At a critical juncture in its political transition, Yemen needs to urgently rethink the route to economic recovery and stability.

Among the many challenges currently facing Yemen’s ailing economy is the growing fiscal deficit, which reached 6.2% of GDP in 2012 and is estimated to increase to approximately 8.5% of GDP in 2013.

In order to reduce the deficit, the IMF has periodically encouraged Yemen to phase out its energy subsidies, which amounted to 9% of GDP in 2012.

According to the IMF, while subsidy reductions will create fiscal space for pro-growth spending, it must be coupled with a better social safety net to protect the poor.

Yet, subsidy reform remains a controversial issue in Yemen’s economic policy discourse due to the absence of effective alternatives and the dangerous political consequences of reducing subsidies.

Phasing out fuel subsidies in Yemen’s fragile political environment is a recipe for widespread domestic unrest, for a number of reasons, including limited institutional capacity to carry out subsidy reforms.

It is, however, the very social safety net eluded to in IMF recommendations that is one of the most significant obstacles to reforming Yemen’s subsidy system.

A social safety is a combination of welfare programs, cash transfers, benefits, and social services to support vulnerable groups.

In Yemen, a significant part of the budget for the country’s social safety is doled out to the public through the Social Welfare Fund (SWF) and Social Fund for Development (SFD).

The SWF implements cash transfer and loan programs as well as other welfare projects, while the SFD supports community development programs in education, health, and small/micro enterprises.

In the event of subsidy reduction, the SWF’s cash transfer program would need to play an important role in protecting the poor against the rising prices of fuel and food.

However, due to technical and logistical challenges, Yemen’s current welfare scheme cannot fill the financial hole that will be created by subsidy reform.

Below is a graph showing the budget allocation for fuel subsidies, SWF, and SFD (in YER million).

Data source: Ministry of finance, Yemen.

Data source: Ministry of finance, Yemen.

The various weaknesses with Yemen’s current social safety net have resulted from increasing poverty rates, imprecise income distribution data, and underdeveloped social and economic institutions for coverage and delivery of services.

In Yemen, poverty increased from 42% in 2009 to 54.5% in 2012, with approximately 45% of the population (around 10 million people) identified as food insecure.

By the end of 2009, the SWF reached 1,020,965 beneficiaries and increased to 1.5 million in 2012.

Yet, among the 1.5 million families covered by the SWF, 297,000 are not qualified to receive social welfare benefits – a situation that has raised concerns about the transparency and efficiency of targeting methods.

The SWF’s budget is also limited and cannot adequately fund the safety net.

Despite increasingly severe economic conditions since 2011, the budget for the SWF has, in fact, contracted. The institution maintained a budget of YER 80,653,000,000 (around USD 375,036,450) in 2012 and approximately YER 69,338,000,000 (around USD 322,421,700) in 2013.

Fortunately, the World Bank has provided a grant of $100 million to fund the additional 500,000 SWF cases, channeled as cash transfers.

Given these circumstances, it is unsurprising that cash transfers to individual recipients have been insufficient.

The SWF indicates that individual cash transfers ranged between YER 2,000 (USD 9.31) and YER 12,000 (USD 55.84) per quarter (3 months) in 2009.

In the event of subsidy reduction, these transfers will not compensate for the increasing poverty rates, especially as poor households typically spend up to 98% of their incomes on food.

This concern was echoed by Wael Zakout, the World Bank Country Manager for Yemen, during his meeting with the minister of social affairs and labor in August 2013, when he highlighted the inadequacy of cash transfers to the poor.

In addition to the challenges facing Yemen’s social safety net, subsidy reform proposals must not overlook the historical marriage between political and economic dynamics, and the close link between political unrest and economic calamity.

Yemen observed violent protests in July 2005 as a response to subsidy reductions, which caused an increase in fuel and food prices.

Currently, the political situation in Yemen is very sensitive and cannot withstand an economic shock that would further destabilize the country.

In a recent visit to Yemen, Merza Hasan, a World Bank executive director, said it was not an appropriate time for Yemen to phase out subsidies, as it could derail the country’s political transition.

Indeed, subsidy reduction coupled with a fragile social safety net will likely be the catalyst for further political unrest in Yemen.