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 government is in the process of introducing a range of revenue-raising measures and the public finances will benefit from full liquefied natural gas (LNG) production at Yemen LNG, the bulk of the deficit adjustment was 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 off 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 5.3% of GDP, despite higher oil prices. In 2012 it is likely to widen further, to 6.4% of GDP, as forecast oil prices decline. Financing these deficits could prove challenging, given the shallowness of the domestic financial sector, although the recent launch of the country's first sukuk (Islamic bond) could provide a new avenue for state fund-raising.