Since raids on Red Sea shipping began, the international community – previously mobilized for the past decade’s civil war humanitarian crisis in Yemen with two-thirds of the 20 million population food insecure and in basic need – has reawakened to the awkward ceasefire between the Iran ally Houthis, who control most of the country in the North and the recognized government in the South with its Saudi Arabia and United Arab Emirates backers.

The Houthi rebels from their capital Sanaa have long expressed solidarity with the Palestinians in Gaza, and justify selected drone and missile launches towards mostly Western commercial and military vessels in the name of curbing Israel's resupply and diplomatic support. The US and UK governments have responded with targeted retaliatory strikes around the strategic Hodeidah port but lost in the national security calculus is the underlying economic grievance towards the rival central bank and administration in Aden, which festers after sporadic attempts at UN-brokered dialogue.

According to the World Bank’s Yemen Economic Monitor published in the fourth quarter, from 2015-22 per capita real gross domestic product (GDP) plunged by over 50%, and life expectancy shortened by four years to age 64. Its Human Capital Index reveals that a child born mid-war in 2020 will only reach 40% productivity potential as an adult without access to schooling and healthcare. The hostilities pause between the two sides formally lapsed at the end of 2022 and has been mostly honoured since and enabled rare positive 2% growth that year. However, the Houthis, who have been unable to take over the main oil and gas fields, continue to block exports that fell then another 10,000 barrels per day (bpd) to 50,000 bpd.

Remittances and international aid both rose 10% in 2022, Saudi Arabia pledged $2bn in central bank deposits, and the International Monetary Fund (IMF) transferred $650mn in SDRs under an allocation to all members to provide stimulus. However, FX reserves were down to less than one-month imports, the fiscal and current account deficits were at 3% and 15% of GDP, and inflation hit 30% with riyal depreciation against the dollar.

Only the Aden government has formal relations with official lenders, and these statistics are crudely extrapolated for the country at large, as a nascent economic track under the UN peace process has tried to harness more data and policy consensus to little avail. The absence of progress left a huge public finance hole in particular that has angered Houthi authorities who have not paid civil servants for months and in many cases years, and the arrears may have helped drive them to the latest round of external confrontation.

Before the war, energy was 85% of exports, one-quarter of GDP, and half of foreign exchange reserves and budget revenue. In 2022 $900mn in earnings were almost 60% of fiscal intake, and the Houthi government without a sharing formula launched drones on oil facilities after the ceasefire expired in October, leading the World Bank to project a 40% drop in revenue for 2023. The showcase Balhaf LNG plant has been dormant since the conflict onset, and fuel subsidies for domestic use at 20% less than full price cost an estimated 200 billion riyal annually.

Tax and customs duty have been 30% of revenue, but as a condition of laying down arms Saudi Arabia agreed to lift its blockade on Hodeidah port, and import tariffs were immediately hiked 50% accompanied by trade restrictions on Aden-based goods so that proceeds would exclusively benefit Sanaa. In the five years pre-war tax collection was a paltry 7% of GDP anyway, half the region average. Almost all businesses are small traders, who contribute a mere 5% of the total.

In the South, Saudi Arabia provided a $400mn fuel grant for electricity, but the government still shells out $100mn per month for diesel with hours of daily rationing, and paid bills covering only 5% of the Saudi outlay. Telecoms has fallen into disrepair with the main state operator selling a 70% stake to an Emirati partner. Wages and salaries are half of public spending, and civilian workers and security forces are now paid through new private banks considered more trustworthy than traditional intermediaries.

The banking system essentially collapsed in 2015 when the government defaulted on Treasury bills, which were half of assets, and froze deposits in place wiping out citizen savings. Commercial bank deposits declined by 10% over the past decade to 15% of GDP, with micro-finance and hawala informal channels filling the breach alongside a proliferation of licensed and unlicensed FX dealers such as those subject to US sanctions for acting as Iran conduits.

Dual central banks refuse to recognize rival letters of credit and currency notes or cooperate on basic oversight. The YER/USD rate in the North is 1500 versus 650 in the South, as the Houthis have banned new supplies from Saudi-financed printing. As strict Islamic followers, their regime is designed for full Sharia compliance with interest prohibited. Both sides agreed on a connection to the SWIFT cross-border payments system out of humanitarian and commercial necessity, but a joint roadmap as in Libya split between East and West is out of the question.

Under these circumstances the World Bank predicted a 1% GDP contraction for 2023, and at best 2% medium-term growth from a rough peace dividend while all these fiscal, monetary, and banking sector issues are outstanding. The international community can redouble efforts to strike an economic compromise that offers a brighter scenario, which could serve indirectly in tamping aggressive tendencies at the margin in the overlapping Red Sea passage crisis. 

–  Gary Kleiman, senior partner, Kleiman International Consultants, Inc.