WASHINGTON (Reuters) - Yemen’s central bank said on Monday it was using state reserves in overseas banks responsibly after the Saudi-backed government, fighting a civil war, asked international financial institutions to deny the central bank access to the funds.

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

An Aug. 8 letter to Yemen’s president from the central bank governor’s office, seen by Reuters, said the central bank was carrying out its duties transparently and in accordance with international banking measures.

A civil war is raging between the Iran-allied Houthis, who control the capital where the bank is situated, and Prime Minister Ahmed bin Daghr’s internationally recognised government based in the southern port city of Aden.

A report carried by the state-run sabanew.net news agency on Saturday cited an official in bin Daghr’s office as saying the premier had received “confirmed information” that the central bank was tapping Yemeni foreign reserves held at banks in Europe and the United States after exhausting funds in Sanaa, the capital, and elsewhere for the war effort.

“Out of concern for the funds and belongings of the Yemeni people, and in order to preserve the remaining public funds, ... the Yemeni government has decided to take this step, which includes suspending dealing with Central Bank Governor Mohammed Awad bin Humam,” the official was quoted as saying.

The Aug. 8 letter from the central bank, signed by bin Humam, said: “What was included in the Prime Minister’s letter over the irresponsible use of the country’s external reserves is baseless.”

Bin Humam urged President Abd Rabbu Mansour Hadi to ask the International Monetary Fund to name an international auditing firm to review the activities of the central bank, “whether those dealing with external reserves or internal operations”.

The International Monetary Fund had no comment.

CENTRAL BANK A BASTION

The central bank has been considered the last bastion of the impoverished country’s financial system, and is effectively running the economy, according to central bank officials, foreign diplomats and Yemeni political sources on both sides of the war.

Political and central bank sources have said the Houthi rebels were likely to have received more central bank cash for their troops because when they seized the capital thousands of their militiamen were added to army rosters and became entitled to state pay.

Hadi’s government has accused the Houthis of squandering some $4 billion (3 billion pounds) in reserves held by the central bank on the war effort, but the Houthis say the funds were used to finance imports of food and medicine.

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 suffer from malnutrition.

According to an internal document seen by Reuters, the gross reserve balance as of Dec. 31, 2015, was $2.085 billion and had fallen to $1.318 billion by the end of June 2016 after payments, including basic commodities, servicing external debts, and supporting Yemeni embassies and student scholarships.

In January 2016, the central bank sent a memo to the prime minister entitled “The Position of External Reserves” that warned of the deteriorating reserves.

The memo, labelled “extremely urgent, extremely important and not for circulation”, said that if the bank pursued its current policies while the conflict continued, “it would no doubt lead to the (reserves) running out completely by Sept. 2016.”

One alternative was to stop paying external debt service temporarily and decrease the number of commodities that the central bank pays for. Another was to stop paying for basic commodities and oil products. The bank said it would pursue the first alternative and then move to the second when reserves reached a minimum level.

A Western diplomatic source following Yemen criticized the government for trying to prevent the central bank from accessing funds.

“The concern is that the Yemeni government, and implicitly the Saudi-led coalition behind them, are trying to weaponize the economy by preventing the central bank access to funds abroad,” the source said.

“The Central Bank of Yemen’s governor is a highly competent technocrat, largely doing his job under difficult circumstances, so this doesn’t bode well,” the source continued. “Yemen is one of the world’s worst humanitarian situations, already afflicted by high levels of food insecurity, lack of healthcare and general economic decline.”