Progress on Implementation of the CPA and Darfur Negotiations

2. Despite a slow start and some initial delays due to various factors, including the untimely death of First Vice President, John Garang, implementation of the Comprehensive Peace Agreement (CPA) is on track. All commissions envisaged under the CPA had been established and transfer of oil revenues to the Government of South Sudan (GOSS), in line with the wealth sharing provision of the CPA, have started to take place. The Government of National Unity is trying its best to operationalize all the institutions of the CPA. Oil receipts have been verified by all parties concerned and there are no disputes on this matter. Implementation of other key elements of the CPA are also on track, such as the establishment of a central bank branch in Juba, issuing of rules and regulations on conventional banking for South Sudan and issuing of a new national currency with Fund TA. There are still some problems in the South with respect to budget preparation and execution due to capacity constraints and the authorities are requesting Fund TA to strengthen public expenditure management systems of the GOSS and states, in order to overcome this problem.

3. Following the last Board discussion on Sudan, the authorities have intensified their efforts to finding an amicable solution to the situation in Darfur. They expect to reach agreement soon along the lines of the CPA. A Joint Assessment Mission (JAM), comprising the World Bank, African Development Bank, Donor Community and UN agencies is planned, to conduct an assessment on the post-conflict requirements for Darfur, followed by a donor conference. It is expected that the JAM will focus on three key elements, namely, debt relief, development, and humanitarian needs. In this respect, the authorities request the Fund to play visible and pro-active role, in determining the post-conflict requirements of Darfur.

Recent Economic Developments and Prospects

4. Notwithstanding internal conflicts and the difficulties of concluding and implementing the CPA, Sudan’s economic performance in recent years has been outstanding. Growth has been robust, inflation kept under control and a number of important reforms implemented. Furthermore, higher oil prices supported the balance of payments and allowed for further accumulation of reserves and appreciation of the Sudanese dinar against the U.S. dollar. So far, the appreciation of the currency has not led to loss of competitiveness, but the authorities are closely monitoring the situation. Going forward, economic growth is expected to be in the range of 8-10 percent in 2006, supported by a large increase in oil production and continued high growth in the non-oil sector; inflation is expected to remain at a low single digit level and reduction in poverty levels will be enhanced.

5. As staff note, a number of challenges and risks remain. The authorities remain vigilant and agree with staff on the need for prudent economic policies, to which they are fully committed. The authorities are aware of the enormous developmental challenges facing the country going forward, including full implementation of the CPA, tackling regional inequalities and reducing poverty as well as avoidance of the “Dutch disease”. In this regard, they have launched a strategy to meet the Millennium Development Goals and will finalize their interim Poverty Eradication Strategy by the end of this year. The authorities will continue to reorient public spending towards less developed regions and social and infrastructure projects, as well as on capacity building and revamping of public financial management systems at all levels of government. They will need comprehensive and deep debt relief beyond the traditional mechanisms to clear arrears and achieve debt sustainability.

Fiscal Policy

6. The Authorities remain committed to implementation of prudent fiscal policies aimed at achieving fiscal and debt sustainability and restoring borrowing relations with the international community, including international financial institutions. In 2005, oil revenue was lower than programmed because of delay in commencing oil production in some oil blocks. In line with stipulations of the CPA, the authorities initiated transfers to the government of South Sudan.

7. In 2006, the fiscal deficit will be contained at below 1 percent of GDP. Oil revenue will increase because of higher international oil prices and estimated higher production, while non-oil revenue will benefit from improvements in administration, including collections in the South and other states, and from rationalization of tax exemptions. With respect to the latter, the Ministry of Investment will not refer to the Council of Ministers any proposal to renew expired business profit tax exemptions granted under the Investment Encouragement Act. By October 2006, the authorities will, in consultation with Fund staff, finalize a program to rationalize the system of investment incentives in line with international best practice. The authorities will also examine the scope for expanding the VAT base by bringing exempted items into the tax net.

8. On the expenditure side, the authorities will contain the intended increase in civil servant’s salaries, expenditure on goods and services, transfers to the northern states, and domestically financed capital expenditures to ensure that the fiscal framework is compatible with their goal of maintaining economic stability. Expenditure prioritization will be done in a manner to ensure spending on programs that directly benefit the poor is protected. The authorities hope that increased development assistance from the international community in 2006 will also help co-finance pro-poor programs. They agree that subsidization of domestic fuel prices is not sustainable. In this respect they prefer a phased reduction of fuel subsidies, starting in June this year by sensitizing Parliament and the public and ultimately adopt an automatic pricing mechanism in line with world market prices for petroleum products.

9. With regard to structural issues, the authorities are committed to further strengthen public expenditure management systems in 2006, implement the Government Finance Statistics Methodology (GFSM 2001), and enhance transparency in oil revenue management. Fiscal decentralization and improvement in fiscal reporting and accounting will also continue to be prioritized in the 2006 SMP. All measures to strengthen public expenditure management and enhance transparency are articulated in the authorities Memorandum of Economic and Financial Policies. These measures would, however, require a great deal of Fund and World Bank Technical Assistance which the authorities hope they can continue to count on.

Monetary, Exchange Rate and Financial Sector Issues

10. The Sudanese Authorities remain committed to price stability through reserves management within the context of a flexible exchange rate system. High external inflows have recently led to an appreciation of the real exchange rate, but thus far there are no visible signs of tangible loss of competitiveness and overall the non-oil economy remains competitive. The authorities believe that for long-term prosperity, focus should be on improvements of total factor productivity for enhancing external competitiveness. Therefore, as these trends are expected to persist, the authorities will intensify efforts to improve the business climate for private sector participation, through removal of structural bottlenecks and other institutional reforms, as well as efforts to foster rural development.

11. With respect to financial sector reform, the authorities will implement restructuring plans for the central bank and commercial banks, as well as the financial reform program discussed during the recent FSAP. As envisaged in the CPA, a main central bank branch was established in South Sudan, rules and regulations were issued on conventional banking and a new national currency will be introduced in the whole country by June this year. The Bank of Sudan has also initiated a reform program to develop and restructure commercial banks during the period 2006-2009, with the first steps being an increase in the minimum capital requirement from SDD 3 billion to SDD 6 billion and an increase in the capital adequacy ratio from 8 to 12 percent by end-2006. Additional reforms include, the requirement of commercial banks to implement action plans to meet provisions and capitalization requirement and the encouragement of mergers of commercial banks according to specific guidelines.

Non-Concessional Borrowings

12. As a matter of policy, the Sudanese Authorities do not consider it prudent to borrow on non-concessional terms. They would refrain from such borrowing if they had access to concessional resources. They request that the special circumstances of Sudan be considered with respect to the conditionality on non-concessional loans. Currently, Sudan does not have access to any form of concessional or development funding from multilateral financial institutions, including the World Bank and the IMF and the African Development Bank. There is also a big shortfall from major bilateral donors. At the same time, there are enormous pressures to implement the CPA and provide key social services and physical infrastructure to sustain the peace and keep the country together and to enhance the long-term growth potential of the non-oil economy. In this respect, all non-concessional loans are directed to key projects, such as the North South Railway, the Darfur highway and provision of basic services such as hospitals, water and rural electrification. The authorities have been very transparent on the use of all non-concessional loans.

13. Nevertheless, to demonstrate their commitment to a strong program, the authorities together with staff, are exploring innovative ways to reduce the level of non-concessional loans, including usage of any excess revenue from higher than projected oil prices and negotiation of concessional terms with key creditors. With these remedial actions, the authorities hope that Sudan will maintain RAP quality equivalence on all their policies so that they can move quickly to a formal successor program, arrears clearance and debt relief. In the meantime, they request the international community to provide concessional resources to enable them implement key social and physical infrastructure projects, that will make the peace dividend more tangible.

Technical Assistance

14. The Authorities are grateful for technical assistance being provided by various Fund departments. However, the challenges that Sudan face are enormous and have been further amplified by implementation of the CPA and the forthcoming agreement on Darfur, hence requiring additional TA. Under the CPA a number of new institutions had to be established at federal and state levels. The key challenge going forward would be to get these institutions operationalized, and this would require additional technical and financial assistance. Specifically the authorities request Fund TA in the following areas: implementation of Government Finance Statistics Methodology (GFSM 2001); budget reporting, fiscal decentralization and public financial management; issuance of the new national currency; banking supervision; liquidity management; microfinance and balance of payments, monetary and real sector statistics.

Roadmap/Way Forward

15. Sudan’s end-2004 debt stock remains unsustainable and significantly above the HIPC threshold. In addition, Sudan needs substantial resources to finance post-conflict needs, including the development and reconstruction of Darfur. Indeed, to effectively reduce Sudan’s debt burden, the country needs debt relief beyond traditional mechanisms and under the Enhanced HIPC Initiative and MDRI.

16. After seven years of successful implementation of high quality SMPs, with the last four being implemented to the level of Upper Credit Tranche conditionality, the authorities request that creditors and donors come up with a clear and timely road map for Sudan in terms of the way forward with respect to arrears clearance and debt relief under HIPC and MDRI. As discussed by the Board in December 2005, contributions from donors may need to constitute the bulk of resources needed to solve Sudan’s debt and arrears problems. We, thus, request the creditors and donors to begin considering how to mobilize the necessary resources to address this issue.

17. We are still of the opinion that Sudan’s strong track record of policy implementation under successive SMPs since 1999 should be adequate to justify a waiver of the RAP for arrears clearance, qualification for a successor program and speedy reach of the decision and completion points under the HIPC Initiative. Given the expiration of the sunset clause by the end of this year, we urge creditors and donors to move quickly in mobilizing the necessary resources to ensure that the protracted arrears cases will benefit from HIPC and MDRI debt relief as soon as possible so that these countries make progress towards the achievement of the MDGs.

Conclusion

18. In conclusion, the authorities would like to reaffirm their strong commitment to prudent and market oriented policies aimed at growth, employment creation and poverty reduction. The authorities are aware that without peace, no development is possible, and therefore implementation of the CPA and peace in Darfur will remain centre stage in the authorities development strategy. Their task is, however, complicated by the high debt burden and lack of access to concessional and development finance resources. They trust that the Fund will continue to be fully responsive in providing technical assistance in the areas requested to build their capacity, strengthen the macroeconomic management and implement the reform agenda going forward. The authorities are looking forward to normalizing their financial relationship with the international community in the context of a formal arrangement with the Fund, instead of continuing with SMPs for an undetermined period of time. As proof to their commitment to normalize relations with creditors, the authorities have increased their payments to the Fund by 50 percent under the current SMP. We urge the international community to recognize and fully support the authorities’ efforts by releasing concessional resources, including grant financing and removing sanctions to assist implementation of the CPA and the forthcoming Darfur peace agreement.