reform.<sup>5</sup> The social impact of fuel subsidy reform has been less widely studied, yet there are indications that the poor may be the main losers from reform. Coady et al. (2006) find in their six-country study that real incomes of the poorest household groups decline between 1.8 percent in Mali up to 9.1 percent in Ghana. This is consistent with empirical evidence from Hope and Singh (1995), who find decreases in real household incomes of 1–3 percent due to subsidy reform. These findings are further confirmed by the experience of the 2007/2008 global food and fuel crisis, where rising prices for petroleum products and food have led to an increase in poverty (Breisinger et al. 2010; Ivanic and Martin 2008).

Past experience with subsidy reform suggests that protecting the poor from the negative impact of reform is most important for success. The immediate negative effect on real household incomes, especially those of the poor, may explain why petroleum subsidy reform is often accompanied by social tensions or even riots. However, reform experience from other countries shows that social unrest can be mitigated, if targeted compensation is provided, accompanied by effective publicity campaigns that raise awareness of the social inequality created by subsidies (Bacon and Kojima 2010) and the removal of obstacles to sustainable growth created by subsidies. Several countries have successfully applied direct cash transfers to protect the most vulnerable household groups from the negative consequences of reforms. For example, Chile used several rounds of cash transfers to the poorest 1.4 million households, China compensated the poor with monthly payments to offset rising fuel costs, and Indonesia installed quarter-annual payments of US$30 during one year for 15.5 million poor households, or 28 percent of the population. Ghana used a more indirect approach and abolished fees for all public primary and secondary schools and a program to improve public transportation (Bacon and Kojima 2010).

Yemen is among the countries that most recently reduced its petroleum subsidies. A combination of declining oil revenues and the high fiscal costs to sustain the subsidy in combination with a resulting large budget deficit in 2009, estimated at about 10 percent of GDP (IMF, 2010), which led policy makers in Yemen to reconsider the future of the petroleum subsidy. Yemen is the country with the lowest per capita income in the group of high subsidizers; there are only a few other countries in the world with lower fuel prices than Yemen, among them Libya, Saudi Arabia, Bahrain, Qatar, and Kuwait, which all have a significantly higher per capita income (Figure A.1 in the Appendix) and higher oil or gas reserves per capita.

Reforming the petroleum subsidy may provide a new impetus for Yemen’s ailing economy and may become an important part of a broader effort to tackle Yemen’s economic and social development problems. Yemen faces a number of challenges: slow non-hydrocarbon growth, little economic diversification, high population growth, decreasing oil production, unsustainable use of water resources, and high levels of poverty and food insecurity. The economy is dominated by the hydrocarbon sector (oil) and non-tradable services, while manufacturing and export-oriented services make up a relatively small share of the economy. Agriculture contributes about 10 percent to GDP, and about 30 percent of

> 5 Clements et al. (2003), Jensen and Tarr (2002), Burniaux (2009), and von Moltke, McKee, and Morgan (2004) are based on economic modeling. Hope and Singh (1995) base their results on simple correlation analysis, which makes isolating growth effects from reform and other factors challenging.

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