In conjunction with the IMF, the government has set itself a target to reduce the fiscal deficit to the equivalent of 3.5% of GDP in 2013-an ambitious goal, in light of declining oil production. Under the government's recently published medium-term budgetary plans, the shortfall would decline to below that target by 2012, but achieving this will prove difficult. Although the public finances will benefit from full production at Yemen's first liquefied natural gas (LNG) project, Yemen LNG, the bulk of the deficit adjustment is to come from expenditure cuts. However, given the strong and growing public pressure on the leadership, we now believe that any major moves to rein in spending (including lowering fuel subsidies further) will be deferred this year-indeed, moves to raise public-sector wages and broaden the scope of the Social Welfare Fund will add to spending.

Overall, we now expect that the government's new spending and tax commitments will cause the fiscal deficit to widen slightly in 2011, to 5.6% of GDP, despite higher oil prices. In 2012 it is forecast to widen further, to 7.2% of GDP, as oil prices decline. Financing these deficits could prove challenging, given the shallowness of the domestic financial sector. In addition, given the present widespread social unrest and the history of disgruntled tribes sabotaging pipelines, there is considerable risk that oil (and possibly gas) export revenue could be disrupted.