By Yara Bayoumy and Mohammed Ghobari
SANAA (Reuters) - Saudi Arabia has suspended most of its financial aid to Yemen, Yemeni and Western sources said, in a clear indication of its dissatisfaction with the growing political power of Shi'ite Houthi fighters friendly with Riyadh's regional rival, Iran.
Yemen, which is battling an al Qaeda insurgency, a southern secessionist movement, endemic corruption and poor governance, has often relied on its richer northern neighbor to help finance everything from government salaries to welfare payments.
But soon after Houthi fighters took over the capital Sanaa in September, Sunni Saudi Arabia promptly suspended much of that aid, concerned the rebels will use their military muscle to dominate domestic politics and project Iran's influence.
The Saudis also fear the movement's strong emphasis on Zaydi Shi'ite rights will aggravate sectarian tensions that al Qaeda could exploit to carve out more space in Sunni areas and launch attacks against the kingdom.
A deal signed in September between political parties and the Houthis called for the formation of a new unity government followed by the Houthis' withdrawal from the capital. But even though the new government has been formed, Houthi fighters continue to man checkpoints around the city and guard many state institutions in the capital.
"The Saudis have conditioned any aid on the implementation of the (deal). The Houthis have to leave before they pay," a senior Yemeni government official told Reuters.
Despite the suspension, Saudi Arabia this week announced $54 million in food relief for 45,000 families. A Western source, who asked not to be further identified, said the Saudis were also still funding some development and infrastructure projects.
But the source said the Saudis had stopped making other essential payments.
"The Saudis' approach is that 'we'll step back and let Yemen see the consequences of their choice of the Houthis and eventually they'll come to their senses'. We have serious doubts about the wisdom of this," the source said.
The Yemeni official, who declined to be identified due to the sensitivity of the issue, said the Saudis last paid $450 million for social security payments, as well as $950 million worth of fuel products before the fall of Sanaa, in the summer.
Riyadh then refused to pay $500 million earmarked for military purposes, including the purchase of ammunition and spare parts for an aging air fleet, the official said.
A Western diplomatic source in Sanaa also confirmed Saudi aid had been suspended. "The Saudis see everything through the prism of Iran," the source said.
In early November, "the Saudis have said this to us, that the money has stopped coming in", said the source. The Saudis said, according to the source, that they could not be seen to be "putting money into Yemen while it may be used by the Houthis".
In Riyadh, finance ministry officials did not respond to Reuters' requests for comment. A Saudi foreign ministry spokesman said all financial assistance was handled through the finance ministry and so he was unable to comment.
Yemen has struggled to regain stability since 2011 protests that eventually unseated veteran ruler Ali Abdullah Saleh. The country is one of the poorest in the Arab world and more than half of the 25 million population is "food insecure".
Sanaa's finances have deteriorated rapidly this year as attacks on oil pipelines by tribesmen and militants deprived the state of key revenue. The government's fight against al Qaeda militants and other rebels has also drained its budget.
The West is concerned that Riyadh's approach of withholding aid to Yemen's fledgling government may backfire and push the country toward more instability.
(Additional reporting by Martin Dokoupil in Dubai and Angus McDowall in Riyadh, Editing by William Maclean and Sonya Hepinstall)