US embassy cable - 05SANAA1919

C O N F I D E N T I A L SECTION 01 OF 03 SANAA 001919 
 
SIPDIS 
 
PLEASE PASS TO MCC FOR A. BAYLOR 
 
E.O. 12958: DECL: 07/17/2015 
TAGS: PREL, PGOV, ECON, EFIN, EINV, KMCA, KMPI, YM, ECON/COM 
SUBJECT: SALEH PURSUES TRIBAL APPROACH TO ECONOMIC REFORMS 
IN YEMEN 
 
REF: A. SANAA 1875 
     B. SANAA 37 
 
Classified By: CDA Nabeel Khoury for reasons 1.4 b and d. 
 
1. (SBU) Summary.  Yemen's Parliament approved a general 
sales tax law in early July, which met with fierce protest 
from business leaders.  After hearing their complaints 
regarding the potential for abuse and corruption, President 
Saleh locked business leaders in a room with ROYG officials 
and demanded they reach an agreement.  Details of a tentative 
accord include cancellation of the law, to be replaced by a 
one-time tax of eight percent for imported goods and five 
percent for those produced domestically.  The ROYG will 
continue its dialogue on remaining issues on shared 
committees with the business community.  Although markedly 
different from the original IMF proposal, the new GST plan 
indicates some willingness on the part of the ROYG to find 
much needed sources of non-oil revenue.  Nevertheless, most 
Yemenis remain suspicious about painful austerity measures, 
and implementation of the economic reform package remains 
slow.  End summary. 
 
-------------------------- 
Saleh Hears GST Arguments 
-------------------------- 
 
2. (C) Amidst controversy, Parliament passed the long-awaited 
general sales tax on July 5.  The major opposition parties, 
including Islah and the YSP, opposed Sales Tax Law No. 19, 
which was approved with the support of the majority GPC 
party.  With businessmen threatening to strike and a history 
of civil unrest over the issue, President Saleh agreed to 
meet with business leaders.  According to Nabeel Hayel Saeed, 
President of NATCO (a domestic subsidiary of the Hayel Saeed 
Group, one of Yemen's biggest companies), Yemen's businessmen 
told Saleh that the GST would lead to increased corruption 
and declining business profits.  Upon hearing this, Saleh 
turned to Prime Minister Bajamal, saying:  "Is this true? 
Why didn't you tell me?"  Bajamal then offered to create 
ministerial committees to study the concerns of the business 
community, but Saleh rejected the idea. 
 
---------------------------------------- 
"...And Don't Come Out Until You Agree." 
---------------------------------------- 
 
3. (SBU) On July 10, President Saleh locked business leaders 
and government officials together in his compound, 
instructing them to find a solution to the GST impasse. 
Mahfoudz Shammakh, Chairman of the Sanaa Chamber of Commerce, 
recounted that Saleh provided food and qat, but that no one 
was allowed to leave until an agreement was reached.  "In the 
end," said Shammakh, "the President was the only one who 
understood our point of view." 
 
4. (SBU) After one day of negotiations, the parties did reach 
a tentative agreement on taxation.  According to the Chamber, 
the ROYG capitulated to the demands of business and agreed to 
eliminate the GST as approved by Parliament.  In exchange, 
the business community accepted a substantial tax increase of 
eight percent for imported goods and five percent for 
domestically produced items.  The taxes will be collected 
only once at the point of entry/production.  Coupled with 
recent tariff reductions to 5 and 10 percent, businesses hope 
these measures will reduce corruption and decrease the 
incentive for smuggling, as well as raise new revenue. 
 
5. (SBU) The ROYG and business representatives also agreed to 
create joint committees to study pressing taxation issues. 
Among these is a proposed reduction in the corporate tax rate 
(currently 35 percent), implementation of tax exemptions 
under proposed amendments to the investment law, and a review 
of customs valuation (septel).  The Chamber promised that if 
the negotiations are successful, they will accompany the ROYG 
to Parliament and explain the new agreement to MPs. 
According to government-controlled newspaper al-Thawra, the 
Federation of Trade Chambers and bank officials also agreed 
to help stabilize prices, which have been skyrocketing in 
recent weeks due to economic uncertainty (ref A).  The 
President set the duration of the agreement at one and a half 
years, meaning it must be renegotiated following to the 2006 
elections. 
 
----------------------------------- 
The Winding Path to Economic Reform 
----------------------------------- 
 
6. (SBU) This is but the latest chapter in the ROYG's attempt 
to implement an IMF-WB economic reform package, which 
includes a sales tax, cuts to the fuel subsidy, civil service 
reform, and changes to the investment and financial laws. The 
package was finally presented to Parliament seven months ago 
when MPs demanded the ROYG respond to a list of twenty-five 
questions dealing with ROYG reform before they would approve 
the laws (ref B).  The questions were never answered, 
however, and in June the ROYG resubmitted the economic 
reforms to Parliament, contending that it had taken measures 
to accommodate Parliament's demands. 
 
7. (C) In a July 6 conversation with econoff, Islah MPs Abdul 
Karim Shaiban and Ansaf Mayo vehemently denied this claim. 
In their view, amendments to the laws provide for even more 
centralized control resting in the Ministry of Finance (MOF), 
which they believe will lead to increased corruption.  The 
opposition MPs criticized the reform package for its focus on 
increasing the revenue stream by raising taxes, rather than 
on reducing tax evasion and corruption. 
 
8. (U) With Parliamentary approval, the ROYG now has the 
green light to begin lifting the fuel subsidy, which the 
World Bank estimates at USD 800 million for 2005.  It is 
unclear when the new prices will go into effect, however, 
long gas lines in Sanaa indicate that Yemenis believe it will 
be soon.  Despite high profile debate and the passage of some 
laws in Parliament, it is also unclear when any of the 
economic reform package will actually go into effect.  Even 
those laws that Parliament has passed are as yet unsigned by 
the President. 
---------------------------------- 
ROYG Has Little Credibility on GST 
---------------------------------- 
 
9. (C) The business community and much of the political 
opposition remains suspicious of a GST, believing it to be a 
power grab by MOF and the Tax Authority.  The private 
sector's main objection, explained Shammakh, is that the Tax 
Authority already falsifies tax claims during yearly audits 
in order to maximize personal benefit to ROYG officials. 
With the GST, tax collectors would visit businesses once a 
month, creating the opportunity to demand more regular 
tribute.  Because the GST is a value added tax, the Tax 
Authority would also be able to collect revenue at every 
stage of production, creating entirely new opportunities for 
bribery and corruption.  Shammakh insisted that the private 
sector has "no objection to paying taxes," but opposes a tax 
mechanism that will create additional friction with the Tax 
Authority.  On a practical note, Shammakh suggested that 
considering most shopkeepers do not have cash registers or 
transaction records, the GST would be impossible to 
implement.  He charged that tax collectors use the ignorance 
of most business owners to extract additional bribes. 
 
10. (C) Khaled Mustafa, Vice Chairman of the Sanaa Chamber, 
contended that the GST law would allow the government to 
search private homes and businesses at will and prevent 
traders from leaving the country without a proper tax permit. 
 Another concern is that the law encourages Yemenis to inform 
on each other by rewarding those who provide information with 
five percent of taxes levied in a successful tax evasion 
investigation.  Based on these and other issues, the Sanaa 
Chamber of Commerce is suing the ROYG, charging that the 
proposed tax measures are unconstitutional.  Shammakh said 
the Chamber would not drop its case until the objectionable 
clauses have been removed. 
 
------------------------------- 
Business:  IMF Misses the Point 
------------------------------- 
 
11. (C) Shammakh pointed to the IMF as the source of current 
discord, claiming that for several years the organization has 
refused to meet with the business community.  In addition, he 
accused the IMF of relying on "false numbers" used by the 
Central Bank of Yemen to hide evidence of corruption. 
Shammakh contrasted this with the early years of economic 
reform (1997-2001), during which the IMF met regularly with 
the private sector and followed a results-based program with 
the ROYG, denying the ROYG funding if it did not enact 
specific economic reform policies.  In general, Council 
representatives indicated that the IMF was out of touch with 
the reality of corruption in Yemen. 
 
12. (C) Ahmed Bazara, Vice President of the AMTC Toyota 
Dealership, noted that the majority of products on the shelf 
in Yemen are smuggled goods rather than legal imports. 
According to ROYG figures, 63 percent of goods reaching the 
Yemeni market are smuggled in. As a result, Bazara estimated 
that the ROYG captures only about 20 percent of potential 
revenue under existing tax laws.  This means that honest 
businessmen must compete with smugglers, now putting them at 
a further disadvantage as smuggler are unlikely to pay taxes. 
 The business community believes that if current tax laws 
were implemented more effectively, the ROYG could recoup 
approximately 140 billion YR (over USD 725 million) in lost 
revenue without having to impose new taxes.  In Shammakh's 
view, Yemen must first stabilize its economy, implement 
existing laws, and control corruption before creating new and 
complex systems of taxation. 
 
------------------- 
Like Making Sausage 
------------------- 
 
13. (C) Comment:  Passage of the GST law in Parliament served 
(after four years) as the opening of public debate on the 
issue, rather than the final word.  President Saleh's tribal 
approach to crafting important macroeconomic policy appears 
to have succeeded in the short term, although it remains to 
be seen what new legislation will be submitted to Parliament. 
 By negotiating an agreement with business representatives, 
the ROYG managed to avoid popular unrest in response to the 
tax hikes.  Prices will still rise, but the average Yemeni 
will not feel the intrusions of the Tax Authority directly. 
There is much speculation that Saleh orchestrated the entire 
exercise to brandish his influence, highlighting his role in 
achieving consensus rather than in implementing unpopular 
austerity measures.  International observers at the World 
Bank and IMF are unsure of how to react to these 
developments.  Although confused by the Yemeni legislative 
process, most express satisfaction that the ROYG was able to 
expand its revenue base away from oil.  End comment. 
Khoury