Reuters International

A view of the Central Bank of Yemen is seen in Yemen's capital Sanaa, November 15, 2015. REUTERS/Mohamed al-Sayaghi

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By Sami Aboudi and Noah Browning

DUBAI (Reuters) - In Yemen's war of attrition, the Saudi-backed exiled government has now decided that the central bank is an easier target than the capital, shielded from its troops by 60 kilometres (40 miles) of daunting mountains teeming with fighters.

A decree this month to cut the bank from the outside world is aimed at using economic pressure to vanquish the Houthi fighters of the Zaydi branch of Shi'ite Islam, who have ruled the capital and most of northern Yemen for nearly two years.

It means the Houthis may struggle to pay state employees, including teachers, doctors and the soldiers from an army that mostly fights on their side in the civil war.

But it also means that millions of people in territory controlled by both sides will become poorer, and a country that imports 90 percent of its food may have no way to feed itself.

Diplomats, economic experts and employees of the central bank itself say the move risks destroying the lifeline for millions of impoverished Yemenis and pushing the Arabian Peninsula's poorest country to the edge of starvation.

"There is a trend ... that what could not have been achieved by military means can be achieved through the economy, through an economic war," Rafat al-Akhali, a former cabinet minister, told Reuters.

The moves against the central bank were part of a new strategy: to "allow the economy to fail, and that's going to put more pressure on the Houthis" and their ally, ousted former president Ali Abdullah Saleh, he said.

LIFELINE

Yemen's central bank, under veteran governor Mohamed Bin Humam, is one of the last state institutions to survive the rift that split the country when the Houthis took over the capital and forced President Abd-Rabbu Mansour Hadi to flee.

Saudi Arabia and its Arab allies accuse the Houthis of being pawns of Iran and launched a military intervention to restore Hadi to power. The Houthis have held on, having made an alliance with Hadi's predecessor Saleh, who enjoys the support of most of the military.

Despite meagre means, the bank has continued to provide lines of credit guaranteeing imports and to pay the salaries of state employees, including troops in units that have fought on both sides of the conflict.

However, with the Houthis in control of most population centres and state organs, and enjoying the support of most of the army, the bank's activities disproportionately benefit them.

Hadi's own hastily recruited forces, paid largely by Saudi Arabia and other Gulf countries, have struggled to push back the Houthi-allied forces as frontlines have barely budged in more than a year.

Sources in Hadi's administration have said the president was looking to name a new board for the central bank and a new governor to replace Bin Humam, and to relocate the bank to the southern port city of Aden, which is under government control.

Farea al-Muslimi, an analyst with the Middle East Institute in Washington DC, said action against the central bank would cut "the only artery" holding the country together.

"It is ridiculous to think that you can clone the central bank so quickly in Aden," Muslimi said.

The security situation in the city, which had seen repeated suicide bombings targeting senior officials, including the city governor and police chief, makes Aden unsuitable for the bank, he said.

A spokesman for Hadi's government did not reply to a question on the issue. The government has said in the past its decisions over the bank are guided by the need to protect public funds that rightly belong to the Yemeni people.

PLUNGING RESERVES

Hadi's government asked international financial institutions on August 6 to block the central bank from accessing state funds abroad, accusing it of guiding $4 billion (3.04 billion pounds) in foreign exchange reserves toward the Houthi war effort.

The bank denies that. Diplomats say Yemen's foreign exchange reserves are kept abroad and could not be readily pilfered or paid out to fighters in the country.

Nevertheless, the bank's reserves have eroded as the war has ground on, eliminating revenue from oil sales and other sources.

According to an internal document seen by Reuters, the gross reserve balance had fallen as low as $1.318 billion by the end of June 2016 from $2.085 billion at the end of December 2015.

A central bank official in Sanaa argued in June that the bank remained independent in its effort to mitigate the economic fallout of the conflict and accused the exiled government of seeking to foment instability and even revolt in Houthi areas.

"If there were no central bank in Yemen operating like this, the effects of the war could be much worse, and that's what they (the exiled government) want," the official, who spoke on condition of anonymity, told Reuters.

"They want people to be angry inside Yemen, they want people to go out on the streets and try to push them to change the Houthis."

STRANGLING

Hadi's government has already started to shun the central bank. The government announced over the weekend that it would no longer cooperate with the bank, and would withhold customs revenues and revenues from oil exports that resumed this month.

"We have seen senseless attempts to delegitimise the central bank governor," a senior Western diplomat said, speaking on condition of anonymity because of the sensitivity of criticising an exiled government that foreign states still recognise.

"Why would a truly patriotic government do something like this?" the diplomat said.

The diplomat said the government should put the interests of Yemen's citizens before its war aims: "This is even more valid given how poor Yemen is and the humanitarian situation."

Poor and dry, Yemen imports more than 90 percent of its food, including most of its wheat and all its rice. Some 21 million of Yemen's 28 million people need some form of humanitarian aid and more than half the population suffers from malnutrition.

Running short of cash, the bank was forced to shed its guarantees of vital staples like rice and sugar.

Muslimi, the analyst, said any measures against the central bank would be more dangerous than the decision to go to war itself.

"The president may think he will be strangling the Houthis, but he will be strangling Yemen."

(Editing by William Maclean and Peter Graff)

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