1 compares the proposed priority expenditures for 1996-98 with theresource envelope dictated by the macroeconomic framework. Priority expenditures areestimated on the assumption that the sectoral policy reforns (identified sections C-H ofthis Chapter) are implemented and the sectoral and macroeconomic objectives of thereform program are achieved. In making the expenditure projections the first priority isgiven to making adequate provisions for O&M and other recurrent expenditures to fullyutilize the current facilities and those coming on stream in 1996-98. The priority capital

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expenditures are estimated on the basis of first completing ongoing projects with highreturns. New projects are few and are initiated only if the existing capacity is fullyutilized and adequate recurrent resources are available to operate new capacity coming onstream.

3.6 Even with the highly selective approach followed above, as indicated in Table 3.1,the total priority expenditures for 1996-98, exceed the resource envelope dictated by themacroeconomic framework. Within the total, the priority current expenditures areroughly in line with the resource envelope while the priority capital expenditures exceedthe resource envelope by nearly 30%, and are therefore unsustainable. The high demandfor capital expenditures basically arises from the electricity and the transport sectors. Inthe electricity sector, large capital outlays are needed for the completion of the ongoingextension of the Hadramawt power station and rehabilitation of the Hiswa power stationin 1996, and for the construction of the Marib combined cycle plant beginning 1998.Large outlays are also required for the GAREWS rural electricity and water schemes.These are considered high priority because of their high contribution to improving ruralhealth and alleviating poverty. In the transport sector, large outlays are needed forcompleting the ongoing road construction program and the crucial investments in theairport sector to complement the privatization effort.

3.7 Thus, the expenditure restructuring strategy should aim to meet the recurrentexpenditure requirements and further prioritize the proposed priority investment program

24to stay within the overall resource envelope . This requires increased selectivity in allsectors to ensure that only projects with highest returns are continued. On the basis of thesectoral analysis presented in section G-H, the following areas are possible candidates for

25realizing further saving

* The electricity investment program could be further prioritized by protectingthe investments in transmission and distribution (which have high returns),and slowing the expansion in generating capacity. The extension of theHadramawt power station could be delayed to 1997-98, and the constructionof the Marib power station could be delayed to beyond 1998. Finally, furthersavings on public resources could also be achieved by accelerating theprivatization program, the preparation of BOO schemes for foreignparticipation, and implementing a faster increase in electricity prices to equalthe long run marginal cost.

24 This assumes that the institutional problems in sectors which affect project implementation areresolved and the government is able to spend the full allocation of the capital budget. In the past, thegovernment has been able to spend only 70% of the capital budget (see section 3B). If institutionalconstraints are not resolved, the expenditure will remain within the envelope. However, the cuts willnot necessarily fall on the lowest priority projects and will therefore adversely affect growth.

25 This is only one possible pattern of expenditure reduction to stay within the overall resourceenvelope. It is possible for the government to choose to protect the investments in electricity - butthis would, for example result in falling short on targets to expand education and health or water.

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* Further savings are also possible from the nearly YR2 billion p.a. (about 8%of the total investment program) GAREWS program for small water andelectricity projects. First, the institutional capacity of GAREWS needs to bestrengthened before it can undertake the proposed large investment programwhich consists of a large number of small projects. Second, it should also bepossible to save on public resources by increasing the share of costs borne bycommunities benefiting from the GAREWS projects.

* Further savings are also possible in the large road construction program. Thiscould only be done after the detailed analysis of the ongoing projects beingcarried out under the transport rehabilitation project, is completed. Similarly,nearly half the public resources planned for the airport reconstruction programcould be saved if implementation of the privatization program is accelerated.

* Finally, the functional classification of the total expenditures (Table 3. 1,Annex 3.1) shows that in 1996, only about 27% of the total expenditures canbe identified as current or capital expenditures in specific sectors. Of theremaining, 56% are for interest payments, subsidies and defense, and anadditional 17% are ad hoc administrative expenditures whose developmentalimpact (or what it buys) is often dubious. In short, even small improvementsin efficiency/expenditures reduction in areas such as defense, administrationcould release large resources for increasing the growth potential of theeconomy.

B. Issues Common to all Sectoral Expenditure Programs

3.8 There are three issues common to almost all sectoral expenditure programs.

* Inadequate O&M expenditures to operate existing facilities and those beingcreated by projects currently under implementation.

* Weak data base on projects.* Project implementation faces severe problems.

3.9 Inadequate O&M Expenditures: In almost all sectors, the allocation of O&Mexpenditures is inadequate to operate the existing facilities and those coming on streamupon completion of the ongoing projects. As discussed before in para. 1.6, the squeezeon O&M allocations arises because line ministries are under great pressure to stay withina total budget envelope dictated by the overall squeeze on resources. At the same time,the ministries are saddled with a very large workforce (for reasons discussed in chapter 2on civil service reform) whose salary bill takes up an increasing share of the ministry'sallocation. Since salaries and wages have priority over everything else, the allocationsfor O&M expenditures are reduced almost by default year after year. In the past, thegovernment and donors responded to the squeeze on O&M expenditures by changing the

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structure of projects included in the investment program. Investment programs in 1996consist of small schemes grouped together as projects. Many of these "projects" usedonor financing to finance high priority recurrent costs and/or carry out the much neededrepair and maintenance activities 26. Further, most donors also responded by financingfollow up projects to finance recurrent costs of their ongoing projects. While this is arational response to the squeeze on O&M expenditures, it postpones rather than solves theproblem.

3.10 Data on Projects are Weak: For most projects no data are available on the totalcost of the project, amount spent so far and financing needed to complete the project.Even for the large, multi-year projects it is not possible to relate the expenditure carried

27out so far to its physical completion . This makes it hard to project investment needsinto the future, and to set priorities consistent with available resources.

3.11 Project Implementation Faces Problems: Yemen has traditionally been able tospend far less than the budgeted capital expenditures. On average, as indicated in Table3.2 below, only about 50% of the budgeted funds were actually spent in 1993-94. In1995, this proportion increased to about 80%. Even in the case of IDA - supportedprojects, in FY95, disbursements were barely 10% of the total undisbursed balances. Thesituation is of particular concern in health, education and agriculture where funds aredirectly spent by the respective line ministry, and a little better in electricity and transportwhere investments are implemented by autonomous agencies (like the PEC) based onfunds transferred from the ministry's account.

3.12 The Country Portfolio Performance Review (CPPR) carried out by IDA incollaboration with the authorities in June 1995 suggested that part of the reason for poorproject implementation could be attributed to the unstable macroeconomic situation atthat time -- especially the rapid depreciation in the exchange rate and the rise in inflationin 1994. Civil works contractors who had written their contracts in Riyals28 were not ableto deliver on their promises, and works stalled. Under the CPPR, the process ofrenegotiating the contracts has begun.

26 For example the "investment program" in education for the Abyan Governorate contains about 70projects some with 1996 outlays of less than $1000 each. Projects include: upper floor for AlShaheed school-6 classes or fence to the north of Hasba (cost $5000). Exactly the same situationexists in agriculture, (water) GAREWS and in the health sector.

27 For instance, in agriculture, from the data available in the Ministry of Planning (or Agriculture), it isnot possible to tell whether the $93,000 allocated to the forestry improvement project during 1996,(See Annex 3.4) will complete the project in 1996 or will require substantial additional resources inthe future.

28 It would have been difficult to foresee the magnitude of price contingencies that would have to bebuilt in.

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Table 3.2: Budgeted and Actual Current and Capital Expenditures(YR billion)

1993 1994 1995

Current

Budgeted 63.7 75 110.8

Actual 58.6 76.7 114.7

% of Budget 92 102 104

Capital

Budgeted 12.3 14.5 18.3

Actual 6.3 6.5 14.4

% of Budget 51 45 79

Source: Ministry of Finance, IMF

3.13 The second, and in some ways, more important and intractable reason is related toinstitutional constraints-- specifically the system of release of funds to contractors againstamounts approved in the budget. At present, all payment accounts are reviewed by theMinistry of Finance and the Ministry of Planning (for development budget) before acheck is issued by the spending agency. This procedure requires signatures of no fewerthan 12 senior officials. As indicated in Annex 3.3, based on actual interviews, it takesabout 42 days to approve an invoice for an IDA - supported project. For a non IDAproject, financed from local funds, this process could take an additional 3 to 6 months.This highly centralized and bureaucratic process is exacerbated by the weak civil service,suffering from low pay and morale.

3.14 The implementation problems also result from a lack of availability of counterpartfunds. In most cases, however, the problem is one of slow disbursements rather thaninadequate budgetary allocations. Implementing agencies are spending less than theirallocations. Thus, in general, the availability of budget as such does not seem to havebeen the main problem in project implementation. Second, most bilateral donors havebegun to finance all the local costs, thus doing away with the need for counterpart funds.IDA is an exception requiring at least 10% local counterpart financing.

Addressing the Common Problems

3.15 Addressing the common problems described above would involve the followingactions.

29 The difference between budgeted and actual expenditures (and revenues) is reflected in less thanplanned borrowing by the government, from the banking system.

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* Increase O&M outlays. As indicated in Chapter 2, resources amounting tobetween 3 to 8.5% of GDP p.a. are likely to be available by the year 2000,depending upon the success in reducing subsidies, transfers and efficiencyimprovements in the sectoral expenditure programs. In all sectors, beforeinitiating new projects which add to new capacity, the additional resourcesmust first be deployed to increase the O&M expenditures to fully utilize theexisting facilities as well as those coming on stream by projects currentlyunder implementation.

* Improve the data base for the projects. First, a reliable data base for projectshas to be developed to include the total cost of the project, the amount spentso far and the financing needed for completion. Second, small schemes couldbe aggregated for planning purposes into a smaller, manageable number ofexpenditure programs so that their relative priorities could be assessed.Currently the government is engaged in creating a computerized data base forall ongoing projects with the assistance of the KfW. Completion of thisactivity would provide inputs to further work in this area.

* Improve the implementation of ongoing projects. To begin with, civil servicereform, which is being considered by the government, would improveadministrative efficiency and result in improved project planning andexecution. The CPPR process for IDA - supported projects has alreadysucceeded in streamlining the procedures for those projects. Prior to thisreview3 , all tenders above $0.2 million were sent to the High Tender Board(HTB), which had become a bottleneck. Under the CPPR, the limit of tendersneeding the HTB approval has been increased to $1 million. Further,contractors are now denominating their contracts in foreign currency ratherthan in Riyals and there is improved compliance with audit reporting andsubmission of financial statements. An IMF study carried out in April 1996 'also makes a number of suggestions in the area of budget execution,expenditure control and government accounting. These include: devolvingmore spending powers to the spending agencies, disbursing funds to thespending agency according to a quarterly as against monthly advance scheduleof work and giving greater freedom to the spending agency to reallocateexpenditures between budget subitems. This report is currently being used todevelop a financial management improvement program.

30 These were mainly focused on Bank projects rather than the "systemic" problem of the investmentprogram.

31 Republic of Yemen, "An Evaluation of Government Budgetary, Accounting, and Expenditure Controlsystems", IMF, April 1996.

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C. Agriculture3 2

Background and Institutional Arrangements

3.16 Agriculture (including fisheries) contributes around 18% of GDP, providesemployment for about 60% of the labor force, and accounts for less than 2% of exports.The average annual sectoral growth rate of 2.2%, up to the early 1990s, was lower thanthe population growth rate of 3.3%. As a result, the food import bill has been rising. In1995, Yemen imported about 80% of its food requirements compared to about 57% in1970.

3.17 The Ministry of Agriculture and Water Resources (MAWR) has the overallresponsibility for the agriculture sector, including irrigation. The institutional setup in thesector consists of:

* MAWR, which provides the main farmer services such as extension andresearch.

* Four autonomous authorities (Tihama, Eastern Region, Sana'a-Saada-Hajja;and the Agricultural Research and Extension Authority-AREA).

* Cooperative and Agricultural Credit Bank (CACB).

* Economic units, which include 31 state farms, 13 machinery rental stations, 7public enterprises engaged in poultry and dairy marketing, and well drilling.

Sector Issues

3.18 The agriculture sector faces four issues which have implications for publicexpenditures. First, the agriculture sector suffers from low yields and productivitybecause the farmers do not receive quality services in the form of research, extension andother rural infrastructure which are normally provided by government. The main reasonfor this is the high wage bill, estimated to be about 55% of the total agricultural budget in1996. This has crowded out outlays on operations and maintenance (O&M) andadversely affected the delivery of research and extension services.

3.19 Second, the continued subsidy on wheat and flour has depressed wheat prices andhas disproportionately benefited consumers and traders over farmers - the producers ofwheat.

32 One of the features of the agriculture sector is that increasing areas are being devoted to theproduction of qat. Qat being a water intensive crop this shift into qat has created an immediateproblem of depletion of a scarce resource. The issues surrounding the production/consumption of qatare not discussed in this report.

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3.20 Third, the sector is burdened with public agencies (both parastatals andauthorities) which are a drain on the budget and which engage in production andmarketing of grain, poultry and dairy products which could easily be done by the privatesector. In 1995, the total current and capital transfers from the budget to these entitiesamounted to around YR1 billion or 25% of the total expenditures in agriculture.

3.21 Fourth, the demand for credit in agriculture has increased substantially in recentyears due to the provision of subsidized credit at rates of 8-9% compared to market ratesof around 27-30%. In addition, the administrative costs of CACB are high and therecovery rates are low amounting to only 60%. There is no clear justification for thiscredit subsidy in Yemen. Subsidized credit affects the efficiency of public expendituresbecause its availability may lead to financing investments which would otherwise beunviable. Further, subsidized credit is often cornered by well - connected, richerborrowers and therefore has an adverse impact on equity.

Recommended Policy Actions

3.22 The main policy actions to address the issues identified above are as follows:

- The allocation of recurrent expenditures for agriculture, as indicated in Table3.1 needs to be increased from the present level of YR2.2 billion to YR4billion by 1998. This would more than double the outlay on O&M, dependingon the success in reducing the wage bill, which accounts for 55% of the totalagricultural budget in 1996. Such an increase in O&M expenditures wouldallow sufficient resources to operate the existing facilities.

3 Subsidies on wheat need to be eliminated to remove the bias against domesticproduction as well as reduce the burden on the budget. The program for theelimination of these subsidies is discussed in Chapter 2.

* Agricultural parastatals which are engaged in purely commercial activitiessuch as the Machinery Rental Stations, Mareb Poultry Company, the GeneralOrganization for the Marketing of Fruits and Vegetables, GeneralOrganization for Drilling and the General Organization for AgriculturalServices, should be privatized to reduce the transfers from the budget as wellas to improve their operational efficiency. The current policy of thegovernment regarding these agencies is in the right direction. Theprivatization program discussed in section 2D, includes the agriculturalparastatals engaged in commercial activities and machinery rental stations.

* The current import ban on fruits and vegetables should be removed andsubstituted with a modest tariff to enhance revenues and promote efficiency in

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production. This policy is being supported by the Bank's Economic RecoveryCredit (ERC).

* The government should introduce fees to recover a part of the costs of theveterinary services until such time that they can be privatized. Thegovernment should also fully recover the cost of the nurseries.

* CACB should be exposed to market forces to improve its efficiency. Thehighly subsidized, negative lending rates should be raised to levels closer tomarket rates, and the recovery rates should be raised substantially.Administrative costs should also be reduced considerably by reducing theoverstaffing.

Priority Expenditures

3.23 The agricultural investment program contains a large number of small projectswith outlays of less than $0.5 million in 1996. Further, the agricultural program is highlydonor dependent. Nearly 77% of the total 1996 outlay is financed by donors. IDA is themost important donor financing 9 out of the 46 ongoing projects which account for 55%of the total outlay for 1996. The investment strategy for 1996-98 in agriculture should beto first complete the ongoing small and large projects before initiating any new projects.The total projected outlays for investment and operating expenditures are presented inTable 3.1 and Annex 3.4.

3.24 Depending on the additional resources available, priority should be given to thefollowing projects in making new investments,.

- The proposed IDA-supported Seeds and Services project ($15 million), whichimproves the agricultural productivity mainly in the neglected rainfedagriculture through the production of certified seeds adapted to localconditions in Yemen, by setting standards for seed production and provisionof the needed support services.

* The proposed IDA-supported Southern Governorates project ($20 million),which raises the incomes of the displaced tenants and other very poor peopleliving below the poverty line, in the four southern governorates throughirrigation development and promotion of off-farm economic activities such asmicro-enterprise development, fisheries and tourism related business.

D. Education

Background - Status, Financing and Delivery

3.25 The education system in Yemen has developed rapidly since the beginning of the1980s. Despite this, substantial and sustained increases in enrollments will be necessary

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in the medium and long-term in order to achieve adequate educational coverage andattainment. Adult illiteracy is extremely high: 62% of all adults and 74% of adult womencan neither read nor write, compared to low-income country averages of 43 and 51percent, respectively. Low female literacy and educational attainment is also animportant contributing factor to the country's poor health status, and in particular to highmaternal, infant and child mortality. In 1996, the boys' gross enrollment ratio33 in basiceducation is estimated at 80%, which compares favorably with low and lower-middleincome countries. However, the girls' rate, at 39%, was only half that of boys. In thesecondary stage, enrollments for both girls (at 13%) and boys (at 32%) are much lower,and the gap between the two is wider. Amongst those who do attend secondary school,there is much less difference in transition to higher education, with 72% of males and62% of females proceeding to university or higher technical institutes.

3.26 Both input and output quality indicators reveal serious problems. The quality ofteachers is low. Materials such as charts, writing materials and books are inadequate, andteaching and examinations emphasize rote memorization. National student - teacher andstudent - classroom ratios, at 35 and 32 respectively, hide extreme urban/rural variations.Class sizes are as high as 70 in urban and as low as 14 in rural areas. Facilities at alllevels are rudimentary: 49% of primary and 30% of secondary schools have noelectricity, and 47% and 27% respectively have no water. A recent study on schoolmaintenance needs revealed that the Government needs to spend approximately YR17billion (equal to about four times the 1996 MOE budget for goods and services) toupgrade MOE schools to an acceptable level. In basic education, repetition rates are 35%for boys and 20% for girls. Approximately 55 percent of those who enroll in first gradecomplete the basic education stage, which is about average for low-income countries.Dropout is higher in secondary education due to social and economic obligations for allstudents and particularly so for girls, due to early marriage.

3.27 Provision of pre-university education is carried out mainly by the Ministry ofEducation (MOE) and the General Authority of Educational Institutions (GAEI). Theseare parallel school systems; the GAEI is more religiously-oriented and subsidizeschildren's education to a greater degree than does the MOE (although transfers from theMOE budget appear to fund GAEI investment spending). Public higher education isprovided mainly in the Universities of Sana'a and Aden. The quality of higher educationis compromised by a low level of teaching skills, non-standardized assessments andcurriculum and course design not relevant to labor market requirements. Privateeducation services are growing rapidly (though from a very small base) in urban areassuch as Sana'a and Taiz. Many private for-profit schools and several private universitieshave been established in the last few years. Little is known about the number of studentsenrolled, class sizes, or student - teacher ratios in the private system.

33 The gross enrollment ratio is defined as the number of students enrolled in a grade or stage as aproportion of the population corresponding to that grade or stage.

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3.28 Public expenditures on education in 1996 are 14% of total government spending,or 5.3% of GDP. While these proportions are high in the range of lower-middle incomecountries, Yemen's spending needs are unusually substantial, given the country'sextremely low levels of literacy and educational attainment and the fact that it only beganto develop the education system in the last two decades. Pre-university education makesup 86% of total education spending while universities account for 12%. The emphasis ondeveloping basic skills in the population which this implies is appropriate, howeverfurther development of higher education will also be required to enable diversification oflabor market skills and thus export potential. The remainder of public educationexpenditure is allocated to research and development and the vocational educationsystem. School fees covered a very modest 1.5% of total expenses in 1990; more recentdata are not available, nor is information on private education spending.

Table 3.3: Total Public Expenditures on Education

1991 1992 1993 1994 1995 1996EDUCATION EXPENDITURES (%)

as share of Total Public Expenditures 18 19.5 21.0 19.3 17.0 14.3as share of GDP 7.6 7.9 8.0 6.1 5.1 5.3

TOTAL EXPENDITURES (YR Billion) 8.5 10.7 13.6 16.1 22.1 35.3

SHARE OF TOTAL (%)Ministry of Education 80 78 78 79 73 71General Authority for Educ. Institution 9 9 1 10 12 12General Authority for Vocational Trg. - - 11 0 2 1Universities 1 1 3 10 1 13 15Research institutions 10 0 0 10 0 0

Source: Ministry of Finance and World Bank.

Structure of Expenditures

3.29 In 1996, 86% of total public education spending was allocated to pre-universityeducation: the MOE system accounted for 73% of total education spending and the GAEIsystem for 13%. The basic education stages received 85% of the total pre-universityallocation, and the secondary stage 15%. Wages and salaries amounted to only 70% ofthe MOE budget, and only 78% of MOE recurrent spending, which is low byinternational standards. GAEI wages and salaries are somewhat higher, at 89% of bothtotal and recurrent spending (GAEI budgets record less than 1% of total as investmentspending). Despite the relatively high allocation of 18% of MOE spending to goods andservices, inadequate maintenance is one of the most severe problems in the sector. Inhigher education, investment currently commands 42% of total spending, goods andservices 24%, and wages and salaries 32%. This reflects the current expansion in highereducation. Investment spending accounts for 9% of total pre-university spending in boththe MOE and GAEI systems combined. However, a review of present school designsindicates that construction is not efficient and that the Government is spending about 17%to 20% over optimal cost per square meter.

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3.30 Due to the wide dispersal of the population, 80% of which is scattered throughoutthe country in hamlets of 350 people or less, unit costs vary widely: in rural govemorateswith rugged terrain and low population densities, unit costs are much higher than in urbansettings. In Al-Mahara governorate for instance there are fewer than 10,000 students andthe unit cost is nearly YR9,000, while in urban Taiz, which has nearly half a millionstudents, the unit cost is approximately YR2,500. This is due to differences ininvestment costs per student as well as the widely differing class sizes between rural andurban areas noted above. Moreover, these differences are exacerbated by the fact thatrecurrent cost allocations are made in part on the basis of govemorate population size.Rural govemorates with low enrollment rates have higher unit costs than would an urbangovernorate with a higher enrollment rate but the same population base.

3.31 Educational subsidies are fairly equitable. Higher education students make up 3%of all students and receive 5% of total subsidies. Of the two pre-university systems,GAEI students receive a substantially higher subsidy than do students in MOE schools.This may in part be a reflection of the fact that fees are not charged in GAEI schools,unlike in MOE schools.

Policy Recommendations

3.32 The short and medium-term objectives of the education system should be to focuson increasing the overall level of literacy in the country. Efforts should be continued toincrease enrollments in basic education, with an emphasis on girls and underserved areas,while ensuring that the quality of services delivered is at least sufficient to achieve thebasic purpose. This will require a number of specific measures discussed below.

3.33 Increase recurrent spending in order to ensure that needed expansion at all levelsof the system, including secondary and university education, is not achieved at theexpense of untenable sacrifices of quality. Presently, insufficient resources are allocatedto maintain, supervise, and operate schools, which results in schools and staff beingineffectively utilized. It is likely that construction of new schools, when undertakenwithout raising real allocations for operating budgets would result in lowering the qualityof education.

3.34 Allocate substantial expenditures to upgrading physical facilities in basiceducation in order to provide water and toilet-rooms in basic education facilities. Lack ofwater and toilets has repeatedly been identified in many settings, and particularly inconservative areas, as a significant constraint to female enrollments.

3.35 Target annual allocations to governorates according to a formula which wouldweigh the following factors in determining expenditure levels: the number of studentspresently enrolled; the difference between the national and govemorate enrollment rates;govemorate specific population growth rates to highlight internal migration flows andthereby avoid overbuilding in rural areas being depopulated by urban migration; and, anindex of population dispersal which takes into account inherent differences in unit costsbetween different types of areas. Allocations to govemorates with enrollment rates lower

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than the national average would not be reduced, while those with lower rates would betargeted for increased investment.

3.36 Eliminate mandatory school fees in compulsory and secondary education. Theseneither mobilize a significant portion of the MOE's total costs nor provide schools withsignificant resources, yet can represent a significant barrier to girls enrollment. Feesshould be collected on an ability to pay basis and should be retained by local authoritiesfor use in the school.

3.37 Prepare revised school construction designs to correct inefficient buildingstandards. Savings should be reallocated to partially offset needed increases ininvestment for new schools or to upgrade existing facilities.

Priority Expenditures

3.38 The recurrent and investment expenditures are projected on the basis of thefollowing assumptions3 4 on enrollment and expenditure restructuring:

- Increase the gross enrollment rates for both boys and girls in secondary schoolto 32% and 17% respectively by the year 2000 from the present level of 24%and 10% (Annex 3.5).

- Provide places for children already in the system.

* Increase enrollment for higher education by about 60% by the year 2000.

* Increase the student per classroom ratio marginally from the present level of32 to 35 by the year 2000.

* The 1996 recurrent expenditures per student are assumed to stay constant inreal terms. Investment expenditures are estimated to be $14,000 perclassroom.

3.39 On this basis, (Annex 3.5) total public education expenditures are projected toincrease by nearly fifty percent in real terms over 1996-2000. Proportional increases ininvestment spending would be more significant than those in recurrent, with investmentin elementary education rising by a factor of four; in secondary education it wouldincrease by nearly five times. Public education spending would increase to 19% of totalgovernment spending, or 6.4% of GDP. This would not only place Yemen among thebetter low-income countries in spending on education as a proportion of GDP, but isnecessary to significantly improve the country's educational attainment and literacylevels, as well as indirectly improve the population's health status through femaleeducation.

These are discussed in detail in Annex 3.5.

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E. Health

Background - Status Financing and Delivery

3.40 The health status of Yemen's population is extremely poor, with basic indicatorssignificantly below those of other low income countries. Low health expenditures, livingstandards and levels of education, as well as the difficulty of providing services to thewidely dispersed population, are the primary factors accounting for this (80% of thepopulation lives in rural areas, mostly in hamlets with fewer than 350 inhabitants). Only55% of the population is estimated to have access to health services. The infant mortalityrate (IMR) is 117 per 1,000 live births, nearly twice as high as the low income countryaverage of sixty-four. Only 7% of married women use modern contraception methods;this is reflected in the total fertility rate of 7.5 (TFR, average births per woman), which is50% higher than the low income average of 5.2 and is among the highest rates in theworld. Maternal services are sparsely provided and what is available is sparsely utilized,resulting in a maternal mortality rate (MMR) of 800-1,000 maternal deaths per 100,000live births, also among the highest in the world. IMR and MMR are significantly moresevere in rural areas and in the North than they are in urban areas and the South. Lifeexpectancy is 51 as compared to the low income country average of 63, andcommunicable diseases continue to be the main causes of mortality and morbidity.

3.41 Health care services are principally delivered by the public sector through theMinistry of Public Health (MOH), which accounts for 96% of public health expenditures.The public system includes several levels, from primary facilities (1,282 in 1993), tosmall and medium-size hospitals at the secondary level, to large specialized (tertiarycare) hospitals in the main cities. There were a total of 75 public hospitals in 1993.Private delivery of services has been developing rapidly and now includes diagnosticand clinical services. In large cities, the private sector also focuses on specialized,high technology services in small and medium-size hospitals financially accessible toonly a small part of the population.

Sector Issues

3.42 The health sector faces three main issues, all of which have public expenditureimplications. First, public expenditures on health, in Yemen are very low and areunevenly distributed. At 3.2% of total public expenditures in 1996, or 1.2% of GDPand US$4.21 per capita p.a., health expenditures are one of the lowest in the region.Consequently only 55 % of the population has access to medical facilities. Further,some urban governorates such as Aden receive over 40 times the per capita allocationsof rural governorates such as Saadah. These variations, can not be entirely explainedby the higher operating costs in urban tertiary facilities, indicating that public healthfacilities are effectively absent from some rural areas.

3.43 Second, there is a tendency amongst rural Yemenis to bypass public primaryhealth care facilities and go directly to secondary and tertiary facilities. Primary care

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facilities are poorly staffed, suffer a chronic lack of drugs and supplies, and, as a result,have a poor reputation among the population. The efforts to bypass primary facilitiesalso drives up private costs which are estimated to be as much as 60% higher than publicexpenditures. These are mainly carried out on transport and accommodation costs,followed by payments to health workers and purchase of drugs and other medicalsupplies. Much of private spending therefore is presently a complement to the use ofpublic secondary and tertiary facilities. A survey currently being conducted on privatehealth expenditures will help to identify more precisely the level and composition ofprivate spending patterns on health care.

3.44 Third, the recurrent budget in health is highly inadequate. The share of therecurrent costs in the total health budget has fallen sharply from 90% in 1994 to 70%in 1996. There has been a concomitant increase in the share of investment. Within therecurrent budget, over 1994-96, wages and salaries have fallen to 60% from 70%, andgoods and services have risen to 27% from 20%. However, half of all public sectorhealth workers are stationed in central administrative offices, and there is a severeshortage of funds for maintenance, equipment, supplies and medicines. Thesedistortions in resource allocations and shortfalls in personnel are debilitating to theeffectiveness of facilities. An IDA mission found that supplies and medicine availablewere adequate for less than four months in a year in the facilities which it visited.

Policy Recommendations

3.45 First, the structure of public expenditures needs to be changed to improve theutilization of existing facilities. The budgets for equipment and medicines need to beincreased, and the share of health workers in administration decreased. Real recurrentspending on goods and services may have to be as much as tripled, in order to provideadequate medical consumables in health facilities. Other measures include improvedstaff training and supervision as well as designing facilities so that women will feelcomfortable receiving prenatal care.

3.46 Second, in view of the extremely low proportion of the population which hasaccess to health care and the fact that the major causes of morbidity and mortality arecommunicable diseases most suitably addressed through preventive and curativemeasures in primary and secondary facilities, a top priority should be given toincreasing the population's access to health care facilities below the tertiary level. Therate of expansion would need to be closely tied to the Government's ability to ensuresufficient financing of the recurrent costs necessary to operate its entire network offacilities, including existing as well as new infrastructure. This would in turn dependon the ability of the Government to draw the private sector in as a partner in deliveringand financing services. The current survey on private health expenditures will soonprovide an indication of the level of private resources in the health market, andtherefore of the possible size of the public and private shares in financing recurrenthealth costs.

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3.47 Third, in addition to the expansion of the health facility network and improvementin the quality of services delivered, a major priority should be assigned to the expansionof public health programs to deliver preventive care to the population. Therefore, publicservices should concentrate on improving immunization and pre-and postnatal carecoverage rates, and on increasing access to nutrition programs. The role of NGOs andcommunity organizations in service delivery could be increased in these areas byallowing them to deliver public health activities through existing or plannedgovernment health infrastructure. Public financing should be provided for private sectordelivery of essential higher level and longer term services such as surgery, long hospitalstays and tuberculosis treatment. Development of an incentive and regulatoryframework for non-public sector actors would be a necessary, non-expenditure,component of this strategy.

3.48 The share of investment expenditures allocated to public tertiary hospitalsdelivering specialized services should reflect the epidemiological patterns of the countryand its regions. Where these would mainly deliver services which secondary hospitalsand outpatient clinics are capable of providing, additional investment in tertiary facilitieswould be inefficient given the higher unit costs which they entail. At this stage, whilethere is a case for improvement in management and some increase in allocation of O&Mbudgets, there is no case for an increase in the number of these facilities.

Priority Expenditures

3.49 The projected priority recurrent and investment expenditures are estimated on thebasis of the following assumptions35 on the increase in access and reflect the policyrecommendations made above.

* The access of the population to health services is increased from 55% in1996 to 70% by the year 2000.

* The number of administrative staff is reduced by 50% over 1996-2000.

* Expenditures on the doctors and health workers pay are increased by 25% inreal terms over 1996-2000.

* The outlay on operations and maintenance is tripled over 1996-2000, and

* Per capita investment is projected to increase from $1.97 to $4.0 over 1996-2000.

3.50 On this basis, the total expenditures in health would almost triple over 1996-2000.As a share of GDP total public expenditures by 2000 would amount to about 2.6%,which, although higher than the present level, is still modest for a low income country.

5 Detailed assumptions and the projections are indicated in a technical note presented in Annex 3.5.

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F. Power

Background and Institutional Arrangements

3.51 Expenditures in the power sector are carried out by the Ministry of Electricity andWater (MEW). The ministry has only policy making responsibility. The main items ofexpenditures in power are the current and capital transfers which finance the autonomousagencies supplying power under the ministry. Electricity is supplied by three sources:

(i) The Public Electricity Corporation (PEC).

(ii) The General Authority for Rural Electrification and Water Supply(GAREWS), which was created to supply electricity to isolated and remote ruralareas.

(iii) Private generation. Because of the unreliability of public electricity supply,many well-to-do Yemenis have installed their own generators for their householdsand businesses. Power generation in the remote areas away from PEC's networkis mostly by diesel engines. In 1988, in the northern region, out of an estimatedelectricity generation of 769 GWh, about 71% was generated by PEC and theremaining 29% was by private generation36.

Current Demand-Supply Balance

3.52 The public electricity supply system in Yemen consists of three main subsystemseach providing generation, transmission and distribution facilities for its area. The threesubsystems--Aden, Northern Inter-connected, and Wadi Hadramawt subsystems accountfor more than 90% of the electricity generated.

3.53 In addition to the demand on the inter-connected system, there is a large ruraldemand which is far too expensive to be met through a grid. This demand is expected tobe met by the GAREWS by investing in small projects, which also have an element ofcommunity participation.

3.54 An analysis in Table 3.4 shows that in 1996, capacity and demand in the south areroughly in balance whereas the capacity of the Northern Inter-connected system isinadequate to meet the gross maximum demand. This leads to chronic brownouts in thenorth, especially in and around the high demand area of Sana'a.

36 This is a rough estimate based on the Household Energy Strategy study conducted in 1991 under thejoint UNDP/World Bank Energy Sector Management Assistance Program (ESMAP).

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Table 3.4: Systemwise Demand-Supply Balance for 1996(MW)

Wadi NorthernSystem Aden Hadramawt Inter-

Connected

Installed Capacity 1/ 217 28 310

Available Capacity 2/ 162 24 265

Gross Max. Demand (actually met) 124 19 247

Reserve Margin observed (%) 3/ 31 26 7

Reserve Margin needed 4/ 30-40% 30-40% 30-40%As a % of max. Demand

I/Nameplate capacity.2/ Capacity available at site taking account of site conditions and derating due to age.3/Available Cap/Gross Max Demand-1.4/For no brown outs.

Sector Issues

3.55 There are two main issues facing the power sector. First, is the challenge tofinance and implement a large investment program for meeting the rapid growth indemand over the next five years. The demand growth for 1996 and 1997 is likely to belimited to about 3% p.a. in the southern system and about 1.5% in the northern system.This low growth is due to the damage to the industrial units in the Aden region during thecivil disturbances in May/July 1994, and a low overall economic growth under thestabilization program. If the economic reforms agreed under the ERC are successfullyimplemented, the demand growth in both the regions could increase to about 6% p.a.from 1998 onward.

3.56 Second, the financial situation of PEC is precarious. PEC generates no operatingsurpluses to finance investments (see Annex 2.5). The government substantiallyincreased electricity tariffs on January 1, 1996 from 2.09 YR/KWH to 4.60 YR/KWH.This increase will however be more than compensated by: (i) an increase in the officialexchange rate from 50 to lOOYR/$, (ii) fuel and diesel price increases of about 7 YR/litreand 6 YR/litre respectively, and (iii) about 15% increase in salaries of the employees.Consequently, PEC will require subsidies amounting to around YR4. 1 billion to merelycover the operating deficit in 1996. In addition, PEC suffers from a huge accountsreceivable problem. As indicated in Table 3.5, four government agencies: Defense,NWSA, Ministry of Health and Ministry of Housing account for 76% of the accountsreceivable. The accounts receivable are however matched by PEC's accounts payable toYemen Petroleum company (YPC).

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Table 3.5: Breakup of Accounts Receivables

Consumer category Accounts Receivables in YR million (12/95)Northern Southern Total

Government Sector 434 775 1209Non Government Sector 474 350 824Total 908 1125 2033

Source: PEC

Policy Recommendations and Priority Expenditures

3.57 The investment program proposed by the PEC and GAREWS is presented inAnnex 3.4. The planned investments contain not only new projects to augment capacitybut also critical rehabilitation of generating units and transmission and distributionfacilities. As indicated in Annex 3.4 and in Table 3.1, the investment requirements forPEC are very high, amounting to nearly 30% of the total available resource envelope for1996-98. Further, in view of the financial problems of the PEC, all these investmentswill probably have to be financed from the budget which would be increasingly difficultto do. Even for 1996, as indicated in Table 3.1 the budget makes provision for only 50%of the PEC investment requirements. For the future, therefore, the investment programwill have to be further prioritized by slowing down the extension of the Hadramawtpower station and the Marib combined cycle plant. The investments in transmission anddistribution should be protected as they have very high returns.

3.58 For 1996, the GAREWS program contains about 26 very small (less than 50-60,000 YR each) schemes which can be implemented in less than one year37. As per theGAREWS rules, once the schemes are implemented, they are handed over to thecommunity to operate with no prospect of government support thereafter. Theexpectation is that these schemes will be run efficiently for two reasons: (i) the projectbelongs to the community, and (ii) there is no prospect of further assistance from thegovernment. Therefore the cost recovery and maintenance are likely to be good. TheGAREWS program should be expanded only if the experiment is successful.

3.59 Financial situation of PEC. Over the near term, the government strategy shouldbe to minimize/eliminate the need for transfers on the current account by increasingtariffs from 4.60 /KWH in 1996 to about 10.56 /KWH in 1999 to fully eliminate theoperating deficit. In parallel, the governmnent should eliminate inter-enterprise arrears. Inthis regard, PEC needs to work with the Ministry of Finance, YPC and the variousgovernment sector consumers to offset accounts receivable against accounts payable. Inparallel, PEC should follow a strict policy of disconnecting the delinquent consumers so

The GAREWS has no multi-year investment program.

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that the accounts receivable are no more than four months of average electricity salesrevenue.

3.60 In the longer term, the solution to PEC's financial problems is like to involve itsprivatization and/or increased private sector involvement. Privatization is needed to raisefinance for new investments, reduce current transfers and increase operational efficiency.Strategically, PEC privatization would give a positive signal for the overall privatizationprogram. International experience shows that there are many steps before privatizationcan be carried out. These are: (i) separating the regulatory and policy functions of theMEW from the commercial and ownership functions of the PEC, (ii) exposing the powersector to more competition, and (iii) creating an enabling environment for private sectorparticipation in new generation projects through independent power production schemes.

3.61 Currently, PEC privatization is not being actively considered by the government.Under the ERC, however, an IDA financed utility regulatory study analyzing options toincrease the role of the private sector in electricity generation is expected to be completedby the end of 1996. In addition, the government is considering an unsolicited Build Ownand Operate (BOO) offer for a 35MW combustion turbine capacity. In this connection,the Council of Ministers issued decision No. 279 of 1995 which allows for privateinvestment in power.

G. Water38

Background and Institutional Arrangements

3.62 Yemen has one of the lowest per capita renewable water supplies in the world,and few countries are depleting their water supplies at a comparable rate. Yemen faces anurgent water crisis. Its limited surface waters were long ago fully exploited and thegroundwater is being extracted at a rate that, in many places, is more than five times thesustainable yield and water quality is declining in low lying and many urban areas.

Table 3.6: Water Sector Ministries and Authorities

Ministry Agency Responsibilities Regardine Water

MAWR (Ministry of Agriculture Bulk irrigation planning and infrastructure contracting, bulkand Water resources potable water delivery in some coastal areas, contracting for

dams and weirs.MEW (Ministry of Electricity and NWSA National Water and Sanitation Authority: Potable water andWater) service in urban areas with more than 30,000 population.MEW GAREWS General Authority for Rural Electricity and Water Supply:

Potable water in rural communities with populations below30,000.

Prime Ministry NWRA Water sector planning, legislation, regulation and enforcement.

Source: Ministry ofPlanning

38 The section draws on: Yemen, "Towards a Water Strategy" IBRD, Report No. 15718 - YE, August31, 1996.

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3.63 The responsibility for water management is dispersed among four agencies asshown in Table 3.6. Of these four agencies, NWSA and GAREWS come under theMinistry of Electricity and Water (MEW) for administrative purposes, and NWRAreports directly to the Prime Ministry. The recurrent and investment expenditures of theagencies in the water sector are as indicated in Table 3.7.

3.64 As a result of the 120% tariff increase during 1996, NWSA's revenue is nowexpected to cover its operating costs. However NWSA is expected to continue to receivecapital transfers from the budget to cover its capital budget. GAREWS, on the other handraises about 30% of its budget from community participation and the remaining from theMEW budget. NWRA, which is still not operational, has no sources of revenue and willreceive all its 1996 budget from the MEW. (See Table 3.7).

Table 3.7: Estimated Budget Impact of the Water Sector (1994-1996)(YR million)

1994 1995 1996Agency (Actual) (Estimated) (Budgeted)

GAREWSRecurrent 25 27 37Investment 303 1491 2290

NWSARecurrent 7 120 -0-Investment -0- 1917 3695

NWRARecurrent N/A N/A 26Investment N/A N/A -0-

MAWR (for irrigation and potable water only)Recurrent (est.) 587 687 515Investment (est.) 194 364 966

TOTALSRecurrent 619 834 578Investment 497 3772 6951

GDP (YR billion) 262.7 434.7 633.7

Sources: Recurrent Amounts=from: Financial Report, General Budget, Budgets ofEconomic Sectors and Budgets of Authorities & Other Units" 1996, Ministry of Finance,Republic of Yemen. Investment Amountsfrom: White Budget Books, Ministry of Finance,1994, 1995 and 1996.

Sector Issues

3.65 There are four main issues facing the water sector. EirLi, is the lack of a singleinstitution/authority responsible for water resource planning and management. Thisshortcoming has been addressed by the recent setting up of the NWRA. However, muchremains to be done to make the new institution effective. Second, is to returngroundwater use to a sustainable levels. As indicated above, in many places in Yementhe rate of groundwater extraction is five times the sustainable yield. The situation hasarisen due to many factors such as population growth, technological advances in tubewelltechnology and above all the failure of government to correct the failure in the market forwater. Since the private cost of mining a common aquifer is far less than the social cost,there a natural tendency for an individual to mine water at rates exceeding the socially

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optimal/sustainable rates. The situation is exacerbated by cheap diesel, underpricedelectricity, cheap credit for buying pumps and potentially high returns for qat production.ITid, is to facilitate transfer of water from rural to urban areas. In many instances whilethe urban areas suffer from severe water shortages there are no developed market-basedor institutional mechanisms for transferring water from nearby rural areas to meet urbandemand. Fourth, is to increase access to safe potable water in both rural and urban areasto improve health and reduce poverty. Currently only 49% of rural households haveaccess to safe drinking water . Although, in theory, all the urban areas are expected tohave access to drinking water from NWSA or one of the many private sources, in reality,the supply is highly unreliable and urban dwellers have to pay very high prices to privatevendors. The situation is particularly acute in cities such as Taiz where the current supplyof water is only 25% of what it was four years ago and NWSA is able to supply wateronly once in 40 days.

Recommended Policy Actions

3.66 The first set of policies to address the above issues are macroeconomic policieswhich essentially increase the price of water in order to encourage conservation andefficient use. These policies include: higher price for diesel, higher tariffs and taxes forpumping equipment and eliminating credit subsidies for pumps. In addition, thefollowing sector specific policies could be adopted to address the issues identified above.

3.67 Centralizing water resource management. With the creation of the NWRA,Government has put in place an institution to manage the country's water resources,determine inter-sectoral allocations and approve investments to develop this preciousresource. The mandate of this essential new organization should be expanded to includethe following:

- All water planning, resource assessment should be done by NWRA,consulting with other agencies when needed.

* NWRA should plan and program all sector investments. At the least, allproposed investments should be scrutinized by NWRA.

* NWRA should be responsible for donor coordination in the sector. It hasbegun to work towards this objective through its chairmanship of the Multi-Donor Group (MDG) and its management of the donor Water ResourcesAssistance Program (WRAP).

3.68 Return Groundwater Use to a Sustainable Basis. First, NWRA should be fullysupported -- institutionally as well as financially to enable it to develop regional watermanagement plans, with priority given to particularly vulnerable areas such as Taiz and

39 This is about 82% for other Arab countries.

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the Sana'a basin. Second, NWRA should begin to test the feasibility of regulationthrough the licensing and control of wells and drilling rigs to control the mining ofgroundwater. Third, NWRA, together with the MAWR should develop a program forwater conservation in agriculture. Such a program could include further research andextension in irrigation, subsidies to maintain terraces and giving users the responsibilityfor spate irrigation schemes. Finally, NWRA should begin to test a partnership approachto water management by working with communities on water conservation and self -regulation.

3.69 Facilitate Transfer of Water From Rural to Urban Areas. First, a program ofexploration and development of new sources of supply for cities needs to be carried out inthe context of the regional management plans being developed by NWRA. Second,current informal water markets need to be regularized to allow the transfer of water fromrural to urban areas in a sustainable way by setting up a regulatory framework whichdefines ownership, rights to market and rules for conservation.

3.70 Increase Access to Safe Drinking Water. For the rural areas, the issues are; thecapacity to expand coverage, sustainability of supply schemes, and poverty focus. Toexpand coverage will require both project financing and development of institutionalcapacity, particularly in GAREWS, which should decentralize operations and adopt aparticipatory approach. Sustainability depends on the ability and commitment ofcommunities to operate and maintain schemes. Here the key elements are participation(financial and moral) from the very beginning, and ownership of completed schemes.Support for major maintenance is also required. GAREWS also needs to sharpen itspoverty focus. At present more than half of its schemes are built in Sana'a Governorate,which is relatively prosperous and easily accessible, whereas GAREWS has virtually nooperations at all in many of the poorer, remote governorates.

3.71 For the urban areas, the first priority is to develop new resources within anintegrated plan developed by the NWRA. For the future, NWSA will continue to remainthe lead agency supplying about half the urban water in the country. NWSA is howeverin a very weak state. The institution is overstaffed, it has 6-24 staff per thousandconnections as against an international norm of 2-5; unaccounted for water is 40% andcollections are only 64% of the billing. A reform program for NWSA currently beingformulated would be implemented in two stages. In stage I, NWSA would bedecentralized, branches would have more autonomy and there would be staff reductions.In stage II, branches would be turned into regional corporations that could invite privatemanagement and ultimately capital. Finally, since NWSA could not by itself meet all thedemand, Yemen needs to create a framework for expanding the role of the private sector.This would involve passing legislation defining the rights and duties of private operatorsand developing a series of concession agreements for organized private supply to towns.The urban program should be carefully prioritized by first focusing on towns where wateris very short.

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Priority Expenditures

3.72 The recommended expenditure priorities by agency to support the policy reformsare:

NWRAFinancing the capital and recurrent costs of NWRA estimated to be YR1.5billion and YR1 billion respectively over 1996-2000. These would enableNWRA to play the role defined above and include resources for studies, andthe development and testing of market frameworks for water transfer.

MAWR* High priority to MAWR programs for research and extension on water

conservation and projects to increase irrigation efficiency such as the Landand Water Conservation Projects. Financing for a program to promotedecentralized water management in rural areas should also be a high priority.Investment in small dams should be scaled down, and the subsidy on credit fordrilling and pumping should be eliminated. These considerations have beenincluded in the investment program for the Ministry of Agriculture discussedin Section C.

GAREWS* The priority investment program, the next two years should focus on the

completion of ongoing projects while giving priority to poorer communitiessuch as Dhamar, Al-Beida and Al-Mahwit.

* Depending on the availability of resources, the next priority should be aproject to rehabilitate the existing system by setting up a "majormaintenance" line of credit to allow communities to carry out systemreplacements and upgrades affordably.

* A pilot project to demonstrate the application of community participation.

NWSA* The NWSA investment program consists of 37 projects. Of these, the 11

largest projects, all of which have donor participation, account for 85% of thetotal program for 1996. NWSA has serious implementation problems asdiscussed above. As a result, the 11 large projects have been carried inNWSA's portfolio for the last few years. The priority for NWSA shouldtherefore be to complete these ongoing projects before any new project isinitiated. As indicated in Table 3.8 below, this would require YR1.4 billion in1996 increasing to 1.8 billion in 1998.

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Table 3.8: Investment Program for Water Sector 1/(YR million)

Agency/Project 1996 1997 1998

GAREWS

Capacity building and completion

of 500 ongoing projects 700 700 S00

Rehabilitation and major

maintenance project 300 500

Pilot project for encouraging

participation 250 250

Total GAREWS 700 1250 1550

NWSA

37 ongoing projects 1400 1600 1800

NWRA 300 300 300

Total Water Sector 2400 3150 3650

Source: Staff estimates.1/ The investmentsfor irrigation/water conservation are included in the agriculture.

H. Transport

Background and Institutional Arrangements

3.73 The responsibility for transportation is shared by two ministries and five public

sector agencies. The ministries are responsible for defining policies, allocating budgets

and administering construction and maintenance programs. The two ministries

responsible for the transport sector are the Ministry of Construction, Housing and Urban

Planning (MOC) and the Ministry of Transport (MOT). The General Corporation for

Roads and Bridges (GCRB), an entity that is part of MOC, is responsible for constructing

and maintaining the country's roads and bridges. The MOT oversees all surface

transport, airport, airline and port activities and is responsible for four parastatal agencies,

Al Yemen Airlines, the Civil Aviation and Meteorological Authority (CAMA), the

General Land Transport Corporation (GLTC) and the Yemen Ports Authority (YPA). In

1996, MOC's overall expenditures are projected to be YR8.2 billion, about 1.3% of GDP,

of which, GCRB accounts for approximately 45 percent or YR3.7 billion. MOT

expenditures during 1996 are projected to be significantly less at YR473 million.

The Road Transport Sector

3.74 There are two main issues in the road transport sector: the inadequacy of roadmaintenance expenditures and the privatization of the GLTC.

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3.75 Inadequacy of maintenance expenditures: Road construction and maintenanceactivities are financed through the budget and are implemented by the GCRB either byforce account operations or through contracts. In the past, almost 80% GCRBexpenditures were spent on the construction and strengthening of asphalt roads, with verylittle allocated for the unpaved network or for road maintenance. Between 1990 and1995, GCRB spent less than 5 percent of its budget on road maintenance, whereas,required maintenance expenditures have been estimated at about 10 times that level. Toaddress this problem, with assistance from IDA, the government has established a RoadMaintenance Fund, administered by an independent body - the Yemen Road Fund Board,which will be funded out of an initial 0.5YR/litre fuel surcharge as well as certain vehiclelicense fees together generating about YR1200 million per annum. These funds will beused exclusively for the maintenance of the road network. The performance of the fundneeds to be carefully monitored to ensure that adequate revenues are generated to meetthe maintenance requirements.

3.76 Privatization of the GLTC: The General Land Transport Corporation operatesfreight and passenger road transport services, and is organized into northern and southernbranches with northern entities operating through the Sana'a General Land Transport

40Corporation (GLTC) , and the southern branches operating through the Aden SurfaceTransportation Company (STC). The GLTC offers intercity bus services only, while theSTC provides freight haulage, as well as inter and intra-city bus services.

3.77 GLTC runs a deficit which is financed by transfers from the Ministry ofTransport. Fare caps by MOT, whereby GLTC must charge considerably less thanprivate operators is part of the problem. Further, with 3500 employees in 1996, GLTCremains highly overstaffed. GLTC is also in need of investments to replace vehicles lostduring the war in 1994. In addition, the cost of spare parts has increased by 500 percentsince 1989, forcing GLTC to defer maintenance and sideline numerous vehicles. Atpresent only 50% of GLTC bus fleet is operational.

3.78 For intra-city transport, subsidies will probably continue to be needed toencourage the use of public transport. The strategy would, however, be to move to amore cost effective institutional structure by promoting municipal transit authoritieswhich would lease vehicles and manage local operating contractors. Such anarrangement would make the subsidies explicit and would still result in a significantreduction in the present burden imposed on the budget by deficits incurred by GLTC.For intercity transport, the Government's strategy to privatize the GLTC operations is themost appropriate policy.

40 For simplification, revenue and expenditure figures for GLTC include both the northern and southernbranches.

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Civil Aviation

3.79 All airports and the air navigation systems are under the management andownership of the Civil Aviation and Meteorological Authority (CAMA). While there arefive international airports in the country, the Sana'a to Aden route attracts more than 70%of all passenger movements. In 1995, CAMA's deficit was about YR300 million, whichis expected to fall in 1996 as a result of a large tariff increase implemented in early 1996.As a result of the 1994 civil disturbances and the lack of past investments, the airportsand navigational infrastructure are in urgent need of rehabilitation and modernization.The immediate needs in this area are being addressed under an IDA-supported transportrehabilitation project.

3.80 In the medium term CAMA should cease to rely on the general budget. Airportoperations, particularly at the major airports should be able to generate surpluses, and theminor airports can easily be cross-subsidized from these revenues. Maintenance of airnavigation aids also should not require budgetary support because of Yemen's strategiclocation on international air routes, and the potential revenues available if overflightcharges were properly levied and collected. It would also be necessary to maximizeprivate funding for airport-related investrnents and transfer operational responsibilities(except air navigation services) to the private sector. Further work in this area iscurrently being done under the Civil Aviation Strategy and Policy Study financed underthe transport rehabilitation project being supported by IDA.

Airlines

3.81 Al Yemen airline was recently created by merging the two flag carriers of theformer north and south - Yemenia and Al Yemen. Al Yemen ran a deficit of YR129million on revenues of YR4,284 million in 1995, which was close to full cost recovery.However, this was partly due to a Govermnent subsidy for jet fuel, which GOY paid forin US dollars at free market prices and sold to Yemenia for Yemeni Riyals at the officialrate of exchange. With the harmonization of the exchange rate, this implicit subsidy willbe removed and it is expected that Al Yemen will suffer a large deficit unless significantsavings can be achieved by rationalizing and restructuring the newly merged airline.

3.82 The merger has so far failed to result in significant cost savings because of theinherent institutional weaknesses in the two airlines. In this situation, the Governmentshould consider a partial sale of the airline to private investors in order to imposefinancial discipline and take full advantage of the synergy between the two operations.

Ports

3.83 The main two ports of Yemen are Aden on the Arabian Sea and Hodeidah on theRed Sea. Of the lesser ports, Mokha and Mukallah are the more significant. In the firstten months of 1995, cargo volumes reached about 10 billion tons at Hodeidah and Adenand about 0.4 billion tons at Mokha and Mukallah. All ports in the country fall under the

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control and management of the Yemen Ports Authority (YPA) and, like the landtransportation sector, are divided along north-south lines. The Port of Hodeidahadministers the ports of Mokha and Al-Salif, while the Port of Aden administers the portsof Mukallah and Nishtun.

3.84 YPA generates a significant surplus, though the surplus has decreased in recentyears. By and large the surplus is generated by the northern ports, primarily Hodeidah,and the recent reduction in the surplus is possibly due to expenditures undertaken byHodeidah to develop the port of Salif as a major bulk port. The port of Aden generallyincurs a loss and is compensated by transfers from general YPA or the governmentbudget. The Government is actively seeking private participation in investment andoperations at Aden with a view to making it a major trans-shipment hub for internationalcontainers. IDA is providing an IDF grant to assist with the formulation of thetransaction. Market studies indicate that if operated efficiently the Aden port has apotential of trans-shipment activities comparable to the ports of Colombo or Dubai. TheAden port, with private participation and investment, can therefore be transformed into aprofitable operation41 and would not require transfers from the general YPA or thegovernment budget.

Priority Expenditures

3.85 Road construction. The road construction program, carried out through theMinistry of Construction consists of a large number (170) of ongoing projects. Under theIDA - supported transport rehabilitation project, detailed data is being collected on eachof the ongoing road projects. When assembled, these data would allow a betterassessment of the relative priorities of the ongoing projects. The largest project in theprogram is the Safir-Hadramawt Road which is estimated to cost $90 million over fiveyears. This project has a high priority because it integrates the eastern and northern partsof the country, connects Hadramawt's agriculture directly to the large markets in thenorth, and therefore has high rates of return. The investment strategy should be to firstcomplete ongoing projects, including the Safir Hadramawt road. This would require thebudget allocation to increase from YR6 to 8 billion, as indicated in Table 3.9. No newprojects are envisaged.

3.86 Civil Aviation. Even after launching the strategy for increasing the role of theprivate sector for the next three years, public investment will be required for the criticalrehabilitation of airports. These investments are primarily safety related, such asnavigational aids and communications equipment, a large portion of which was destroyedduring 1994 civil disturbances, fire - fighting equipment to meet ICAO requirements, andrehabilitation of runways.

41 The operations at the Aden port are projected to make a loss of about YR 70 million in 1996 onrevenues of about YR520 million.

- 60 -

3.87 Ports. The priority investments for the Aden port are being formulated under theIDA-supported "Aden Port Development" project. The project would assist in thedevelopment of a privately sponsored regional container trans-shipment hub and anindustrial free zone in Aden. The project is being considered for a IDA-partial riskguarantee to attract private investment. Consequently, the project is expected to needvery little budgetary capital outlay from the government. As indicated in the Table 3.9,only about YR1 billion is needed over the next three years, mainly for institutionalstrengthening of the public port authorities, miscellaneous equipment such as tugs andcontainer handling equipment. These investments complement the proposed investmentsto be carried out by the private sector.

Table 3.9: Priority Investments Transport Sector(YR million)

1996 1997 1998

Roads Construction Sector

Total 1 75 ongoing road projects 6,102 8,000 10,000

Aviation Sector

Sana'a Airport 707 450 450

Aden Airport 596 605 425

TaizAirport 0 0 156

Hodeidah Airport 50 61 35

Al-Riyan Airport 62 120 0

Sayun Airport 44 70 112

Other Airports 45 95 70

TotalAviation: 1,504 1,401 1,248

Surface Transport Sector

Sana'a Branch 258 212 5

Aden Branch 55 55 130

Total Surface Transport: 313 267 135

Ports Sector

Hodeidah Ports 700 700 700

Aden Ports 300 300 300

Total Ports: 1,000 1,000 1,000

Total Transport Sector: 8,919 10,668 12,383

Source: Ministry of Planning, 1996 Budget.

3.88 Road Transport. To complement the program for the privatization of GLTCpublic investment will be required for the upgrading of intracity buses of about YR300million p.a.

- 61 -

Chapter 4

Operationalizing the PER

4.1 The findings of the PER have many implications for the formulation of a widerange of government policies and the assistance strategies of bilateral and multilateraldonors, including the Bank. The PER has also identified areas where current informationis weak and will require additional data gathering and analysis. This section suggests aprocess by which the important suggestions of the report may be implemented(summarized in Table 4. 1).

4.2 Macroeconomic framework. Starting from a consistent macroeconomicframework, Chapters 1 and 2 provide a methodology and estimate the resource envelopefor public expenditures. The macroeconomic framework is consistent with projectionsmade for the ESAF, the ERC and the Country Assistance Strategy. First, the results ofthe PER could be used as an input into the Five Year Plan currently being discussed inYemen. As a part of the ongoing ESAF/ERC work, the macroeconomic framework alsoneeds to be continuously updated to reflect latest economic developments.

4.3 Public employment, subsidies and transfers to public enterprises. The PERbrings together in an integrated framework three issues which have a high priority in thegovernment's reform effort. The analysis of the civil service, which uses a civil servicesurvey data could be used as a basis to define the elements of a civil service reform. Theanalysis of subsidies could be further refined to design a social safety net and as an inputinto the design of the food voucher scheme. The analysis of the household budget surveydata could also be used in the design of the Social Fund project. Finally, the analysis ofthe transfers to PEs needs to be extended further to assess the implication of thegovernment's privatization efforts to the budgetary transfers.

4.4 Sectoral strategies and expenditure programs. This is by far the mostimportant area in which the analysis of the PER needs to be extended to formulate sectorstrategies and expenditure programs. First, more analysis is needed of the issues ofinadequacy of O&M budgets, poor project implementation and lack of counterpart funds.The work could be done by forming a series of working groups with participation fromdonors to identify the reasons for inadequate O&M budgets and work out the resourceimplications of fully meeting these needs. The lessons of the Country PortfolioPerformance Review (CPPR) for IDA - supported projects could be extended to otherprojects to improve project implementation. Second, more analysis is needed for thesectoral expenditure programs. Better information is needed to assess the outlays neededto complete ongoing projects in health, education and road construction.

4.5 To conclude, the PER should be thought of as an ongoing process by which thepublic expenditure priorities are continuously refined and updated. The presentreport is the first step in this process.

- 62 -

Table 4.1: Operationalizing the PER

Subject covered Proposed policyJ Processflnstrument to i Additionalwork to be; carried out.by PER re~form/sratgy achieve pr4liosed reform

formulation

Macroeconomic Preparation of the Discuss Plan with the Update macroeconomic framework inframework Five Year Plan and government. Contribute to light of new developments.

annual budgets. ESAF and ERC.

Wages and Civil service reform. Input to ongoing civil service Further analysis needed to identifyemployment Labor redundancy reform process. surplus workers and the impact of

issues in the alternative severance packages on theprivatization budget.program.

Transfers to Eliminating Input to privatization Get a better picture of PE finances.public transfers to PEs. component of the ERC.enterprises

Subsidies Reduction of wheat ESAF/ERC. Social Fund Test the feasibility of introducing thesubsidies. project. voucher system for wheat.

Further work is needed on thebudgetary impact of the social safetynet.

Intersectoral Five Year Plan. PER discussions.priorities

Agriculture Lending operations. Provide input to sector strategy Get a better idea of O&M needs.Policy formulation. and appraisal of new projects. Assess budgetary outlays needed for

ongoing projects and priorities withinthe sector.

Education Lending operations. Provide input to sector strategy Get a better idea of the O&M needs.Policy formulation. formulation and identification Develop a strategy for regional

of new projects. allocation of education investment.Refine priorities in expenditures.

Health Lending operations. Provide input to strategy. Get a better idea of O&M needs.Policy forrnulation. Improve expenditure priorities.

Water Improved Provide input to development Carry out an assessment of the NWSAmanagement of of sector strategy relating to investment program including thewater resources. public expenditure. budgetary implications of the ongoingLending operations. Contribute to the preparation of projects.

the new urban water projects. Improve prioritization of theGAREWS expenditure program.

- 63 -

Su4j6ct:cGvered P'roposed policy Process/Instrument to Additional work to be carried out. l

by PEIt: reform/$traqwg achieve proposed reformform-ulation

Transport

Road New and ongoing Contribute to sector strategy Data being compiled under theConstruction projects. and project formulation. transport rehabilitation project. On the

basis of this data, prioritize ongoingprojects.

Road Transport Privatization of ERC - privatization support. Get a better idea of the budgetaryGLTC impact of privatization.

Civil Aviation Privatization ERC - privatization support. Transport Rehabilitation: Civilaviation strategy and policy study.Currently ongoing. Will developoptions and strategy for privatization.

Airlines Privatization ERC - privatization support.

Ports Privatization ofAden port

Power New lending Formulation of sector strategy Update the subsidy implication of theoperations. on privatization of PEC. electricity pricing policy.

Contribute to formulation of Further prioritize electricityelectricity pricing policy investment program and trace its(ERC). implications on the electricity

shortage.

Annexes

Annex 1.CPage 1 of 2

Republic of Yemen at a glanceM. East

POVERTY and SOCIAL & North Low-Yemen Africa Income Development diamond'

Populaton mid-1995 (milions) 15.3 273 3,188 Life expectancyGNP per capita 1995 (US$) 260 1,780 460GNP 1995 (billions USS) 4.0 486 1,466

Average annual growth, 1990-95

Population (%) 5.2 2.7 1.8Labor force (%) 4.8 3.3 1.9 GNP

perMost recent estimate patest year available since 1989) capita

Poverty: headcount index (% of populallon)Urban population (% of total population) 34 56 28Life expectancy at birth (years) 53 66 63Infant mortality (per 1, 000 live bi,hs) 102 49 68 Access to safe waterChild malnutrition (% of children under 5) 30 .. 38Access to safe water (% ofpopulation) .. 83 66Illiteracy (% of populathon age 15+) 62 37 35 -Yemen, Rep.Gross primary enrollment (% of school-age populatson) 76 97 105 _ Low-income group

Male 112 104 112Female 37 90 98

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1975 1985 1994 1995 Economic ra6os

GDP (billions USS) .. .. 4.5 4.8Gross domestic investmenVGDP .. .. 9.7 10.1 Openness of economyExports of GNFSIGDP .. .. 60.3 60.5Gross domestic savingslGDP .. .. 4.5 1.2Gross national savings/GDP .. .. 33.3 25.6

Current account balance/GDP (excd grants) .. .. 3.6 1.4 Savings InvestmentInterest ObligationlGDP .. .. 3.5 3.0

Total debttGDP (IMF) .. ,. 194.9 183.9Total debt service/exports (due, IMF) .. .. 40.8 36.9Present value of debtVGDP .. .. .. . IndebtednessPresent value of debt/exports ..

1975-84 1985-95 1994 1995 1996-04(average annua/ grwth) -Yemen, Rep.GDP .. .. 0.0 3.6 .. Low-income groupGNP per capita .. ..

Exports of goods and nfs .. ..

STRUCTURE of the ECONOMY1975 1985 1994 1995

(% of GDP)Agricuture .. .. 16.0 9.0Industry .. .. 21.0 25.5 aowth rates of output and Investment (%)

Manufacturing .. .. 10.6 7.1 oServices .. .. 44.5 30.1 -25 90 91 92 93\9/ 95

-50Private consumption .. .. 71.9 80.2General govemment consumption .. .. 23.6 18.5 -GDI GDPImports of goods and non-factor services .. .. 65.5 69.5

1975484 1985-95 1994 1995(average annual growth)Agricufture .. .. -2.5 4.5Industry .. .. 20.3 14.1 dfo vth rates of ort and Impots %)

Manufacturing .. .. -18.9 13.1 50Services .. . -1.8 7.5 25o

Private consumption .. .. -15.1 -7.2 -25 90 91 92 93 95General government consumption .. .. -23.7 -23.8 s50Gross domestic investment .. .. -33.3 16.2Imports of goods and non-factor services .. .. -26.7 26.0Gross national product .. .. 13.7 12.0 am

Note: These tables reflect data obtained by the World Bank as of February 1996. 1995 data are preliminary estimates.The diamonds show four key indictors in the country (In bold) compared with its income-group average. If data are missing, the diamond willbe incomplete.

Annex 1.0Page 2 of 2

Republic of Yemen

PRICES and GOVERNMENT FINANCE

1975 19865 1994 1996 Inflaton (%)DomesU pc(X chanpe) so

Consumer prics 71.8 62.0 Impliit GDP defator 54.7 59.7 40

Governent finance o(% of GDP) go D1 92 93 94 95

Current revenue 14.2 21.7Curent budget balance -15.0 4.7 -GDPWa. - CPIOveral surplus/defIt (commitment) -17.2 -7.7

TRADE1975 1985 1994 1995 Export and Import lavels (mill US$)

(millions USS)Total exports (fob) 1,820 2,037 2.50

Fuel 1,613 1.724Food 2.000

Manufactures .. . . . t

Toal Ipot (ci) . 1,655 2,000 2 .000Food.. . 528 618Fuel and energy 240 172 500

CapItal goods 173 153 o

Export price Index (1987=100) ao so 91 02 93 .4 95

Import price index (1987=100) .Y

Terms of trade (1987=100) rm..,gm rih

BALANCE of PAYMENTS1975 1965 1994 1995

(mions USS)Exports of goods and non-factor services 1.963 2,211Imports of goods and non-factor services 2,032 2,431 'di rnnt account balance to GDP ratio (%)

Resource balance -69 -22

NotfactorIncome -810 7899 90 so I 03 04 soNet current transfers 1,044 1,077 | 0

Current account balance,before official transfers 165 67 -20

Financing items (nt) 4 130

Changes In net reserves - -169 -197 |30

Mfemo:Net Foreign Reserves (mill. USS) 342 442Conversion rate (ocaL4S$) 58.0 90.9

EXTERNAL DEBT and RESOURCE FLOWS (DRS)

1975 1985 1994 1996(milins USS)Total debt outsndIng and disbursed 440 3,339 5,959

IBRD a 0 a

IDA 12 348 780

Totaedebt service 6 131 145

IBRD 0 0 0 G G B8

IDA 0 4 13 | 653 760

Composition of not resoure ftlows F e 427Official grnts 185 208 70 37 1720 ' I

EOfficia creditors 55 202 -882 -679 2379

Private credior 0 6 -200 50Foreign direct investment 0 3 12 -218Portfolo equity 0 0 0 0

World Bank programCommItment 47 44 33 | A - IBRD E - SiatonlDisbursements 8 45 37 . B-IDA D - Ow Iusbtatl F - PrivatePrincipal repayments 0 1 7 . C - IMF G - Shoft.twm

Net fows 8 44 30Intere paymenbt 0 3 6Net trafers 8 41 24

MN2CO and Internatbonal conomic Depwrment 9/12196

Note: Daa before 1990 ceme orom Yemen Arab Repubiic end the Peoples Democratic Republic of Yemen, which were unified In 1990.Foreign oil companis shaes' e not hciuded In exports.

Annex 1.1

Financing Requirements

($ million)

1995 1996 1997 1998 1999 2000

Financing Requirements 185 6225 970 955 885 530

Current Account Deficit 110 550 675 625 565 540Amortization Obligations 740 630 515 450 410 130Change in Arrears -745 5160Other 1/ -115 -105 -190 -180 -200 -300Reserves 195 -10 -30 60 110 160

Financing Available

Regular Financing 90 150 150 160 160 160Loans 50 110 110 120 120 120Grants 40 40 40 40 40 40

Exceptional Financing 95 6075 820 795 725 370Debt Relief 5795 565 490 440 0IDA/IMF 230Unidentified Financing 50 255 305 285 370

1/ Includes foreign companies capital and expatriate Yemeni's return capital.

Annex 2.1

Grades and Salaries (YR/Month) For Civil Servants, 1990-1995

Grade Classification Current Total Salary (Basic + Allowance)Basic (YR)Salary(YR)

1992 1993 1995

First A 5600 6200 8440 9560B 5000 5600 7600 8700C 4500 5100 6900 10380

Second A 4000 4600 6200 7200B 3600 4200 5640 6640C 3200 3800 5080 6080

Third A 2900 3600 4760 5760B 2600 3300 4340 5340C 2400 3100 4060 5060

Fourth A 2200 2900 3780 4780B 2200 2900 3700 4700

Fifth A 1800 2500 3220 4220B 1600 2300 2840 3840

Ratio of Top Salary toBottom Salary 3.5 2.7 3.0 2.5

Memorandum Item:

CPI (1990=100) 218 355 987

Sources: Staff calculations based on data provided by the Ministry of Civil Service and

Administrative Reform, 1996

Annex 2.2

Average Wage According to Education and Age of Civil Servants(YR/Month)

Years of Education

Age Group 0 4 8 12 16 20

45-49 5239 6317 8078 9048 11981 139550-54 5648 6550 8023 9768 12677 1468555-59 5986 7298 7552 9526 13297 1472460-64 6012 6905 8463 8659 10470 844065-69 5012 8129 4200 7053 9256 NA

70 4471 4390 5122 5437 9032 NA

Annex 2.3

Beneficiaries of wheat and flour subsidies Page 1 of 5

WHEAT1994 1995 1996 1997 1998 1999 2000 2001

1 Imports Value (USS) 168.3 216.0 240.0 255.0 265.2 275.3 287.9 299.12 Imports (MT) 1175.0 1350.0 1390.0 1432.0 1476.0 1520.0 1567.0 1615.03 Imports (min bags) 23.5 27.0 27.8 28.6 29.5 30.4 31.3 32.34 smuggling I%) 25 25 25 25 25 25 25 255 smuggling (mln bags) 5.9 6.8 7.0 7.2 7.4 7.6 7.8 S.16 Domestic supply 17.6 20.3 20.9 21.5 22.1 22.8 23.5 24.27 Unit value (USs per MT) 143.2 160.0 172.7 178.1 179.7 181.1 183.7 185.28 Unit value (USS per bag) 7.2 8.0 8.6 8.9 9.0 9.1 9.2 9.3

Exchange rates:9 official rate (YRIS) 12 40 115 135 141 145 149 153

10 basics food rate (YRIS) 12 12 30 60 83 107 130 15311 parallel market rate (YR/S) 81 130 140 140 141 145 149 153

Total Subsidies:12 at official rates (YR min) 0 6048 20400 19125 15382 10461 5470 013 at official rates (S mlin) 0.0 151.2 177.4 141.7 109.1 72.1 36.7 0.014 at parallel market rates (YR min) 11613 25488 26400 20400 15382 10461 5470 015 at parallel market rates (S min) 143.4 196.1 188.6 145.7 109.1 72.1 36.7 0.0

Costs per bag for wholesalers (YR) at:6 official rate 86 320 993 1202 1267 1313 1369 1417

17 basics food rate 86 96 259 534 746 969 1194 1417IS parallel market rate 580 1040 1209 1247 1267 1313 1369 1417

Retail price per bag (YR):19 Government conteoled 165 310 670 1026 1432 1860 2293 272020 Private stores 835 1498 1740 1915 2067 2269 2497 272021 Share Govt stores (%) 20 20 20 20 20 20 20 20

22 Average retail price (YR) 701 1260 1526 1737 1940 2187 2456 272023 Retail price corrected for margins 365 656 795 905 1010 1139 1279 141724 Profit per bag 279 560 536 370 265 170 85 0

25 Total profits traders (YR) 4923 11346 11175 7956 5864 3882 1995 026 Total profits traders (S mln) 60.8 87.3 79.8 56.8 41.6 26.8 13.4 0.0

27 Total profits smuggling 35.8 49.0 47.1 36.4 27.3 18.0 9.2 0.0

28 Profit consumers 46.8 59.8 61.6 52.5 40.2 Z7.3 14.1 0.0

29 Total Subsidies 143.4 196.1 188.6 145.7 1o9.1 72.1 36.7 0.0

21 Share Gov't stores (%) 50 50 50 50 50 50 50 50

22 Average retail price (YR) 500 904 1205 1470 1749 2065 2395 272023 Retail price corrected for margins 261 471 628 766 911 1075 1247 141724 Profit per bag 175 375 369 231 166 106 53 0

25 Total profits traders (YR) 3077 7588 7688 4973 3665 2426 1247 026 Total profits traders (S mln) 38.0 58.4 54.9 35.5 26.0 16.7 8.4 0.0

27 Total profits smuggling 35.8 49.0 47.1 36.4 27.3 18.0 9.2 0.0

28 Profit consumers 69.5 88.7 86.5 73.8 55.8 37.4 19.2 0.0

29 Total Subsidies 143.4 196.1 188.6 145.7 109.1 72.1 36.7 0.0

21 Share Gov't stores (%) 80 80 80 8o 80 0o 8o so

22 Average retail price (YR) 299 548 884 1203 1559 1942 2334 2720

23 Retail price corrected for margins 156 285 460 627 812 1012 1215 141724 Profit per bag 70 189 201 93 66 43 21 0

25 Total profits traders (YR) 1231 3831 4201 1989 1466 970 499 026 Total profits traders (S min) 15.2 29.5 30.0 14.2 10.4 6.7 3.3 0.0

27 Total profits smuggling 35.8 49.0 47.1 36.4 27.3 18.0 9.2 0.0

28 Profit consumers 92.3 117.6 111,4 95.1 71.4 47.4 24.2 0.0

29 Total Subsidies 143.4 196.1 188.6 145.7 109.1 72.1 36.7 0.0

Annex 2.3Beneficiaries of wheat and flour subsidies Page 2 of 5

FLOUR1994 1995 1996 1997 1998 1999 2000 2001

I Imports Value (USS) 105.3 144.0 160.0 180.0 196.2 205.1 216.0 225.92 Impirts (MT) 616.0 720.0 747.0 774.0 803.0 833.0 863.0 895.03 Iniports (mIn bags) 12.3 14.4 14.9 15.5 16.1 16.7 17.3 17.94 smnuggling (%) 25 25 25 25 25 25 25 255 smuggling (min bags) 3.1 3.6 3.7 3.9 4.0 4.2 4.3 4.56 Domlestic supply 9.2 10.8 11.2 11.6 12.0 12.5 12.9 13.47 Unit salue (USS per MT) 170.9 200.0 214.2 232.6 244.3 246.2 250.3 252.48 Unit value (USS per bag) 8.5 10.0 10.7 11.6 12.2 12.3 12.5 12.6

Exchange rates:9 official rate (YR/$) 12 40 115 135 141 145 149 153

10 basics food rate (YRIS) 12 12 30 60 83 107 130 153

11 parallel market rate (YRIS) 81 130 140 140 141 145 149 153

Total Subsidies:12 at oaticial rates (YR min) 0 4032 13600 13500 11380 7794 4104 013 at otficial rates (S mln) 0.0 100.8 118.3 100.0 80.7 53.8 27.5 0.014 at pi;rallel market rates (YR mln) 7266 16992 17600 14400 11380 7794 4104 015 at parallel market rates (S min) 89.7 130.7 125.7 102.9 80.7 53.8 27.5 0.0

Costs per bag for wholesalers (YR) at:16 officsil rate 103 400 1232 1570 1723 1785 1865 193117 basics food rate 103 120 321 698 1014 1317 1627 1931

18 parallol market rate 692 1300 1499 1628 1723 1785 1865 1931

Re2Tol price per bag (YR):

19 Government contruled 223 312 790 1517 2205 2864 3537 419820 Privite stores 1129 2120 2445 2 2832 3183 3493 3851 4198

21 Share Gov't stores (%) 20 20 20 20 20 20 20 20

22 Average retail price (YR) 948 1758 117 2754 2988 3367 3789 419823 Retail price corrected for margins 436 809 972 1181 1374 1549 1743 1931

24 Profit per bag 333 689 651 434 360 231 116 0

25 Total profits traders (YR) 3080 7438 7294 5616 4338 2892 1497 026 Total profits traders (S mln) 38.0 57.2 52.1 40.1 30.8 19.9 10.0 0.0

27 Toti. profits smuggling 22.4 32.7 31.4 25.7 20.2 13.4 6.9 0.0

28 Proit: consumers 29.3 40.8 42.2 37.0 29.8 20.4 10.6 0.0

29 Totil Subsidies 89.7 130.7 225.7 102.9 80.7 53.8 27.5 0.0

21 Share Gov't stores (% S0 50 50 50 50 50 S0 50

22 Average retail price (YR) 676 1216 1617 2174 2694 3179 3694 4198

723 Retaid price corrected for margins 311 559 744 1000 1239 1462 1699 193124 PromI per bag 208 439 423 302 225 145 72 0

25 Total profiEs craders (YR) 1925 4744 4736 3510 2711 1807 936 0

26 Total profits uraders (S mln) 23.8 36.5 33.8 25.1 19.2 12.5 6.3 0.0

27 Total prof-its smuggling 22.4 32.7 31.4 25.7 20.2 13.4 6.9 0.0

28 Profic consumers 43.5 61.5 60.5 52.1 41.3 27.8 14.4 0.0

29 T w.il Subsidies 89.7 130.7 125.7 102.9 80.7 53.8 27.5 0.0

21 Sharte Gov't stores (% 80 so go so 80 80 80 80

22 A eriLge retail price (YR) 404 674 1121 1780 2400 2990 3600 4198

23 Rec.md price corrected for margins 186 310 516 819 1104 1375 1656 193124 Prowl per bag 83 190 194 121 90 58 29 0

25 Tow.l profits traders (YR) 770 2050 2177 1404 1084 723 374 026 Tut.,l prof-its traders (S min) 9.5 15.8 15.6 10.0 7.7 5.0 2.5 0.0

27 Tow.l profitts smuggling 22.4 32.7 31.4 25.7 20.2 13.4 6.9 0.0

28 Prowi zonsumers 57.8 82.3 78.7 67.1 52.8 35.3 18.1 0.0

29 T, l.ji Subsidies 89.7 13 n 7 125. 7 102.9 80.7 53.8 27.5 0.0

Annex 2.3

Beneficiaries of wheat and flour subsidies Page 3 of ;

WHEAT

1994 1995 1996 1997 1998 1999 2000 2001Traders (mi n)

1. 20:80 official and private 60.8 87.3 79.8 56.8 41.6 26.8 13.4 0.0I. 50:50 official and private 38.0 58.4 54.9 35.5 26.0 16.7 8.4 0.0111. 80:20 official and private 15.2 29.5 30.0 14.2 10.4 6.7 3.3 0.0

Consumers:

1. 20:80 official and private 46.8 59.8 61.6 52.5 40.2 27.3 14.1 0.0Average price per bag (YR) 701 1260 1526 1737 1940 2187 2456 2720growth rate 79.7 21.1 13.8 11.7 12.7 12.3 10.8

I. 50:50 official and private 69.5 88.7 86.5 73.8 55.8 37.4 19.2 0.0Average price per bag (YR) 53 904 1205 1470 1749 2065 2395 2720growth rate 80.7 33.4 22.0 19.0 18.0 16.0 13.6

III. 80:20 official and private 92.3 117.6 111.4 95.1 71.4 47.4 24.2 0.0Average price per bag (YR) 299 548 884 1203 1559 1942 2334 2720growth rate 83.1 61.5 36.1 29.5 24.6 20.2 16.6

Smuggling 25% 35.8 49.0 47.1 36.4 27.3 18.0 9.2 0.0

Total Subsidies wheatI. 20:80 official and private 143.4 196.1 188.6 145.7 109.1 72.1 36.7 0.0IL. 50:50 official and private 143.4 196.1 188.6 145.7 109.1 72.1 36.7 0.0111. 80:20 official and private 143.4 196.1 188.6 145.7 109.1 72.1 36.7 0.0

FLOUJR

1994 1995 1996 1997 1998 1999 2000 2001Traders (mln $)

1. 20:80 official and private 38.0 57.2 52.1 40.1 30.8 19.9 10.0 0.011. 50:50 official and private 23.8 36.5 33.8 25.1 19.2 12.5 6.3 0.0III. 80:20 official and private 9.5 15.8 15.6 10.0 7.7 5.0 2.5 0.0

Consumers:

1. 20:80 official and private 29.3 40.8 42.2 37.0 29.8 20.4 10.6 0.0Average price per bag (YR) 948 1758 2114 2569 2988 3367 3789 4198growth rate 85.5 20.2 21.5 16.3 12.7 12.5 10.8

ll. 50:50 official and private 43.5 61.5 60.5 52.1 41.3 27.8 14.4 0.0Average price per bag (YR) 676 1216 1617 2174 2694 3179 3694 4198growth rate 79.9 33.0 34.4 23.9 18.0 16.2 13.6

III. 80:20 official and private 57.8 82.3 78.7 67.1 52.8 35.3 18.1 0.0Average price per bag (YR) 404 674 1121 1780 2400 2990 3600 4198growth rate 66.6 66.4 58.8 34.9 24.6 20.4 16.6

Smuggling 25% 22.4 32.7 31.4 25.7 20.2 13.4 6.9 0.0

otal Subsidies FlourI. 20:80 official and private 89.7 130.7 125.7 102.9 80.7 53.8 27.5 0.011. 50:50 official and private 89.7 130.7 125.7 102.9 80.7 53.8 27.5 0.0III. 80:20 official and private 89.7 130.7 125.7 102.9 80.7 53.8 27.5 0.0

Annex 2.3Page 4 of 5

Beneficiaries of wheat and flour subsidies

Official : private 20:80 50:50 80:20

WHEAT 1994 1996 1994 1996 1994 1996

raders 60.8 79.8 38.0 54.9 15.2 30.0Consumers 46.8 61.6 69.5 86.5 92.3 111.4Smugglers 35.8 47.1 35.8 47.1 35.8 47.1Total 143.4- 188.6 143.4 188.6 143.4 188.6

FLOUR

Traders 38.0 52.1 23.8 33.8 9,5 15.6Consumers 29.3 42.2 43.5 60.5 57.8 78.7Smugglers 22.4 31.4 22.4 31.4 22.4 31.4Total 89.7 125.7 89.7 125.7 89.7 125.7

TOTAL WHEAT & FLOUR

Traders 98.8 131.9 61.8 88.7 24.7 45.6Consumers 76.0 103.8 113.1 147.0 150.1 190.2Smugglers 58.3 78.6 58.3 78.6 58.3 78.6Total 233.1 314.3 233.1 314.3 233.1 314.3

Retail prices per bag (YR)av. annual

WHEAT 1994 1995 1996 2001 growth rate

20:80 official and private 701 1260 1526 2720 12.350:50 official and privace 500 904 1205 2720 17.780:20 official and private 299 548 884 2720 25.2

FLOUR

20:80 official and private 948 1758 2114 4198 14.750:S official and private 676 1216 1617 4198 21.080:20 official and private 404 674 1121 4198 30.2

Annex 2.3Page 5 of 5

line 1: information from IMF staff paperline 2: information from IMF staff paperline 3: 50 kg bagsline 4: assumption about the share smuggled tooutside Yemen, see paper 2 of background material on trade policiesline 5: see line 4line 6: calculated as total imports minus smugglingline 7: calculated line I/line 2line 8: calculated line 1/line 3line 9: data from Central Bank of Yemen and IMF staffline 10: data from Central Bank of Yemen and IMF staffline 11: data from Central Bank of Yemen and IMF staffline 12: Imports value multiplied by the difference between official and basics food ratesline 13: see line 12, using official exchange rateline 14: Imports value multiplied by the difference between parallel market and basics food ratesline 15: see line 14, usuig parallel market exchange rateline 16: unit value in YR per bag using official exchange rateline 17: unit value in YR per bag using basic food rateline 18: unit value in YR per bag using parallel market rateline 19 multiplied by ratio gov't controled price/basic food rate price in 1994

line 20 For 1994, 1995 and 1996 a multiplicator of .75 has been used, which increases to 1.0 in 2001 after 1996,indicating the price pressure.

line 21: assumption on the share channeled through gov't storesline 22: average of gov't controled price (line 19) and retail prices in private stores (line 20) with weights from line 21line 23: line 22, corrected for trade and transport margins, using the ratio line 17/line 19 in 1994 (=92%)line 24: line 23 minus line 17

Annex 2.4

Subsidies on Petroleum Products

92 93 94 95 96 97 98 99

Refinery inputs:

Crude (barrel per day) 65.00 70.60 52.10 65.00 67.00 69.00 71.00 73.00

Pric.e per barrel (S) 19.70 16.70 15.80 17.00 16.80 16.30 16.50 16.70

Value (S min) 468.00 430.30 300.20 403.80 410.00 410.50 427.60 445.00

Value (YR min) at off.rate 5,616 5,164 3,603 16,152 47,135 55,420 60,291 64,521

LPG (l,OCO mt) - - - 361 374 392 414 439

Price (SJMT) - - - 169.60 167.10 162.50 164.40 166.40

Value (S min) - - - 61.20 62.50 63.70 68.10 73.10

Value (YR min) at off. rate - - - 2,449 7,185 8,598 9,597 10,595

Total value Oil & LPG 5,616 5,164 3,603 18,601 54,319 64,018 69,888 75,116

Revenue (YR min) 8,926 9,692 7,154 16,115 34,995 47,061 60,543 75,116

Subs. (YR min) at off. rate - - - 2,486 19,324 16,956 9,345 -

Subs. (YR mi) at market rate 6,706 11,223 17,104 44,332 31,143 19,327 9,345

Note 1: Refinery output differs from what has been projected for governmentoil revenue (see table 1.2)Note 2: From 1996 onwards more output in barrels is produced per unit of input;in other words implicitly it has been assumed that the refinery becomes more efficientAssuming constant efficiency at 1996 level gives the following subsidies: 1997: YR17903; 1998: YR 12199; 1999; 4726Note 3: Demand grows at a similar rate as GDP, namely between 4 and 5 percent per annum.Note 4: The different ratios for petroleum products output per barrel of crude has beenassumed constant; as a result gasoline, diesel, kerosene, aviation fuel, and fuel oil growat the same rate, namely about 5 percent per annum. In conclusion, no substitutionbetween one or the other takes place, although the prices of the various products showvery different growth rates.

Annex 2.5

Subsidy on Electricity

(YR million)

93 94 95 96 97 98 99

Power sold (min KWH) 1586 1482 1594 1657 1740 1836 1946

Average tariff (YR per KWH) 1.14 1.32 2.09 2.09 2.09 2.09 2.09

Other revenues 238 301 - - - - -

Total revenues 2046 2257 3331 3463 3637 3837 4067

Operating expenses 2796 367 5100 11746 14971 17701 20554

Op expenses except fuel 1935 2443 3138 6622 7756 8218 8515

Fuel:

- fuel oil (min ltr) 407 560 640 660 693 731 775

- diesel (min Itr) 52 72 82 84 89 93 99

official prices: (YR/litre)

- fuel oil 1.7 1.7 2.7 7.0 9.3 11.6 13.8

- diesel 3.0 3.0 3.0 6.0 8.6 11.0 13.5

Fuel costs 861 1184 1962 5124 7215 9484 12040

Total operational exp. 2796 3627 5100 11746 14971 17701 20554

Subsidies 750 1370 1769 8282 11335 13864 16487

Average tariff 1.14 1.32 2.09 4.60 6.81 8.83 10.56

Subsidies 750 1370 1769 4123 3122 1490 -

Annex 2.6

Transfers to Public Enterprises

1992 1993 1994 1995 1996

Current Transfers (% of total) 100 100 100 100 100

Boadcasting and Television Corporation 22 19 18 21 36Al-Thawra Hospital 16 15 12 19 15Organization for Agriculture Research 10 9 8 8 7Touhama Development Organization 5 6 6 5 6Yemen News Agency(Saba'a) 4 3 3 3 2Rural Development Org. 3 4 4 4 4Oil Exploration Organization 0 0 3 6 5Mineral Resources Exploration Org. 0 0 5 4 5Other Agricultural & Industrial Enterprises i 23 29 15 9 8Others 17 15 26 19 12

Capital Transfers ( % of total) 100 100 100 100 100

Broadcasting & Television Corporation 5 2 2 5 6Al -Thawra Hospital 0 1 2 2 2Civil Aviation 3 3 5 2 3Posts & Postal Service Organization 2 1 6 1 1Rural Areas Development Organization 7 8 11 1 3Public Auth. for Electricity & rural Water 0 18 31 15 21Public Electricity Corporation 53 24 21 53 44Water & sewage Corporation 16 34 17 12 15Public Authority for Roads and Bridges 0 0 0 0 0Others 13 9 4 8 6

Source: Ministry of Finance1/ Different from Table 2.31 due to different in sources.

Annex 2.7

Status of Privatization Effort March 1996

Number Labor

I Enterprises Advertised for Sale 16 135511 Enterprises Planned for Sale 60 7324III Enterprises identified for privatization 100(+) 33334

Annex 2.8

Government Share of Profits From Public Enterprises(ln Millions of Rials)

1992 1993 1994 1995 1996

Total Gov. Share of Profits 5684.14 4291.92 6679.21 8817.25 17017.98

Gov. Share I Fish & Agriculture Sector 9.03 8.78 9.09 92.31 147.42

-Agriculture Coop.Bank 0.00 0.00 0.00 19.88 48.23

- Org. for coastal Fishing 4.69 0.97 0.00 20.09 11.37

- Marib Co. for Chicken 3.67 4.55 9.09 24.34 31.37

- Delta Dev. ( Ebeen) , 0.00 0.00 0.00 10.40 33.11

- Others 0.66 3.27 0.00 17.60 23.34

Gov. Share / lndustrial Sector 233.76 155.49 345.95 1426.13 2311.80

- Public Org. for Cement 203.14 98.10 310.00 1177.09 1473.85

- Others 30.63 57.39 35.95 249.04 837.95

Gov. Share /Transport Sector 118.99 177.02 419.04 1096.20 1215.60

- Public Org. Wire Wireless Comm. 19.72 26.22 56.55 391.57 476.00

- Public Org. for Ports 87.00 91.00 292.00 451.02 446.98

- Others 12.28 59.80 70.50 253.61 292.63

Gov. Share / Trade Sector 4.36 11.72 2.46 348.92 856.01

- Public Auth. for Electricity 0.00 0.00 0.00 61.57 0.00

- Public Auth. for Water & Sewage 0.00 0.00 0.00 0.00 58.13

- Others 4.36 11.72 2.46 287.35 797.88

Gov. Share/ Banking & financial Sector 3878.35 3162.22 4296.09 3205.20 10116.50

Gov. Share / Construction Sector 10.00 26.22 0.00 96.34 195.14

Gov. Share / Petroleum & Mineral Res. 1427.75 750.00 1602.31 2552.16 2175.52

Gov. Share I Other sectors 1.89 0.48 4.26 0.00 0.00

Total Except Banking and Finance 378.04 379.70 780.81 3059.89 4725.97

* .~~~~~ a a- - a. ~~~~~~~~~~~~ .a . aa. . . . . . -a a a

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Annex 3.2

Ministry of Education, Branch 1

General Budget Estimates for Financial Year 1996

Omvision (t16 Mristr's af Ezu=3;:on General Buoget Esttimates for tte ni-ancrai Yoar 1996 Amhunts n Thousands of Rials I

Branen (1) jChater 151:Investment Expenorrures. ry Suo-Chapters anC Local and foreign Finance

1`13rhe ol Project ITota 5sfimates lor 1996 Sul-Chapler 3 jSub-Chapter 5 l

- F ________ I I - SiJiOulam 5 Construnimon! !Equrpment & Furntfure

T __al -rof acts -Loeal fForeign Total Locil Foretgn Tets Local I ITotal Prolec:s 1-0 1o0! ssoa 16isco; 1546O 990011eS 4900

Upper Floor for Al Shaneec Scnooi Al AhImar 8 classes | = 739. 1391 | 39j 500i

Upper Floor forAeslla Sonool 13 Classes 756j i 758; i581 lisl so8I

Upper Floor for Dar-P! Olurn Scnolt 13 Classes 750i 75Cti tso iSO!50j 1fOO

Upper Floor for Kiadija Sc.tcol 10 Classes j 7501 _7l 150r 1501 600

Annex for Khawla Bent A: A-war Scnool 8 Classes 300j | 3CCI C | 001 200jo

Pence next to Athreo .%.1os;iue 65j 1 aS: 65j 5

Annex forAl-Mutassem Scrioci 5 Classes I 52001 527 Co I OC0! I 5C00I 2001

Annex for Arwa School fo. gitns S Classes | 301 3Sol 6i 601 3001

Completion of Khateed Ben Al vtalid School 6 Classes 1 371 _ 37 371 T 37! 1 i

Um Salmn Schoolj 5431 j 531 1431 1 "43 4001 _

Annex for Saoa'a Sca-ool S Classas 1 j 5000j j 500C s0ool I scoo; __

HaretAl Salam Scnool Hiac±en 12 Classes j 30005 3OCOl 300ow j I0001

Ghazal el sasna School. Nueum 12 Classes I 15000! 150coiC 1s0o0 I 15000

AI-SalamShoub Sc!tcol 1C Classes 1 40001 40coi 40001 1 4COO

Hafsa School for Girs. Nucurm 12 Classes I 5000j sOco a00 0I 5e0oi i _ =

Beet Meyad School. Al KaCisryan 12 Classes. 5000| I SCOOr 5000! 1 50001

Uoper Floor for Khadi!a Scnc_l ; Classes for girls j 40001 4002 4000; 4CCOI

Fence to the North of 7ayaran - 50asba | SCO | 500! 500S 5001

Annex for Unesco 3u.lcing | 2000! 2CC3i 2000! 0 ' _____

Fence to the 'Nest of Al Thawra garcen i 0!lol 1000I !oool c0 _ __ol ___Fence to Mazoan Scnool 500! sc 500 5001 _ I

Al Shaheed Al Kaoali Sc.nt 5 C:assestSreef 45 j 34001 3fCC: 3000! 3ooo I o 4001

Annex to Al Shaneec ScC-too. Ai Anmar 6 Classes, Al Cakherian Street 4600 I 46C5: 4000! 4000 8 00i _

Annex for Aesna Stcc!t i =3sses 3rr at Shaet 4000 e 4CC; 45000! 1 40COI | i

Annex for Car El Olur- S_-o:; 45 Classes. Haora _22001 ! 2255 2000! ; 20c0! 200C

Annex fro Al 7aoamun Scho-ol -i -'asses *I Sadij 22ai C 222C- 20001 20C01 2001 j

Storage for SchQol SOOKS | 20001 | 2eCC: 20001 i 20001'i i

Teacners College.10 stucents oatoaCty j 500w 46001 100CC: 5400! 46001 100001 __ j _ _

Training Canter aunng S et-ics | 7000i 3000? 10CCC!5 0ooo0 IO0! 000Ca-

RexmteTecihanrg Canter -.ecrS!g for ar away) I 700! 3001 10C0 750i 3C01 1000I f I

Ar Multamaa (Socier'/i 400 20001 24CC 4001 20001 3400;

Al Tanmryan Scnool se swan :2 Classes 500j r 50C0l 0 00!a 500i C -__

i aret i_ Maid Schoof i C;:asses 3000! i 3CCC- 3C00010 2o I

Annex to Zaeo oen marett-a Scocri _ 40001 4 GCC, 4000! 40001 j

Serf Sen Sc Yazan Scnzvc -2 ::asses I 40001 4lC00 4000! -001_____

Comprets Kincergarten 20001 1 2CC5 20001 2000I _ i

Haret el Kheir wa Al salant Swcho 10 Classes Mazoah 3000! i 35CQ 30001 0 I _ _

Zaid Al Mushkr ScIool Annex 3 Classes | 3co00 3000 3000| I 3000 | _ -

Al Shaheeo Al Celelir SC:O-t 3 S:assex 1 30001 30CCo 3000! 3000! _ol -

Fence next to Mosque ! 500 i cr 500! 50al j - j

Fence fext to a sanoani Stacrn i 5001 i sc5 ! 500! 520! i -_

Aboul Ranman Al Fafll SoC-oar I2 Classes * Utdifies 5COO 5 so005 5000! 50001 j - __ -_

Fence unit 371 next to ati otsouc 100 I 1002, i00!ooo; ¶000____ I i -

Fence forunil376next.'eLca j 1000I l ocal 10001 0oo! I

ience for Aser Senool 5001 C50 SOOI 5s0o i

Fence est al Lfana Al Cae.a Snool I 10001 I lCCC 1000! 0Cr I

Fence east of Pres,irential ricusa Unit 353 j 10001 j 0CC. 1000! sCCCl

Compietion af Al Shaneer Al S A7tava Sc ool I1 Classes j OOO1 I 4GC0. 40001 40001 i

Annex to AOdul Nasser Sc-tool S Classes |_ 600j__SCO_ _co__I i

Annex to Al tusan Scoo ; C;asses 20CC! 1 20CC 2000! i 2CO I

Bel Bous Scnool. Al Murlancessin C'Y. 5 Classes -Uflqles I zoI 3002 3000!00| 'I

OCMman zen Affan Scniocr S Classes - Utilities j 200Cr 20C0- 2000! i z000 oooj

Annex to Haisa SchCci 3 Cl:asses 30001 I 3000 30a0 30CC! I

Muaz ben lioal Al Racas Scr.ci1 3 Classes 2GOO! 2CC. 20O0 0I 500 i

Annex to Unn Sainma So-wicr -': . ins 3 Classes ! 3000i 3C0-2 00ool 3CZO:

Annex to Saren Ai Saza'. CZr;egs 3 Classes . Utilities 300 01 300a 30o0l 3 _coo_ i

Control Bulomng "arge ;3 -> _:re-on I I1000 10: icooC rOGO;

AsaC Al Kannel Ma: :an Sz-:o- 5 ~asses * Laboratonry 4000! 03 4000! 4000! I

ICentrai worksnoo lar sc. -ii: _iniure maintenance anc repair F 2000! 2C02 20001 2000' j

Orounod ene tor ansee-:- sanool nest to Al Tawra Farm 1000! 1022 1000! 'loc o, -

;nnnex 1o1tl4 MrlisiS cn-i 50001 CC 5000! 500Cr!

. . _ _ . . _~~I

Annex 3.3

Timetable for Settling Claims

During January to March when the budget is being discussed in the Parliament, no fundsare released. Central Bank is closed from 26th to the end of the month. The followingtimetable assumes ideal conditions:

* The contractor personally goes from table to table with the claims for the bill.* The claim is settled in say June.* The project is in the Sana'a area. (the example is of a health project)

Case A. Disbursement of Local Funds. IDA Financed Project.

Step No. Description and comments No. of days

1. Approval by consultant 22. Approval by the director PIU in the MOH 33. Finance department of the MOH. This requires, 10

. about 1O signatures

. often translation from English to Arabic4. Ministry of Planning: requires about 4 signatures, goes 7

to the Departments of Investment, Loans and Planning.5. Ministry of Finance: To obtain the Taziz. Official copy 10

sent to the CBY, and copy to contractor and copy to MOH.6. Back to the MOH to issue the cheque 107. To CBY for the release of money

42Total

Case B. Disbursement of Foreign Funds, IDA projects

Step No. Description and comments Days

1. Approval by consultant 22. Approval by Director PIU 33. Ministry of Planning for the issue of Cheque 44. Central Bank for releasing the money 7

Total 16

Annex 3.4Yemen - Investment Program Page 1 of 2

(YR million)

Ref. 1996 1996 1997 1998No. Project Budgeted 1/ -- - Proposed 2/

AGRICULTUREOngoing ProjectsLand & Water Conservation 462 - - -

Wadi Hadramout Ag. Develop. 315 - - -

Northern Region Ag. Devp. Project 297 - -

5th Tehama 251 - - -

Eastern Areas Ag. Develop. 288 - - -

Ag. Sector Mgmt Project 187 - - -

Central Highlands 128 - - -

Wadi Al-Jawf Ag. Dev. Project 95 - - -

Southern Region Project 97 - - -

Sub-Total 9 IBRD Projects 2120 - - -

7 Projects from YR 60 m to YR 526 m 1,232 - - -

30 Small Projects of less than YR 50 m 468 - -

Total Ongoing Projects 3,820 - -

New ProjectsSeeds and Services - - 60 70Southern Gov. Agricultural Privatization - - 60 100Total New Projects - - 150 235

Total Agriculture Investment 3,820 3,820 4,400 4,900

EDUCATIONBasic and Secondary Education 2,715 - -

University 1,841 - -

VTE 288 - - -

Research Institutes 944 - -

Total Education Invesent 5,788 5,788 9,300. 13,200

HEALTHPrimary Health Care Units & Health Centers 876 - - -

Polyclinics 46 - -

Maternal & Child Health Care Facilities 49 - -

Hospitals 592 - -

Medical Institutes 175 - -

Projects & Related Activitities 216 - -

o/w Family Care Project 209 - -

Health Colleges & Nursing School 61 - -

Miscellaneous 555 - -

o/w Emergency Related Facilities 255 - -

o/w Equip & Related Act of Storage & Maint. 164 -

o/w Compounds 51 - -

Total Health Investment 2,570 2,570 3.700 .5200

Annex 3.4Yemen - Investment Program Page 2 of 2

(YR million)

Ref. 1996 1996 1997 1998No. Project Budgeted 1/ - Proposed 2/

POWERGeneration (PEC)Sana'a Gas Turbines - 598 5,280 1,200Marib Combined Cycle PLant - - 1,311 4,485Aden Emergency Project (KHM) - - 563 5,121Hadramawt Power Station Extension - 2,445 1,153 2,643Lawder and Attaq Extension - 286 506 -

Hiswa Power Station Rehabilitation - 562 360Ras Katenib Power Station Rehabilitation - 96 -

Sada'a Power Station - 243 54 -

Sub-Total (Generation) - 4,230 9,227 13,449

Transmission and Distribution (PEC)Aden -Taiz 132 KV link - 1,557 658 -

System Control Center - 76 46Dhamar Rural Electrification - 420 221Power IV (Package C) - 609 371Jahana Rural Electricification - 111 4 -

Fourth Power (Package A) - - 512 2,339Power V (Loss Reduction and Rehabilitation) - - 330 749Third Power Project (Aden) - 1,870 - -

Government Rural Electrification - 401 469 -

Aden Flood Damage Project - 122 32 -

Amran-Hajjah Transmission Project - 122 55 -

Sub-Total (Transmission & Distribution) 4000 3/ 5,288 2,698 3,088

GARWES (22 small schemes) 1,300 1,300 1,500 1,700

Total Power Investment 5,300 1 8 l$,4i5

WATERGAREWSNWSA 700 700 1,300 1,500NWRA 1,400 1,400 1,600 1,800MAWR - - - -

Total Water lnvestment 2,100 211000 2,0 3,300

TRANSPORTRoad construction 6,100 6,100 8,000 10,000Other Transport 300 2,800 2,668 2,383

Aviation - 1,500 1,401 1,248Surface Transport - 300 267 135Ports - Aden and Hodeidah - 1,000 1,000 1,000

Total Transport Inves_tent 8,400 80& 0,888 12,38

....E&TMENT - _ _ _ _ _ _ _ _ _ _ _ _

Sources: Ministry of Planning, Ministry of Finance and staff estimates.1/ As per the published 1996 budget.2/ Proposed expenditures are estimated on the basis of meeting sectoral objectives, while implementing the expen-

diture restructuring program3/ Transfers from the MEW to PEC for 1996. Details not provided.

anxdta

Annex 3.5Page 1 of 2

Technical Note

For both education and health, population growth rate is assumed to be constant at 3.5% p.a. forall ages from 1992 to 2003. Other specific assumptions are as follows:

Education

* The target Gross Enrollment Ratios (GER) to be reached in 2000, are as follows:

Boys GER Girls GER1994 2000 1994 2000

Basic 78.1 % 80.0% Basic 34.5 % 42.6 %Secondary 24.3% 32.0% Secondary 9.8 % 16.8 %

* Student per classroom ratio for basic education (32: 1) in 1994 will increase to 35:1 in 2003. Thepresent ratio is high for a country at the level of income of Yemen. In Egypt, for instance, the ratiowas 45:1 in 1994. The total enrollment ratio in higher education, is assumed to increase by 62%over 1994 to 2000.

- Expenditures for the General Authority for Educational Institutions (GAEI) are assumed to remainconstant (19%) relative to the MOE budget throughout projection years.

- Recurrent Expenditures: Calculated by multiplying per student recurrent expenditure andprojected student enrollment. Per student costs are projected by applying local inflation rates to perstudents costs in 1996.

- Investment Expenditures: Unit construction cost of US$ 14,000 per classroom (in 1995) areused for estimating pre-university investment expenditures. An assumption is made that it takestwo years for basic and three years for secondary education schools to be constructed. Forexample, calculation of 1997 investment cost is made against projected enrollment of 1999 forbasic education and that of 2000 for secondary education. In higher education, projections arebased on per student investment cost and enrollment.

Health

* The population which has access to health care services is assumed to increase to 69% of the totalpopulation in 2000 from 45% in 1992.

* Recurrent Expenditures:

* Salary expenditure on doctors and physicians will increase by 25% in real terms from 1996to 2000;

* By 2000 the number of administrative staff will be reduced to half of its size in 1996; and* Per capita expenditure on goods and services (Chapter 2) will be tripled in real terms from

1996 to 2000.

Annex 3.5Page2 of 2

Investment Expenditures:

* Per capita investment expenditure will be increased to US$4 in 2000 in real terms fromUS$1.97 in 1996.

Table 1

Public Expenditure on Education * & Health as Share of Total Public Expenditure & GDP

1994 1995 1996 1997 1998 1999 2000Act. Act. Est. Proj. Proj. Proj. Proj.

GDP at Market Prices (YR Billion) 262.7 434.7 633.7 735.1 814.5 889.0 970.0Public Expenditures (YR Billion) 83.3 129.1 238.3 249.9 275.3 304.9 325.0Public Expenditures (% of GDP) 31.7% 29.7% 37.6% 34.0% 33.8% 34.3% 33.5%

Public Expenditures on Educationas share of Total Public Expenditures (%) 19.2% 16.7% 14.1% 17.3% 18.3% 18.5% 19.2%as share of GDP (%) 6.1% 5.0% 5.3% 5.9% 6.2% 6.3% 6.4%

Expenditure Breakdown of Public Expenditure on EducationRecurrent Expenditures (%) 97.2% 86.0% 86.7% 78.4% 73.8% 72.6% 72.1%Investment Expenditures (%) 2.8% 14.0% 13.3% 21.6% 26.2% 27.4% 27.9%

Public Expenditures on Health (Ministry of Health)as share of Total Public Expenditures (%) 3.6% 4.0% 3.2% 4.2% 5.0% 6.0% 7.6%as share of GDP (%) 1.1% 1.2% 1.2% 1.4% 1.7% 2.1% 2.6%

Expenditure Breakdown of Public Expenditure on HealthRecurrent Expenditures (%) 98.0% 69.8% 66.6% 64.5% 62.6% 60.6% 59.0%Investment Expenditures (%) 2.0% 30.2% 33.4% 35.5% 37.4% 39.4% 41.0%

Public Expenditures on Education(a) Recurrent Expenditures

Ministry of Education + GAEI 14.1 16.9 26.7 30.8 34.0 37.4 41.0Universities 1.4 1.6 2.4 3.0 3.2 3.5 3.9

Total Recurrent Expenditures 15.5 18.5 29.1 33.8 37.2 40.9 44.9(b) Investment Exnenditures

Ministry of Education + GAEI 0.3 1.8 2.7 7.1 10.8 12.9 14.5Universities 0.1 1.2 1.8 2.2 2.4 2.6 2.9

Total Investment Expenditures 0.4 3.0 4.5 9.3 13.2 15.4 17.4(c) Total Expenditures 16.0 21.5 33.5 43.2 50.4 56.3 62.3

Public Expenditures on Health (YR Billion)(a) Recurrent Expenditures 2.9 3.6 5.1 6.8 8.6 11.2 14.7(b) Investment Expenditures 0.1 1.5 2.6 3.7 5.2 7.3 10.2(c) Total Expenditures 3.0 5.1 7.7 10.5 13.8 18.4 24.9

Note:Public Expenditures on Education do not cover expenditures on Vocational & Technical Education, Research Institutions,which represents 3.8% of total public expenditure on education in 1996.

IMAlGING

Report No: 16147 YEMType: ER